Determining an hourly rate; working hourly and agile instead of fixed-fee, following a quick ballpark estimate

Another testimonial to the benefits of agile development and hourly pricing.

http://www.thisux.com/articles/on-the-pricing-of-service-work/

Minimal hourly rate. To compute a minimum hourly rate, we need to divide the minimum revenue we need to make per person, by those 1,226 chargeable hours. The total minimum revenue equals our employment costs (salary, benefits, social security, etc.), all overhead expenses (office rent, support staff, marketing, accounting, legal, etc.), plus the minimum profit we want to make.

Example. In a hypothetical scenario in which a company’s staff costs, on average, $75,000 per year per person, with overheads equivalent to say 20% of employment costs, and wanting to make a 15% profit, the minimum hourly rate would be roughly $85/hour. (That wasn’t the particular number in Makalu’s case ten years ago, but might seem a reasonable starting point today.)

Fixed-fee projects tend to put the client and provider on opposite sides of the table, with orthogonal motivations. The client’s motivation is to achieve as much as possible within the fixed price, while the provider’s motivation is to complete the project as quickly as possible, maximizing profit and minimizing risks (and as a possible consequence, minimizing innovation).

Fixed-fee projects also tend to demand that detailed requirements are agreed up front, the production of which often waste time and money, as final products rarely reflect original specifications. And such projects also suffer in the close monitoring of requirements, and the production, negotiation and agreement of contract modifications when the inevitable scope changes occur as the project evolves.

Charging hourly, on the other hand, works to align the client and provider interests, and allows for the agile, iterative approach to project development that’s becoming ever more accepted as the best path to efficiently meeting objectives, while maintaining a balance of value and cost.

When Makalu gets a project request, twelve years of experience allows me to make a reasonable rough estimate of the required effort, which I can multiply by our standard hourly rate to immediately provide the customer with a ballpark estimate. It won’t be perfect, but at least we can quickly establish whether the project is financially feasible.

If it is, and based on that rough estimate, we’ll begin working on an hourly basis (invoicing our time periodically; say monthly). This allows us to manage cost and scope, together with the customer, and generally has resulted (for us) in the development of successful products, with little of the friction typically found in fixed-price engagements. And that makes us happy!