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Setting Fees For a Service Business

by Cathie Izor, Writing and Instructional Design

(Adapted with permission from “Seven Ways to Set Fees” and “Calculating Minimum Hourly Fee” by Nancy Shepherdson)

Setting the right prices is a tough part of running a business, as I learned in a class taught by Barrington, Illinois, business writer, Nancy Shepherdson. If you sell a manufactured product, you start by tracking the cost of producing that product. It’s usually pretty easy to track cost of materials, overhead and employee labor (if your business has employees). However, you also have to consider a pesky element: your time. How much is your time worth? How much do you need to earn?

If your business is service-based, the fees you charge are probably the major portion of your income. Your time may now be the largest cost for your business. The determination of a fair hourly fee is difficult but critical to your success.

The purpose of this article is to help you analyze various factors to figure out how to set hourly fees for a service business. Since I am a one-person business, the ideas here apply best for an entrepreneur in that position.

The fees from my writing business are charged to clients using one of two methods:
1) Hourly Fees—I track my work hours and charge by the hour, or
2) Project Fees—I am paid a flat amount for all the work on a project, including revisions. Even when I charge hourly fees, my clients usually want an estimated total cost upfront. Therefore, I need to track all project hours so that I can bill accurately and make good project estimates for the future.

But, how do I determine what I should be charging on an hourly basis? Here are some ideas that may help you.

Seven Ways to Set Fees

You can look at setting fees from several different directions. By considering all of these, you take a balanced approach to the final result. When I first started my business, I went through this analysis and immediately increased the hourly fee that I planned to charge.

1. Your Cost to Live

How much do you need to get paid?

Average Hourly Rate=
Personal Expenses + Business Expenses + Benefits Cost
                          Billable Hours

Billable hours – aim at 900 per year (20 hours per week for 45 weeks). Billable hours do not include all the work you put into marketing, paperwork, etc. (See the section later in this article on Calculating Minimum Hourly Fee for more information.)

2. Set by Client

This method is customary in some specialties, such as proofreading and magazine writing. Can you afford to take the job? (See #1)

3. “What the Market Will Bear”

Your Cost + Market Premium = Hourly Rate
OR
Your Cost - Market Discount = Hourly Rate

This method depends on uniqueness of your skill (supply/demand), budget of client, your desire, nature of project, area of country, or state of the economy.

4. Project Fees

This type of fee is based on hourly rate known only to you. The fee is a firm quote, no matter how much time you must spend. This method gets financially painful if you significantly underestimate the amount of time you must spend on a project. It’s why you need to add a “fudge factor” to a project fee.

Project Fee = (Hourly Rate x Estimate of Hours) + Expenses + FF**

**FF= Fudge Factor (usually 10 to 25%)

5. Client Budget

This method is an extension of #3 and/or #4. Some clients only have a certain amount of money for a project. With this information, you can tell the client what kind of work s/he can afford.

6. What Your Competitors are Charging

What is the customary rate of pay? Call friends in the industry or others who do the same work. Consult outside sources, such as publications or salary surveys by professional groups. One source for writers is the Writer’s Market.

7. Guess

When all else fails....you may need to guess. You'll know you guessed high if you don't get the job. Or, you’ll know you guessed low if you make less money per hour than working at your local burger joint!

Calculating Minimum Hourly Fee

Here’s one way to figure out what you need to live (#1 in the methods above). You look at personal expenses, business expenses, benefits and billable hours to calculate the result. This may look complex, but it really isn’t, once you sit down and do it.

The following expenses are appropriate for my writing business and need adjustment for other types of businesses. These categories should get you started.

Personal Expenses

Your current monthly expenses, minus any related directly to any current “day job” (commuting? lunches? regular day care?)

Business Expenses (If unsure, estimate or ask others in your specialty.)

  • Rent/Utilities (if in rented office)
  • Telephone (does not include line charge for home line)
  • Internet and Database
  • Transportation (check IRS web site for deductible rate per business-related
  • mile; or use direct cost)
  • Office Supplies
  • Equipment (depreciated over life of the item)
  • Continuing Education/Organization Dues
  • Reference Materials
  • Copying
  • Postage
  • Administrative Support Services
  • Advertising/Promotion/Marketing Expenses
  • Accountant/Attorney/Other Experts
  • Income Taxes and Social Security***
class="webkit-indent-blockquote list2" ***Calculated as a percentage of gross income. Hint: calculate income minus expenses minus deductible benefits costs first, and then calculate tax on that figure; add to expenses then figure hourly rate. If you want to take a quicker approach, just estimate 25% of net income (income minus expenses). This is not absolutely accurate, but a decent ballpark.

Benefits

Insurance (Health, Disability, Life)
Retirement Plan
Savings

Billable Hours

A full-time employee, excluding sick leave, holidays and two weeks vacation, works about 1800-1900 hours on average per year.

40 hrs. x 52 weeks = 2080 hrs. – 80 hrs. vacation – 40 hrs. holidays – 40 hrs. sick time = 1920 hrs.

Full-time entrepreneurs, counting marketing time, office management and general hassles—and sick time and vacation—yes, you'll need them, can bill an average of 900 hours per year.

Formula

Now you have the information to use method #1.

Average Hourly Rate=
Personal Expenses + Business Expenses + Benefits Cost
                          Billable Hours

Calculate the hourly rate and stick to it. And, don’t forget to recalculate it annually and give yourself a raise. As your expertise increases, you may find that you work faster and more efficiently. Also, you deserve it!

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