A Beginning Entrepreneur’s Guide To Pricing Professional Services

I have long promised to blog on how best for a self-employed person to price his services.

Until now, I have basically said that you should charge as much as you feel is appropriate, given the amount of work you need to invest and the ability of your customer to pay. That, I know, comes off as either smug or glib. But the fundamental idea is sound.

You work for yourself because it is, in one or many ways, better than working for someone else. Most people work for someone else because it provides security and stability, or because they’re not good at the things it takes to be self-employed, such as project / time management or social networking. Most people choose self-employment because they want the ability to pursue interests a 9-to-5 job doesn’t allow, or believe they can be much more successful working for themselves.

That said, let’s first talk about how to set an hourly rate, and then how to go about pricing projects.

"Walmart $4.88 laptop" by Ryan McFarland, via Flickr.
If you index the price of your labor to what others charge, there will always be downward pressure on your price; you can’t easily raise it, and you’re encouraged to cut it. “Walmart $4.88 laptop” by Ryan McFarland, via Flickr.

Don’t Become A Commodity

It’s natural for people who are used to working for an hourly wage to price their services in line with what others charge. Most people figure that charging more than other persons in a similar market, offering similar services, will effectively price them out of the market.

That certainly can be true if you are charging a significantly higher rate than your competitors, especially if you cannot provide a reason why your rate is so much higher.

But pricing to the level others charge is a significant mistake. It actually has the effect of limiting your ability to earn, far more than charging more for your services does. Because when you charge what everyone else charges, you effectively make your labor a commodity — and the one thing that’s true about commodities is that the lowest price always wins.

Let’s look at this from the viewpoint of your customer. Suppose he’s presented with four possible contractors:

Contractor Hourly Rate
Acme Web Design $70
House Of HTML $70
Mike’s Discount Coding $40
Pretty Pages Inc. $80

Automatically, I see that there is no price difference between the first two options. Therefore, whatever differences they offer are qualitative, not quantitative.

In other words, whichever one is “better” will be determined by whether I like one’s designs over another, or if I think one company having more employees is better, or whether the approach taken by one company toward me is better than the approach used by the other, etc.

By pricing themselves exactly the same, the first two companies have left who gets hired to the potential customer’s opinion of their relative qualities. As much as Acme may think it’s better than House of HTML, and vice-versa, it’s really the customer’s decision, often determined by things neither company can control.

For all that’s worth, if everyone is charging $70 per hour, except for one guy charging $40, I start to assume I’m getting the same thing from everyone else, and perhaps the guy who is so much lower in price is actually offering something I can use, versus everybody else selling me what they have to sell.

For example, suppose all name-brand toothpaste costs $3 a tube, but a generic brand costs $1.25 a tube. If the label says they all contain the same amount of fluoride, maybe I figure that whatever else is in those name-brand tubes just isn’t worth it — even if I would normally prefer the taste and breath fresheners they offer.

Acme and House have turned their labor into a commodity: Something that is bought on the basis of subjective opinions of the people doing the buying, not the people doing the selling. It may well prove that as a rule, Acme tends to come out on top of such decisions; it may well prove the House gets the better clients as a rule.

The point is, they’re not setting themselves apart in some quantifiable manner. That makes choosing one over the other a craps shoot.

File:Sagger at Tate Modern, London.jpg by user Fae on Wikimedia Commons, CC:BY-SA Generic license.
File:Sagger at Tate Modern, London.jpg by user Fae on Wikimedia Commons, CC:BY-SA Generic license.

Don’t Drop Your Pants

Mike’s Discount Coding is vastly underpriced compared to the other three operators. This alone will mean he gets a significant amount of business from potential clients. But Mike will soon discover two things about discount pricing that are always true, whether you’re buying toothpaste, yachts or professional services: Things are cheap for a reason; and when you drop your pants, you tend to get spanked.

I’ve employed this old saw before but it bears mentioning again: Good, fast, cheap: Pick two.

In other words, good, fast work isn’t cheap. Fast, cheap work isn’t good. And good, cheap work isn’t fast.

