UPDATE: I’ve since done more reading about pricing and, whilst I think the approach outlined below is certainly a lot better than no approach at all (otherwise known as picking a figure out of the air), I don’t think it’s the best approach. I’ll write on this topic again when I’ve had more opportunities to try out different approaches. In the meantime you could do a lot worse than read Alan Weiss on value-based pricing.
“How much will this cost us?”
The question’s come up quite a bit recently and, every time it does, my heart leaps into my mouth and I want to go and hide under a rock. It seems so innocuous. It’s just business, after all, and I mean: I ought to know the answer, right?
But I feel terrible about charging people lots of money, even when they can blatantly afford it. And this despite the obvious fact that one of the multitude of reasons I left my job at Red Gate was that I wanted to earn more money.
(Nothing against Red Gate: it was just time. Those of you who’ve been through a similar thing will know exactly what I mean. By the way: if you’re a consultant you should be earning more. You are in an inherently riskier and more precarious situation, and your income will be lumpier. If you’re not earning more then what’s the point? Why take the risk? You may as well go back to working for somebody else.)
Some of you will be mercenary as hell and won’t identify with this at all. You’re probably sat there thinking, “What is this guy on?” and, honestly, you can safely move on. I don’t think you’re going to have any problems at all, and I wish I was more like you.
Unfortunately I’m not, and this lead to the inevitable situation where the first job that came my way, via a friend working for a local company, I underquoted for. He asked me how much and I agonised. I looked at contractor rates for the local area, and added about half again on, then submitted a quote including a justification of why the fee was so “high” and heard nothing for a couple of days. Then he sent back an email saying, “yes, that’s absolutely fine,” with no hint of a quibble, and I thought: “Oh balls, I should have quoted more.”*
Well, yes, I should have done, but that’s not exactly very scientific, is it?
To the list of unscientific methods of setting your consultancy rates I’d also add asking your friends what sounds reasonable when you’re next down the pub with them even if – especially if – they work in the same domain. They’ll probably underquote because (a) most of them aren’t consultants, (b) they’re already appalled (and secretly jealous) of how much they perceive consultants to earn, (c) they might confuse consultancy with contracting, and (d) they probably haven’t sat down and worked through the calculations I’m about to lay out for you below.
Also, despite all my artsy tendencies, I’m a programmer with a science education and there are a lot of questions where I just feel a lot more comfortable and confident when I know the “right” answer and, more importantly, can follow the route that led to that answer. This is true even where the answer has some element of error/uncertainty associated with it.
So what is the “right” answer to the question of how much you should charge?
OK, so I’m not going to give you a figure. Nobody will because the answer depends very much on your situation. What I can do is map out the route by which you can arrive at that answer, and feel comfortable that the answer is reasonable. As with many seemingly intractable questions, it involves breaking the problem down into more manageable chunks.
The first thing you need to do is answer a few simple questions:
- On average, how many billable hours will I work each week? This will be less – most likely significantly less – than the total number of hours you work.
- How much do I want to earn? For the sake of argument we’ll call this your salary, although the exact mechanics of how the money finds its way into your pocket are best discussed with an accountant.
- What are my costs? Strictly, costs include your salary (2), but here I’m really talking about all the other things that you need to spend money on. The combination of (2) (before tax) and (3), taking into account (1), will allow you to calculate your consulting fees.
Let’s deal with each of these questions in turn…
1. On average, how many billable hours will I work each week?
As I said, this will most likely be a lot less than the total number of hours you’ll work.
Because you need to spend time on business development (marketing, wooing clients, actively searching for work, developing other revenue streams) and admin (finance, etc.).
For example, I reckon I’ll average around 24 billable hours/week, giving me 16 hours (2 days) to work on everything else. In reality I’ve accepted that the “everything else” bit will take more than 16 hours, meaning I’ll work more than the 40-hour work week that’s become standard in the UK, in order to pursue other business opportunities whilst still meeting my financial goals.
2. How much do I want to earn?
As I said, let’s call this your salary. You need to work out what you want this to be before tax.
Say you want to earn £100k/year, and take 5 weeks holiday. You’ll work 47 weeks and, since you only earn when you’re working, your salary for those weeks will be £2130.
If you’re trying to think about what a reasonable salary might be, here are some issues you should consider. Some of these are domestic expenses, whilst others are things that might be provided as employee benefits were you working for a larger company:
- How much money do you need to survive for 6 months if, for some reason, you can’t work?
- How much is your mortgage/rent?
