How to determine good rates for your business? A practical guide
One of the most difficult things to consider when you just started a business, is setting the rate you want to charge your (future) clients. Many starting entrepreneurs are unsure what to do, since there is a very fine line between undercharging and overcharging. You don't want to pull yourself out of the market with too high a rate, but a rate that’s too low isn't a smart option either. After all, you must be able to pay all your bills and finance your life from your business income. A good hourly rate depends on several factors, such as the circumstances of the project, the assignment itself, what your client’s wishes are and the sector you are active in. Whilst some markets and sectors have fairly standardized rates, other sectors are more prone to large fluctuations, for example. In this article, we will outline all the necessary information you need, to be able to set a perfect rate for your business activities.
3 basic principles to start with
There are some basic factors that you should take into account, when you start thinking about a good rate. The most important one is obviously the income you require, as a person. You must be able to pay all your monthly expenses, plus save enough to be able to buy all the necessities you need. After the deduction of your operating costs, your hourly rate must be sufficient to keep at least this amount. Another essential factor are the rates your competitors charge, as this will give you a fairly good idea about what is realistically possible. We will discuss this a bit later in the article. The third important factor is your distinctiveness and whether you have many competitors. In general, you can ask for a higher rate when you are unique in some way. We will also discuss this more elaborately in this article.
First determine your business costs
If you want to determine how much money you require, you need to start by providing insight into all the business costs you will have per month. For example, all fixed and variable costs that you incur to start your business and keep it running fall under this category. List these costs for yourself, so you have a clear overview of what is necessary. You should divide the business costs into two separate categories: fixed costs and variable costs.
Fixed costs are roughly the same every month, meaning these costs will not suddenly change anytime soon. Fixed costs are also not related to the number of sales you make. Some examples of fixed business costs are:
- The rent you pay for your office space
- The utility bills you have to pay monthly
- Wages of your employees, including social security contributions
- The costs for insurances you might have
- Sales and marketing costs, such as your website
- The monthly costs for your lease car
- Pension accrual
- Subscription fees
- Costs for your income taxes or VAT return
- Costs of your accountant or accountant
If an expense isn’t a fixed cost, it logically falls under the category of variable costs. Variable costs are generally associated with the number of products or services you sell. The more you sell, the higher these variable costs are. Examples of variable costs are:
- Purchasing costs
- Import costs
- Transport or shipping costs
- Payment of commission to third parties
Once you have listed all these costs, you have more insight into the amount of money you will need to cover all these costs. You should then also make an overview of all your private costs.
Then determine your private costs
In addition to your business costs, you also have to deal with costs that you have to deal with privately as an entrepreneur. By listing all these costs, you know what amount you need per month to cover all private costs. Examples of private costs are:
- The rent or mortgage of your house
- Utility bills such as gas, water and electricity
- Costs for internet, telephone and other subscriptions
- The insurances you pay, such as health insurance
- Costs for children, such as school and childcare
- Monthly costs for your groceries
- Monthly expenses for extra’s such as clothing and holiday(s)
- Money you wish to save
If you have finished this list, you should now compare the two lists, in order to have clear insight into the amount of cash you will need on a monthly and yearly basis.
The required turnover to pay all necessary costs
Once you start earning money with your business, then the revenue you need should be enough to cover the business costs from step 1, as well as the private costs from step 2. The sum of the costs from steps 1 and 2 forms the total costs that you have to pay on a yearly basis. Your turnover will therefore have to be at least equal to this amount, but preferably slightly higher. Keep in mind that during life, strange things can happen, like machines breaking down before the ending of their lifecycle. For example, your notebook might malfunction suddenly. If you own an online business, this can seriously hinder you in carrying out your daily business activities. We therefore strongly recommend you to always have a small buffer, to be able to deal with such unpleasant situations swiftly.
