The Smarter You Get the More Profit You Lose

By Jason Swenk on October 22, 2014

Did you know that the smarter you get, the less money you’ll make? It’s true! If you keep charging the same amount you’ve always charged, you will actually end up losing money in the long run.

But don’t worry. I’m going to help you see where you’re going wrong, and tell you how to fix it.

The Debate.

There has long been a debate on whether charging hourly or by the project is the best way to go. Most of us probably started out charging by the project. We based this amount on what we thought the client would pay. When I started out, I was charging $500 to build a website. That amount was way too low and I ended up losing money.

Charging by the hour seems like a great option. You just figure out how much you want to make and set that as your hourly rate. However, what you’ve actually done is set a ceiling to limit yourself. There are only so many hours in a day, in a week, and in a year. This makes hourly a hard model to scale.

Let’s look at an example:

You have a client that wants a WordPress site. You estimate it will take 100 hours to complete, at $50 per hour. You’ll end up making $5,000.

But over time, you get better and better at what you do. You get faster and more efficient. Now it only takes you 75 hours to complete the same project. If you’re still charging $50 per hour, you’ll actually end up losing $1,250.

Charging by the hour penalized you for your experience, cripples your billing potential, makes your clients nervous, and encourages lower productivity. It’s time you stopped!

The right hourly rate.

Knowing the right hourly rate sets the baseline and you need to make sure you’re charging it. So, let’s talk about the fully burdened rate. This is what your costs are (insurance, rent, paying contractors, etc.).

The formula for figuring the fully burdened rate is as follows:

(Employee hourly wage * number of hours available per year) + other total expenses
number of actual hours worked per year

Let’s assume you have employees that make $50,000 per year. Your fully burdened rate would look like this:

($25 per hour * 4,160 hours available) + $50,000
2,500 actual hours

Note: 4,160 and 2,500 are just made up numbers for this example

That means your fully burdened rate is $62.60 per hour. That’s the baseline of what you should charge. So, if you’re only charging $50 per hour, you’re losing money.

The Effective Rate.

The effective rate is the amount earned in a set timeframe divided by the amount of hours worked in a set timeframe. Once you know your effective rate, you can adjust your rate accordingly.

For example, I was able to increase my effective rate to 50%; sometimes 500%. This meant I went from charging $100/hour to $500/hour for the same amount of work!

By the numbers.

Let’s look at the numbers.

  • You charge $100/hour
  • You work 40 hours in a week
  • You make $4,000 per employee, per week
  • You have 5 employees, all working 40 hours per week

By increasing your effective rate by just 50%, you’ll earn an extra $10,000 a week. That’s an extra $40,000 a month. Get your calculators out and prepare to be astonished by how much that is in a year.

Showing value with the 3 I’s.

I use the 3 I’s to change the conversation with the client right from the beginning. Find the answers to these three points from your client so that you can better understand the value of their problem.

Issue
Impact
Importance

By knowing the value of the problem you are solving, you can adjust your price accordingly. Think about it – if you tell a client that you can fix their $100,000 problem for just $10,000, the client is just going to think you don’t really understand their problem. In their minds, $10,000 could never solve their issue.

What you need to do is pitch a solution around $50,000, even if you can really solve it for $10,000. The client gets their problem solved and you end up with a huge profit margin.

Putting it all together.

First, use the 3 I’s to figure out the issue, impact, and importance. Then, look back at similar projects you’ve completed in the past to see the amount of time spent. Next, make sure you pad the hours 25% for profit. Also, pad the hours by 25% for risk (there’s always risk!) Be sure that the project aligns with the clients budget and sell the value of the result to the client.

Finally, look for ways to deliver more efficiently and reward your team for doing so. Bonuses and incentives are huge motivators.

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