One of the key questions that plagues nearly all sectors of business is how much to charge for a service or product. My companies have usually dealt with services, so I’m going to focus on that area in this post. Determining product pricing is a science all onto itself, which I’ll have to cover in a different lesson. We’re going to start off by estimating a single individual’s worth, and then explain how this formula can be applied to multiple employees through your company to determine your overall payroll and expenses.
The Golden Rule Of Getting Paid What You’re Worth
I have told friends for more than 20 years that the secret to getting paid what you’re worth is to know what you must charge in order to survive, and to ensure that if you bring something special to your art, that you are confident in that profit margin. The goal is to stare a client in the eye with confidence rooted in your bone tissue that you are worth X amount of dollars per hour, per year, or per service. If there is any hesitation in your voice, or in your bodily frequency, your client will smell it a mile away and know that you’re over charging them, and unless they are backed into a corner, they simply won’t pay it. You don’t want to be this person. You want to reek of confidence in not only your rate, but that you are the best person for the job.
In order to achieve this enlightened level of confidence and security, I’m going to help you organize your expenses, and see the rate in your heart of hearts. You will ask for the right amount of money, and if denied, you will leave the potential work behind with the knowledge that if you took less, you would not be able to survive on the revenue generated.
Getting Your Costs Organized
Why do we charge money for anything? If we do what we love, why charge for it? Isn’t it enough that we get to do what we want? Obviously a million answers come to mind; most namely, because we have to live, and it is this basic necessity that forces our hand to charge for our time. If you sat down with 20 people and asked them to write down why they had to charge money for their time, you would have 20 lists with largely diverse results. When combined into a single list, you’d notice some patterns, but also some chaos. I’m going to begin by breaking down these areas into logical piles to make it as easy as possible to come up with some base numbers that will feed your minimum hourly rate, as well as your profit margins.
Category One – Your Personal Bills
If you’re like everyone else in the world, you have to either pay rent or a mortgage to keep a roof over your head. Most of us have a car payment that keeps us on the road. Add to that the utilities, cellphone bills, internet connections, meals, perhaps student loans, essentially every single bill we pay on a monthly basis to survive. Your first task is going to be to write down or document perhaps in Excel or Numbers these expenses so that you know what your minimum monthly net income needs to be. I say net, which means after all forms of taxation are removed. I’ll give you a little trick of removing taxes in a moment, but first we need to add more costs to your list.
Category Two – Your Business Expenses
One of the initial mistakes people make is combining their business expenses with their personal expenses. What do I mean by business expenses? The simple rule is “any expense you incur as a result of having your business that would otherwise not exist.” This is usually meals in foreign places, travel costs such as gasoline and wear and tear on your vehicle, clothing that is necessary to keep up appearances, absolutely anything that is triggered by the needs of the business. I want to clarify that not all these expenses will be tax deductible, but you must know them nevertheless, and you must account for them 100% before finishing your expense sheet.
In addition to ongoing costs such as fuel, meals, etc., there are usually some one time setup costs such as business cards, website setup, perhaps some hardware that need to be accounted for and averaged over the year. The truth is you can’t start a business without some out of pocket money in most cases, but you can often get by on very little money in the beginning. You could write these on your list to be recouped during the first month of operation, but unless you already have a client with a paying project, and the knowledge of a large down payment with extra monies, you most likely won’t recover these setup costs right away. However, you should attempt to earn this money back over time; they are business expenses.
Category Three – Your Sanity Money
People often forget this layer of much needed money. Depending on what type of individual you are, your sanity money is going to vary from other folks you meet. Some of you own every toy in the world and need nothing to keep entertained as the weeks go by. Others have hobbies where you perhaps see movies, go to an amusement park, or down to a local restaurant. Regardless of your pastimes, you need to account for the fact that money needs to be set aside for your mental health. It could be something as simple as a massage to keep your stress level down, a little extra money to eat organic food, or that $3,000 for the yearly vacation (divided by 12). Whatever it is write down what you think you need to spend each month to enjoy a bit of life.
Examining Your Initial Costs
By now you should have a very interesting lists of solid and potential expenses that will start coming in the mail once you start your business. Understand that this is serious. No bill collector is going to care about your heartfelt story of failing to start your business when they want their money, and this is why you need to be as brutally honest as possible when making these three lists. At this point we want to total your monthly expenses into a single number. For the sake of this lesson, I’m going to pick a nice number like $50,000.
Calculating Your Salary And Hourly Rates
Okay, so we’ve totaled everything up, and we have a need to net $50,000 after taxes. So how much is that before taxes or rather what is our gross income? Everyone is in a different tax bracket as you know, but I usually try to play it safe when estimating my withholdings. I like to claim ZERO on my W9 and let the government take maximum withholding so that I rarely owe anything at the end of a tax season. The percentage I use is 38% withheld. You may be lower based on your end number, so feel free to adjust. Once you have your tax withholdings percentage you can subtract that from 100% and whatever you have left, move the decimal two places to the left. So in my case I have 72% left, which becomes .72. Once we have this number we divide $50,000 (or your total expenses) by .72 giving us (in my case) $80,000 roughly.
