I first wrote this article in 2001. Since then it’s been published in books, magazines, and numerous times on the web. Since most of the sites it was published on have long since vanished I thought I’d post it here, as it seems that it’s more relevant now than ever.
Step 1 – Preparation
So you’d like to be your own boss, or maybe you are picking up some contract jobs while looking for full-time work. Either way one of the most difficult things can be knowing how much to quote a client.
Many of your contemporaries are hesitant to advertise their rates, in case they are undercut in a bid, and potential clients would undermine their ability to negotiate if they were to advertise what they are prepared to pay. So how do you find that magic figure that is low enough to get work, but not so low that you can’t pay the rent? High enough to compensate your time appropriately, but not so high that you price yourself out of the bid?
The very first thing to do is to research as much as you can. One of the best places too look up is IT recruiting agencies. Often they will publish average or expected pay rates for different types of jobs. If you are lucky you will find not only salary rates, but hourly rates as well. Also look at job advertisements, for work similar to what you are doing, to see how much they are offering.
Network with as many people as possible doing your kind of work, even in vaguely related industries. Quite often they’ll be open about their standard rates, and it’ll give you a better idea of the market in your area.
As a freelancer you are basically running your own business. This means you need to consider things like phone and internet costs, electricity, rent, and most importantly both hardware and software upgrades. Once you have factored these into a budget you need to look at your personal items such as loans, food, entertainment, hobbies, toys (or ‘reference’ as I like to call them) etc.
You need to prepare as detailed a budget as you can, for at least a 12 month period. This will allow you to include the major hardware and software upgrades, which you should budget for once a year. Don’t forget to allow for income tax. Usually at this stage adding 25% to the bottom line is sufficient.
Don’t undervalue yourself
Now you’ve done the research, and prepared your budget, Let’s do some preliminary calculations to get things started. Have a look at the budget, and your total costs for the 12 month period. Now you need to decide how much you want to work. For now let’s assume a normal working week of 40 hours and 46 working weeks a year (Giving yourself 4 weeks break plus 2 weeks emergency/sick time per year).
Divide your total costs by 46 (the number of weeks) and then divide that figure by 40 (the number of hours per week). The figure that is left is your average hourly cost. (If it seems excessively high you may want to leave that 150” Sony plasma TV off the budget for now)
Before we continue, let’s think about the figures we’ve used. 46 weeks work a year is certainly good to aim for, but how likely is it that you will find that much work? Certainly in my experience the ratio of paid work to self-promotion, looking for and generating work opportunities is usually starts at around 1:2. Unless you’re really lucky the best it will probably be for a while is 1:1. What this tells us is that out of those 46 weeks you are planning to work, you are likely to only be paid for 15 to 23 of those weeks.
You may be asking why the ratio is so low when many production companies usually have a much better ratio. Well the reason is simple. Companies are in a position of having people dedicated to promotion and work generation, while others in the company are doing the work. On the other hand you have only yourself to do both tasks. When the pressure is on to complete work by a deadline you rarely get the opportunities to get out and network to promote yourself. Of course as time goes on and more people are aware of you, and you have more jobs under your belt the ratio should rise, hopefully to the point you have to turn down work, or sub-contract because you’re too busy.
So getting back to our sums, let’s do that last one again, this time using 15 paid working weeks, and again 40 hours per week. Quite a difference isn’t it?
Now this exercise has given us a good understanding of just how much it costs to be in this business, but there’s still a little way to go before we have our actual hourly rates figured out.
Step 2 – Calculate your rate
Now that you’ve done some preparation and worked out your costs, it’s time to work out your asking price. There are 2 figures that you need to arrive at. One is your optimum rate, the amount you believe you are worth, and that you should usually quote. The other is your cut-off rate, the lowest amount for which you can work and still comfortably pay the bills. We can use what we’ve already done to calculate both those figures.
You’ve already estimated how many paid hours you are likely to work and arrived at a figure that is your average hourly cost but we need to factor in some more things before it can be used effectively.
A business only exists to make profit. Sure, it’s nice to think that it’s providing valuable services, and is a fun place to work, but at the end of the day the profit margin is all important.
