One of the questions I get asked often is how to price a service. When pricing a product, it is a little easier because there are tangible costs such as stock costs, freight and insurance to cover. But with a service, there are few or no tangible costs to build into your pricing so it can be a bit more challenging.
The most common way to charge for services is by an hourly rate. But how do you come up with an hourly rate that will make sure you have everything covered?
I suggest using a step-by-step process to come up with the starting hourly rate that will cover your costs, any downtime that you need to account for and holiday periods where you won’t be able to work.
What income do you want to be earning per year? If you are moving from a job to your own business, then you will have an idea of the level of income you need to support your lifestyle.
Next, you need to work out the expected costs of running your business for the year. This will include rent, insurance, travel expenses, website costs and all of the other expenses you will incur to deliver your services.
Add these two figures together.
Example: Bill needs to earn $50,000 (before tax) to cover his living expenses, and he estimates that the expenses to deliver his service for the full year will be $15,000. Therefore, for one year the business needs to generate $65,000 in income ($50,000 + $15,000).
Your chargeable hours
Next you need to work out how many chargeable hours there are going to be in the year.
- There are 52 weeks in a year.
- You estimate that you will take two weeks annual leave each year.
- This leaves you with 50 weeks in the year to earn income.
- Calculate the number of public holidays. For our example we will say one week.
- This now leaves you with 49 weeks in the year to earn your required income.
- 49 weeks x 5 days a week x 8 hours equals 1,960 hours to earn your income.
- When you are self-employed, it is unlikely you will be able to fully charge for all hours available. There will be what we refer to as “downtime” that includes activities such as marketing, doing your books and improving your business processes. So for this step you need to estimate how much time you will need to cover all these non-chargeable activities. In our example we are going to say one day per week, or 8 hours.
- Next you need to work out the total non-chargeable hours for the year. Our example is 8 hours per week, which we multiply by the number of weeks available to work (49 from step 6). Our non-chargeable hours will then be 392.
- Now calculate the total number of hours for the year that you can earn income by taking the total amount of available hours from step 6 (1,960) and deducting the downtime hours from step 8 (392), which gives us a total of 1,568 chargeable hours.
In our example, Bill needs to earn $65,000 and he has 1,568 hours in the year to do this, so we divide his total income needed by the hours available ($65,000 / 1,568) and come up with the answer of $41.45 per hour. So in order for Bill to earn $65,000 per year (before tax), taking into account he will have two weeks annual leave, one week of public holidays, and he has one day a week where he cannot charge for his service, he will need to charge $41.45 per hour for his services.
This will give you a starting point to ensure that you are charging the minimum rate per hour to cover all your costs and non-chargeable hours in the year.
However, there can be additional elements you can add to these steps depending on the type of business you are running. For instance, if you must submit proposals or offer free consultations to earn business, be sure to account for more non-chargeable hours, which will ultimately increase your minimum hourly rate.
After you have determined the minimum rate given your operating costs, compare it with the rates of your competitors. You may be able to charge more if you have better experience and other competitive advantages, or you may need to lower your rate and ultimately reduce your living expenses.
When you listen to your clients and solve a problem for them, you’ll become an invaluable part of their business. They’ll be happy to pay your rate and refer you to others.