So what does that tell us? Well, we know we now have to charge a minimum of $80,000 for a person of our capability and status in life to get by. If we need an hourly rate, we simply divide $80,000 by the number of hours worked per day, 8, by the number of days per week, 5, per the number of weeks we’re actually going to work, lets say 48 out of 52 weeks. This gives us an hourly rate of $42/hour. I subtract four weeks from the total number of weeks knowing that I’m going to be on vacation, and the client is most likely not going to work through major holidays. What this does is increase our hourly rate to account for the lost wages earned during this time. If you divided by 52 weeks, you’d come up with an hourly rate closer to $38/hour, which would leave you paying expenses for four weeks off out of your savings. You don’t want that.
But What About Profit??
Yes, we haven’t done anything for profit. All we’ve done is calculate our base needs. Now we need to determine if we have room to add more to our rate based on our industry health, and very importantly our skills within that industry.
Right off the bat we need to comes to terms with our skills. Are you an expert? A beginner? Or a moderately talented person? People sometimes struggled to come to grips with their abilities, because our egos get in the way of a clear answer. I summarize my own skills by this regimen:
- How long have I been in this business?
- How many projects have I led to completion?
- How successful / profitable have my projects been for clients or companies that I’ve worked for?
- Do I know something that very few folks know that cut costs, reduce risk, and result in higher levels of success?
- Is my knowledge of the industry current?
- Am I still operating at expert levels of contribution?
- Is my industry healthy enough to pay prime rates for service?
- Is my industry outsourcing what I do for a living?
The answers to these questions will determine how much profit one can rightfully add to the current going rate for what I do. If you know your industry, and I’m sure you do given that you want to start a business in it, you’ll know the going rates for the services that you’re going to offer. You need to understand where you plug into that rate structure and based on the questions above, how well you fit into the equation. Let’s go through two scenarios just to illustrate a point.
You’re hot on the trail of something new, something edgy. Your industry is booming. Investors are literally dumping money into your market and can’t find enough workers to complete the backlog. You know it all! You are the expert of experts. You’ve worked in the trenches. You’ve excelled into upper management. You’re the head guy who knows how to train, roll up your sleeves and get dirty, and you’re hungry for everything that could come your way. In this example, you are poised to demand the highest rate your industry will allow. If you were an iOS developer, that might be an hourly rate of $150. Regardless, this scenario means you’ve answered every question with glowing results, and should have nothing to worry about. Now let’s flip that upside down.
You’ve been in the industry for decades. You’re tired of being pushed around at the company you work for. You see them hiring younger folks straight out of college living in rented rooms, driving beat-up cars, and working 14 hour days. You’re often tired, and you just know you could run things better if you could just get out of this rat race. You quit your job. You dust off that home office with the dot matrix printer that you know has more life in it. You go down to the local bookstore to brush up on your skills, and you instantly feel ill looking at all the new technology that’s polluted your previously pristine world. Your industry is sagging too. It isn’t growing. What used to be done by humans has now devolved into automated or overseas outsourcing that although suffers in quality, has every CEO in your industry convinced it’s worth the hassle. This scenario speaks of disaster. If you are able to find work outside of the corporate dinosaur you work for, you’ll most likely have to survive on a starving hourly rate. Your best bet is not to get fired, and use that spare time to transition to a new career. Perhaps turn a hobby into something profitable.
You might be asking yourself why I gave such a dire example. The reason is this scenario happens all the time, and spouses can see it coming a mile away and try to support their loved ones only to plunge the family into financial ruin. There are ways out of any job, but you need to be smart, and devise a backup plan first.
What If You’re Young?
I had an issue when I was in my early 20s. I graduated high school with a college level of understanding and skill in computer programming. By the time I got into programming only months after graduation, I grabbed an hourly rate of $5.75, but I was allowed to work as many hours as I wanted to. It resulted in a yearly wage of $36,000, which in 1987, wasn’t bad money. A year later I had moved deeper into development, and was in need of a new car. I had a new boss, and went to her to ensure that I was going to get a raise in my hourly rate to cover the costs of my new car. She said yes, and so I agreed to finance the car by myself. The risk was high, but I had done my homework. I was the best at what I did in the company. What I could do in one day took folks in their 30s a week to complete, and mine worked the first time.
I got back to work and my newly appointed boss handed down a salary of $24,000. What?! When I asked her why, she flat out told me “You should be thankful to make that much money at your age.” Well it didn’t take too long before the company ran into financial trouble and laid me off, which sent me into the video game business two days later.
