"How to Set Prices for Your Services"


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A Step by Step Guide to Calculating What You Must -- or CAN -- Charge

by Daniel P. Dern

(c) Copyright 1992, 1994, 1997 Daniel P. Dern

[ Versions of this article have appeared over the years, in Home Office Computing (October 1991), newsletters of the Boston Computer Society and of the Free-Lance Editorial Association (FLEA), and probably lots of other places. - dpd ]

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Permission is hereby granted to link to, repost or forward this piece of my copyrighted work to free-for-access Web sites, online discussion groups, Newsgroups, forums, etc., so long as a) My name, copyright information, and this permissions notice are included, and b) No modifications are made to the text without my approval. If possible, I would appreciate being told of any such re-uses in any case.

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    Of the many "business of being in business" skills, knowing 
how to set prices for your services is one the key skills for any 
business.  (Other important areas include your marketing/sales 
process, billing and collecting, and office-support mechanisms.)  
    Yet the underlying methods and issues are all too often 
unfamiliar to home-based service providers, consultants and other 
start-up entrepreneurs.  
    Pricing plays a central role in how much (or little) you earn 
for the work you do, and the psychological subtleties of your 
business relationships.  Set prices too high and you may lose 
valuable business.  Lower prices may garner you assignments and 
projects you'd otherwise miss.  But too-low prices can also 
translate to unnecessarily long hours, to earning less than you 
should for your efforts, and, in the worst case, to failing to 
earn enough to pay yourself the salary you need and still stay in 
business. 
    There are a number of strategies you can use to set prices, 
ranging from the going rates to "Until they say Ouch!" and "A 
Piece of the Action." 
    But you need to start from COST-BASED PRICES -- prices that 
reflect what it COSTS you to be in, and stay in business.  You 
may decide or negotiate different rates at times.  
    COST-BASED PRICES are relatively easy to determine.  It will 
take you some thinking, perhaps a few phone calls, and then a 
minute or two with pencil and maybe a calculator.
    In return, you get real, bottom-line information essential to 
starting and running your business.  (You may discover that what 
you need to charge is more than people will pay.  Perhaps you can 
change your underlying business assumptions -- or maybe you'll 
want to look into a different business.) 

    This article provides a step-by-step guide to figuring out 
your essential price-setting data, plus a "quick-and-dirty" way 
to get a rough answer.  The process applies to anyone selling 
time and knowledge as service: contractors, management 
consultants, health care services, accountants, programmers, 
artists, translators, tour guides, writers, editors, dance 
instructors, etc.  (Selling products -- donuts, computers, ties, 
etc. -- adds issues like materials and inventory, all outside the 
scope of this article.)
    There's nothing mysterious or secret about this process I 
describe here.  You'll find it in almost every book of self-
employment and consulting.  Yet a surprising number of self-
employed individuals and small businesses I've talked with have 
never done this exercise.  

CALCULATING COSTS

    The first step is to determine your costs -- what it will 
cost you to be in, and run, the business you're looking to start.
    People who haven't previously run a business more often than 
not underestimate the full costs of starting up and maintaining a 
business, even if it's something as simple as doing 
transcriptions using a computer perched on your kitchen table. 
    Just like the full cost of running a car includes not only 
the purchase price, but also insurance, maintenance, repairs, 
gas, parking, tolls, auto club membership and an occasional car 
wash, running a business requires on-going spending, for 
recurring costs and fresh investments in equipment.
    Costs can be categorized as follows:
    o Business and office expenses
    o Salary and personal taxes 
    o Benefits.
    
Business and Office Expenses:

    You can start up a business on a shoestring -- an answering 
machine and business cards, to be precise -- but it's hard to run 
one on this basis for long.  
    This is part of the cost of being in business -- the cost of 
running your business, to be precise.  Don't underestimate its 
importance -- or the probable level of costs.  Your pricing has 
to reflect these costs -- and it's one reason that the rate you 
charge is different from what a full-time employee appears to be 
paid.
    With few exceptions, you'll need to run some kind of office, 
even if it's a room where you live.  
    You'll have on-going and recurring expenses, such as phone 
and electric bills, postage, copying, stationary and office 
supplies, memberships, subscriptions, travel, professional 
services such as advice from accountants and lawyers... 
    Plus you'll need to make on-going investments in office 
equipment and furniture: computer purchases and upgrades, filing 
cabinets, fax machine, copier, desk, telephone headsets .... 
    And quite possibly business-related taxes -- sales tax, 
service tax. 
    Excluding rent on office space, many home-based independents 
report that phone bills are their biggest expense, followed by 
on-going computer purchases, like a new laser printer, or a 
bigger hard disk, better monitor, or back-up power supply, or a 
laptop computer.  It's also easy for memberships and 
subscriptions to add up to a thousand dollars a year or more.  
    Put together a business budget.  Ask some people running 
their own business what categories of expenses they have, and how 
much they spend.
    Some expenses can wait until you're established, and have a 
predictable cash flow.  But as a start-up, some of your expenses 
will be higher.  You're gearing up a business -- you may not have 
any office equipment or furniture, and may need to make larger 
investments in marketing.
    One piece of good news:  As a rule, these expenses are PRE-
TAXABLE dollars, subtracted on your Schedule C from your gross 
revenues to yield your taxable net. 
    For purposes of this article, assume business expenses
of $30,000 per year, or $2,500 per month.

