Determining Your Rate
This has been an excellent year for Syllogistic Group. We have done more business than any other year of our existence, and we have some bright prospects lined up for the future! To say that we are ecstatic doesn’t cut it!
Then today, I heard from an old colleague who thought he could join our team. As I talked to him, he said he only wants to work in Atlanta, specifically on the north side. My response was, isn’t that where you were operating your business? To make a long story short, he was unwilling to go beyond his comfort zone. The same comfort zone helped put him in the situation where he needed to shutter his business and look for a job.
As I continued talking with him, he said he had 30 active customers. I was shocked that a small business with 30 active customers was hurting. After I inquired about his expenses, it became clear that income was the issue, not expenses.
As his income was the issue, I asked what he charged customers. His rate is well less than half of what Syllogistic Group charges. I wondered aloud how he set that price. When he said that he and his partner, his wife, discussed it, they just picked a number that sounded good. I said that perhaps he should raise his rates to his existing customers, and that would put him back in the black.
I was unwilling to tell the guy what I am about to write below. He and I didn’t end my working for his company on a good note. I had to threaten legal action to get my money paid, and it was still late. I can’t say that 11 years later that I still hold a grudge, but perhaps I am. I’m still working on me!. 🙂
How do you determine your rate?
Determining your rate has to be one of the most challenging things to do in business. Then if you are dealing with government agencies at times as we do, you have the added issue of dealing with that dreaded term, “most favored rate.” The government wants you to give them your most favorable rate even if they haven’t been your most favored customer. Weird, but I’m digressing.
To calculate your rack rate or fully loaded rate, you need to know your business. I mean, really know your business. You need to understand what your general and administrative overhead is, your equipment costs, your mileage costs, vacation costs, benefits, bonuses, etc. The most important thing to know is your desired profit percentage. I’m not going to use my numbers below. After all, I don’t want to give competitors an edge. The numbers below are based on each consultant being 100% billable, 2,000 hours, for the year with a two-week vacation. We all know that 100% billable year after year is dang near impossible for many of us.
Acme Corporation needs to pay each consulting employee $100/hour, which is a good round number that is easy to calculate. Acme has 30 employees whose customers are external, companies that pay Acme money. Those consulting employees are a profit center.
General and Administrative
A good rule of thumb for general and administrative (GA) is 5-10% per hour. Acme’s GA should be $300k-$600k a year. That pays for the president, the receptionist, the HR, and IT salaries. As Acme grows, they can hire more staff that only have Acme employees as customers—also known as a cost center. Hint: Many IT departments have forgotten that they are only a cost center in most businesses. That is bad.
The next area to know is overhead. Overhead is things like the servers, computers, laptops, mileage, travel budgets, etc. A good rule of thumb is that overhead should be 30% or less of the bill rate, so $1.8 million in Acme’s case. That seems like a lot unless it is a year when you need new stuff, then it can look like peanuts.
Fringe costs: vacations, benefits, and bonuses, should be 35% or less of your costs.
Vacation, who needs vacations anyways!? I will work all year, every year! Anyone saying that needs to be forced to go on vacation. While they are gone, analyze their books and records! 🙂 So our 30 consultants need two weeks off a year to stay mostly sane. That works out to be 2,400 hours/year or $240,000/year of consultant vacations.
Benefits will often be the largest eater of the fringe, with healthcare matches, education programs, gym memberships, training costs (which could also be in overhead or shared), and other things that keep your employees happy. As often heard around the water cooler, bennies sometimes are worth more than the salary.
Bonuses are also covered in this. Many company’s bonuses come only from what remains of the fringe. Others have the remaining fringe plus profit sharing. Employees should know how bonuses are determined because they can help make that bonus a reality. You should tell them because if they are getting a bonus, you as the owner/manager will also. Not only in $$$ either.
Of course, a ton of things can be added to the fringe. Just keep it below 35% if you can, and if you can’t, whatever, the percentage is what it is.
The Meat and Potatoes
Just as meat and potatoes have been the staples of America’s dinner menus for the last 100+ years, profit is the only reason you are in business. You are a charity if you are not in it for the profit. Charities often get donations from the public, or they fold. If your business doesn’t make a profit, it will soon fold. Profit keeps you working those long weeks until you are over the hump. The hump is that point where beyond it, your business will continue to operate without you. Recommended profit percentages vary widely, yet most seen centered around 8%. So we will use 8% as our desired profit.
Based on the above, we take 1 (consultants), the 5% (GA), the 30% (overhead), the 35% (fringe), and finally, the 8% profit. In our scenario, that makes the rack rate, or fully loaded rate ratio, 1.78. Therefore, we charge customers $178/hour. You can validate whether or not that price makes sense at many places around the web, but I sometimes use a free one https://calc.gsa.gov/. This lets you check awarded ceiling rates for labor categories as charged to the government. Remember that most favored rate that I mentioned earlier? Yeah, that. So, the rates found at the GSA are about 20% lower than they typically are in the corporate world.
If you worked through all your numbers with costs, you know what your rack rate is in a perfect, 2,000 hours/year world. I’d probably fluff it with the world being what it is. Only you know your business and your employees or contractors. How much you fluff is a decision only you can make.
Back to my old colleague, I hesitate to call him my old boss. 🙂 But, knowing what he paid people, I asked, and what he charges, he told me. There is no way that he could have survived by charging customers the buddy rate. You should never use Buddy rates, and Buddy rates hurt businesses such as yours and mine when we show up with a well-reasoned rack rate.
I hope this helps some of you, and as always. Be hungry!
Edited: June 30, 2022