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The First Book to Address to Business Side of the Web Design Business!

By Bob Schmidt

How To Set Rates by Bob Schmidt
Time is Money! 

Universal Time

 

 

Last Updated 05/18/2012
Send comments to Bob Schmidt
For a revised and expanded version
see The Geek's Guide to Internet Business Success
published by John Wiley & Sons
ISBN 0471288381

Historical note from Bob Schmidt: This page first appeared here on my web site and was later contributed to the HTML Writer's Guild for their FAQ on setting rates. I am the author of that FAQ.

Relevant to: web designers, web developers, consultants, freelancers and others who are trying to figure out how to set their own rates

Authoritative for:pricing methodology for setting professional service  rates, pricing policy, hourly rate calculations, pricing rule of thumb

1. Introduction

The question of how much to charge is a popular one in the minds of web developers and it's a topic which crops up often on discussion lists. However, it's a subject which is difficult to discuss. For instance, see the HTML Writers Guild Pricing FAQ for an explanation of the legal issues involved with such discussion among members of an industry or profession.

Nevertheless, the purpose of this guideline is to provide web developers with a number of ways to arrive at rates, and to do so without once discussing the actual rates of any particular web developer.

Certainly web development is a new profession, but web developers are not the first to confront the task of setting rates for the work of creative professionals. Ad agencies long ago figured out how to set profitable rates for work that is in many ways similar, if not identical, to that of web development. Copywriting, art direction, graphic design, illustration, and related creative problem solving and technical work are services provided by ad agencies and web developers alike. Indeed, it is this author's opinion that web developers can learn much from ad agencies in many aspects of running a business. Consequently, we will begin by taking a look at how ad agencies go about the task of setting rates.

Of course, when one thinks of hourly rates, there are many other types of professions which come to mind and we will look at some of the ways attorneys, accountants and others set their rates.

We'll consider too how you might go about determining an hourly rate for your entire business and why you might want to do so. And finally, we'll take a look at how you can figure out just exactly how much your services are really worth!

It is my hope that by understanding the different approaches outlined here, you'll be able to choose the one that is best for your web development business. This discussion may be the only time you will actually enjoy doing math!

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2. How Do Ad Agencies Set Rates?

Let's begin by looking at the analogy of the ad agency. Ad agencies long ago solved the problem of setting hourly rates for a variety of creative work. They arrived at a rather simple formula, but you have to understand some details about the components of it in order to calculate it.

This is the basic formula:
Determine the number of billable hours per year
Take annual salary and add an overhead factor
Add a Secret Ingredient many forget to add
Divide salary + overhead + secret ingredient by billable hours.

We start with the number of billable hours in a year.

Normal Work Week: 40 hours
Year: 52 weeks
40 x 52 = 2,080 Total Hours per year

Now we adjust the total hours to arrive at the billable hours. This compensates for the fact that some of the time we are sick or on vacation or taking the day off for July 4th or Christmas. Naturally, we would still like to be paid for those days, even though we can't bill for them. So we have to look at just the number of billable hours we really have. Traditionally, ad agencies have reduced 2080 to 1600 and used that as the standard number of billable hours. So we will use that figure. If you're self-employed and spend a lot of your time selling, then you might want to reduce this further.

And, if you want to get technical about it, we can do that, too. In other words, what percentage of your time is billable? If you can figure that out, then you can use that figure instead of 1,600. But, I can already tell you that the industry average is going to be right around 60% billable, which is only 1248 hours, or a little over half of your time. So if you're doing better than that, you're above average. In order to be profitable, however, I recommend that you set a goal of 80% which is 1664 hours, very close to the 1600 figure from above.

Now we need to take the amount of money you expect to earn this year, whatever you would say is your "salary" if someone asked you. Let's say it's $10,000 just to make our calculations easy.

Next, we must look at the real cost that you represent to your business. That is, not just your salary, but any associated overhead that the business incurs because you work there. This would include some personnel related expenses such as employer share of payroll expenses or self-employment tax, health insurance, disability, life insurance, and other "non billable" expenses that are vital to you and unavoidable to your business. Other things in this category might include a car allowance, or typical mileage expenses, the prorated cost of your computer, scanner, desk, chair and other office equipment and furnishings as well as a prorated cost of your office space. You need to include this even if you are a one person operation and self-employed working at home and living with your parents! Otherwise you stand a very good chance of going broke. And if you have employees, you will need to add up their "contribution" to overhead to set their rates.

After many accountants worked long and hard on this in the agency business, a rule of thumb was devised whereby you figure the employee's overhead at 100% of the salary amount. In other words, to get salary and overhead, just double the salary. So, in our example, we would double $10,000 and arrive at $20,000.