Salary and Personal Taxes:

    You are going to be running a business.  You're working for 
yourself.  Even if you don't write yourself "paychecks," the 
principle is the same. 
    One rule of thumb for self-employment is you should plan to 
earn more or less what you'd get as a full-time employee -- 
otherwise, being an employee may be a simpler way to pay your 
bills.  (Lower stress and higher satisfaction are also important 
benefits, but economic issues usually must come first.)
    Another way to answer the question is to determine what 
salary-equivalent you need, in annual, monthly or weekly terms, 
If you're part of a family unit, what salary equivalent do you 
consider appropriate?   
    Taxes: DON'T forget to consider personal taxes in making this 
calculation.   Forgetting, underestimating or miscalculating the 
tax bite is another all-too-common pitfall for start-ups -- the 
money due to the government out of each "paycheck" before you can 
start paying bills of your own.  These taxes include: 
    o Federal Income Tax
    o Social Security Tax (twice the employee bite, although you 
      get to take some of this as deductions)
    o State and City income taxes
    o Other (property, real estate, etc.).
    As a Massachusetts resident, I pay a 6% income tax in 
addition to Federal and Social Security.  The tax bite on my 
income runs about 40-42%, according to a graph I did recently. In 
other words, for every $1,000 I want for take-home pay and 
benefits, I need to earn about $1,600.  
    (Tip: The prudent person will open a separate bank account, 
designated for Our Friend the Tax Collector, and put the 
appropriate percentage of each received check in it -- so it's 
there when payment times roll around.) 
    For this discussion, let's try assume a salary-equivalent of 
$50,000 a year.
    It's possible that you can afford to need less salary -- if 
your spouse works, you have savings in the bank, etc.  But don't 
include these factors in your calculations at this point -- 
because you're determining what your prices should be, for a 
self-sustaining, long-term business. 

Benefits:

    As an employee of a company, most people receive "benefits" 
-- health, life and disability insurance, retirement, profit 
sharing and other items, whose value can be as much as a third of 
your salary.
    Don't underestimate the cost of providing your own "benefits" 
and its impact on your rates -- the amount withheld from your 
salary as an employee is usually less than their real cost -- and 
only a fraction of what you'll have to pay to "roll your own" as 
a self-employed individual or a small organization.  Some of 
these expenditures are deductible on your Schedule C, some in 
your 1040, others can't be deducted by individuals.  (There are 
tax pros and cons of incorporating, and having your corporation 
pay for certain benefits, versus paying them out of take-home 
pay.)  
    Health insurance may cost significantly more.  Disability 
insurance will definitely cost more (although it may be for a 
more comprehensive package.) 
    For this article, let's assume that health, disability and 
term life insurance and other benefits costs slightly over $400 
per month, or $5,000 annually.  For an unincorporated individual 
paying out of after-tax income, to earn the money for this, after 
taxes, this means about another $8,000/year. 
    Let's also add in $6,500 in annual contributions to a 
retirement fund, such as an IRA SEP (Simplified Employee 
Pension).  These are exempt from federal income tax (but NOT 
from FICA, state or other taxes!), so let's add another $8,000 
to required annual revenues.   
                                #
    This gives annual costs as follows:

        Business/Office Expenses        $30,000
        Salary and Personal Taxes        50,000
        Benefits (Insurance, IRA, etc)   16,000
                                        -------
                TOTAL                   $96,000 / year

                                      =  $8,000 / month

    In other words, you're looking for annual revenues of nearly 
hundred thousand dollars, or eight thousand per month.  You can 
get by on less -- but this is the amount you'd like to earn, and 
you'll want to base your prices on this. 