When a customer sees a price that’s nearly half what others are charging, he doesn’t assume that everyone else is charging too much. He assumes the lower price comes with a significant catch: Either the work isn’t going to be good, or it’s going to be fraught with problems.

For some customers, price sensitivity is enough to send them to the discount provider, period. But these types of customers are also the hardest with whom to do business, because they’re interested in squeezing every drop of blood out of their dollar.

In short, price-sensitive customers are not good customers. They show loyalty only to price; the second they find someone cheaper, they go to that provider. They will be reluctant to pay for changes, even when there’s clearly more work to be done as a result. They constantly ask to exchange X for Y at no additional charge (again, even when Y is far more expensive than X), and otherwise haggle with you about everything. They may well refer you via word-of-mouth, but their social networks consist almost exclusively of other price-sensitive customers: Misers attract other misers.

If your attitude is that you’re brand-new and you really need the work, you might consider such a customer acceptable. I would not begrudge you it, especially if your skill level and body of work so far are such that you’d have difficulty winning head-to-head quality comparisons to other competitors.

I also think that if you take that approach, you’d be far better off simply working for someone else, and letting him put up with the haggling while you develop your skills to the point where you don’t need to compete on price any more. The amount you make won’t be much different (more on this in a bit), and you’ll have the benefits of learning your craft on someone else’s dime.

Diamonds are worth a lot in large part because De Beers says they are worth a lot. Photo by ColiN00B via Pixabay, in the public domain.
Diamonds are worth a lot in large part because De Beers says they are worth a lot. Be ethical about it, but remember: The price of something is determined by the willingness of another to pay the price. Photo by ColiN00B via Pixabay, in the public domain.

Reinforcing Your Quality With Proper Pricing

That’s why I firmly believe it makes more sense to price your labor toward the top end of what the market bears.

A slightly higher price implies better quality. Mind you, absent any other proof that you are, indeed, providing higher quality than your competitors, pricing yourself higher than the competition is ruinous and results in exactly what most people would expect: Few people pay more for something than they must.

But if you take the approach that you are providing a quality service and charging accordingly, you’ll be far more successful by charging a price that is somewhat higher than what others charge, because your price will be in line with your value.

Sure, you cost more; but you’re worth it. That ought to be your attitude, and you ought to conduct your business with that thought in mind at all times.

Again, to be able to price this way, you must deliver. If you quote a price, that must be the price, period; you cannot go over it. If you promise to deliver something on a specified date, you must deliver at least what you promised no later than when it was promised; it would be far better to deliver slightly more somewhat earlier.

This comes down to your attitude and drive. If you have a relentlessly positive attitude with your customers; if you always hold what’s best for them over what’s best for you; if you are always operating from the viewpoint that their happiness is the only measure of your success, charging more won’t be a problem.

This is often spoken as, “The customer is always right.” That is not correct, and you shouldn’t take that attitude. The right way to phrase this attitude is, “The customer’s success is my success.”

I don’t want to digress into a discussion of how to recruit and retain customers; that’s for another time. But how much you charge is entirely dependent on how well you relate to your customers. If you are unpleasant, if you create new problems, if you fail to deliver as promised, it doesn’t matter what you charge. You’ll be gone before you know it.

To this end, I have only one bit of advice: Read How to Win Friends & Influence People. Read it over and over again. Treat every word as canon. Practice its lessons constantly.

It is exceedingly difficult to be the kind of person Dale Carnegie was and to act as he describes in his book, even some of the time. Lord knows, I constantly fight myself to do as Carnegie says. But the more of his lessons you can employ, the more successful you will be.

And you’ll find you won’t meet price resistance for charging a higher fee. There is no limit to the amount of money people will spend in order to feel better about things and to make problems go away. Yes, you need to deliver quality work; you need to do as you say, when you say. But most business success comes from your ability to build positive relationships with others.

Think of yourself as a chef: You're not charging for the ingredients, you're charging for the meal. Photo bycocoparisienne via Pixabay, in the public domain.
Think of yourself as a chef: You’re not charging for the ingredients, you’re charging for the meal. Photo by cocoparisienne via Pixabay, in the public domain.

