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As freelancers scale into agency owners and hire subcontractors, business model changes often become necessary. Our recent episode tackled a common scaling question from listener Jim on the best way to structure payments as team members are added.
Jim’s Question: I know I shouldn’t bill my clients hourly, but…should I hire freelancers and pay them by the hour?
As a long-time listener, Jim recognizes we always preach against hourly billing.
But then he asked a follow-up question: If the freelancers I hire bill by the hour, doesn’t it make sense for me to bill clients hourly too? That way things match up across the board.
And you know what, at first glance that does seem logical. But after digging into it more on the podcast, we realized keeping an hourly setup long-term likely isn’t the best play, even with hourly freelancers.
Key Takeaways from this Episode:
- Strive for fixed-fee arrangements with subcontractors to enable value-based client billing.
- If subcontractors only accept hourly payment, estimate averages to incorporate into your fixed fees.
- Price services as if you’ll use subcontractors, even if handling work yourself initially.
The Risks of Hourly Billing
We first validated Jim’s aversion to hourly billing altogether. As we’ve covered before, hourly incentivizes inefficiency – the more time something takes, the more both the freelancer and subcontractor earn.
There’s no motivation to streamline and optimize processes. And cost unpredictability also increases for clients.
From the client perspective, value-based pricing is vastly preferable. They pay for the end result, not roadblocks and rework along the way.
Ideally, congruency between client billing and subcontractor payments is best. But if necessary, consider these options to align incentives:
Approach #1: Negotiate Fixed-Fee Rates With Subcontractors
While some subs prefer hourly billing, you may find many willing to provide a project quote if approached strategically.
We suggested requesting a fixed-fee quote for typical projects, which gives them flexibility to estimate based on experience. This also caps your internal costs upfront.
For example, a web subcontractor may charge $X per typical website build of Y complexity. They price based on known hourly averages. But you gain predictability while still charging fixed-fee website packages to clients.
Approach #2: Estimate Averages to Incorporate into Your Fees
If subs only accept hourly billing, estimating your typical costs is crucial.
Track hours and expenses per subcontractor over time to calculate averages. Pad your numbers to protect profit margins.
For example, data may show:
- 5 project hours on average per website from your web subcontractor
- Subcontractor hourly rate of $50
- Average cost per website = $250
Factor overhead, profit margin, and buffers into your flat fee pricing to clients. This allows you to absorb outliers while maintaining congruency.
Approach #3: Price as If You’ll Use Subcontractors
To enable future scaling, consider pricing as if you’ll use subcontractors even if handling the work initially.
For example, freelancer Jim may be able to build websites himself right now in 10 hours at a personal rate of $50/hour. This totals $500.
But if he priced sites based on subcontractor averages of $250, he maintains room to scale. Jim can then choose to perform sites himself if bandwidth allows that month.
This approach positions you for growth into an agency model whenever desired. You won’t have to scramble to raise rates later.
This transcript was auto-generated and may have grammatical errors.
Hello and welcome back to another episode of Freelance to Founder. This is a special Q&A episode. We do these Q&A episodes every Tuesday. And on Thursday, of course, we do our long form coaching episodes where we have people just like you, freelancers, agency builders, call in and we coach them through whatever hurdles they’re facing in their business. But on today’s episode, we have a Q&A. We have people right in from all over the world ask questions.
and we do our best to answer them in a bit of a shorter format. And of course, we’ve got a question today as well. This question clay actually comes from Jim, I don’t know how to say his last name, Jim Crizon? Anyway, we’re going to call you Jim, Jim. But Jim was on the show in March, so it’s October right now. So he was on about six months ago and we talked about his business. So Jim, thank you so much for writing back in.
I’ll just call him Jim.
Here’s his question, he says, a recent theme you guys have been talking through is not to charge an hourly rate, not to charge on an hourly basis. Which he’s right, we’ve been harping on that a lot lately. And he says, I 100% agree with that value-based fees are the way to go, but, how would you approach paying your subcontractors? I’ve run into subcontractors who prefer to go hourly rate, as I think they’re afraid they can’t accurately estimate project costs or efforts for them.
