5. Setting Consulting Rates for Greater Income and Client Retention
Consulting rates can be hard to set when you are a new consultant. Rates seem to be either plucked from the air or calculated based on hourly work.
Setting your consulting rate is not easy when you start.
Too high and you lose the job.
Too low and you devalue yourself and go broke.
There are six ways of setting your consulting fees. The ranges of fees that come from these six ways depend on your branding, your experience, the value you prove to the prospect, and your competition.
When you combine the skill of setting profitable but competitive consulting fees with the client getting methods from earlier stages you will be well on your way to a highly profitable and thriving consulting business.
Warning - the New Consultant's Dilemma
As a new consultant you have skills, but you may lack the brand, client testimonials, and experience to compete with more established consultants. This situation often forces new consultants to work as freelancers paid by the hour or by the short task.
Working as a freelancer can get you into companies and earn short-term revenue, but too often the client views you as an hourly contractor and freelancer. Once you are seen with that image it can be difficult to be seen as a high-value, high-fee consultant.
If you do work with a client using time-based fees, build rapport with the stakeholders and learn their positions. Learn the client's pains and opportunities for adding value. Continually look for situations where you can step out of hourly and skills-based jobs and step into decision making and consulting roles. When you begin getting more of these opportunities you’ve earned a new Statement of Work and proposal.
Setting Consulting Fees
There are many different methods of setting consulting fees. Here are descriptions of the most frequently used methods.
As a consultant with little or no experience in an area, one way to get work, learn skills, and get testimonials is working pro-bono. These combine to mean more work and higher pay in the future.
You might think that pro-bono work won’t help you, but it can. A lot!
“Pro bono” is a Latin phrase meaning, “for the public good.” This isn’t the same as volunteer work. Pro bono work is professional work done as a service for the public good.
One of the easiest ways to do pro bono is to partner with experienced consultants who need assistance. Spread the word amongst your colleagues that you are available for pro bono work in the areas where you want to gain expertise.
There are many different methods of setting consulting fees. Here are descriptions of the most frequently used methods.
How Pro Bono Consulting Helped Me and the Community
As one of Microsoft’s first twelve independent consultants I had a great, but overwhelming career for 17 years. The non-stop pace was exhausting and I was ready for change.
I had always been interested in strategy and performance so I began reading every book I could find on business strategy and execution. When I saw the first article on Balanced Scorecards in Harvard Business Review, how to use objectives and metrics to measure strategic performance, I was hooked. I took a certification course from Kaplan and Norton on Balanced Scorecard and earned my Six Sigma Black Belt through an extensive well-done online course with Villanova University.
Then I faced the problem of finding clients. Two friends said they were going to do a pro bono for our county’s childhood development organization. It was an umbrella non-profit that covered preschool education, children’s healthcare outreach, and more. The three of us did a multi-week pro bono consulting project that involved interviews, objectives, projects, and metrics. Everyone benefited.
A month later, I heard that one of the largest performing arts centers in northern California was changing its strategy to prepare for commercial competition. They were going to do the facilitation and strategy in-house. I volunteered to facilitate and guide the work. That “mostly weekend” engagement lasted six-weeks and involved facilitating executives, operations staff, and million-dollar donors. The strategy and objectives they developed with my facilitation was used for three years.
With those two “pro bono” experiences and two certifications, I was ready to start the next ten great years of consulting in strategy and strategic performance management. A few years after starting in this new direction I wrote what for years was one Amazon's top selling books on strategy and Balanced Scorecard.
It all started with a pro bono.
Another way to start consulting with little or no experience and get paid is by sub-contracting to another consultant. Sub-contracting enables you to work for another consultant, help with lower-skill work, gain experience, and get paid.
Not all sub-contracting jobs require expertise. For example, if you want to be a facilitator or trainer you can assist the primary consultant by taking the role of course registrar, responding to student’s questions, and assisting in-room preparation. While the primary trainer runs the course or facilitation you can be in the back of the room visualizing how you will do it when you are on your own.
There are many ways to assist even if you are not yet an expert. You can do research, backroom preparation, mentoring, interviewing, writing code, or preparing reports.
Hourly and Daily Consulting Rates
Most consultants start by using an hourly rate. It’s easy to calculate and you can find competitive hourly rates on freelancer websites. Using an hourly rate makes it easy to calculate a daily or monthly fee. Although many consultants start here because it’s easy, you don’t want to use hourly or daily rates as a permanent pricing structure.
There are many problems with charging at an hourly or daily rate.
Employers will view you not as a consultant being hired for the value you add to their business, but rather as a freelancer doing skilled work by the hour. From that viewpoint, it becomes easy for them to see you as a commodity that can be replaced with a few minutes search on the internet.
If you use hourly rates or use them as a base for other calculations, make sure you include all the hidden “wages” you would receive if you were a full-time employee. Make sure you adjust the salary for your overhead costs, marketing time and costs, self-employment tax, healthcare, retirement, missed time for professional education, and vacation. These are all “costs” that usually don’t show in online salaries for full-time employees.
A rule of thumb is to use 30% of the salary as overhead. Personally, I recommend adding a minimum of 40% as overhead because you should be spending 30% of your time doing marketing. In addition, the US Federal Self-Employment tax is 15.3% in addition to federal and state income tax.
