The Rule of Thousands – Setting Your Hourly Rate

One of the hard questions for someone starting their own service or consulting business is “How much should I charge per hour?”.  You need to charge enough to cover your expenses and make the business profitable but you don’t want to charge so much that prospective clients never call back.

In addition to finding out what your competitors are charging, one rule of thumb for setting hourly rates is called the Rule of Thousands and it’s essentially this: take the annual salary that you could reasonably expect to earn for the work that you’re doing when working full time and divide it by 1,000 – there’s your beginning hourly rate. For example, if you do web design and site management and you determine that you could reasonably earn $70,000 per year based on your skills and the local market, you divide that by 1,000 and you get an hourly rate of $70 with which to start estimating your billing rates – more on that emphasis in a second.

Why does this work? Consider that hourly and many salaried employees are typically paid for 2,080 hours a year – that’s 40 hours multiplied by 52 weeks. (Even vacation is figured in hours so the employee is being paid a certain number of hours even though they’re not there which figures into the 2,080 hours.) The benefit for the employee is that they’re being paid for that 40 hours whether they’re doing anything or not. They are being paid as an employee just for being there. Whether the employee is slammed with work, looking for things to do, in training or hanging out by the coffeepot, they are still on the clock and being paid.

The independent person doesn’t have this benefit. As a consultant, I can only legitimately bill clients for the time that I’m actually working on their project. That doesn’t include time for the following:

  • Researching and training on technology – Unlike an employee, an independent consultant doesn’t generally get paid training. It’s roughly equivalent to the time a carpenter or mechanic would spend equipping a workshop. The need for continuous training on new technologies can be factored into the basic hourly rate but I won’t charge a customer specifically for the time I spend learning how to use a tool.
  • Marketing the services and getting new business – This is probably the next biggest demand on a consultant’s time after keeping the skills and equipment up to date. Unlike an employee who receives assignments and instructions from further up the chain, an independent person has to go after their own jobs and they don’t get paid until they get one.
  • Business administration – This includes bookkeeping, taxes, insurance and the hundred other details for which an employee might get paid to discuss with Human Resources. They’re not billable either.

After all those activities are removed, The client only gets charged for the time spent specifically working on their project. In addition to the actual construction, that might include meetings, analyzing project requirements or the current system, determining the best approach to use to get the results the client has asked for and verifying the work after it’s done. Combined with the need to keep getting new business, the consultant is doing well if he or she can bill 1,000 hours a year between various clients, or roughly 20 hours a week, even if they’re devoting 12 hours a day to the business in some way. This obviously works well for the clients who are getting just the work they need without paying for a full-time employee with benefits and administration costs.

There are a couple of qualifiers for this. First, there’s what the local market will bear. Not all clients recognize the benefit of paying a consultant the higher hourly rate over reworking the project into something they can give their existing employees or just putting it off until it becomes an emergency of some kind and they have no choice. There’s also the danger of overestimating the salary that your work, experience or skills would command in the local area. On the other hand, you don’t want to underestimate and leave money on the table. Your skills might be a lot more valuable than you believe, especially if you promote them well.

Secondly, for some work, you might be asked for a fixed project price by clients who simply want an idea of how much the work is going to cost them in the end. In these cases, it will be up to you to determine how many hours that it’s going to reasonably take you to complete the client’s requirements and to present an estimate generally based on your hourly rate multiplied by those hours and maybe discounted based on how much it’s worth to you to get the project. There’s also the possibility that you will underestimate some projects and end up working for less per hour than you want to but that’s part of the cost of experience.

One thought on “The Rule of Thousands – Setting Your Hourly Rate

  1. Andrew Gibbs

    This is a really great article and keeps things nice and simple. It’s really good for people starting as independent consultants.

    One thing that some people will be asking is, should additional benefits be included with the salary that you’d expect if you were working on payroll full time for a company, e.g. medical cover, pension, bonus etc.? I believe they should, and maybe this could be made clear in any future repeat of the article.

    Reply

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