Project Pricing: It Costs More Than You Think

I’ve spent a bit too much time talking about setting an hourly rate, because most good-paying work is done by the project, and the worst thing you can do when trying to pitch a project is price by the hour.

In other words, if a client wants you to build him a Web site, the worst way to price it is by the hour; how long it takes is of interest to the customer only to the extent of when the project will be done.

Hourly pricing also causes a number of problems for the customer, the biggest being that he doesn’t have a bottom-line price. When a customer undertakes a project such as a new Web site, he has a budget in mind, and it’s not an hourly rate, it’s a final dollar figure. That’s what he wants you to pitch, because you’re either charging less, more or in line with his budget.

Further, an hourly rate will leave the customer susceptible to the impression that you are gouging him. If it takes you, say, 15 hours to get most of the static pages ready, but another 30 hours to complete two or three remaining labor-intensive pages, the customer isn’t likely to be sympathetic with the fact that you had to do more work on those three pages, nor is he going to be in a position to figure out if the amount of time you are investing on them is fair. If he could make such judgments, he would have made the site himself.

It’s nearly as bad to offer a “menu” price: For example, charging $50 a Web page, $100 for a feedback form, etc.

Menu prices are another way of making your labor a commodity.
Assuming your competitors are of roughly the same skill, what you charge vs. what they charge is easy to balance, and again, the decision for the customer comes down to qualitative choices only he can determine, with a bias toward purchasing the less expensive option.

The proper way to price a project is to figure out how long it will take, how much money you need to front, and then charge a flat rate that is in line with that estimate.

A Sample Project Pricing Process

Here’s an example: Suppose your customer wants a 10-page Web site. He needs for you to arrange hosting for a year, domain registration, e-mail setup for 10 accounts, a security certificate, a Zen Cart install and custom skin. The customer will provide you with all the copy and images for the site.

Let’s deal first with your out-of-pocket expenses. Suppose you can purchase Web hosting for $10 per month, a domain name for $9, and an SSL certificate for $50. That’s about $180 out of pocket.

You should apply a 20 percent markup, for the simple fact that you are fronting money. Markups of this sort are common in the industry, and the most important thing they do is reward you for taking money out of your hands. Any time you put money out to get work — be it in advertising, taking clients to lunch, or buying parts for customers — you must see some sort of positive return. So, you’ll actually charge the customer $215 for your out-of-pocket costs.

Zen Cart is free, and it takes someone with basic PHP / MySQL skills about two hours to install, configure and test. A similar amount of time is reasonable for setting up a new Web server, e-mail accounts and associated technical stuff.

Depending on your skill, coming up with a basic site design will take 2-3 days (read: 16-24 hours). From there, you can pretty much bang out the pages in another day and a half; let’s call that 10 hours, a hour per page.

Skinning Zen Cart is a real bear, especially if you haven’t done it before. Let’s assume it takes another two days (16 hours).

So, we have a total time investment of about 50 hours.

Now, we’re going to multiply that time estimate by at least 1.5; by 2, or even 2.5, if you are really new to doing contract work. The reason is because every project always takes longer than you expect, and because you want to have a cushion to accommodate changes your customer is sure to have.

For example, if you only charge for 16 hours to do the basic site skin, and the customer hates it, you haven’t allowed yourself any time to make changes. Every hour you invest, therefore, in changing the design to meet the customer’s desires is unpaid time. But if you’ve allotted, say, 8 hours extra, you probably can salvage what you have to meet what he wants within that time frame.

Further, the customer is going to appreciate if you have the flexibility to make changes to the project without having to charge for a change order. If, as he goes along, the customer decides he really needs to break what was supposed to be one page into two pages, he’ll appreciate that your price allows that to happen at no extra cost; and you’re not losing anything because you’ve anticipated that sort of thing happening.

Also, the newer you are to providing contract labor, the less likely you are to have a realistic expectation of how long it takes to do things; that’s why I advocate using a longer multiplier in your price. Don’t worry about that; your more experienced competitors know much better how long it takes to do certain jobs, so while it may seem like doubling your time estimate is pricing you out of the work, there’s a strong chance you’re still underestimating the effort needed, while your competitor is dead on.

