Setting professional charge out rates is a simple formula process once you understand the critical factors impacting your professionals in the work they perform.
The most common consideration, when setting charge rates, is the direct relation to revenue. Reviewing this old mentality concept when work was plenty, you could plug your Full-Time Equivalent (FTE) professional numbers into a simple formula to generate your forecasted revenue for the year.
Using this train of thought, the higher the charge rate or additional FTE professional, the higher the revenue. A slightly more sophisticated calculation than using a back of the envelope guesstimate from the year before.
A modified version of this formula would be something similar to the following:
Revenue = FTE Fee Earners X Available Hours X Productivity X Average Charge Rate X Recovery Rate
With many professional industries seeing decades of plentiful work, this type of mentality has been dangerously imbedded within most professional business when approaching their charge out rate setting for professional employees.
Below are some critical factors that professional businesses need to consider in today’s professional landscape.
The biggest issue when relying on a formula to set your charge out rates is Productivity. Firstly, the assumption is made that employees will hit their productivity targets consistently across the board with no exceptions. This is never going to happen, so you need to factor in a contingency.
If by chance your professionals have the ability to hit their intended productivity hours, the business then needs to consider if there is enough work to keep your professional employees busy. If there isn’t enough work, productivity per FTE drops and the business’s contribution margin (gross profit line) shrinks. This may be isolated for a specific team, due to the nature of the work they perform, or could affect the entire team.
You also need to consider your business’s value for money. Is the Average Charge Rates accepted within the current market; i.e., costs for services verse perceived client value?
Use of personal discretion
As a modern professional business, we need to consider factors like decreasing recoverability rates as markets refuse to accept a rate increase.
We need to be aware of the increased personal discretion by employees, adjusting WIP or timesheets before the job/matter/task is reviewed by the decision maker and invoiced accordingly. This occurrence is more prominent in professional businesses that set unachievable billable targeted hours. No employee wants to generate high WIP write off percentages, regardless of any higher billable figures that could be generated when capturing all time spent.
Employees will start to not capture all their time spent on their job/matter/tasks, or worse, lose motivation in their work and/or the business, dumping time until they finally move along.
Employee burn rate
One of the most critical factors that hardly receives consideration when determining your professional charge rates is the connection of higher charge rates leading to increase employee burn rate (turnover).
Leading on from personal discretion in billable time, top employees will avoid showing high write off percentages, working additional hours that go unbilled to reflect market expectations while retaining the workload quality.
This means, employees will be working well in excess of their paid available hours to achieve their billable/WIP targets, and if maintained for the medium term or longer, will lead to professional burn out.
If someone is near 100% recoverable in their productivity time, then they haven’t put all their time onto the job/matter/task, especially if the charge out rate was set too high.
Large firms in all professional services industries are prone to this mentality, I myself was one of these employees, as was everyone else in my team, in every mid and top tier firm that I worked at during the first decade in my career.
Training and development
You also need to consider factors like technical training and learnings on the job/matter/task for developing employees. In the professionals’ early years, they will not be efficient or will require more research time to perform the same task as their seniors.
Early year professionals also have a greater disconnect to charge out rates, based on performance, and what your employees get paid.
You might say that doesn’t happen in your firm, but I can tell you it happens in every firm; how much may be the difference between 30 minutes to 20 hours a week per employee.
Changing the charge out rate to one that is more appropriate will identify the need for system/process improvement, or when someone is ready for a pay rise or promotion. And once improved, would enable a higher charge rate.
Setting charge out rates too low
Like with charge rates being set too high, there are also many issues in setting them too low. Consider the following issues with rates being too low:
- Time dumping will start to creep into the culture to counter distractions throughout the day. These will be absorbed into the fee replacing any gained efficiency.
- Risk associated with different types of work and the recoverability become miss aligned.
- Profitability is low but capacity is also low. This indicates that the current rate calculations are not enough to cover the costs to run your business. You need to consider the following:
- Direct costs linked to income producing activities; i.e., software
- Adjustment to include overhead coverage
- Adjustment to include profit
Where do you start?
A. Start with a simple FTE formula and build from there.
B. Set two rates for split work; i.e., court attendance or high risk tasks verse a usual work rate.
C. Once you have an understanding of the concepts to consider, tailor your charge rates per professionals.
D. In determining what rates to use, consider the following:
- The individual and the role the play in the firm
- The higher the experience in a technical role, the higher the rate
- If you have a quality service and are known for it, the higher the rate
- If you don’t factor in support costs, the higher the rate
- The higher the efficiency, the higher the rate
- Utilisation of technology to gain firm wide efficiencies
- Utilisation of best practice or precedence to gain efficiencies
- Specialist type work may need to attract a second hourly rate
- High level technical experience
- High level risk in recoverability (personal injury, litigation)
- Court appearances
The above concepts are just the high-level considerations your professional business needs to consider when setting the right charge rate.
If you would like to learn more about setting charge rates and fee earner budgets, Jason is offering firms in the ALPMA community a free half-hour virtual meeting to discuss current practice management issues or considerations.
To learn more, contact Jason directly by email at firstname.lastname@example.org
Adapted with permission from Importance of Setting the Right Charge Rate for Your Professionals, Odyssey Advisors, 2022.
A portion of Jason’s recent QLD Seminar, Considerations When Setting Your Firm’s Remuneration Targets, is available On-Demand now.