- How much do you need to pay for childcare?
- How much is income protection insurance going to cost? Think about at least being able to cover your bills (NOT live the life of riley, unless you can afford to pay a lot),
- How much time do you want to take as holiday each year? Remember: when you’re on holiday, you’re not earning, so treat it as a cost. (IMPORTANT NOTE: don’t forget to buy travel insurance, including medical cover!)
- What about healthcare? The UK has the NHS and you can get free hospital care throughout the EU with a valid EHIC card but, in some instances, private healthcare can ensure you receive treatment more quickly for non-emergency conditions.
3. What are my costs?
Salary is obviously a cost, but as I said before, this is exclusive of salary.
So, here is a non-exhaustive list of business expenses you need to take into account when calculating your costs:
- Car (or other vehicle)
- Purchase or finance costs
- Insurance – expect this to go up (social, domestic, leisure and commuting use won’t cover you if you spend a lot of time on the road visiting different clients)
- Tax (known as Vehicle Excise Duty in the UK)
- Annual roadworthiness test (known as MOT in the UK)
- Rail (also metro/underground, and bus for large cities)
- Car (or other vehicle)
- Professional indemnity
- Travel (make sure it covers both business, personal, and medical expenses!)
- Health (optional: depends on where you live)
- Domain names and hosting
- Equipment (including software licenses, and SaaS subscriptions)
- Administrative services (accountancy, legal, company registration, etc.)
- VAT (depends on how much you earn/anticipate you’ll earn)
- Property/council tax
- Food (especially if you’ve previously worked somewhere with a subsidised or free canteen)
- Pension (you contribute to this from your salary but your employer would also normally make a contribution so I think it’s worth highlighting as a cost)
(It’s non-exhaustive because I keep thinking of things that need to be added to it.)
You need to work out how much these will cost you per annum. Do NOT underestimate them…
Business Expense Example 1
I have a pretty good bead on my car costs, as they stand right now, but I anticipate they’ll change significantly over the next 12-18 months. For starters, I may buy a newer car since my current car is getting a bit tired. I’m also not exactly sure how much of my mileage will be business mileage, or how many miles I’ll drive, so I’m assuming the “worst case” scenario: most miles will be for business, and I’ll have to drive longer distances (albeit perhaps less often) than I was simply commuting to and from my old job. Thus I’ve budgeted to be able to cover any increase in car costs.
Business Expense Example 2
Right now I’m paying next to nothing for hosting and domain names. My hosting (on Azure) is covered by the MSDN subscription Microsoft have kindly given me so I can continue working on NTVS, whilst my domain names currently cost well under £100/year. However, over the next 12 months I have plans that I anticipate could increase my hosting and domain costs to as much as £200/month which, in my cost breakdown, I’ve rounded up to a convenient £2500/year. They may go higher (in fact, I sort of hope they do, because that would indicate success… or possibly terribly inefficient code, but hopefully the former) and, if so, I’ll need to adjust. I anticipate a gradual ramp up though, so £2500 should be sufficient for the first year.
You might also be able to consider a portion of your mortgage or rent as a business expense if you work from home but BE CAREFUL. If you get this wrong you can run into hot water with the Inland Revenue, so make sure you know the rules for your jurisdiction.
Once you’ve worked out what your business expenses are per annum, divide by the number of weeks you’ll be working (NOT by 52) to work out what they’ll be for the average week. You’ll probably be surprised by how much they are. In fact, I’d go as far as to say that if they’re running at much less than £500/week you should be suspicious that you’ve miscalculated. Depending on your exact circumstances you may find they’re much higher – maybe closer to £1000. For the purposes of the calculation below I’m going to split the difference and say £750/week.
So, how much should I charge?
So, we want to pay ourselves £2130/week and our costs are £750 week, which means we need to earn £2880/week.
BUT we’re only billing for 24 hours, which means we need to charge out at £2880/24 = £120 per hour.
Or £960 per day.
And, of course, at that level over the course of a year (unless you’re particularly lazy) you’ll easily hit the VAT registration threshold, which means in that your fees are in fact £960 + VAT per day, which is basically £1200 per day.
Sounds like a lot, doesn’t it? But in consultancy terms it’s actually still pretty cheap. That in itself may be a problem – I don’t pretend to have figured that out yet. It also gives you some idea of why large consultancy firms are so eye-wateringly expensive: they have to pay for all that glitzy marketing, aggressive recruitment, graduate training, and those fancy offices somehow.