Finally, the nice thing about multiplying your time estimate is that you can always return money to the client and deliver the product early, if you overestimated either factor.

Delivering a project early and under budget is one of the best ways to impress a client. You shouldn’t overprice your project wildly, or seriously overestimate the time needed, just to be able to offer a refund and be done early; but any time you can do either — or, better, both — you’re building a stronger relationship with your client. People appreciate honest business dealings and love contractors who agree that business is all about time and money.

So, back to our example: We have a 50 hour time estimate, but we’re going to bid for 75 hours. If our hourly rate is $70, that’s $5,250. Add in the $215 in marked-up out-of-pocket expenses, and our bid price is $5,465, with a three-week time to delivery (because we can’t devote every waking hour to this project alone; we have to be able to assist others).

Let’s compare that to the other two pricing models.

If we went with a menu price and passed through our costs, our bid would have been $680 for everything other than the Zen Cart install. If we then charged our hourly rate of $70 for that, and estimated two days (16 hours), our bid would be $1,800.

That seems like a much better deal for the customer, and it sure is. Because if the project does, indeed, take 50 hours to complete — our best-case estimate — our actual hourly rate of pay would be $32.40. That’s not a bad hourly wage, but it’s nowhere near our quoted hourly rate; it’s actually cheaper than what Mike’s Discount Programming charges. If it took closer to 65 hours, our hourly rate of pay falls to $25 per hour, and we’re probably going to deliver the project later than specified. You can make $25 an hour working a temp tech job, and suffer none of the headaches of running your own business — such as having to explain why you’re not done when you said you’d be done.

On the other hand, suppose we quoted $5,465, but the job only took us 65 hours to complete, and we were done after 12 business days. We’re now in position to return to the client $700 — 13 percent of the contract price — and to deliver the project three business days ahead of schedule. Trust me, that makes you look great.

The real challenge in project work is finding the next project. Photo by skeeze via Pixabay, in the public domain.
The real challenge in project work is finding the next project. Photo by skeeze via Pixabay, in the public domain.

You Must Earn Enough From Work To Enable Earning More Work

Another mistake new entrepreneurs make is pricing in order to earn a specific annual salary. That is totally the wrong way to look at being in business.

If you absolutely, positively must earn a certain amount of money, you are best off working for someone else. Self-employment simply is not secure enough to guarantee a wage.

Actually, it’s more complicated than that. At the risk of sounding smug, you have no business being in business for yourself if you cannot create and maintain a social network capable of providing enough work to pay for your basic needs. If you cannot manage that, you cannot be in business for yourself, period. If you question whether that’s the case, you’re not ready to be in business for yourself.

Once again, I do not want to get on an extended aside about network and attitude. Instead, I want to point out something most entrepreneurs don’t consider when they are starting out: Most of your time isn’t spent working, it’s spent earning work.

Let’s consider the project example I just provided. People used to working for a wage, or new to self-employment, might look at a $5,000 project for 2-3 weeks of work as the mother lode. In their minds, since there are 50 weeks in a year (allowing for 2 weeks’ vacation), that project price suggests they could earn over $80,000 a year.

The problem is, projects aren’t lining up outside your door, especially when you are starting out. You have to go out and earn that work.

Note that I don’t say “find” that work; I mean earn. Getting contract work isn’t a passive activity; you don’t put an ad in the paper and wait for the phone to ring. You spend time going out to the places where your customers go, meeting people who can help you secure work, and putting in the effort to grow your reputation and elan with people who can give you work, and the people who know such people.

Here, again, I don’t want to digress into a discussion of how to find customers; that’s for another entry. I simply want to emphasize that for every hour of work you get paid to do, you are investing many more hours of work trying to earn that work. “Earn,” because building and maintaining a social network is hard work, especially for people who are not used to the entrepreneurial world.

In the course of a common week, I maybe work 10 paid hours (sometimes, no paid hours; sometimes, 60 paid hours). The rest of my time — usually about 20 hours a week, sometimes more, sometimes less — is invested in doing things that build my reputation, keeping in touch with customers, building my relationships with other professionals, etc.

