When you sell services, what you’re really selling is your time.
That’s why time is a key factor in price assessment. The second key factor is the billing rate.
Therefore, estimated time multiplied by the billing rate equals fees.
But it is not always straightforward.
There are many other factors, as well.
For example, if you need 3 hours to formulate advice for a client facing a problem worth $1 million, and your billing rate is $100 – does that mean you should charge the client $300? That would be a paradox, wouldn’t it?
Or, if you knew your competition bills $2000 for the same service.
The knowledge you’ve been building for years sometimes can’t be condensed into 3 hours you will bill.
Hence, the price should be based on the scope of the pain you’re solving for the client as well.
If we were to show this graphically, here is what the price you’re charging would look like, considering all factors.
Define the billing rate first
The simplest model to determine the prices is by multiplying estimated hours by the billing rate. The price calculated this way represents the level of the first two rectangles from the picture above.
The billing rate actually represents the Cost rate + Margin.
Before you adjust the price while considering other factors, you first need to calculate the billing rate for each team member.
Here is how you can do that (for one team member):
Here are a couple of explanations regarding the table above (download the table in Excel here).
Overhead costs represent the costs of business without salaries. These are, for example, office rent, office materials, marketing, phone bills, etc.
You enter the overhead costs per employee in the table above. So, if the total overhead expenses are $600.000, and you have 20 employees, the overhead per employee would be $30.000.
Hours per year
You should enter the assessment of how much an employee works in a year. If you don’t have a time tracking system that will give you this information, you can conduct an assessment.
For example, if an employee works for 40 hours a week, and 48 weeks per year, that makes the yearly total 1,920 hours.
You get billability utilization when you calculate the ratio of billable hours and total work hours. You can get this ratio from the billable hours tracker if you track billable hours per client.
In the end, you need to round up the billable rate. For example, if the result for an employee is $146 per hour, you can define their billable rate as %150 per hour.
Final fee calculation model
When you determine the billable hours for all employees, you can start working on further adjustments.
You will notice that the rest of the factors in the final fee calculation table are pretty subjective. They are based on the best possible assessment at any given moment.
Download the service fee calculation model.
The estimation of hours should be calculated by cross-referencing several sources.
Time tracked on a similar project from the past is the only objective source. You can get this information from the time tracking tool, if you have one, or from earlier timesheets.
The second source would be the service provider’s assessment.
However, you should be careful here. If you ask the service providers, who are directly engaged in similar services, how much time they need, they can be subjective. They can tell you they need more time than it’s realistic so they can work with less pressure later.
The third source is based on the discussion between the managers and team members.
The premium for service risk
If you offer tax advice and make a mistake, you can make huge damage to your client. this would be a high-risk service. On the other hand, if you provide some services that can’t create problems for the client, the risk is lower.
Therefore, you should definitely factor this in when calculating the price (even though it is included in the expected margin, as higher-risk services have a higher margin too).
Client’s understanding of the pain we resolve
No pain, no sales.
Big pain, big sales.
Even though these are facts, the client needs to be aware that you’re solving a problem for them. If the client knows they’re getting rid of a large problem through your engagement, that represents room for a price increase for you.
Here is an example of the percentages you should include in the model.
0% – the service doesn’t fix a significant problem for the client
10% – the service fixes a significant problem for the client, but the client isn’t sufficiently aware of it
15+% – the service fixes a significant issue, and the client is aware of it.
You can apply this scale to other factors as well. However, these percentages would be in the negative with the factors that can impact price reduction (for example a discount due to you expecting future engagements).
You can certainly additionally improve the model. for example, you can assign each of these factors a certain weight.
So, fee calculation depends on the assessment. However, with a good model, you can make the assessment fair and more credible than forming the fee without considering these factors.
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