Articles

Getting the Numbers Right

Rethinking Hourly Rates for Creative Service Firms
by David C. Baker

There's a lot of confusion in the marketplace about hourly rates, and the bad practices in the past don't deserve emulation now. Let's think a little more clearly about the function of hourly rates at your firm.

Hourly Rate: From Financial Tool to Positioning Tool
If you want to make money, charge for at least 60% of all the time at your firm (composed of individuals who will bill more or less than that average for the group). Your utilization rate is far more integral to making money than the hourly rate you use to charge clients. Let me state it this way – Your utilization rate is a financial tool; your hourly rate is a positioning tool. Utilization x Positioning = Wealth. At one point or another, nearly every firm has fallen into the trap of thinking they should fix their lack of wealth by raising their rate. You might very well need to raise your rate, but that's only because you aren't positioned properly. If you aren't making enough money, you need to charge for more of your time. (By the way, the national average is a woeful 42%.) If you aren't positioned highly enough, you need a higher hourly rate—whether or not the client knows what that rate is—because that will result in higher project costs.

So the high school of making money is to fix your utilization problem. Once you've fixed that and the group as a whole is billing for 60% of the available time (with individuals billing 0-85% of their time, based on the role they play), you go to the college of pricing and maintain that utilization at a higher hourly rate. Finally, you go to the third step, graduate school, and start selling your services in packages for a flat fee, which results in much more money per hour than your hourly rate would ever yield. But you cannot go to graduate school without first finishing college. Fix your utilization first or the talk about "value billing" is hollow. Which leads to a discussion of why billing for time and materials is a midway stop between losing lots of money and making lots of money.

Time and Materials, or When to Talk About Hourly Rates
Before answering that question, consider this. The only time it makes sense to work for time and materials (commonly referred to as T & M) is if that allows you to capture more of your time than you otherwise would. In other words, if your utilization (billable efficiency) is less than 60%, you'll make more money on a T & M basis. Otherwise you're minimizing opportunity by locking yourself into how much time you can sell instead of charging fees that reflect the true value of what you do. In fact, I'd recommend that you never talk about your hourly rate(s) except when you need to position yourself highly in the eyes of the prospect or client. Engagements should be priced in large, round numbers and should never break out hours. Even dreaded "scope creep" shouldn't use the language of hourly rates. Instead, you should identify any scope creep by using the document that defines the engagement, and then simply tell them how much more it will cost to make those changes (not how much you are going to charge per hour). Don't automatically go into T & M mode at the border of scope creep, since scope creep needs to be defined, too.

Before moving on, think for a minute about the pressure the procurement departments are placing on agency compensation these days. The biggest problem this poses for well-positioned firms making a lot of money is that it stalls the relationship at the college level (see above), yielding a profitable relationship that is also transactional in nature. It's one more reason why you need the power of marketing to give you the option of saying no. Now back to hourly rates and how they should be constructed.

Tiered vs. Blended Hourly Rates
Thank goodness the trend of hourly rates is away from complexity, because in the past there were separate rate structures for different clients, different tasks, and different employees. Mapping it out looked like an aerial view of a snake pit. So for decades the trend has been toward greater simplicity, but you still see different rates for senior and junior people, and at times you'll even find rates for non-profit and for-profit work. But the steady trend has been toward blended rates, and from the surveys I've seen, the majority of firms are now using them. This is a movement that I endorse because there are three important reasons why blended rates make more sense than tiered rates. First and foremost, hourly rates are positioning tools and not financial tools (see above). The message of a blended rate is this: all the work our firm does is of the same quality. It's not like a cable with strands of different materials, but rather more like a pipe fed by different sources, all mixed together so that the sources are indistinguishable to the client. What the client sees is X Agency's work, not the work of a certain individual. Second, a blended hourly rate focuses your job as a principal or manager on shaping other people's work, not doing the work yourself. If a client wants to buy your personal work, your staff is incompetent or you've positioned them inappropriately or you are a control freak. And you are really a freelancer with a lot of helpers! "But I should be giving my time away with a blended rate that's lower than I would charge personally?" No. Your work is to make the work of others better, and that should be reflected in the rate that they are charging. Third, a blended hourly rate makes it easier to estimate project costs and to marshal the resources to do the work profitably.

Setting Your Hourly Rate
If you agree that your hourly rate is a positioning tool, don't use a spreadsheet to establish the right one. Instead, start with the most important rule: it must have three digits ($100 or above). The second important rule is that it be rounded to retain that consultative feel (vs. a transactional one). That means $100, $120, $125, $150, $160, $175, $180, and $200 promote better positioning than $110, $115, $130, etc. Be the agency your client wants you to be, and if they want you to be something that doesn't fit you, find another client.

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