How Much is One Hour of Your Time Worth?

More and more people in the service sector of the economy are independent contractors setting their own hourly rate. For many self-employed people, it is one for the most important business decisions that they make.  It is also often one of the most difficult.

I worked as a lawyer for many years and I would periodically adjust my hourly rate upward, usually on the first of the year, to reflect the added expertise I had acquired during the year. Being self-employed allowed me the luxury of setting my own rate.

My hourly rate took into consideration that I had office rent and employees to pay as well as all of the ancillary expenses that come with running a business. However, that does not mean that I reduced my rate when I moved out of a pricey financial district office tower and into a lower rent office in the suburbs.

I was recently contacted by a very large international consulting firm that wanted to add me to their stable of experts. They had a client in need of a consultation about a fairly new regulation that I had written about and they invited me to call in and sign up.

The person with whom I spoke had all of my information from Linked-in and was happy to sign me up and explain their procedures. The assignment was a one hour phone call with an executive at one of the large Wall Street investment banks.

The last question the interviewer wanted to know was the most important; she wanted to know my hourly billing rate. Now that I am semi retired, I have even lower overhead and fewer expenses. I intended to handle this consultation sitting in the shade on my deck.

I asked my interviewer what she thought the right hourly rate would be.  We settled on a rate that she felt was appropriate.  The rate was the same that other experienced lawyers who were still working and paying overhead expenses would charge. I could have charged less because I had no overhead. Because I had written about the regulation I had demonstrated expertise and did not need to charge less.

Three factors will always come into play when setting your hourly rate; how good you are at what you do, your overhead and expenses and what the market will bear. It sounds much easier than it is.

In a perfect world, if you are very good at what you do, you should be able to charge more. That is not always the case.

In a great many cases, the customer is not looking for the best of the best. The customer is looking for someone who is good enough to get the job done.  I call it the good enough economy and there is a lot of it going around.

Basic economics teaches that the one universal factor determining how much you can charge per hour is what your competition charges. Price matters and it is going to throw the old idea about hiring the best people who went to the best schools and then worked at the best companies out the window.

The easiest example of this is code writers. It is an industry full of freelancers and independent contractors.  I live near Silicon Valley where I have heard many people say that the best code writers congregate.  Except those code writers have priced themselves out of the market.

If you have a fair amount of student loan debt because you learned code writing at Stanford or MIT and you live in Silicon Valley where rents are higher than almost anywhere else outside of San Francisco or Manhattan the amount that you need to earn in order to cover your monthly overhead is substantial.

There are excellent code writers living near Seattle or Austin as well as London, Moscow and Mumbai who will get the job done and charge far less because they need a lot less to pay their bills. I appreciate that Silicon Valley is where the action is, but even the big Silicon Valley companies have been outsourcing overseas for years.

This is not limited to tech jobs.

There are radiologists in India and the Philippines who read x-rays for hospitals and insurance companies in the US and Europe. There are teams of lawyers and paralegals in other countries who handle the volume of documents produced in large cases litigated by large Wall Street law firms. These firms have lawyers and paralegals on staff and would be happy to bill them out to accomplish the same tasks. But the clients do not want to pay Wall Street rates for tasks that they can buy cheaper even if they hire the most expensive law firm to represent them.

The simple truth is that a significant amount of student debt may actually be an impediment to making a lot of money as an independent in your chosen field. It may require you to work at a big company for a big salary. It can restrict your ability to take chances, like working with a start-up that could have a big time pay-off.  It can even rob you of the kind of opportunities, like a business convention in Hong Kong, that could really open up doors for your career.

Self worth is an interesting concept. Many independent contractors have difficulty setting their hourly rate because they do not have a good feel for how they stack up against their competition.  If you post a higher hourly rate you are advertising that you are better than your competitors. Of course, you need to back that up by doing a better job if you are hired.

It seems that a better approach would be to charge a little less and deliver a little more.  I have certainly read articles by many experts who would claim that that is the best way for an independent contractor to build his/her reputation and gain valuable referrals.

Never confuse your hourly rate with your advertising budget.  How you present yourself to prospective clients is still essential. If you want to charge more than your competitors you need to convince potential clients that you are worth more. And you need to reach more potential customers through advertising.

I read business plans and pitch books for start-up companies for free.  I will get on the phone with a budding entrepreneur and spend an hour answering specific questions and offer some suggestions or perspective about their business without charge. I have the experience, a fair amount of free time and I enjoy speaking with people who are starting a business. I often learn a lot more from them about what is going on in the marketplace than I do from reading the business or financial press.

Occasionally, a company wants to hire me to do more.  If I want the assignment, then I often have to charge less than I am worth because the company rarely has the cash to pay me what the NY investment bank paid me.  In most cases the company wants my on-going business and legal advice. In those cases, I usually prefer a monthly retainer to hourly billing.  That way, neither the company nor I are watching the clock.

I was recently approached by a very successful businessman who had started and sold three start-ups.  He had a pretty good idea for start-up number four and offered to give me equity in exchange for my expertise and on-going advice.

He was surprised when I declined because he had spent ten minutes explaining how my small share would be worth millions.  I told him to sell the shares he was offering to me to someone else for a deep discount and use the proceeds to just pay me my hourly rate.

