[I was listening to this podcast that was talking a bit about billing, and it inspired me to go back to this post I drafted in March of 2008. It still seems about right, so here it is. Bonus: A bit about invoicing.]
I was talking to a friend (a small business owner) recently who felt that $200/hour is too much to pay for a software or design contractor. That is indeed not a small hourly rate. But where does that number come from?
Here's how it works. Software developers and graphic designs are people just like you, with rent or mortgages, possibly a family, and a limited number of hours in the day to get anything done. Let's say for the sake of argument that a young contractor wants to make on average $125,000 / year (in a lean year, perhaps that would be $85,000 and in a flush year it would be $150,000). This contractor thinks she has 2,000 billable hours per year. That's really quite a lot of billable hours. It's assuming one bills out eight hours a day, every work day, every week, except for two weeks of vacation. I.e., 8 hours * 5 days * 50 weeks = 2,000 total hours. Yes, the contractor might occasionally work 14 hours, or on weekends, but you get the idea. Personally I think overwork is a recipe for disaster (because overwork impinges on quality and results in billing weak hours, i.e., hours made inefficient due to sleeplessness and inefficiency), and furthermore that the contractor should be including time off of at least four weeks off over the year, to recharge, remember one's family, and so forth.
Now at first it would seem that if you divided $125,000 by 2,000 hours, you'd get an hourly rate of $62.50. But that's not the way it works, because the contractor is also engaging in business development, i.e., finding new customers. Business development can take a full 50% of one's time. You will have to trust me on this, but it's true. There is also a lot of lost business because you are in an existing contract and have no extra bandwidth. So it's pretty unlikely that your book would be full. So now the hourly rate is $125/hour. The $125 basic rate also accounts for variability in billing: Such as: Customers who don't pay; customers who make only partial payment; customers who get a discount for various intangible reasons. This is also why the rate goes down for a longer engagement.
Then there are various forms of overhead. Independent contractors also need to pay for their own health care and consulting insurance; their taxes can be higher, especially if they don't have a good accountant; and they have to pay for ongoing self-education, in the form of books, subscriptions, and non-billable hours in open source projects they participate in. So let us say, now, that a "reasonable" rate is $150. They may also have to pay for an office; add $10/hour, at least.
So why $200? Now we get into questions around quality. You want the best, don't you? The rate is going to be a bell curve like everything else, with the $150/hour biller in the middle. You are going to be able to find people for $75/hour; and there are going to be great people who are in high demand who require a larger number.
So have I convinced you that $200 is reasonable for great work?
The worst thing we do when we build a contract is to make it expensive to stop the work. A good way to make it expensive is to torture yourself and the contractor to define all of the work upfront with a defined schedule, and then introduce charges for changes. Please, stop it. Define your work in two-week sprints that deliver what is most important first. This means that the customer and the contractor must talk about priorities and get that right. At the end of two weeks, has anything been delivered? Yes: Continue. No: Consider stopping right there.
I would suggest sending the bill at the end of each sprint. Keep the sprint short enough (two weeks or a week) so that if the customer doesn't pay you haven't lost too much.
At the same time, insist on payment. I made the mistake once of letting owed money mount up over three months, and the the customer went out of business. Oops. I was out $10,000. I know others who have experienced this. It's not cool and everyone will be unhappy. So insist on prompt payment. Be nice, but be persistent.
Oh, and creating invoices? Use software. When I was doing a lot of billing, I used Freckle which is now Noko Time. You track your hours, and out the other end comes a pretty invoice, ready for the customer.
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