And finally, we must add one more thing-- the Secret Ingredient. It's the one thing many ad agencies (and possibly web developers) forget: Profit. Most businesses aim for 20 per cent profit and we will do the same. So we must add 20% to $20,000 and we arrive at $24,000.

Now we divide $24,000 by 1,600 billable hours and arrive at an hourly rate of $15.00. This works "per 10 thousand". So, if you make say, $30,000, just multiply by 3 and you'll get the correct figure of $45.00 per hour, or for $100,000 just multiply by 10 to get $150 per hour.

That's the standard ad agency method. It is an excellent method to use and it's the only one you really need to know. But, just to round things out, (and for a little entertainment) we will look at some more exotic methods.

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3. How Do Attorneys Set Their Rates?

Or, How My Accountant Says His Lawyer Calculates *His* Rate

When I asked my accountant about setting rates, he told me this story. He was discussing this subject with his attorney who told him how he does it.

"How much money do you want to make? How many hours do you want to work? Divide. That's your hourly rate."

This is a very simple method, offered somewhat for amusement. Let's see how we would do this if we were attorneys.

Amount to make: $1 million
Hours to work: 1

Rate: $1 million per hour

Right away, we can see why this method appeals to attorneys. But this is actually a quick and dirty way to arrive at a ballpark hourly rate:

1. Figure out how much the job is "worth".
2. Figure out how many hours you're going to put into it.
3. Divide.

That's the hourly rate you'll be getting.

This is helpful when dealing with hourly rates on the other side of the coin -- when you want to see how the hourly rate you actually earned compares with the rate you think you're charging the client.

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4. How Does My Accountant Set His Rates?

What about my accountant? How does he set his own rates for his people?

He multiplies what he pays them by 5 to get the rate.

In our example, this would be:
$10,000 / 2,080 = $4.80 per hour
$4.80 X 5 = $24 per hour

This is 1.6 times (or a little more than 1 1/2 times) what we got in the ad agency example. Using a multiple of 5 is good, you can use it as your method, as long as it does not make your prices uncompetitive. Consider it the upper range for your rates.

5. How Can You Set a Rate for Your Entire Business?

Or, How I Calculate It for My Business

In addition to figuring the hourly rate for each employee and each service offered to clients, I also want to know what it is costing just to keep the doors open.

In other words, I add up all my costs to operate on an annual basis (remembering to include the Secret Ingredient). Then I divide by 2,080. This gives me the "pay rate" for the business itself.

This is very useful. For instance, suppose the annual costs are $100,000. That's an hourly rate of $48.08. That means the business is spending on the average, $48 an hour or $1900 a week or $8,300 a month, whether there is a lot of work or no work at all. These are very useful figures to have in mind as one is setting sales goals and hourly rates. You might want to calculate the figures for your own business. How much did your business spend? How much did your business bill?

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6. So, You Think You're Worth How Much?

When you go about setting your hourly rate, you'll probably become much more aware of the rates other people are charging for their time. Plumbers, appliance repair people, attorneys, psychiatrists, and photographers are a few who come to mind. Occasionally you'll see hourly rates posted in various businesses or in the media. Here's a way to use those rates to help figure your own.

We all have an idea of how much we think we are worth and how much we think others are worth. Ten years ago, when I discovered this method, the ones that concerned me most were the rates charged by my attorney and auto mechanic. But you could compare your rates to the rates of just about any other service business.

My attorney was charging, let's say, $125 an hour. The auto mechanic charged a labor rate of say, $32.50 an hour. As I got to thinking about it, I figured that, to my clients, my services were worth roughly half what an attorney charges, and certainly, at least twice what an auto mechanic charges. I decided to calculate a rate based on this, but you could just as easily use the rates of a babysitter or an electrician or whoever, simply adjusting upward or downward based on how much more or less you feel your services are worth in comparison. Here's how I calculated my rate at the time:

Half Attorney Rate: 125 / 2 = $62.50

Twice Auto Mechanic Rate 2 x 32.50 = $65

Naturally, I rounded up to a bit above the higher of the two calculations. At the time, this represented about a 25% increase in my rates. Interestingly, as I eased up my rate over a several month period, clients did not seem to mind or even notice, probably because I used the rate only to calculate cost estimates by the project.

An added bonus, it proved great protection against inflation. As my benchmarks raised their rates, I raised mine and I had the peace of mind of knowing I could always afford to get my car fixed!

So there you have it, five ways to figure your rates. They have served me well and one of these methods, or some variation, should also work for you.

Bob Schmidt
Orlando, Florida


Take a look at these additional useful resources for setting prices
to see my principles in action

AIGA Practice Center - Calculating a Freelance Rate

Drupal Web Design Development Fees - Idonny

Graphic Design Business Ideas and Tips - About.com

And here is a useful Google search

 

     

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Last modified: May 18, 2012