For those of you who think that I was foolish for passing up what may have been a great opportunity, I can only tell you that I have been there before.  If you pay for my advice and then don’t take the advice, well okay, every lawyer has clients like that.  If I have equity and you don’t take my advice then I should not have taken you on as a client in the first place.

Do I really think that my advice is that good?  Yes I do, but mostly I know that advice that is not paid for is often disregarded.

Being semi retired and overhead free, I can give or sell my time to whomever I wish at whatever rate I wish to charge. It is truly liberating.  I only take on clients I like and projects that interest me. I can apply myself to only those projects where my experience and skills will add value.

I am not going to be giving seminars on this but I invite any independent contractor to adopt the same mindset, at least as an exercise.  What would you charge a really nice person who really needs your help?  Someone with a project that you could really enjoy sinking your teeth into even though they cannot pay you what you would like to get paid.

I suggest that amount is your base hourly rate. Charge more for mundane projects or difficult clients. There is no Nobel Prize winning economics behind this but I suspect that you will be happier when you are compensated at above your base rate for work that you do not enjoy and clients that you do not like. I suspect that you will probably be more productive, as well.

What is an APP worth? Finding Rational Valuations in an Irrational World

Determining the value of any business can be an interesting process. Even in a data-filled discipline like economics, business valuation often remains very subjective.

If you stayed awake in Economics 101 you might have learned that in a liquid market, we believe that prices are determined by rational buyers and sellers of goods and services, each assessing the transactions in regards to their own self-defined best interests.

Price theory was developed in the 18th Century for a mercantile economy where the buyers and sellers were primarily merchants. Adam Smith considered merchants to be rational because they all wanted to buy goods for a price less than the price for which they could re-sell them. Little consideration was given to how the ultimate consumers might act or think.

In our modern consumer economy rationality plays a diminished role. Many consumer transactions are emotionally based. If you do not believe me consider the vast amount of economic activity that emanates from a single, strategically placed dab of perfume. The human mating ritual is full of transactions that are not based upon a rational allocation of resources.

It would seem easier to find rational buyers and sellers in the financial markets. People buy stocks because they believe that the market price of the shares will increase. The people who are selling those same shares in the same transaction may be doing so because they believe that the price will rise no higher. A buyer and seller in each transaction may be assessing the exact same data and reaching opposite conclusions. Each still acts rationally.

We seem willing to accept that a company’s value as being equal to the number of shares that it has outstanding in the market times the last price at which the shares were sold. But is it?

In active trading markets, the price of a stock may change constantly. For any stock, the last trade of the trading day is the price upon which margin accounts are valued and capital computations will be made throughout the global banking system. All that actually occurred between the next to last trade and the very last trade of the day was that one person bid the stock up or down. Valuing a company’s shares at the last trading price of the day eliminates the rational thinking of the other market participants who traded the shares seconds or minutes earlier.

Consider the case of Uber. Recent reports suggest that the not yet public company might have a value of $50 billion.This valuation was assessed at the time of its latest round of financing in mid-2015.

For a private company that is fairly new, an actual value of $50 billion would be quite rare. There are not a lot of larger companies that could spend $50 billion to purchase Uber. It would require $25 billion to take one-half of the company public and more to maintain a liquid secondary market.

Uber has demonstrated that its business model is viable and expandable and should certainly be profitable, given that its direct cost to provide the labor that it sells is zero. Uber operates in more than 200 cities, worldwide, cultivating its brand and customer loyalty.

At its core, Uber is essentially an APP, which the company itself will tell you. The company has structured its business so that the “employees” whose labor is the primary source of the company’s revenue are not employees at all. They are independent contractors.

The independent contractors (drivers) utilize the APP to connect with customers who might hire them. Once hired, the APP does the billing, Uber takes its cut, and the contractor gets a check. It is not a complicated concept.

If one assumes that Uber captures $2 (net) per transaction worldwide, it would need ½ billion transactions per year and a 50/1 price to earnings ratio to achieve a $50 billion valuation. Even with a lot of customers and a lot of drivers to service them, that is a lot of rides. There is no indication that Uber has ramped up to that level.

The replacement cost of Uber’s APP would seem to be a fraction of that $50 billion value. The APP is, of course, just a few million lines of code. Its functionality now defined, could not 1000 code writers replicate the APP’s functions in 1000 days, more or less?

Uber already has credible competitors. Some amount of Uber’s “loyal” customers could be coaxed away with price incentives and clever advertising. Some number of Uber drivers could be incentivized to change firms for a higher payout or a different business model. Certainly the $50 billion valuation for Uber seems high.

Valuation is one of the most elusive concepts in economics. If Uber’s value may be off by $10 or $20 billion despite its simple business model, what values can we trust?

For their first week’s home work assignment, I would send my Economics students into one of the large department stores in San Francisco’s Union Square. I would instruct them to make a purchase but not to pay the price on the product’s tag. Rather, I wanted the students to actively bargain and to convince the sales clerk or department manager to let them have the item for less. You would be amazed how easy it is to accomplish this.

Modern economics is based on price theory. We just have to remember that prices are rarely rational and always negotiable.