How to create a desirable compensation plan
Businesses only charge clients 60% of the hours they’ve dedicated to completing a project. This is because complementary tasks like administrative work often go uncharged. Neglecting expenses that aren’t directly related to the project at hand can put your business in a tricky situation. In fact, one of the most common reasons businesses fail at their early stages is often not having enough revenue to cover expenses.
This is why business owners have to account for all expenses when setting hourly rates, from staffing and wages to equipment. The good news is - we can help you create a strategy in determining an hourly rate that is broken down across common cost components. Alright, let’s cut to the chase.
First things first - Regulations
Before you determine an hourly rate that makes sense for your business needs, first take a look at the regulations that apply in the state you operate in.
For instance, states across the US vary in minimum and average pay in almost every industry. The hourly mean wage for construction workers in Texas is $15.69, while in California it is $23.20. These differences are important to your firm when estimating labor costs. You want to make sure that you’re paying your employees an hourly rate that is in line with state regulations.
If you’d like to find information about the hourly rate in your state, please visit the U.S. Bureau of Labor Statistics webpage.
See Related: Calculating a Fair Price of Labor
This brings us to our next point.
Look Within Your Team
To know what to charge on the hour, start off by looking at what your employees are costing you on the hour. Depending on the different job positions at your company, those rates will vary. For instance, a safety engineer and a construction assistant don’t earn the same amount.
On average, how many hours does the safety engineer and construction assistant in your company put in to get a job done? How much is it costing you? After having looked within your team for cost estimations, you have a clearer picture of your operating costs. As a result, you are more likely to estimate an hourly rate that represents your actual costs.
Case Study: Construction Company in Ohio
Let’s look at this hypothetical small construction company in Ohio whose specialty is building outdoor patios. Most jobs can get done with a construction manager, two construction workers, and an equipment operator. Let’s say that they’re building a new patio that generally takes three days to complete, 8 hours per day. That’s 24 hours total. Let’s also say that the first three workers will be needed on-site throughout the whole time, while the construction equipment operator will not be required to attend work on the last day.
Construction Manager - $46.54
onstruction Laborer - $15.74
Construction Equipment Operator - $20.08
Construction Manager: $46.53 x 24hr = 1116,72
Construction Laborers: $15.74 x 2 x 24hr = 755,52
Construction Equipment Operator: $20.08 x 16hr = 321, 28.
Total Labor Costs = $2193,52
Total Hours = 24hr
Hourly Rate = $91.40
Based on how much the team is costing the company for this patio to be built, we now know that the hourly rate (only including labor costs) is $91.40.
It’s important to include your labor costs into your hourly rate so that you can maintain consistent profit margins over time. A staggering 50% of construction business owners are omitting certain costs, like the costs of initial raw materials or preliminary legal advice from their estimates, whereas they themselves identify this as an area an improvement for future profits.
If you’re not sure whether you’re on top of your labor estimations, consider getting some help from a digital tool. Many small business owners, like Jack, have turned to Atto to get accurate estimations on workers’ hours worked and productivity. These accurate estimations help hardworking business owners like Jack charge an hourly rate that maximizes profit.
See Related: 5 Reasons Why You Are Underbidding Your Projects
Don’t Stop There
Now that you’ve looked within the team, don’t stop there. You and I both know that there are many other costs other than labor when it comes to completing a contract.
Fixed costs, such as rent, insurance, wages are consistent, making it easy to keep track of. On the other hand, variable costs such as electricity and water bills, transportation, bonuses, overtime, and materials used differ from one period to the other. These costs are unique to each industry. Think about your own business. What kind of different costs do you face?
Now that you have a list or at least a mental list of all the different costs, think about how and whether you will include these in the hourly rate. Some business owners may own the facilities they use without having to pay rent, while others may rent several facilities to carry out their operations. Whatever the case is, think about how those costs play into your hourly rate.
Case Study: Cleaning Company in Delaware
Bill owns a small cleaning company. He pays his cleaners $10 on the hour and bills clients $25 on the hours. Clients can order full-service cleaning, where the cleaner uses the company products. Clients may also order regular cleaning, using just household products.
In this case, it is not smart for Bill to include the material cost in the hourly rate because not every service provided uses the company materials. This is why Bill has introduced a “service fee” of $4.99, which is charged only to customers who request full-service cleaning.
You might not be in the cleaning business, but you can still apply the same logic to your calculations. Think about whether your company’s hourly rate encapsulates all relevant costs. Some costs irrelevant to the chargeable hour, like Bill’s product costs, are better charged in addition to the hourly rate.
Don’t forget that your hourly rate is will set you apart from the competition. If you are after a low-price strategy, including all costs in your hourly rate may not be the best idea. However, chasing a low-price strategy may lead to some quality issues. On the other hand, if you’re chasing a high-quality strategy instead, then make sure that your hourly rate is enough to finance your quality services,
Decide Your Profit Margins
Every business operates at different costs and profit margins. Usually, there is a minimum threshold of profit, under which a company does not take on a job. Some companies have a standard profit margin that they apply to each contract, while others estimate a different profit margin based on the contract. Which strategy to adopt is entirely up to you.
The main takeaway from this is to not forget about your profit margin estimation. Many business owners don’t base their profit margins on real data but rather choose to trust their gut instinct. No matter how many years you have in the industry, this strategy can more often than not lead to problems, including a loss in quality, profit, and reputation.
The reasoning behind calculating profit margins is to keep your company not only afloat, but profitable. If your hourly rate accurately reflects your costs, then you’re simply breaking even. Adding a profit margin to your hourly rate ensures that you’re also getting a return on investment, whatever that might be.
If you are unsure of what your profit margins should be, look up industry margin averages. For instance, the construction industry averaged a profit margin of around 18% in 2008.
Glenn Gutek, an experienced CEO, described profit margins as return on investment on your expenses. If profit margins are low, then you are not getting the optimal returns on your investment. Analyzing low-profit margins can often reveal underlying problems in your business, such as inadequate pricing or cash flow problems.
Bring It All Together
Now that you’ve broken down your hourly rate into components that can be estimated, it is time to bring it all together. Let’s look at this rule of thumb to get you started.
Decide your total costs (those that you have decided to include)
(/) Divide total costs by the total billable hours
(+) Add the profit margin
= The basic hourly rate
As always, we like to bring you closer to meeting your company goals with simple and informed guides on useful business practices like hourly rates.
An hourly rate helps you standardize processes in your company by serving as a point of reference. This strategy is attractive because it provides accuracy in estimation, in contrast to a case-by-case pricing strategy. Clients say they like hourly rates because it’s transparent, they know exactly what to expect. If necessary, reevaluate your hourly rates so that you know exactly what costs to expect.