This is one of the most commonly asked questions by freelancers (both newbies and veterans alike.) Well-meaning responses posted on message boards often include a link to one of several online calculators. The inputs include questions like “how much is your monthly Internet bill?” and “How many vacation days do you take each year?” The final question on the of most popular of these calculators is “How much profit do you want?” What a curious question… For anyone trying to grow a business, there is only one correct answer: As much as possible. These pricing tools are broken at a basic level because they’re asking the wrong questions.
The most valuable class I ever took in college was ECON 101. It fundamentally changed the way I viewed business and has had lasting influence on how I make decisions. One of the lessons that has stuck with me is that the price of something has almost nothing to do with it’s cost. Neither the cost of a beef patty or the hourly wage of the cashier affects what McDonald’s charges for a Big Mac. What matters is the price of the Whopper down the street and what a customer is willing to pay to avoid having to pack his own lunch. Businesses seek to maximize revenue; they will always charge what the market will bear, regardless of the product cost. The price the market is willing to pay is a function of the available alternatives.
Quite simply, your clients don’t care what you pay for Internet access so it has no bearing on what you can charge them. Your overhead does affect how much money you have leftover at the end of the month (profit). It’s important to be mindful of costs, but they don’t belong on a spreadsheet used to figure an hourly rate.
The problem with the question “how much profit do you want?” is that getting the answer wrong means that you’re either undercharging (thus missing out on income) or overcharging (and losing business you could profitably undertake). And, unfortunately, there’s no way to arrive at the correct answer by examining your costs.
Figuring out how much to charge as a freelancer means understanding the price of the client’s alternatives. This tends to be more of an art than a science, thus does not neatly fit into an online calculator—and “price” isn’t always purely dollars. There’a IBM WebSphere partner here in Michigan that bills $750/hr for what is largely Java development. Yet, I can find someone similarly skilled via ODesk.com for less than $40/hr. Additionally, anyone who has been in the business for even a short amount of time knows that talent has very little to do with how much you earn. So, your costs and your skills have nearly no influence on your income as a freelancer. What gives? The two most important factors to consider are: a) the size of your client and b) the probable value of your work.
The size of a client affects their buying decisions and what rate they’re willing to pay. Starting a business is a very risky endeavor, thus when talking directly to a small business owner, buyers tend to be very risk-tolerant people. They’re also being persuaded to part with their own, personal money. Most small business owners are willing to tolerate a higher risk of project failure in order to save on costs. For freelancers just starting out, this is why smaller clients are ideal: as someone with an unproven track record, it’s an easier sale if the price is right.
Larger businesses operate very differently. They tend to be more sophisticated buyers who are working with an allocated budget. Their primary concern is ensuring that a project is done correctly and on-time because its a component of a much larger initiative or strategy. The decision makers are often much more risk-averse than small business owners because it’s their reputation on-the-line, not their own pocketbook. Freelancers with a roster of proven successes can frequently charge larger businesses an hourly rate matching those of a well-paid lawyer, yet would struggle to get a fraction of that from a smaller client for very similar work. People who provide social marketing or online lead generation services often see this massive divide in rates.
We tripled pageviews and increased annual sales by more than $1.2 million dollars.
This is a pretty powerful statement that is listed directly on my company’s website. It was the result of work we did over a few months for a client that dramatically increased the SEO of a SaaS application and streamlined some e-commerce operations. Unlike a typical portfolio piece, I don’t have a screenshot of the client’s website (which we didn’t design anyhow), I instead explicitly quantify the value of our work. Crunching the numbers takes a whole lot of guesswork out of figuring out what a similar client might be willing to pay for similar services. I highly recommend that this process be done after the completion of every project.
While it does get simpler with hard numbers, there’s no magic formula because it depends on the size of the prospective client, the size of the opportunity, and a multitude of other variables. Most importantly though, it’s dependant upon your ability to communicate the value of your services. In other words, your ability to sell yourself is one of the most important factors in determining what you can charge as a freelancer. For the readers who’d rather gouge out an eye with a spoon than consider themselves a “sales person,” this sounds like a raw deal. However, it’s not all that scary once you really understand what “sales” actually entails. Most technical people have the potential to be way better at sales than they realize. I will expand upon this topic in a future article (follow me on Twitter and stay tuned.)
Okay. What if you’re a new freelancer and don’t yet have any proven, quantifiable successes? Where do you start? Return to considering the price of the client’s alternatives. Predictably, this would include the rates other freelancers in your industry. But a common mistake is to confuse your alternatives with the client’s alternatives. If a small web design client doesn’t know about oDesk.com (and wouldn’t consider it even if she did), then you don’t have to pay mind to price of your competitors there. US-based workers frequently complain about the prices their Indian counterparts charge via the online marketplaces. However, unless both people are bidding on the same jobs posted on these sites, they are not direct competitors.
Alright, alright… a lot of readers are going to be disappointed if they’ve read to the end I never lay out exactly how to figure out how much to charge as a freelancer. Here is what I’d recommend if you’re starting from zero:
Your mileage will likely vary. Keep a close eye on your market and make sure you’re listening to clients. Good luck to you.