Now fast forward some years later. I was working for a huge corporation making $22.50/hour at the age of 23. I was again, one of the top database programmers in the industry, and I was happy as a clam to be making what I was making. Then a different company offered me $45/hour. What?! People make this sort of money? I was naive. I called my employer and demanded more money. He was a shady guy who talked me out of the exact rate of $45/hour claiming he would take care of me if work dried up. I took his reduced offer of $39/hour and BAM, I was making nearly double overnight. I was 23 years old in 1993 making $80,000. Guess what that did to my confidence from that point on? I started to do my research on rates. I started to examine and compare my skills with other developers before walking in taking a job.
I tell you these anecdotes to help you understand my answer about age verses rate. They are going to try and screw you. You don’t want to work for folks who will screw you. If you know in your heart of hearts based on my questions above, you have the skills to do the same job as a person twice your age, then you go get that rate. You ask for it in a calm confident voice, and if need be you bring examples of your work. Where you lack maturity, and you will, you let them know you’ll make it up in overtime and dedication (they know their workers over 40 are slackers, trust me).
There is one little question you need to ask yourself if you’re young, and you may not like it. But here it is…are you a cocky asshole? Do you have more ego than experience? Have your parents paid your way up until the moment you present your rate? If so, it’s a good time to chill the F out. You’re playing in the big league now, and where you might have been the tallest basketball player in your little hometown, you are about to be crushed by seven foot tall monsters who know all your tricks. Be humble. Be smart. Keep quiet until you know you have something to contribute of value, and not merely to contribute your voice into the room. Carefully observe every person around you for the qualities you want most in yourself. Don’t just mimic others. Make their actions your own. Try to improve them, and get paid what you’re worth regardless of your age.
What About My Partners?
Now that you know how to estimate your own rates, it’s time to apply these equations to your partners. Have them do the same exercise you did. Brace yourself for higher expenses from other folks. You may have a partner with more bills than you, or higher ones at a minimum. You might have the opposite, which means your partner may be able to save more than you do if you pay yourselves the same wage, which I recommend against unless you do exactly the same thing. I’ve run companies where my partners were all paid the same amount, while not contributing to the same level. I’ve also paid my employees far more money than I pay myself. You have to do what’s right in terms of work output and sustainability. If you know you’re not going to be contributing a ton of sweat to a project, you can opt to pay yourself less if things are tight. Chances are you might get a bonus and they don’t.
What About My Employees?
The golden rule for billing employees is that “Time is Money.” Aside from understanding how long it takes to complete a project, you need to understand how much it’s going to cost you to keep that employee during that time. If you make a mistake in estimating a project’s length, it could cost you everything if the client isn’t willing to endure some additional charges. Don’t make that mistake.
Above all you need to lean on the industry rates. If you know your business you know what to pay folks. Once you’ve decided on their individual rates, you need to estimate their cost to the company. Do you have benefits? Bonuses? Computers? Software licenses? Do you cover expenses? Do you train your employees? Every single dime need to be pushed into a single number that can be billed to a client.
If you’re employee runs you $65/hour, you need to probably charge $85/hour just to break even. Given that you need to generate profit, you’re probably going to charge something in the neighborhood of $100 to $120/hour to be able to pay rent, and hire new folks to find more work.
Fixed Bids Verses Hourly Rates
This is one of the most vital lessons you can learn in this post. When to charge using a fixed rate, and when to charge using an hourly rate. I have a very simple approach for this.
If the client is dreaming, meaning, they haven’t made up their mind, you bill them for every single hour they are “imagining” what they want. This will keep the stress off your back as long as there isn’t a deadline sliding out. You’ll have the funds to pay the bills, and if you’re smart, you’ll make that À la carte rate high. You don’t want clients building things out of bouts of uncertainty unless they have the money to back their indecisiveness. Your company needs to operate on a schedule as well, and you need to know if you’re going to be out of work the next day. A client that can’t make up their mind sometimes decides to quit trying, and you’ll need money in the bank to carry your employees to the next opportunity.
If the client can group a sector of work into a nice bundle, and you feel confident that you’ve gathered all the requirements, and understand what finished means, you can quarantine that work into what is called a fixed bid. One price for all the work. It is vital that you define what work is inside the bid. Any ambiguity can lead to slimy clients pushing more work into the project with demands that it’s included in the original price. Some clients do ask for more and understand they need to pay more. Be careful getting angry until you know which client you’re working with. Also make sure to document your work to prove what you’ve done in case there are any disputes. Sometimes both parties can be angry for a moment until clarity is found.
One can also incentivise the client into making up their mind by offering the “discounted” rate. As mentioned above, you want your singleton rate to be high. This is to cover your costs, but also to demonstrate a lower rate to give them a goal to decide. Also consider giving discounts for longer term projects. A client that is willing to pay you over 10 months should get a 5% to 10% discount, because they are giving you stability in your own company. Just remember that sometimes clients go out of business, or refuse to pay for some reason. I’m going to be writing a separate lesson how to structure a contract to hopefully cover this area in more detail.
I know this lesson was rather long, but hopefully you can find some valuable information in the niches that are seldom documented.