Feb

16

Steady Job vs. Independent Consulting: Salary vs. Average Daily Rate

February 16, 2007 |

Is it better to be an employee or an independent contractor? There are many ways to answer this question, including some sense of security vs. freedom, guidance vs. creativity, and topics like liability, paperwork, taxes, and skills learned. In this article we want to discuss how much you should expect to receive at the end of the year, assuming a target average daily rate.

In any industry there are engagements that demand more or less money due to a variety of reasons including skillset required, length of the engagement, project budget, and simply offer and demand. In some projects you may be able to charge more than your average rate, and in all projects you should set your asking price at a point that is equal to your expected average daily rate or higher (preferably higher). For the discussion in this article I assume that all travel expenses (transportation, meals, accommodations) and supplies are paid by customer.

First of all you have to determine your inventory: what you are trying to sell. If you are a one person shop, your time is your inventory. This is how I calculate my inventory:

  • The year has 52 weeks, or 260 weekdays (Monday through Friday).
  • I must allocate some time for holidays (10 days), vacation (20 days), sick time (10 days), and training (20 days). Total of 60 weekdays that I can’t count on my inventory.
  • This leaves me 200 days for which I could potentially charge for my services.

I establish that there is a potential for 200 days because in reality it is very rare to be able to sell all of those days. Some of them will be spent on business development - finding new customers. And, unless you are extremely good at selling yourself, some of them will also be lost due to lack of business — no projects that day. One problem with this type of inventory is that it does have a very precise expiration date (every day expires that very same calendar day): if it is not used on time it is lost from the inventory. I like to set the expectation that out of the 200 days of inventory, 50% of them, or 100 days will become billable days. That is the number that I like to use for consulting vs. employment expected earnings comparisons.

Lets look at the following table for expected earnings at different utilization rates (billable days / inventory) and average daily rate (what you charge per day, on average):

Average Daily Rate 25% (50 days) 50% (100 days) 75% (150 days)
$250 $12,500 $25,000 $37,500
$500 $25,000 $50,000 $75,000
$750 $37,500 $75,000 $112,500
$1,000 $50,000 $100,000 $150,000
$1,250 $62,500 $125,000 $187,500
$1,500 $75,000 $150,000 $225,000
$1,750 $87,500 $175,000 $262,500
$2,000 $100,000 $200,000 $300,000
$2,250 $112,500 $225,000 $337,500
$2,500 $125,000 $250,000 $375,000

Even by doing this kind of calculation, the numbers have to be adjusted in comparison to a permanent employment salary. Things like self-employment taxes (an 7% SS/Medicare tax), medical insurance (if your spouse can’t provide via their workplace), tools/equipment (which may account for 10% of your earnings or more) and services (accountant, lawyer, federal/state/county/town fees, marketing).

When deciding if it is better to work for someone or as an independent consultant you should think about what is the salary you could fetch and also what average daily rate you could fetch (and the 50% utilization rate number). Your 50% utilization rate income should be 25% about or higher than your expected base salary. I purposely didn’t mentioned bonuses, as bonuses are usually tied to performance: and that is the money you would get if you performed at the 75% utilization rate.


Comments

2 Comments so far

  1. And Like That, He Was Back : Money And Investing on February 28, 2007 5:51 pm

    [...] Just like that, a month and a half since I left the world of gainful employment I will start at a new job in a Pre-IPO startup company (beginning of April 2007). So much for my self-employment trial, and I say that with sadness as I was already enjoying the fun of having my own business (which I will keep on the side for miscellaneous purposes).There is something I discovered during my numerous hours thinking about the business model: there is a stage in anyone’s career where the value of the ability to decide how perform a work exceeds the value of the ability to perform the work. My late employer valued my ability to decide how to perform a task or implement something a lot. The market also values my ability to perform it, but I have discovered that if I did 100 days of billable work at my current rate I would make close to what I made in gainful employment in base salary. If I do more than a 100 days of billable work the number will most probably come closer to what I have been doing, plus bonuses. [...]

  2. No Shortage of Salespeople: Of Workers Maybe : Money And Investing on March 15, 2007 10:43 pm

    [...] The second finding I get is that what percentage of the earnings go into each bucket has a direct impact on the minimum amount of money that the salespeople could charge to their clients for consulting services. I have seen too many salespeople who try to outbid (or underbid) their competitors in order to win the business to later find out that they can’t find consultants willing to work for the amount of money they can pay them. For example, in our 15/15/20/50% example, this means that if you charge $1000/day for a consultant, the most you can pay such person is $500/day. From my previous 100 day/year billable time analysis I can conclude this consultant would earn $50,000/year (before paying all of his/her taxes insurance and administrative costs). Almost no computer worker would be willing to work for that amount. $2,000/day ($1,000/day for the consultant) would be more realistic, matching more closely what big companies charge for their average consultant. [...]

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