And he says, it’s more cost effective for me to pay for the hourly rate, which is why I push my clients for value-based billing. So I’d like to hear your thoughts on how to best structure payment for retainer or subcontractors, particularly if you’re trying to build a team. So I’m gonna sum this up for me. The question is, yes, hourly is, sorry, value-based or project-based is better when I’m charging someone else, but when I’m paying someone, shouldn’t I want to pay them by the hour? What do you think, Clay?
Hmm. I can see where this can be a little, what’s the word I’m looking for? Less than simplistic. Less congruent, right? Because you’re charging, maybe you’re charging a flat fee to your clients, but then you’re having to turn around and pay hourly to subcontractors. Like, so it makes, I mean, logically on paper, I guess it makes sense to
Be congruent, here’s my, I guess what I would do is, it really comes out to the same, to be honest, in my opinion, but if you wanted to be congruent, I would just try to negotiate with my subcontractors and pay them a flat fee.
per project or something. If you don’t, and you have to pay them hourly, which I guess is okay, and you’re still charging a flat fee to your clients, I would venture to say you know the average amount of hours it takes to do a certain project, right? Which means you know the average amount of dollars it costs you to pay a subcontractor, on average.
Is that, like, am I, I’m kinda thinking there.
Yeah, yeah, I think so, particularly if you have followed our advice about really systematizing your business and building processes so that you don’t sell a hundred different items, you sell one or two things and you do them really well, then yeah, you should be very clear on how many hours it takes to do certain things.
Yeah, so I think you can easily guesstimate how much it’s gonna cost you. So let’s just take a website project. Did he mention what kind of projects?
No, he didn’t
Okay, let’s just say it’s a website project and you charge, I don’t know, $5,000 for a website. But then you turn around and pay a subcontractor, maybe you’re the person who deals with the client, right? But you pay a subcontractor, a web designer to design it. And maybe this web designer charges hourly to do it. I think with websites, you…
You know, if you have enough experience, you know about how long a website takes to build for a particular, if you have like a brochure type website that’s just like, yeah, less than 10 pages, you know, like brochure website, it probably like, I don’t know, less than 20 hours, less than 10 hours, you know, it takes me less than 10 hours to build something like that. You times that by whatever the hourly rate is, you know?
Right, then it takes a certain amount of time.
And then consider that your average cost. Now, I would pad it.
Yeah, give yourself a little bit of wiggle room.
Yeah, because some projects might take more. But based off that, that’s just what I would base that number.
to use in what you charge your client. And you just gotta know that you’re gonna be over a little bit on some projects, you’re gonna be under a little bit on some projects, but the goal is to average around that.
Yeah, you have an average profit margin that you’re aiming for. I think that’s one way to do it. I think another way you could do it is you know what you’re planning on charging your client for a project. And as a reminder, I just re-looked it up to remind me because it has been a little while. We love you, Jim. Sorry that we forgot. So Jim does Salesforce work. So he’ll come in and help a company get all set up on Salesforce and does customized…
like customized Salesforce stuff for his clients. So stuff, Clay and I frankly don’t know a lot about, but I do remember having this conversation with you, Jim. And I think for me, you could look at it that way, or you could also say like, I know I’m gonna charge my clients $5,000, right? So now I need to find a freelancer who can do it for $2,000, or whatever it’s gonna be, right? And so then when you’re looking for freelancers, instead of saying like, how much do you think this’ll?
how much do you think you could do this for? And then they’re trying to figure out their hourly rate and it’s just like all over the place. Instead, you just say, could you do this for $2,000 or less? It’s a simple yes or no, right? And so that’s what I do with the freelancers I hire. I know what my budget is for the task that needs to be done because I know how much money we’re gonna make from it. And then I have to keep it under that certain amount or we’re not profitable.
And so I actually prefer to go the other direction where as an agency owner, because that’s essentially what you’re becoming, if you’re starting to hire subcontractors and freelancers, you’re starting to become an agency more. As an agency owner, I have to say, here are my expenses, and I have to keep my expenses under a certain amount. Instead of saying, here are my expenses, and then I’m gonna work in profit on top. And it can work either way, right? But I think there’s two ways you could look at it for sure. You know, if a freelancer comes to me and says, I only do hourly,
First of all, unless they’re just like the most incredible person in the world, I just know I can find a freelancer who will do it on a fixed rate. And I just prefer fixed because it’s more predictable. Because what happens if you bill your client three grand for a project and your freelancer works hourly and he goes over the three grand because he can’t figure something out. He’s actually rewarded for being less efficient and being less talented and less capable.
