How do I set my hourly rate?

Q & A by C.J. HaydenI’m often asked by service business owners how to go about setting appropriate hourly rates. Entrepreneurs are often advised to compare their rates to the competition, but this isn’t the whole answer. As one business owner told me, “My competitors are charging anywhere from $50 to $150 per hour!” So what other factors should you be considering?

When you’re charging by the hour, your rate is the most important business decision you can make. The rate you set must pay not only for your time, but all your expenses and obligations.

Start by considering your living expenses. Total up your regular expenses, including housing, utilities, food, clothing, health care, family care, transportation, and entertainment. Add to that required payments for your debts and income tax, an allowance for emergencies, and a budget for savings.

Then add your overhead expenses. What will you need to pay for office space, supplies, computer equipment and software, travel and transportation, phone and Internet, and anything else you need to run your business.

Now consider your marketing costs. How much might you need to spend on expenses like advertising, marketing collateral, website design and maintenance, networking lunches, and attending events and conferences?

Your rate must also pay for the same benefits you would expect to receive as someone else’s employee. These might include health, disability, and life insurance coverage, a retirement plan, sick leave, vacation time, and one-half of your Social Security payments.

And, your rate should cover reimbursement for your startup costs and professional development expenses. You need to consider the risk factor, too — there is no guarantee you will bill as many hours as you would like.

Keep in mind that over the course of a year, a successful professional may bill only 20 to 25 hours per week. Don’t set your fees expecting to bill 35 to 40 hours. Especially for the new professional, work more typically follows a 3-to-1 rule — you spend up to a third of your time marketing, another third managing the business and keeping up in your field, and the last third working on client projects. Assuming three weeks of vacation, these guidelines suggest you should count on billing no more than 1100 hours per year — 22.5 hours times 49 weeks. Some professions might average more, but others average considerably less.

To decide on your rate, add up your annual estimates for all the costs described above, and divide by the number of billable hours you can project. For example, if your living expenses, overhead costs, marketing budget, and employee benefits total $90,000 per year, and you’d like to add 10% more for reimbursing your startup costs and allowing for risks, divide $99,000 by 1100 hours. That would indicate an hourly rate of $90.

After you know how much you need to charge, then compare that to what others in your field and market area are charging. Even if your needs are low, you should charge at least as much as the low end of the competition. Don’t discount your rate below that just because you’re new. When rates vary widely, try to choose a level within the range that seems appropriate for your experience and education.

Once you’ve decided on your rate, stick to it. When clients ask you to work for less, instead of lowering your rate, negotiate the scope of what you offer. You could perform a no-frills version of the client’s project that will pay you the hourly fee you require, but reduce the total cost to the client. Or include a not-to-exceed clause in your agreement to eliminate any concern about runaway costs. If you work by the session, you could schedule fewer sessions per month. Clients are often more concerned about their monthly or total budget than they are about the rate they are paying you.

You can always expect some people to question your rate, so if no one says it’s too high, you’re probably not charging enough.

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Reader Comments

Thanks for sharing this, C.J. This is an issue CTA students struggle with (hey, let’s face it, all of us struggle with this). You’ve laid out a comprehensive method and I hope my students will take advantage of your experience. Nan 🙂

Concerning setting rates: I must disagree that what a client or customer pays for something so greatly depends on what a business owner wants or needs to earn. I couldn’t charge more, for example, if I chose to rent an office in NYC rather than work out of a home in the woods. And if I work out of my home, I’d still want to charge as much as I can get. That’s how a business grows, so it can spend or save or hire others. Rather, a service or product has intrinsic value (or not) based on the evaluation of the person who’s paying the bills.
The “formula” and details set forth in this article are an excellent start, however, for several things: 1. to compare a business owner’s potential earning rates (based on current market averages, for ex.) with all relevant expenses, to see if those rates would meet personal financial goals; and 2. identify and evaluate parts of the business plan that might be up-scaled or downsized to increase net earning potential. (The expense of having an office location of NYC vs. home is one example; the type or quality of health insurance is another great variable in expenses.) The details in this article can also help point a business owner to thoughtfully set goals for specific parts of a business plan—for everything from how many hours needed to bill, how much time and money needed for marketing, and how much savings one might need to live on until the business reaches desired goals. As you suggest, setting hourly rates and planning for success ain’t easy, but business owners aren’t looking for easy! Best wishes!

Nan, thanks for your acknowledgement, and Amy, thanks for your thoughtful comments. The reason I put such emphasis on figuring out what you need to earn in order to set your rates is because I find that most professionals either a) set their rates too low, b) overestimate the number of hours they can realistically bill, or c) don’t stick to their rates when a customer questions them. I think that if an entrepreneur begins by determining the amount they really need to earn, they will be more likely to set — and stick to — a rate that will allow them to build a sustainable business.

What I’ve learned for myself, after much trial and error, is that determining my rate goes back to the niche I’ve chosen. Amy’s example is great: I can’t raise rates for the same clients just because I work out of an office in NYC rather than out of a home in the woods. The corollary to that, I’ve found, is that sometimes premium clients will expect that you work out of an office in NYC; so it’s not always feasible to save money by cutting down on business expenses.

Barbara, you’re right about the bearing of your niche on your rate. That’s one of the many reasons it’s so hard to price what you do based on the value of the work. The exact same work is valued differently by different market niches. Determining what you need to earn can be an important part of the equation, because that can guide you to choosing a niche that can pay the rate you require. If you leave that step out, you can choose your niche, set your rate based on what others in that niche seem to be charging, and then discover you can’t meet your expenses with those earnings.

C.J. – Seems to me that the value of my service to the client is more the determination of rate — versus my internal costs, no?

Jak, the issue becomes how do you determine your “value”? In my experience, most professionals “value” themselves too little, and often end up charging a rate that won’t sustain their business. And in most professions, rates are all over the map. For example, I’ve paid anywhere from $15 to $80 per hour for graphic design work. So what is its value? This is why I suggest you begin the process by determining what you need to earn, then compare your rate to what others in your market are charging, then choose a rate that reflects your own market position.

I hear that. Thank you

This post has some really helpful tips for me as I plan and set business goals for the new year. I think it is very relevant to consider how much money you need to make and go from there.

Now people may find that what they need to make and what their profession pays is not compatible, but it’s important to understand that and then figure out what to do about it.

I think it’s also great advice to be aware that your billable hours are only about 1/3 of the time you spend working each day/week. I just completed my first year of full-time business, and overestimating how many hours I can work in a day was probably one of my biggest mistakes. I’m working on correcting that now, and this blog post gave me some helpful info. Thank you!

great article here