How we've grown Error 100% year-on-year using a variable day rate

In our previous article, Martin discussed moving away from thinking about a day rate. In this follow-up, I’ll show you how using a variable rate works in practice, and how we’ve used it to grow Error 100% year-on-year for several years.

Let’s recap on the maths for our variable day rate:

$$\frac{\text{Business costs + variable profit}} {\text{Working days in the year}} = \text{day rate}$$

Once you’ve got used to the idea that you can flex your return depending on the project, you can move on to the practicalities of using your variable day rate when estimating.

Two rules (just two)

There are 2 things you need to do to manage your day rate properly.

  1. Set your cost price, Target Rate and Top Rate
  2. Never ever, ever, sell a piece of work below your cost price. Ever.

Three rates (yes, three)

You need to have in mind 3 rates, and the relationship between them.

  1. Cost Rate - the rate at which your income matches your outgoings
  2. Target Rate - the rate you generally sell your work at, in order to make money for other things (the subject of a future article)
  3. Top Rate - the most the market will bear for your services

Cost Rate

Your Cost Rate is the set-in-stone figure that you’ll never go below. It’s the absolute minimum day rate you’re prepared to sell at, because you’ll be just covering the costs of your business, over the number of days you work.

Your cost rate is probably the most important figure you need to know. Provided you have accounted for all your business costs (including paying yourself), you’ll know that you can break even by charging this rate.

 Target Rate

Your Target Rate is a day rate you think is reasonable for the market and your skills but will give you a return you feel good about. This is the closest you’ll get to a traditional fixed ‘day rate’ but it’s function is to guide your pricing - not dictate it.

Top Rate

Your Top Rate is the top price you can charge for your services. In short, it’s the most a client would ever pay. At Error, we arrived at our Top Rate by comparing our work to others in the industry, and how much we’d ever sold a project for. You should be happy to charge this rate if you think you can achieve it.

Here’s an interesting example of how we’ve used our Top Rate at Error.

On a Friday afternoon, a large client of ours unexpectedly asked for some new work from us, with a deadline of later that day. Everything in our guts as business owners needing to pay our mortgages made us want to hustle all evening on the job.

But our actual, considered, response was to tell the client we’d do the work on Monday. We’d be disappointing someone else, so we needed to charge them a top rate. They were delighted with the work, and Monday wasn’t a problem.

Don’t confuse your Top Rate with a 'rush rate’. You might equally decide to charge your top rate in other circumstances.

A worked example of flexible pricing from Error

Let’s have a look at an example of how we’d flex our day rate on an imaginary project at Error.

Our business costs are 595.00 per day. This is everything we need to keep the business running: salaries, rent, savings for corporation tax, and so on. (But not VAT, a UK sales tax, which we charge on top of our day rate and treat as 'non-existent’ for budgeting purposes1). On this basis, we have decided to set our Cost Rate at 600.00 per day. We never, ever sell below this, because we might as well not be doing the work.

Error has some good current and former clients, an interesting portfolio, and we’re proud to say that we are good at what we do. Our Target Rate is 750.00 and we frequently bill at that price.

When deciding our Top Rate we’ve looked at our peers in the industry, what we charge on projects for blue-chip clients where we’ve had to disappoint other people, and those where the risk to the business has been higher than normal. We’ve arrived at 1,000.00 per day.

So, Error’s variable pricing looks like this:

  • Cost Rate: 600.00 per day
  • Target Rate: 750.00 per day
  • Top Rate: 1,000.00 per day.

Most of our projects in the past year have been priced at somewhere close to our Target Rate. Some have been closer to our Cost Rate, and one has been at our Top Rate.

Why do these rates change for different projects?

The single most important reason for a variable rate is negotiation. Negotiation both with yourself (whether you’re a one-person company or a company of many), and with the client.

An example of how we negotiate on day rate

Let’s say potential client, Widgets Ltd, gets in touch with Error and asks them to bid for their big web app project. We figure out that it’ll take 50 days (including some contingency time) to complete the work, using a detailed list of estimate items to avoid forgetting anything. At the Target Rate, this comes out at 37,500.00 (plus VAT sales tax, but because they’re a business, they can claim this back anyway).

Widgets Ltd loves Error’s proposal document and ideas, but the project is coming in above their budgeted cost. After some discussion, we decide that we’d really would love to win this job. It’s a decent chunk of work, the client seems sane, and it’s a really interesting project which fits with Error’s strategy. We look at our estimate once more to see what can be done to match Widgets Ltd’s cost expectations.

At this point, there’s one of two things (or both) that can happen to win the work. Widgets Ltd can decide to reduce the amount of features to work on, which will reduce the effort and price. Or Error can decide to accept a lower return on our day rate.

At 750.00 a day, Error would make a return of 150.00 per day above our Cost Rate. We decide that 100.00 per day would be an acceptable (and still good) return on a project of this complexity. Sliding down from the Target Rate to 700.00 would bring the project total to 35,000.00.

Unfortunately, it’s still not enough. Widgets Ltd have only budgeted 30,000.00. Can Error do it for 30k?

To hit this overall total, we’d need to slide our variable day rate down to our cost rate of 600.00 per day.

We know we can’t go below that price. But if we chose, we could continue in business and charge 600.00 per day for the project. We would pay ourselves, staff salaries, our taxes, rent and other costs.

So: we have some serious thinking to do. Do Error want the work that much? Do we have time to fill in our production schedule? If we work at our cost price we’ll need to be very hot on the project management to avoid sustaining a loss.

Error decides to make a revised offer to the Widgets Ltd of 32,500.00. This works out to be 650.00 per day. There’s a return of £50 for every day we work on the project, and if our estimate is right, that’ll all be profit.

While this is above the client’s budget, we’ve moved down substantially from our previous estimated price. We explain that we’ve cut our return on the project because we’re excited to work with Widgets Ltd, and they agree to the project.

Some key points to take away

  • If Widgets Ltd had had a budget below 30,000, we wouldn’t have been able to do 50 days’ work without going below our cost price.
  • If that were the case, we would have needed to reduce the size of the project (remove features), or walk away.
  • Crucially, Error knows its Cost Rate. Although, for example, 29,000 sounds like good money, it wouldn’t have kept us in business.

Knowing your cost rate is vital. It arms your business with a concrete figure below which you should never go.

Although this example is fictitious, our process for almost every project is the same. Pitch at a price which sounds sensible, keep in mind your Cost Rate, and differentiate yourself from your competition. You’re worth more than you think.

  1. If you’re in the UK you might be on the VAT flat-rate scheme, which gives you some money back on your VAT. We were in the early days of Error. We always considered this a bonus, and not worth budgeting against. 

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