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The 6 Ways To Set Hourly Rates

And some unexpected benefits from the process

At one time or another I have used each of these methods. Those sometimes painful experiences are the basis for my recommendation.

I can think of 6 Ways to set hourly rates.

The 6 Ways

Guessing

Dictated by others

Mimic others

Work backwards from a typical fixed fee project

What the Market will bear

Calculation of breakeven plus profit markup

Before looking at the PROs / CONs of the 6 Ways, let’s briefly consider the uses of hourly rates.

The uses of hourly rates

Hourly rates have more uses than the obvious one of charging per hour for your work. These are the three main uses.

Charging clients for your time

Determining the hours available to complete a fixed fee project

Setting a price for a service

Charging clients for your time

Every project is an opportunity to use hourly rates. I had several repeat clients that preferred the simplicity of this method. Most clients prefer some sort of fixed fee arrangement. Even those clients usually prefer hourly rates for additional services.

I know of firms that never use hourly rates. Often the reason is that they don’t want to track time. There are inherent limitations to this approach. First, you are forced to guess a fee when a one-off service is requested. Second, you have no way of knowing which projects are profitable. Or why. Third, you only have ‘gut feel’ to warn you that a project is not going well. Finally, you have only your income statement to tell you how you are doing, but not why.

So knowing your breakeven hourly rates and your billing rates help you bill clients appropriately. They also help you manage your work based on facts.

Determining the hours available to complete a fixed fee project

When you have a fixed fee project, you can’t realistically think that you have all the time in the world to complete it. When I haven’t watched the progress of a project, it has always gone over budget. Once half the fee is spent and you aren’t in the Construction Documents phase yet, you cannot prevent a loss without cutting the quality of the service - a lot.

With hourly rates, you can simply calculate the hours available per phase by dividing the net fee by the rate.

Setting a price for a service

Let’s say you want to charge a fixed fee for a pre-design estimate of the construction cost of a proposed project. Using hourly rates and an estimate of the hours needed and perhaps a contingency, you can arrive at a fee in an hour, or less if you have done this before.

Benefits

As you will see in the following PROs / CONs of the 6 Ways, your choice of method will have ramifications. By choosing a method based in reality you will know more about how efficiently you are organized, and what is holding you back from better organization.

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The PROs / CONs of the 6 Ways

In reverse order of the initial list above.

CALCULATION OF BREAKEVEN PLUS PROFIT MARKUP

PROs

The only method that gives results based in reality

Provides guidance for the “What the Market will bear” way

Shows you what your profitable hourly rates are

Also shows you how to be more efficient

CONs

Takes a bit of research.

The calculations are hard to find (

except here⁠

)

Architekwiki has a tool that makes the analysis and calculation simple.

Learn more about the Financial Model Workbook here.

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WHAT THE MARKET WILL BEAR

I routinely raised rates at least once a year. Often the amount of the increase had nothing to do with data of any kind. I never did get pushback so I never found out what the “market will bear”.

PROs

Very easy to implement.

Has to improve profitability

The ideal situation

CONs

Doesn’t tell you whether you are as efficient as you should be, and may encourage inefficiency.

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WORK BACKWARDS FROM A TYPICAL FIXED FEE PROJECT

By taking a project that had a ‘good’ fee and that was completed in a timely manner, you have data to establish reasonable hourly rates. I looked at this way after completing a couple of fixed fee projects. The exercise was worth the effort, but wasn’t a full solution.

PROs

Data-based approach.

Improves accuracy.

CONs

Takes a fair amount of work and analysis.

Difficult to make valid assumptions about overhead allocation.

Profitability might be a guess.

Unlikely, despite the effort, to be completely accurate.

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MIMIC OTHERS

If you have a colleague who will share their rates, or access to information like this, then you are better off than using the Guessing method. I decided to raise rates once when I learned what another firm was charging.

PROs

Better than Guessing.

Could be an improvement

CONs

Might not be an improvement.

Low chance that the other firm(s) have similar overhead factor and utilization rate. Especially true if the other(s) are larger than you.

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DICTATED BY OTHERS

Sometimes you don’t get to set the hourly rates. I had a governmental client that would only pay the rates set by a state agency. When I suggested that the rates were at least 25 years out of date, it was suggested that other firms had figured out how to live with the rates.

PROs

No-brainer easy.

CONs

Almost guaranteed to lose money unless you turn a blind eye to ethics.

Introduces an element of special data manipulation to adjust reported hours into billable hours.

Getting your consultants on board with the method is not guaranteed, so there could be more special methods needed.

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GUESSING

Guessing is just that. You pick a number that appeals to you for the top or bottom rate and adjust up or down to fill in the other levels. My first hourly rates were done just this way. Several years later I learned just how much I was losing per hour using these rates.

PROs

Very easy

CONs

Very low chance that your rates will perform as hoped.

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Recommendation

Use a fact-based method of determining your rates.

Finding your fact-based rates tells you a lot about how profitable you can be, which is valuable information.

Knowing how you might be limiting your profitability is more important than almost anything else, except how to get work in the first place.

If you need help, check out Architekwiki’s

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