CALCULATING SALABLE TIME

    On to the other leg of the equation: figuring out how much 
time you have to sell.
    Over-estimating salable time is the first trap most start-up 
business planners fall into.  "Let's see, if I work forty hours a 
week, fifty weeks a year, then if I charge this much--" 
    BRRAPP!  That's the sound of the alarm bell going off.
Back up several assumptions and start again. 
    You don't have fifty or fifty-two working weeks to sell time 
from. 
    If you are going to treat self-employment like a job and 
business, start by defining a real (and realistic) work scenario.  
Sure, you are bound to work harder -- because that's what it may 
take, and because you know that YOU get the rewards, and even 
because it is more emotionally satisfying.  But if you need to 
work much harder than you would as an employee, it's time to 
rethink your basic assumptions.
    From the fifty-two weeks in a year, subtract:
    o Two weeks for holidays
    o Two weeks for sick/personal days
    o Three weeks for vacation
    That brings you down to forty-five working weeks per year -- 
relatively standard.
    But that's not all billable, revenue generating time -- not 
by a long shot.
    Depending on how your business works, you'll need to spend 
some to lots of time doing marketing and selling.  Interviews, 
phone calls, meetings, contracting, negotiating, going to trade 
shows and conferences, professional meetings, writing follow-up 
correspondence, creating your marketing literature, attending 
seminars, and the like.
    One hour per day, every working day, is one standard 
estimate for marketing
    The same or more is bound to go for administration, support 
and overhead time -- reading trade journals, paying bills, 
installing and learning new software, doing taxes, reloading the 
fax machine, addressing envelopes for couriers, and so on.
    That's about a quarter of your working time you won't be 
reimbursed for. 
    And there's no certainly you'll get enough work to always 
have "pay copy" to work on.
                                #
    To be safe (read, paranoid), let's assume FORTY working weeks 
per year, with six billable hours a day, for a total of 1,200 
salable hours, as opposed to your original guess of 50 weeks x 
40 hours = 2,000 salable hours.
    You may end up being able to work and sell more hours.
Particularly if you tend to do medium-to-long-term contracting 
and temping (4+ week assignments) -- perhaps 1,500 salable, sold 
hours.      
    But don't count on it.  If you don't base your calculations 
on a sane, reality-oriented set of assumptions, you're looking 
for trouble, burnout, or other unexciting forms of life stress. 
    For this article, let's use the 1,200 number.

READY, SET, CALCULATE!

    To calculate your basic hour rate, divide your annual costs 
by the number of salable hours:

        COSTS:  $96,000/year
     ---------------------------  =   $80/hour
        HOURS:  1,200 hours/year

    In other words, to pay yourself a salary of about $50,000, 
plus associated office expenses and insurances, plus contribute 
to your retirement fund, you will need to charge about $80 an 
hour, or $600 per day.  
    That may sound like a lot -- but it's certainly in line with 
what professionals like therapists, programmers, PR consultants, 
and others get.  Many consultants get far more.  
    Obviously, there's a lot of leeway in this figure.  You may 
find you be able to go down to $60, $50 or even $40.  For 
example, you may have minimal business expenses, defer socking 
away that retirement money, be willing to draw a much lower 
salary, or find and work more billable hours. 
    Or you may find that your rate should be $90, even $100 or 
$150 per hour.  
    Like I said, this exercise is very informative.
    Don't apologize for your prices, if they're fair.  This is 
the cost of your business or service, and includes all your 
overhead.  It's very different from being a contract employee, 
going in to someone's existing facility.

OTHER STRATEGIES

    Once you know what you have to charge, you can also consider 
other strategies to base your prices on, which take into account 
factors like circumstance, bargaining strength, etc.: 
    o Going Rates.  What do your fellow professionals charge; 
what are prospects paying?  Call them and ask, or have a friend 
call.  
    Remember that it's hard to compete on price, because somebody 
else can ALWAYS beat your price, if they want to.  What you can 
compete on is value: quality and expertise.  
    Clients who choose based on lowest price tend to be difficult 
from start to finish.  The savvy client will select their 
suppliers (you) based on expectations of quality timely service, 
delivered painlessly and reliably -- for a fair price. 
    o "Until They Say Ouch!"  Raise your rates periodically.  
In this interesting variation on the "going rate" method, the 
goal is to see just how much you can get. Keep raising your 
prices in talking with new prospects, until they fall off their 
chair in shock.  
    Remember, you can always negotiate down, but almost never up, 
unless you're a fast talker.  Leave conversational gambits to let 
you bargain down.  
    o "A Piece of the Action."  Base your fee on a percentage of 
sales or savings you create.  (Get the deal in writing.)
    o "Paying for Priority."  If someone needs immediate, drop-
everything service, that often is worth 25% - 50% more.  (Don't 
be greedy, though.)
     o "Knowing Where to Kick."  This is the plumber's answer, 
justifying the large bill for a five-second kick that brought a 
recalcitrant appliance back into life -- and it can apply to 
consultants and anyone else with the right answer. You can't 
always charge for being the right expert at the right time.  But 
the opportunity may arise. 
    And finally, always remember that it's legitimate to have 
sets of prices, such as: 
    o Large corporations versus start-ups and small businesses
    o Discounts for agencies, job shops, contract houses, etc.
    o For regular, on-going clients
    o Fixed prices for standard types of projects.
    o Sliding scale for individuals based on income, etc.
    o Non-profits and charities and worthy causes
    o Pro bono work for good causes 
    o "Freebies" in return for marketing exposure.

    Remember, you're in control.  You can set the price (although 
your client may challenge it).  Negotiating makes all the 
difference.
    But without knowing what you have to charge, you can't go and 
out sell -- and won't know when to say yes, when to say no, and 
when to say, "Let's keep talking."  So pick up that pencil, fire 
up that spreadsheet, and start figuring! 


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Last modified: Tuesday, 16-Oct-2001 11:08:15 EDT