Too Much? Too Little? How to Set Fees for Your New Consulting Business

This excerpt is part of Entrepreneur.com's Second-Quarter Startup Kit which explores the fundamentals of starting up in a wide range of industries.

In Start Your Own Consulting Business, the staff at Entrepreneur Press and writer Eileen Figure Sandlin explain how you can start a profitable consulting business, no matter whether your consulting business will focus on HR placement, computer troubleshooting,

or anything else you can dream up. In this edited excerpt, the authors offers tips to help you decide how much you should charge your clients so you earn a profit but aren't price gouging them.

To survive as a consultant in any industry, you need to charge fees that will enable you to stay in business; at the same time, both you and your clients need to feel that your fees are fair and equitable. So how do you find the middle ground that seems fair to everyone involved?

When it comes to fees, the first rule in the consulting business is to be flexible. Sometimes, you'll find a client really wants to hire you but can't pay your entire fee. Depending on the situation, you may want to reduce your fee, either so you can get some much-needed experience or because you believe you can set yourself up for more work in the future by working cheaper now. But don't sell yourself short; make sure you're paid what you're worth, since that fee sets the tone for future fee negotiations.

The figure you arrive at should include compensation for your time, and compensation for your business overhead, such as travel, office expenses and so on. But when quoting a figure, leave room for some negotiation, because sometimes clients will ask you to reduce your rates by a set amount or a few percentage points to meet their budget. Just be sure you have a bottom line figure in mind when you sit down to negotiate so you know how much wiggle room you have.

At the same time, don't try to wring out the highest possible fee from your clients. You want to be fairly compensated, but if your fee is too high, you run the risk of losing the business completely. 

When setting your rates, you have several options, including hourly rates, per-project fees and working on a retainer basis. Let's examine each one.

Hourly fees. Consultants often calculate a project cost based on the number of hours they expect to spend on it. To figure out an appropriate hourly rate, you can either use a source like the Careers in Business website to see what consultants earn in your area, or decide how much you'd like to earn in a year and do the math to turn that figure into an hourly rate. Experienced consultants often double or triple the resulting figure to cover overhead, benefits and other expenses; It's reasonable for a new consultant to assume billable time will be around 50 percent, so double your rate so you'll meet your expenses.. And if you think about it, a consulting rate of $40 to $60 isn't out of line when you consider the expertise you're offering.

Project rates. When working on a project rate basis, a consultant normally gets a fixed amount of money for a predetermined period of time (a situation known as "work for hire"). It can be a little tricky to determine a project rate when you first start consulting because you don't have historical information on which to base your hourly estimate. But once you figure out how many hours you think the job will take, simply multiply that figure by your hourly rate, then add 10 percent or so to cover unexpected contingencies.

Retainer basis. Working on a retainer basis gives you a set monthly fee for which you agree to be available for work for an agreed-on number of hours for your client. This kind of fee arrangement is common for computer consultants and other providers of ongoing services. While in the ideal world you'd have a dozen or so clients who hire you and pay you a hefty sum each month, don't get your hopes up. Most companies that hire a consultant on a retainer basis have a clause in their contract that prohibits them from working for the competition.

Working and getting paid by this method certainly has its advantages. You're guaranteed income each month, which helps with cash flow when you're starting out in your consulting business. Some consultants actually offer a percentage reduction in their fees if a client agrees to pay a monthly retainer fee.

Bonus options. It's common for consultants to have some type of bonus option in their client contract or letter of agreement. A bonus may be a percentage of an amount that the consultant saves a client (if the consultant's been hired to reorganize a department or division, for example) or the amount of money acquired for a client (as in the case of fundraising, collections or grant writing). Although it's not always possible to work out this kind of bonus deal, it never hurts to negotiate. If you do, keep in mind that the average bonus is 15 to 20 percent of the funds saved for the client or obtained for the organization.

Source: http://www.entrepreneur.com/article/233301