Because you’re worth it
I’m sure you can see how I’ve landed on those figures which, by the way, are a ballpark (and also chosen to make the sums easy for this example!). You might still have nagging doubts though. You might be wondering, am I really worth it?
This is tricky, and is really something you can only answer for yourself. What you need to think about is the value you’re offering to clients. Here’s a concrete example from my own experience.
Potential client comes to me looking for help with some serious performance and scalability problems – even at minimal loads – with a website and set of associated services they’re planning to roll out in four weeks’ time. Technologies are .NET, ASP.NET MVC, and SQL Server. They want a specialist, with a background in .NET and SQL Server performance optimisation to come in and help them fix their performance problems.
I’m a software engineer with 14 years professional experience across a wide range of projects on various platforms. Of that, I spent nearly 10 years building tools to solve common problems encountered by .NET developers and SQL Server developers and DBAs. That includes the award winning ANTS Performance Profiler, which allow developers to quickly isolate performance problems in .NET code, and will highlight long-running/inefficient queries in SQL Server. I’ve done a lot of user testing, helping people find performance issues in their code, I’ve written about .NET performance, and I’ve spoken at .NET user groups on the topic.
What value do I bring?
The client has already spent a lot of time (and therefore money) trying to fix the problems they’re having, but with only limited success. They therefore want a specialist. With my background clearly I am something of a specialist. This is not a situation in which any .NET developer will do.
I can go in and help them fix their performance problems much more quickly than they might otherwise be able to. Although my day rate may seem high, they will actually spend less overall, and can be much more confident of a successful launch. This means they won’t lose money due to the site being unable to handle the load placed on it.
So, am I worth it?
In this case: yes. (But that doesn’t guarantee that they’ll be willing to pay – that’s a separate issue.)
You too are a professional (I assume). That being the case people should (and will) be willing to pay professional rates for your services. There will obviously be some element of negotiation for at least some jobs, and that’s OK: it’s just business. It’s part of your clients’ jobs to negotiate, and therefore part of yours.
Your fees might vary a bit anyway, depending on the client and the nature of the job. For example, for longer jobs with more billable hours per week you may negotiate a lower fee, because it’s guaranteed work for a longer period of time. I drew a distinction between consultancy and contracting earlier, and this is really what I’d describe as contracting. Consultancy I tend to think of as more being pulled in to advise on a specific issue or to help fix specific problems. It’s all obviously open to interpretation, and is something of a sliding scale.
Not everyone will be willing or able to pay your fees. For example, not many one- or two-man outfits would pay £800-1000 (or more) per day for consultancy, and that’s fine: those are not your customers. But many larger companies will.
What do I mean by larger?
Well, Red Gate regularly paid those kinds of fees (and more) for consultants and trainers from at least the time when I joined the company as employee number 17 back in 2004, and continues to do so. So, by larger, I really don’t mean that large.
I mentioned negotiation in passing a few paragraphs back. There’s an important point here: once you’ve gone through the process I’ve outlined above you’re in a much better position to negotiate. You know how much money you need to earn. You know where you can afford to compromise, and where you can’t.
You know, I hate negotiating, particularly when it comes to money, but it becomes a heck of a lot easier when you take the emotion out of the equation, and can back it up with facts and figures. You probably wouldn’t share those with your clients, because it’s none of their business, but knowing in your own mind what’s reasonable and what’s not will give you a lot more confidence.
Going back to people won’t be willing to pay for your services: that’s OK. They are not your customers. Think about the opportunity cost of cutting your fees to work for them: you may end up turning down a better paying job later on as a result, or you may gain a reputation for being cheap/easy to exploit that is hard to shake. If that happens people will undervalue you and your work, and you really don’t want that.
I’m going to stop now before this completely degenerates into a random stream of unconnected thoughts, but I hope it’s proven helpful for you. And if you have any comments or advice of your own please do come back at me – I’d certainly love to hear it.
Now go forth and charge lots of money**!
*Only half a days’ work so not a disaster.
**By which I mean a reasonable hourly/daily rate that allows you to cover all your costs and earn a decent living on top!
(Oh: one more tale of schoolboy error for your amusement. I recently sent out a quote to a potential client that I calculated using the above, but I still reckon he might think he’s getting a real bargain. Why? Because, like a muppet, I forgot to take VAT into account. Fortunately a short job again so not the end of the world.)
EDIT: Thanks to my friend Claire Taylor for pointing out that I’d forgotten to include a pension in my list of costs.