What Type of Billing Rate is Right For Me?by MBO Partners
As an independent consultant or contractor, you maintain sole responsibility for how much you earn. Your rate can be as high as what a client is willing to pay -- but finding out how much that should be is the tough part. The most important step is understanding the scope of the project and the needs, wants and urgency of the potential client. How do you calculate a bill rate that doesn’t undersell your services or lose you the contract to another consultant? We share three different strategies for calculating an appropriate bill rate.
Terms You Should Know
- Standard Avail Hours – The number of hours you are available in a year. The standard number is generally 2080.
- Billable Hours – Of those 2080 hours, how many you can actually bill for.
- Utilization – Billable hours divided by standard hours, or the percentage of your available hours that are billable.
- Minimum Bill Rate – What is the minimum rate, assuming a set number of hours; that you can afford to accept based on costs and expenses.
- Salary Multiplier – If you’re hiring a consultant, or an employee thinking of moving to the independent consulting business, what do you multiply your salary by to generate enough fees to run a profitable consulting business?
- Target Profit Rate – What you would expect to make if your consulting business ran at maximum efficiency. Around 40 percent is a very good target profit rate.
- Contractor – A person who performs services that are similar with a larger group of people, which are perhaps employees as well as other contractors.
- Consultant –Consultants are often brought in specifically for their expertise or strategic advice on a subject.
Bill Rate vs. Pay Rate
These are two terms that people often get confused. A pay rate is something you receive as a full-time employee. When you get a new job and are negotiating salary, your employer offers you a pay rate number. If you’re charging a client as an independent consultant, then what you’re charging is a bill rate. Bill rates include taxes, overhead, and marketing and administrative costs.
This is the most common starting point for calculating a bill rate. It helps set your baseline or ‘equivalent W-2 number’. It factors in the costs you need to cover to make your target income. Although this is an ideal method for many consultants, it does have its drawbacks. First, it does not take into account the value you are providing the client, so this method could have you undercharging people. You also aren’t factoring in what the competition is doing or charging or how urgent the client may need your services and how scarce of a resource you are to find.
What to Remember About Cost-Based Rates: Always know your floor, and know it exactly – down to the penny. Also, make sure your utilization rate is realistic. Nobody works 40 billable hours every week. An 80 percent utilization rate is pretty optimistic. Your reality might be more like 65 percent. There are always ways to reduce non-billable hours: this is important when trying to increase utilization rate. Finally, don’t forget to include ALL of your overhead costs. Spending the effort to analyze your true cost basis will better prepare you for future rate negotiations.
As you might remember from your basic economics class, the market rate is based on supply and demand. If your billing rate is market-based, you can assure that the amount will meet your client’s expectations. In order to assign a market rate to your work, you must be performing a task that is definable – what do you do? Defining what you do can take into account your experience, industry, title, and region. You can also define what you do in terms of what you make or provide – website design, training sessions, etc. To accurately calculate a market-based bill rate, you must have current market data. Your best source of information is competitive research: who are your competitors, what do they offer, and how much do they charge?
What to Remember About Market-Based Rates: Since market rate is based on supply and demand, you are putting yourself at the mercy of whatever the market does. If demand falls, you’ll have to lower your billing rate to stay competitive. Also, a person charging according to a market-based rate is more likely to be a contractor than a consultant, as it is harder to put a market value on expertise or strategic advice. This is why it is always best to first come up with a cost-based rate and then alter that based on market conditions.
If you own the only gas station on a 300 mile stretch of highway, you’ll be able to price pretty high. The same holds true for independent consultants who have a unique, valuable and scarce skill. The best way to determine the value is to know the client. Try and find out as much as you can about the projects scope to understand the value you can provide. Simply put, this bill rate is very specific to your client and your contribution. As you may have guessed, it’s based on the value you provide to the client and the ROI they receive. This can be a very profitable billing method, but is only appropriate for consultants with a wealth of experience. The client must walk away feeling that they actually got enough value for what you were charging, or else your reputation will suffer.
Whatever your strategy, you should review your rates often (at least annually). You’ll need to account for changes in the economy,your overhead, and market conditions, along with inflation or deflation. Click here to download the full 20+ page guide with more detail on how to calculate your bill rate.