An ethical problem with hourly and daily rates is the conflict between your interests and the client’s interests. You want to earn more which means working longer hours. Your client wants the job done as quickly as possible. This conflict can lead to doubts about trust and competence.
Always track the tasks and time in your consulting work. Data from past work must be used as a base for calculating project-based consulting fees.
An even bigger problem with hourly-based rates is that there is no way to leverage or scale your work. You are stuck at the hourly/daily rate. The only way you can scale your business is to hire lower-skilled consultants and bill them at higher rates and to continually look for ways to expand the scope of work.
One acquaintance, long experienced in consulting with a big defense industry consulting firm, told me that the firm’s standard mode of operation was to win government contracts by bidding low, staff with lesser experienced consultants at high rates, and then expand the scope as quickly as possible.
As an ethical consultant, there are better ways to keep your business small, in control, and scale to a great income. Scaling growth through packaging and productizing your consulting services is covered in Stage 8.
Project-Based Consulting Fees
You should move as quickly as possible to project-based consulting fees. Most consultants charge using project-based fees.
Project-based fees have the advantage that, if you are experienced and know your hourly rates and costs you can make an accurate estimate of costs and then add your profit margin. Don’t forget to add a profit margin for your business in addition to using accurate project estimates and hourly fees plus overhead costs.
The website, Metric.AI, gives a range of profit margins for professional service firms.
“The typical profit margin for a professional services organization is in the range from 15% to 25%, while a particular project margin could be from 25% to 50%, and
the profit margin for a particular consultant could be from 50% to 400%.”
“Why Profit Margin is an Important Metric”
Two metrics you must to track to improve your consulting business are Gross Profit Margin and Capacity Utilization Rate. Your Capacity Utilization Rate is the percentage of time you are doing billable work. Obviously, if you have a high utilization rate you will be more profitable and competitive.
A good rule of thumb is that riskier, more specialized work that is done less frequently has the highest profit margin. Of course, having a highly recognized personal brand translates into higher fees as well.
If a type of project is new to you, look for a mentor. Mis-estimating can be personally painful as well as financially costly.
Consulting Retainer Fees
Most consultants use retainer fees as their first step toward stabilizing and increasing their income. Retainers are funds paid to you by the client on a recurring basis, whether you do work for them or not. You are being paid for your expertise and ability, not for being on-site.
Most consulting retainers are of two types. One type of retainer ensures you reserve a specified number of hours per month for work with the client. If those hours aren’t used by the end of the month they do not “rollover” to the next month. This type of retainer is usually used for onsite work doing a specialized skill.
The second type of retainer is the type you want. This retainer makes you available for your expertise and experience to help the client make decisions. You could deliver high-value in a fifteen-minute phone call that helps the client make a crucial decision.
Retainers are great for stable, recurring income. The downside of retainers is that at some point they will end.
Value-Based or ROI-Based Fees
Value-based or ROI-based fees are fees based on how much value you will add to the client’s business. ROI stands for Return on Investment.
Few consultants use Value-Based or ROI-based fees. The fees are difficult to calculate and easy to refute. You need high trust and high brand recognition in a unique area to use these fees.
There are a few consultants with high name recognition and close personal ties to C-level executives who propose value-based fees. For most consultants there are easier and more viable approaches to high income like those described in Stage 8.
For Value-Based or ROI-Based fees you must determine ahead of time what the measurement will be for determining increased value. From my experience, it is very difficult to get businesses to pay based on an estimated future value. The reason is that future value usually depends upon multiple factors. A tough-minded owner will ask you how you can prove that the increase in sales was due to your consulting when the sales increase could have been from new salespeople, a change in the economy, or decreased competition.
Before committing to a Value-Based or ROI-Based fee, check with other consultants or staffing agencies to see whether the client is reliable and ethical. Some companies make it a practice to refuse or delay payments to small consultants and businesses. The Wall Street Journal, The Week, NPR, Inc. magazine and USA Today have documented how Trump’s businesses have continuously used this tactic to avoid paying hundreds and hundreds of small contractors.
I know two solo consultants who were not paid by very large companies after they delivered the agreed value improvement. In one case, the cable company was entering bankruptcy and told the consultant to “get in line.” In the second case, the company told the consultant to set a court date. The consultants settled for significantly lower fees.
Selling Your Services Based on ROI
While I find Value-Based or ROI-Based fee setting is risky, the use of ROI is excellent for justifying a higher fee for a unique or a new service. You can use ROI-based selling to gain client buy-in for higher fees. Use an ROI calculator and the client’s own estimates of change to justify your increased fee.
I’ve used this method to help an international internet software company sell million-dollar software licenses. I built a robust Excel-based ROI calculator that calculated the increased sales and decreased costs a buyer would receive by using the software company’s product.
The prospective purchasing managers would sit with the software salesperson and enter estimates of employee time savings, increased marketing reach, industry-standard high and low conversion rates, and more. The output from the calculator showed the three and five-year Net Present Value attributable to improvements in IT and marketing performance. It also showed the ROI of the investments using the CFO’s own risk rates. The print out of the inputs, estimates, and background calculations made it much easier for the executives to justify the purchase.