The Art of Business: Setting Rates for Your Small Design Firm

Rate Setting Series
1. Fee Negotiation for Everyone
2. Setting Freelance Rates
3. Setting Rates for Your Small Design Firm

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When you’re a freelancer, setting rates is relatively simple; you fill in a few cost numbers, find a comfortable profit margin (if you can), and divide the cost of business by the number of hours you want or need to work. As a result, most freelancers have a single rate card.
Setting rates is a bit more complicated when you’re running a small design firm or managing a team with a wide variation in compensation and skill level.
When you’re estimating rates for your firm, you also have to take into account a wide range of overhead costs, particularly if you’re paying workers as bona fide employees rather than contractors. This includes (as you may be painfully aware) the additional cost of insurance, FICA, workers comp, vacation time, and sick time.
Here’s a list of the common business expenses:

1. office rent
2. telephone, Internet access, and utilities
3. business insurance
4. advertising and promotion
5. travel and entertainment
6. professional services (accountants and attorneys)
7. office purchases and supplies
8. yearly depreciation
9. business taxes and association dues
10. health insurance
11. vacation and retirement
12. sick leave
13. equipment
14. training
15. FICA (social security tax) and worker’s compensation
16. equipment
17. client entertaining

But that’s not all. To accurately reflect your overhead business costs, you have to figure in the cost of new business development — say, 5% of your total costs — as well as the cost of deadbeat clients and other unexpected losses that can eat up your profit in one swallow. Figure another 5% to insure against business loss.
You’ll also want to figure in a profit margin for your company, which realistically should be in the range of 10 to 20%.
All said and done, you’ll end up with a partial equation that looks something like this:
Overhead costs
+cost of business development (about 5%)
+ cost of business loss (about 5%)
+ profit (10 to 20%)
= cost of operations
Now you have to figure out the second half of the equation: an hourly rate for every employee.
Three Choices
While there are numerous ways to set rates, in the design industry, most firms settle on one of three:

• A single rate for the entire firm
• A different rate for each staff member
• A different rate for each role on the team

The simplest way (but not necessarily the best) is to set a single rate for the entire firm.
You start by figuring the cost of doing business for 12 months by taking into account all of the costs as outlined above and any other expense categories you may have on your profit and loss statement, according to Shel Perkins in Talent is Not Enough: Business Secrets for Designers.
Next, figure out how many hours your company can realistically bill each year per employee.
To save you the math, here’s a common per-employee estimate:
260 working days (5 days a week, 52 weeks a year)
– 15 days vacation
– 8 sick and personal days
– 10 public and religious holidays
– 92 business-management days (2 days a week, 48 weeks)
=
135 available billing days
X 8 hours a day
=
1,080 billable hours a year per employee
X the number of employees
Now you have two figures: the cost of operating your business and the number of billable hours available to produce that money.
Simply divide your total cost of doing business by the total billable hours, and then again by the number of employees you have. This gives you a recommended hourly rate: The amount you need to stay in business without losing money.
Cost of operations
÷ total billable hours
÷ number of employees
= hourly rate
However, there are two problems with a one-size-fits-all rate. First, it means you’re billing clients the same rate for senior- and junior-level staff. This can be a predicament come bidding time, when you will either a) suffer a loss on jobs that require senior level attention or b) overbid on jobs that require more junior-level attention.
Secondly, a single rate provides no incentive for team members to stay on task. When you have senior designers making photo copies, you’re wasting company money.
Floating Rates
A better way to account for your real costs (and create more realistic and therefore more competitive bids) is to create a different rate for each team member.
To calculate overhead, Perkins suggests you once again bring out your 12-month profit-and-loss statement. Now compare total payroll expenses to overhead expenses. Most design firms find that overhead expenses equal somewhere in the neighborhood of 50% of total payroll expense. (If your overhead is significantly higher than this, you’ve got an overhead problem that should be addressed immediately.) Then follow this handy formula:
Individual salary
÷ individual chargeable hours
= payroll per chargeable hour
x overhead factor for company (if your overhead is 50% of payroll, this figure will be 1.5)
= breakeven rate
+ target profit percentage for company
= personal billing rate
Individual rates put subtle pressure on everyone to make the most appropriate use of their skills.
Rate Levels
A drawback to individual rates is that people get hired, fired, and promoted, and job descriptions change. With each of these changes, you should recalculate individual rates.
That’s why some firms set a small number of rate levels based on professional experience. For example, you might set a rate level for each of the following:

• Principals
• Senior staff members and specialists
• Mid-level and support staff
• Entry-level employees and interns

Now you have to determine only four rates (or however many are appropriate for your company), and review your calculations once or twice a year. Less work, and you’ll still have the tools you need to create accurate bids and keep everyone on task.
Staying Competitive
Setting rates is truly an exercise in theory. If the marketplace can’t support your rates, then they’re no good. If you find you’ve priced your firm out of the market, you have a few alternatives:

1. Reduce your expenses. Do you really need an office? If you’re just starting out, forego the four walls and go virtual. And stay that way until your company can really afford and needs office space.
2. Cut your profit margin. “Break even” is better than “in the red.”
3. Find a higher class of clients. Here’s when your business development cost is really worth it.
4. Find talented employees. Brilliant and fast is profitable, mediocre and slow isn’t.

At the very least, the exercise of setting rates can help you determine where you need to cut costs or make personnel changes in order to remain competitive or turn a profit.