One of the most important things you can do as you setup your consulting firm is to properly set your rates. Many (if not most) IT consultants fail to properly set an hourly rate and can’t figure out why they aren’t making any money. We are going to look at three different methodologies for pricing your consulting services: cost plus, competitor based pricing, and value based pricing.
By the far the most popular (and easiest) pricing methodology used by consultants is a cost plus method. Cost plus takes your hourly costs and adds a percentage markup to determine your hourly rate.
For example, let’s assume you have 2,000 potential hours to work each year (40 hours per week X 50 weeks). You estimate that 25% of your time will be spent on non-billable activities such as sales, billing, collections, customer service, etc. This provides you with 1,500 billable hours each year (2,000 – 500 non-billable hours).
You calculate your costs for equipment, home office, utilities, Internet service, office supplies, etc. will be $5,000 per year.
You desire to make $100,000 each year before profits, so you calculate that you need to make $100,000 + $5,000 (your costs) = $105,000. $105,000 divided by 1,500 hours is $70 per hour. You want to make a 25% profit margin, so you take 25% of $70, or $17.50, and add it to $70 to get a total hourly rate of $87.50.
One of the downsides of cost plus is that it doesn’t set rates that are commiserate with going rates in the marketplace for your services. For example, though you calculated an $87.50 per hour rate, the going rate for your particular consulting service is $150 per hour. Cost plus could leave a considerable amount of money on the table.
Competitor Based Pricing
A competitive based pricing methodology determines what your competitors are charging and sets rates above, at, or below their rates (based on your confidence). This is more difficult to determine than the cost plus method as it requires you to find out what your competitors are charging for similar services.
If you have been in IT for a number of years, this can be determined by calling friends in the industry and asking them what they are paying for services similar to yours. If you are focusing on a home-user based consulting service, you can call competitors and find out what they charge for similar services.
Be careful about focusing too much on competitor based pricing as it will often lead you down the wrong path. There is a big difference in perceived value of a McKinley consultant and your consulting services (in one direction or the other) and you could end up charging too little or too much for your service if you don’t find out the rates of competitors offering the same services you will be offering.
Value Based Pricing
A new pricing methodology is value based pricing. Value based pricing determines what value a customer places on your consulting service and than attempts to capture some of that value. Value based pricing is not meant to capture all of the value, but rather determine what a service is worth, than share that value with your customer. This is the most customer focused pricing methodology.
For example, let’s say your consulting service is a disaster recovery service and your client has determine the data they want retrieved is worth $10,000 to them. You could price your recovery services at $5,000 and share $5,000 of the value with your client. The difficulty in this pricing method is to determine what value your client will place on something and then to price accordingly. Once you determine a method to price accurately, this is by far the best pricing method.
For a consultant focused on the home user, your value based pricing methodology might determine that a customer installing his own PC and home network spends eight frustrating hours setting thing up when you can do it in two hours. This eight hours might be worth $400 to a user who doesn’t have to invest the time and frustrations involved with setting up their own PC. With a value based pricing methodology, you might charge $200 and share $200 of the value with your customer.
We recommend you pursue value based pricing whenever you can as it translates into the most profits for you and the best value for your customers.
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