More Hourly Rate Magic…

I thought one last post about hourly rates might be worthwhile, since there seems to be plenty of interest in measuring and ultimately raising the amount of profit that we make with each hour we invest in our businesses.

Many of the hours we work are dedicated to non-billable activities such as marketing or administration and it’s not easy to measure the return on that investment as a ‘dollars per hour’ figure. However, when it comes to the hours you devote to a billable client there are lots of ways that you can increase your profits. In my business, I do it in two primary ways:

1. Upsells
2. Billable employees or contractors

Upsells are simple enough to understand, but highly underrated. Just by adding a small upsell to each client, it’s amazing how much you can increase revenue. For example, I don’t sell hosting to the public but we always reserve space on our servers for existing clients who need hosting services. We charge an annual fee of $250/domain for hosting, which is higher than the industry average but since our clients already trust us they are happy to pay it. We also offer advisory services (tax, legal, bookkeeping, etc.) to known clients at rates higher than we charge for ordinary development services. We can frequently increase the total revenue an individual client brings in through these easy upsells that require little or no marketing.

From time to time, we compare the actual hours worked (including marketing, sales, operations, and services) to the total revenue that a client brought in (including services and upsells) to determine the absolute ‘bottom-line profit per hour’ for that client. This metric tells me how many hours I actually invested in a project, and how much money I earned when it was all over.

The results can be interesting and useful. We find that some clients bring in less revenue in services, but the hourly proceeds are higher overall due to upsells. We also find that the size of a project doesn’t determine its profitability (as discussed in the last post). Most importantly, we’re able to quickly gauge the ‘value’ of each client by determining how much profit we really made for our efforts, and that helps us to make effective business decisions, such as which types of clients to pursue.

The second way is by sourcing work to employees or contractors. Again, this is a no-brainer but many shops don’t accurately account for the ‘bottom-line profits per hour’ very well. A simple model is to simply roll the margins (or gross profit) for each hour that an employee or contractor works into your own hourly rate. In other words, you combine the two into a single hourly rate so that you can make good decisions about priorities, etc.

Say you outsource a project to a contractor who works for $40/hr. You are billing the client $50/hr for the contractor’s time and $60/hr for the time that you spend managing the project. If you spent 10 hours working on the project (providing client service and interfacing with the contractor), and the contractor worked 32 hours, your total bill to the client would be $2,200. You would then owe the contractor $1,280 so your gross profit on the project would be $920, which works out to $92/hr for your time. Having a simple ‘total gross proceeds per hour’ metric like this allows you to understand which projects are really going to make you more money in less time – and that’s a great help in deciding how to actually allocate your time in the best way possible.

Obviously there are many factors that go in to a solid business decision, but understanding the return that you are getting on each and every hour is a great start. This kind of analysis once led me to eliminate the entire entertainment industry from my target marketing audience, because we discovered that the ‘big projects’ we were winning weren’t as profitable as we thought. If you can measure your real hourly rate based on actual earnings, you have taken the first step to raising that rate.

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  • Baroo

    This is a good mentality to adopt. I bill my clients at $50/hr which, to them, is a steal. They are happy with my service and feel like the rate is low. But they don’t realize that because I outsource all of the design work to people overseas, I am really making more like $100/hr.

  • DA 123

    All this theory is relies apon which market place you are in. More established designers with business acumen will secure good projects but those lower down the food chain will be victims of the over saturation of the market place. There is a glut of people working the low to mid ends of the market who have to take what they can get. It ain’t a perfect world!

  • http://www.revmedia.com dhecker

    You are definitely right, but most of those people who are ‘taking whatever they can get’ are either going to go out of business (quickly) or reach 100% at some point. When they reach 100%, they’ll need to make good decisions about what to prioritize, and this kind of mentality is helpful :)

  • lukemeister

    Nice article. I hate to say it, but I haven’t ever really tracked “hours” on projects. I need to for these purposes exactly, and I think I’m at the point that I need to. Thanks for the kick in the ass. I like this cause I’m starting to depend on subcontractors to some point until I can hire full time.

  • Johnny

    This is a very interesting article. Whats even better is it clarifies some external aspects i have never thought of. I believe running and maintaing a business is very efficient if all money coming in is counted for…and where it is going. I work on homes doing handyman type services and renovations. About 1 year ago my wife convinced me to stop working for someone else and work for myself. Doing the work was not a problem and a no brainer. it was the bookwork end i didnt have a clue to. so i agreed with my wife and figured what the hell do i have to lose. So I officially started my own show at the begining of the year and set my self a flat rate of $50 per hour…thus averaging the hourly rate of a plumber, electrician, and carpenter. I have done the math over and over and in different scenarios. I am more effective with my rates and cheaper than all 3 contractors put together on the same project.