Other factors that play a role in determining your rates
Being able to pay all your bills every month is basically the bottom line of determining your rates. But as a (future) business owner, you obviously hope to do better than simply making ends meet! Therefore, it is advisable to do some research into the philosophy of creating a rate, next to which topics you should take into consideration. There are many guidelines that can help you, which we will explain in detail below.
Are you active as a specialist?
We already stated before, that distinctiveness and uniqueness will enable you to ask for a higher rate, since you will have less or even no competition in such cases. This gives you a prime position in your market, and companies will happily pay for your expertise. The assignment itself and your experience and skill in within your niche play an important role in determining your hourly rate. If your work is specialized and few can do what you do, it is logical that you ask for a higher hourly rate. If you are also educated within your line of business, for example a university diploma and/or professional education, then this will also enable you to ask more per hour. The more you know and the more special you are, the easier it will be to ask a substantial hourly rate.
What is the duration and scope of a certain project?
The details regarding the project you aspire to take on, also have a rather large effect on the rate you can charge your client. In general, if the project is long or very big, it is usually correct to charge a slightly lower rate than usual. This is due to the fact, that you have more certainty of gaining income structurally. For smaller and/or shorter projects, however, you can charge a little more. Relatively speaking, a small or one-off assignment costs you more time and energy than a long or large project. Moreover, with a longer-term assignment, you have to spend less time on acquisition to find enough new assignments. In time, you will learn to balance this out for your company.
Look up average hourly rates within your line of business
As we already discussed at the beginning of this article, it is always a good idea to look online at what your competition is charging. You can look this up on various sites that hold such data, but you can also ask around in your direct environment. Maybe you know some people who do the same work as you? It is also possible to contact consulting firms similar to your line of business, in order to know what average rate you are dealing with. Of course, you determine your hourly rate yourself, but it is wise to take into account the current rates in your market. Never go for a rate that is too low, since this will make you look very inexperienced. But also don’t miss out on good projects, by determining an hourly rate that is too high. Depending on your industry, there are often common rates. Your clients usually know these figures as well. So it is considered smart, not to deviate too much from these.
Find out more about your client
In many cases, it is worthwhile to first find out what kind of client you are dealing with and what the company typically spends on activities such as yours. Is it a small client, or a company that has just been established? Then you need to take into account that they are probably not very successful yet. In such cases, you should not expect to receive a very high rate, as they also need to build their company. It is a good idea to try to work with a lot of smaller firms when you are a start-up yourself, as this will give you both the experience you need. Once you have established a small client database, you can apply for projects with bigger and more successful companies. These will accept a higher rate more easily, as they have the appropriate budget to spend on your rate. But to actually be able to work for such companies, you require the experience to prove you know what you are doing.
Is there a lot of competition for your project?
In some cases, you will get a project directly from a client, who chooses only you. This often happens when you have successfully worked for this client in the past, or they heard about you via positive word-of-mouth. But generally you should consider the fact, that there will be competition. Sometimes your client or clients indicate, that they still have potential candidates in mind. Whether that is true is, of course, difficult to verify. Nevertheless, you will frequently have to deal with competitors who would also like to get the same project handed to them. When this happens, there is often also competition regarding the rate. This means, that you will have to distinguish yourself with your added value, next to keeping your rate in moderation. If someone else with the same experience as you offers a lower rate, chances are rather vast that they will get the project, instead of you.
Do you operate within the private or the public sector?
There is also a difference between the private and the public sector. Commercial companies generally look more at supply and demand, than government agencies. This will give you more space to experiment with different rates, but keep in mind that you should still be realistic with what you ask of your clients. At government institutions there are typically fixed rates or, for example, a rate according to education and experience level. This makes it easier to apply for a project, if you meet all the conditions. There is less freedom to apply different rates, though. If you want a bit of diversity in the work you do, we advise you to seek for projects within both the public and the private sector. This will also provide you with a wide variety of work experience.