It doesn’t, the hourly just has never made sense in my mind. The worse you are at your job, it takes you longer to do it, the more you get paid. What’s that about?
Mm-hmm. It’s the same thing like lawyers man. I never understood why lawyers charged by the hour, but like
Yeah, of course, yeah. Because, no, because they sit in a room with you and talk for two hours. That’s why they charge by the hour.
Mm-hmm. Yeah, if you hire a divorce lawyer, they are incentivized to make that, to stretch that divorce, like, hearings longer. And never made any sense to me.
Mm-hmm, yep, yep. And that’s why some of the most efficient lawyers are the ones who are working on a contingency because they know they get paid from whatever the result is, not from just sitting in a room and consulting. And of course, it would be awesome if we could all just sit in a room and consult and make an hourly rate and not actually have to provide any real value necessarily, right? And I’m not saying all lawyers are that way, but.
but in most client relationships with an agency or a freelancer, you should be getting paid by the value. And I never pay for something that’s not directly related to the value they’re gonna bring. I never pay anyone just for like showing up. You know what I mean? So I don’t know. What else do we need to add here for Jim?
Hmm, I think that pretty much sums it up. I mean, I think it’s just all about Getting enough of a data set to know what your what your average cost numbers are Pat pat it a little bit and just let that be it
Yeah, you gotta know your numbers. You gotta have enough of a system worked out to where you know like I have, I need to have six clients on average in any given month. They need to each be paying $2,000 for the month. That gives me $12,000 in top line revenue, which means I have $5,000 to spend on subcontractors. So I need to find maybe three subcontractors who can each do, well now that’s hard math, like 1,200 a piece or whatever. Like you gotta know those numbers.
Yeah, now here’s a little tidbit for everyone, because I know we have a lot of freelancers here. I think when you’re pricing your services, even if you do the services yourself, I think you ought to price your services as if you are going to subcontract it out.
Hmm. Say more about that.
So, well this is how you grow, right? So, if you’re charging based off just, you already know you’re gonna be doing it. So, let’s just take a website for example. So, in the case of hiring a subcontractor, we give the example of like, hey, if it’s gonna cost you 5,000, or you’re charging $5,000, it’s gonna cost you 2,000 to subcontract it out, you make 3,000, right?
We know there’s more to it than that, but we’ll keep the example simple. A lot of freelancers here will be like, well, you know, it’s only going to take me, you know, 10, 20 hours or whatever. So I’ll just charge you $3,000 for the website. That’s what most I think most freelancers do, especially at the beginning, is they know that they themselves are going to get $3,000. But in my opinion, you cannot grow that way.
because eventually if you want to hire people and you don’t want to be a solopreneur, solo freelancer forever, you are going to have to raise your fees at some point anyway. So I would pretend like whether you’re going to do it or not, pretend you are going to subcontract this out, figure out what it’s going to cost, charge your client accordingly to that model, and then at that point,
you decide whether you wanna do the work or you hire it out.
Yeah, I love that actually. I love that.
Mm-hmm. And you can do it, right? You can do it if you want. But this gives you the freedom of, okay, I know I priced it high enough to be able to subcontract it out. If my demand’s high, I got a workload or whatever. So like that. I think that’s the way pricing should be done.
Yeah, that’s really smart because there are going to be moments where maybe you need the cash personally, right? Especially as you’re growing. Or there might be moments where you need the extra time to grow your business. And so giving yourself that flexibility, I love that. I love that. Very smart. Well, Jim, first of all, thank you for continuing to listen. Thanks for coming on the show six months ago. Maybe we’ll reach out to Jim and see if we can have him back on the show. Learn more about your business, answer some questions.
But Jim, thanks for listening, man, and thank you for submitting a question as well. Again, if you want to submit a question like Jim did today, you can go to freelance2founder.com slash ask. Clay and I will do our best to give you our best advice based on our experience in growing a couple of businesses. And yeah, I’ve been Preston with millow.co. Of course, Clay Mosley from getdrippify.com. That’s been us today. Thanks so much and have a great day.
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