It’s easy to forget this principle in our line of work, because more often than not we are made to feel guilty for getting paid to have fun. At least that’s the limited impression of many people outside our industry who rarely factor in the often outrageous working hours and pressures involved. So since we’ve already established that as a freelancer you are running your own business, you need to think about profit.
How much to add? The most accepted figure to aim for in the business world is 30%. A successful business is earning at least 30% profit. Of course this has been re-written in recent years by many IT companies who earn significantly more profit, but let’s keep our initial expectations to the accepted 30%.
Without profit, you will find it very difficult to advance your freelance career. Consider these points:
- If you’re working from job to job just to put food on the table, are you spending enough time planning for the future?
- What happens when a job comes up that requires you to purchase an unexpected piece of equipment?
- What about training? In our business we need to spend significant amounts of time learning new features and programs.
- What happens when a client doesn’t pay on time, or at all?
Salary vs Hourly Rate
Now it’s likely that most of your research resulted in some knowledge of salary rates, but very little in the way of hourly rates. If we want to compare our figures to salaries, we need to break down those salaries.
Take a salary of $50,000 for example. What hourly rate is the company paying? Easy you say…
$50,000 / 1840 (46 weeks x 40 hrs/week) = $27 per hour.
But no, it’s not that easy. When a company hires an employee, it doesn’t only cost them the salary. Other costs include superannuation, workers comp, non-productive time, leave, overheads (coffee, toilet paper etc), just to name a few. When all these are added up they come to roughly 50% of the salary. But that’s not all, there’s also equipment costs and furniture, which are large initial expenses as well as ongoing ones. You’re looking at roughly $10-12,000 to setup an employee, plus yearly hardware and software upgrades. So you can easily add an additional 30%. Those add up to a whopping 80% of the salary.
So let’s look at that salary figure again… $50,000 x 1.8 = $90,000. To hire an employee at $50,000 costs the company $90,000. Surprising isn’t it? So re-evaluating the hourly rate we get $90,000 / 1840 = $56 per hour. The employee is receiving $27 per hour, but it’s costing the company $49 per hour. In other words, to pay the employee $27 per hour the company needs to charge the employees time out at $49 per hour.
So if you do this calculation on all the salary rates you have found in your research, you’ll have a good basis for comparison:
Salary x 1.8 / 1840 = Hourly rate
So let’s take your average hourly costs and add a percentage for profit. We’re getting very close to an appropriate hourly rate now.
Let’s compare this hourly rate to the hourly rates from your research. If the figure lies within the limits of your research then you’re probably on track. If your rates are significantly higher or lower than these rates then you may need to go back and look at your calculations again. Analyze your budget, profit margin and paid weeks estimate to see what areas you can massage in order to arrive at a reasonable hourly rate.
Optimum vs cut-off
So what’s the difference between the optimum rate, and the cut-off rate?
The optimum rate is the amount that falls within the industry standards, covers your costs, covers your unpaid time, and includes some profit. This amount (or a little higher) is what you would normally start with when preparing a quote, in the knowledge that it’s likely to go down a bit through negotiations.
The cut-off rate is the lowest amount that you can afford to work for. If negotiations fall below this amount you walk away from the bid. You may decide that your cut-off rate doesn’t have any profit included, or maybe it’s for longer term work so your paid weeks estimate may be higher. But under no circumstances can you accept lower than this amount. If you do then you will go into debt in order to do the work. You might as well pay the client for the privilege of doing the work.
Once you know these amounts, quoting suddenly becomes a piece of cake. No longer do you have to agonise over how much you think the client can pay, because you know how much you need to do the work.
The other decision you have to make is how flexible you want to be with your rate, how willing you are to negotiate. You may decide that you will nominate a percentage that you will easily negotiate down, after which you become less flexible.
The dreaded tax man will take more than just income tax. Because you are working for yourself you are considered a business by the tax department. This means that you will be responsible for charging and paying GST for your services. If you haven’t already, you should apply for an ABN number, and you will need to fill out a BAS statement each quarter. You should have a few deductions, but basically you will need to pay 10% of your earnings to the tax man.
So whatever you’ve calculated your hourly rate to be, the last step before you quote is to add 10% for GST. If you don’t, then the GST will eat into your costs.