The timing of your quote
Something a lot of entrepreneurs overlook, is that the timing of sending a quote can have a massive impact on the rate you can ask. This is due to the fact that in certain cases, the department in question still has to draw up the budget. Or the contrary is true: the department might be at the end of their yearly budget and they either have extra money to spend, or they have spent it almost all. This is why you should stay reasonable, and don't exaggerate with your rate, unless you know firsthand there is a budget surplus. This way, you prevent yourself from unexpectedly pricing yourself out of the market. It is always wise to ask the client about their budget, but keep in mind that not every client will tell you the truth.
How good are you in negotiations?
Lastly, the topic of negotiating deserves some attention. If you send out a quote with your preferred rate, you will either get a yes or no answer. But if the client says no, it doesn’t necessarily mean that you won’t get the project. Sometimes there is ample room for negotiations. You can also set a slightly higher rate in your quote than the rate you want to receive. If they say no, you can offer them your preferred rate, and chances are they will comply because you lowered it a bit. Practice your negotiation tactics well, because in most cases there is some space between your minimum asking price and the amount that your client wants to pay. If you master this game well, and you can give your clients the feeling that they get a lot for little, then you have done an excellent job.
When should you increase your hourly rate?
One very positive thing about becoming an entrepreneur, is that you can raise your rates periodically. When you receive a salary, this change is generally minimal, unless you receive a promotion. But as a business owner you have much more freedom regarding the rate you charge, next to mainly having more freedom than any employee. If you have been working as a freelancer for a while, it is good to take a periodical look at your hourly rates. Maybe you determined these once, and then never adjusted the rates again. But there are plenty of reasons why your hourly rate should go up, for example:
- Your craftsmanship has increased in recent years
- You have invested in specialized education
- Your business and/or personal costs increase
- You want to create an extra financial buffer for the future
- Due to (hyper) inflation
If you've decided that your hourly rate should go up, communicate this to your customers in a timely manner. For example, announcing your rates will go up in a few months gives the client time to anticipate this. In general, January is a good month to increase your rates. It is good to discuss this in person, so that you can explain why your hourly rate should be increased. But sending an email after changing the rates on your website, is also good, for example when you have a long list of clients and no time to see them all personally. This ensures that your clients won’t be negatively surprised. You can also choose to vary your hourly rate sometimes, by giving longer assignments some discount.
When should you consider decreasing your rate or even undercharge your clients?
In some cases, it is advisable to charge less for your services. This sounds counterintuitive, yet it’s actually pretty logical in a few set examples. Undercharging isn’t always a bad thing. In fact, there are some cases when charging less than the market value for your services can be a strategic business move. One of these cases we already discussed: offering volume discount. This is especially possible, if you have a business model that focuses on volume for profitability. Next to that, it is also acceptable to undercharge when you are breaking into a new market. This basically means you are a start-up again, with little to no experience. Sometimes, in order to gain traction in a new market, it helps to intentionally charge less than market value. By doing this, you begin to attract clients in the market you want to serve and start making a name for yourself.
Another example is building your skill set. We already discussed this in the text above: in order to gain experience, you will sometimes have to take on projects that pay less than your desired hourly rate. In return, you will have more experience that will enable you to charge a higher rate, in the near future. Lastly, some entrepreneurs simply focus on giving back. Maybe you would like to provide high-quality services to underserved and financially challenged communities? In order to do this, you can reduce your prices for this specific client. This is similar to pro bono work, but instead of working for free, you still charge a certain amount. In all of these examples, the decision to undercharge is strategic, and not based on your beliefs about what your market will pay.
Intercompany Solutions can assist you in deciding on good rates for your business
As you can see, there are plenty of factors that play a role when deciding on a good rate for your business. If you do some research, you should definitely be able to come up with a few figures that fit well in your specific market. If you feel you are having a hard time determining rates, you can always contact the team of Intercompany Solutions. We can discuss your business with you, and see whether we can assist you in determining appropriate rates. We can also help you with the entire registration process of your company, financial services and assistance in writing your business plan. Feel free to contact us anytime.