Usually you can charge 2 - 3 ways:
- Time based
- Value based
- Result based
Time based charging is the traditional way. What is critical for time based charging is to determine the SCOPE of the project. Because the scope drives the cost. Finding out the scope can be a real pain. And when you’re new you usually not so good at hitting the mark. That comes with experience. You can try this method:
Estimating the scope
Break up the projects into parts. Then go through each part and find out how familiar you are with doing each task. Give it a score from 1 - 3, where 1 is something you know in and out, 2 you generally know something about it and 3 if it’s pretty unknown to you (but you can still handle doing it, if you can’t handle it you need to outsource that part).
Now go through each part again and try to figure out how long time each part would normally take to do. Then apply this formular:
scope = estimated time * task known factor * estimation known factor
Estimated time is how long time you think it will take.
The “task known factor” is your estimated knowledge score of the task (1 - 3).
The “estimation known factor” is how famililar you are with estimating this kind of task. If you’re totally newbie you can use a factor of 1.5. If you’re a little more experienced you can use 1.25. If you’re a pro or have serious historical data of this kind of task you can go down to 1.
Create a mockup design for the frontpage of a website. Let’s say you know this work pretty well (known factor = 1) and that you have a little experience estimating (newbie factor of 1.25)
12.5 hours = 10 hours * 1 * 1.25
Then put all the tasks together, and you should have the total scope of the project. Adjust for customer communication, project management and other over head. Then do a final check if you feel if the scope feels right: “Should it take x hours to complete a 5 page website?” If you feel a little pain, it’s ok. If you feel a lot of pain you should perhaps go through the estimates again.
Fixed price vs hour by hour
So now you’ve defined the SCOPE. Now you need to decide how to charge your time. You can use fixed cost project or time and material. Fixed price is where you tell your customer that it will cost him x with everything included, no matter if it takes you 1 hour to perform it, or 10 days.
Fixed price puts a lot of risk on you. In general it is recommended only if you know the work very well and little interaction with the customer is necessary. You should also add an overhead factor to the scope to compensate for the risk:
fixed price = (scope * your hourly price * fixed price overhead factor) + material
Fixed price overhead factor could be e.g. 1.3.
You can also mix fixed price and time & material. E.g. you can say that the offer is based on time & material, however it can’t creep more than x % above the estimate.
Figuring out the hourly rate
You also need to figure out your hourly price. Now this is a little tricky because:
- There are no right answers.
- It depends on many many factors.
- You can use many different methods to arrive at a price.
Here are some general answers:
“Your time is worth what someone is willing to pay for it”
“The right price is when the perceived cost is so much lower the perceived gain that it makes the decission maker want to take action and buy.”
“The right price is the magic crossroad between the what the customer is willing to pay, what you want to get paid and how many times you want to get paid”
Now that doesn’t help you much, so see below.
Here are a few factors:
- Your experience within the field and how effective you are
- Your ability to add business value (are you “just” a technical guy, or do you know how to give small pieces of advice throughout the whole process that is valuable for the customer’s business)
- The competition in the market place you compete (can be international online or just in your city)
- What you want to earn
- The balance between price and demand for your services. E.g. if you have higher demand than what you can deliver, you can lower the demand to a balanced level by charging more
- The demand and supply in the market place you compete
- The “normal” price for this kind of services in your market place and market segment
- Your differenciation strategy and what you compete on: Price, service and/or quality. If you want to compete on price, your prices must be low. If you want to compete on quality your prices must not be too low.
One method to figure out the hourly price:
a. Find out the yearly wage for this kind of work in your area or the yearly wage you feel you’re worth.
b. Add the direct cost a company would have to hire this person. E.g. in Norway we have vacation pay (ca. 12%), insurance (NOK 1000,-/year), employment tax (ca. 14,1%) and pension (2 - 3%). You could include other stuff here as well, like bonuses (broadband line, free mobile use etc) and added insurance etc.
c. What you have now is the cost it would be to hire a person full time for one year. There are other cost as well, like computers and stuff, but that should be covered by your margin.
d. Decide what kind of margin you would like to have on top of the direct cost. The margin should cover: a) your administrative and marketing overhead b) your profits. In a normal company the break down can look something like this:
yearly price = 45% labor cost + 30% margin + 25% sales/marketing cost
However freelancers usually does not have their own sales people. And usually they get work with word of mouth, which is cheap. So often they can cut their sales/marketing cost to almost 0.
e. Find out the number of effective work hours in a year (do not include vacation and other holidays). Where I live it’s around 1800 hours/year. Now lower this number to approximately 80%, e.g. 1800 * 0,8 = 1440. Why? Because your time usually never will be 100% billable. You will get sick. The customer will not want to pay for everything you do. etc. A billable factor of 80% is ok.
f. Divide “yearly price” above with the number of billable hours in the year. Wopha! Then you got the hourly rate to charge, included all your costs and profit.
Value based pricing
VALUE BASED charging is a little different. Then you try to estimate how much the work you do is worth for the customer. This kind of pricing works best if you manage to differentiate yourself from all your competition, in the mind of the customer. I.e. if the customer thinks that you are the only one that can provide such value to him.
First figure out the added value your work will provide the customer with. E.g. lets say your create a website that will make him 12 extra customers each year with sales of USD 5000.- each. This is USD 60000.- extra each year, that YOU bring into the customer’s company.
So what can you charge? You can’t charge USD 60000,-, because then the customer will loose money. However you could try 10% - 15% of that. If you see above the sales/marketing overhead was perhaps 25% for a company. However you’re talking estimated value, which there is a risk that you will not hit the mark. So 10 - 15% is probably more fair. In this case it is USD 6000 - 9000.-.
Result based pricing
The final form of pricing is RESULT BASED. This resembles value based pricing, however instead of being based on estimated value, it’s based on actual results. Then you need to agree on a fair percentage of the results accomplished. A variant of this is also equity and joint venture deals, where you get part ownership of the customer’s venture.
Alright, I hope that I didn’t made it too complicated to understand. Please ask feel free to ask if you have any questions.