True, that work makes it possible to do the paying work. But the paying work must enable me to earn new work, too. The two go hand-in-hand. If a job doesn’t pay enough so that I can spend a good stretch of unpaid time, following its completion, looking for more paid work, I don’t do it; I can’t afford to do it.

While taking a day to do a $150 job might be OK once in a great while, you aren’t going to grow your business if you spend most of your time plugging away at small jobs, rather than trying to find big jobs.

In other words, if you waste all day catching 1-pound perch, you can’t search the lake for the 10-pound lunker bass. You might not catch the lunker even though you worked hard to find it, and in that case you would, indeed, have lost out on the perch you could have had; but you definitely won’t catch the lunker if you don’t try. If you’re the type who’s happy with any nibble, your personality isn’t right for self-employment success; if you’re the type who’s never regretted turning down a honey hole full of trash fish to chase a boil on the horizon, you’ve got the right attitude.

Consider this: If I spent two weeks earning a $5,000 job that takes two weeks to accomplish, I’ve made $1,250 a week. If that turns out to roughly be the case for the whole year, after expenses, I’ve earned about $50,000 a year gross; after taxes, I’ve taken home about $36,000, or actually had about $690 a week in take-home pay.

That’s a far cry from an $80,000-plus-per-year job.

Final Notes

A couple of final notes about pricing.

You must price your work the same for everyone. What I mean by that is, you can’t charge Customer A $70 per hour, and Customer B $50 per hour, for doing the same work. That’s illegal.

You can offer discounts on some reasonable basis. For example, you can tell customers you charge $70 per hour on credit, but $60 per hour for cash, so long as all customers get that rate. You can drop your rate from $70 per hour to $60 per hour for customers who have hired you for more than 100 hours a year, provided every customer who has hired you for 100-plus hours gets that rate. You can charge credit customers $70 per hour, but make it $80 per hour if they have a bill more than 30 days overdue, provided everyone who is 30 or more days overdue is charged $80.

You can charge different rates for different services — say, $70 per hour for general consulting, $100 per hour for PHP programming. You can offer discounts on specific packages — for example, 20 percent off Web sites during February, or buy a feedback page, get a custom Google Map free — again, provided every customer in good standing is able to pay the same rate.

In other words, you can charge different rates so long as there is a clear business reason for charging a different rate, and all your customers who meet that business reason are charged that rate. You can refuse to extend credit to customers, and refuse to do work for customers in bad standing. But you can’t decide you like Customer B more than Customer A, and charge a different rate on that basis.

You need to set aside 25-30 percent of what you earn for estimated tax payments. How much you set aside is largely a function of whether your state / county / town charges income tax, and the amount it / they charge.

Roughly every three months, you must send the Internal Revenue Service a quarter of the income / FICA tax obligation you face for the current tax year. This means you must know how much your tax obligation will be; I assume that to be somewhere around 25 percent of my net receipts. If your quarterly estimated tax payments don’t add up to at least 90 percent of your tax obligation, you’ll be subject to penalties and interest.

You may need to register as a sales tax agent. In many states (and some counties / towns), professional services are taxed. Even in states where that’s not the case, if you buy taxable physical goods or services on behalf of your customers, you are responsible for collecting sales tax on that item — even if you paid sales tax to the wholesaler.

For example, suppose a client needs a copy of Microsoft Office. To keep things simple, you buy it for him from the local Best Buy, and pay your state’s sales tax on the item. Even if you then only pass that exact cost through to the client, at no markup, you’ve probably violated your state’s sales tax law — because technically, you are the retailer, and Best Buy was the wholesaler.

Doing that once in a while is not likely to get you the Capone treatment. But doing it a lot will become a major problem if your state / local tax office decides to audit you.

You should consult with a certified public accountant in your state to see if you must collect sales tax, and if so, to provide the forms and information needed to properly file taxes. (Don’t call your state tax office to find out if you ought to pay sales taxes; you’re only inviting trouble if you ask the wolf if it should be eating the chickens.)

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