In my previous post I mentioned that I’m raising rates for most of my clients this year — which brings up the question of how we consultants should determine our rates to begin with.

Most people starting out as independents have no clue how much they should charge, and they typically ask for too little — which their clients are all too willing to pay.  I was either unwittingly brilliant or blindlingly stupid but lucky when I asked one of my early prospects how much I should charge them.

They replied, “Well, what we charge our clients for consulting is $90 an hour…” (this was in 1992).

I replied, “Sounds good to me,” trying not to sound overly excited.  This was about twice what I was charging my other clients, and it made my head spin a little.  I began using that rate for all subsequent clients, and couldn’t believe my good fortune.  But it turns out that not only was this rate very reasonable, it was actually too low.

There’s a lot of good advice out here on the Internet that says that you should start with what you want to make, add expenses, factor in unbillable activites, and then (assuming you’re billing by the hour) divide it out by the number of hours you want to work (PDF).  Using the rule of thirds (in which you presume that one third of your rate goes respectively to salary, expenses, and some combination of unforeseen overhead vs. additional profit), that means that your rate should be about three times what you would expect to make as an employee performing similar tasks.

While I think that you absolutely must figure out how much you need to charge in order to keep your business afloat and profitable, I don’t believe this should be the primary determinant of your rate.  It does provide a floor, however, below which you don’t want to descend.

What ultimately determines how much you can charge (and collect) from your clients is how much value you can provide to them.  What are some key components of value?

  1. Supply and demand.  If you’re one of a handful of available people who can perform a much needed task, you can charge a lot more.  On the other hand, if you’ve got the same skill set as the hordes of offshore developers who’ll work for $15 an hour, you probably need to make some career changes.  Sometimes it can be difficult to get a pulse on competitive rates in your area of expertise.  Online services like Real Rates and Hot Gigs can provide some benchmarks, but often they don’t have enough samplings to give a clear picture for a specific niche.  And remember, it’s not what other people make that counts — it’s how valuable the service is to your client.  If the going rate is over their price threshold, they may either dump the project or assign an unqualified person to do it (without realizing that they’re stacking up future costs thereby).
  2. Quality of work.  If you can demonstrate that nobody does it better than you, then you can add on to your price.  In software development that means that your products are not just ingenious and clever, but also maintainable, extensible, and easily incorporated into the client’s products and support.  As a consultant, you should also be providing guidance on how your client uses your creation.
  3. Relationship.  If you have a long-standing relationship with your client, you are worth more to them than someone new.  You already understand the problems they’re facing, and you know some of their history.  More importantly, you’ve hopefully learned how best to work with them — what their expectations are when they ask for something, what they mean when they’re describing a problem, etc.  That’s why you should get a raise from existing clients from time to time.
  4. Additional benefits.  You are worth more to your client than just the work you produce.  Having you involved with their staff should improve their staff, if you can become part of the team.  If you have a good understanding of their business (and if not, why are you consulting?) there will be numerous observations and insights that you can share with them that go beyond the strict definition of your assignments.  You might even become part of the company’s public image, which could be mutually beneficial to the company and your career.

So, if the value provided to the client exceeds your “floor rate” (your minimum requirement for doing business), then you’ve got room to come to an agreement.  The trick is to distill that value into a figure.  Good luck, and don’t undersell yourself!