Step 3 – Putting it into practice
The most prominent factor when quoting is the value of the work to the customer, or the perceived value, versus what it costs you to deliver the work, the cost of services. Somewhere between these 2 amounts is the amount you and the client will end up agreeing upon for your hourly rate.
So how do you figure out the perceived value?
You should find out as much about the client as possible.
- What kind of work have they done before?
- What clients have they worked with?
- How long have they been in business?
- What impression do others have of the company?
- Does the company already have the project, or are they bidding for it while looking at who might be available?
- Where is the company based?
- Where does the project originate?
Once you have done this you should have a fairly good idea of what position the company is in, whether they will be looking for cheap labour, or are willing to pay for high quality work.
One mistake that many people make when they’re starting out is feeling intimidated by the negotiation process. It’s easy to do, but keep in mind that the client needs you as much as you need them. Be strong and the client will respect you for it. The client may even tell you that they can’t afford your rate just to see how low you are willing to go. Often a client will appear to walk away, before reconsidering and agreeing to your rates. This can be a test to weed out who’s serious and who’s not. The ones who are prepared to negotiate down to nothing are usually not going to provide quality work.
Along the way you may miss out on a few jobs because your rates are too high, that’s normal. Those jobs probably wouldn’t be worth putting on your portfolio anyway. Of course if you haven’t eaten for a few weeks you can always make an exception. But remember, if you accept a job for too low a rate, you may be missing out on a much more attractive offer just around the
corner because you’re too busy.
There are some other factors we need to consider when comparing rates or preparing quotes.
Acceptable hourly rates can differ from state to state and country to country. Don’t panic, this doesn’t mean that if you live in South Australia you will be poor. It means that you may need to adjust your hourly rate up or down depending on where the work is coming from. Take note of where your researched salaries and rates are from to get a feel for the marketplace value in different locations.
Keep an eye on the industry to see where the highest demand is. The higher the demand and lower number of people skilled to fill that demand drive the rates up for that type of work. For example there is currently a glut of web designers in Australia, but there’s been a downturn in the demand for web designers. This means that the rates for web design work are potentially lower than over the last couple of years.
So in considering different rates for different skills, you should break down your skills into different areas, such as 3d graphics, 3d animation, 2d graphics (Photoshop), 2d animation (Flash), traditional illustration, web design, etc. Each of these can demand different hourly rates depending on the level of skill involved versus the number of people with those skills.
Your rate will also depend on your abilities within an area. The better you are the more you can charge. Although the industry may determine that 3d character animation is worth more than 2d graphics, if you’re better at 2d graphics your rates should represent that.
Your level of experience, and the number of satisfied clients will affect your rates. If a client can see that you’ve worked successfully with other clients they are more likely to agree to your rates. Also if the job involves team work, having worked with others on projects will greatly enhance your chances.
Also related to experience is speed. The faster you are at doing something the more you can charge per hour. This can be a difficult one with a new client, but as you do more work for a particular client this can become a bargaining point.
A big factor to consider is the length of the project or job. The longer a project is, the more flexible you can be with your rate. Remember we were estimating a fairly low number of paid working weeks. If a job comes along that is measured in months rather than weeks your estimated paid weeks figure suddenly jumps up which means that you can quote less while still maintaining the same level of finances.
Sometimes you are offered a job that is too much fun to pass up, or will help enhance your skills in a particular area, but the money isn’t great. If you’ve got enough money that you can afford to do the job for less than your normal rates, or even less than your cut-off rates, it can be worthwhile for the experience or just plain fun.
A few years ago I was talking with some contemporaries about hourly rates. I suggested to them that they could look at increasing their rates, as their rates were well below industry standards. At the time I had just adjusted my own rates up. When I told them what rates I thought they could be receiving and told them my new rates, they laughed at me and said I was nuts.
A few weeks later I had a 3 month job at my new rates, and those contemporaries were still working insane hours just to cover the rent.
If you put the time into determining your hourly rate, and understanding what factors influence that rate you will make your life much easier. There will always be exceptions to the rule, but as always, the more you know the rules of the game, the better decisions you can make when bending those rules.