The Money Mustache Community
Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: jorjor on December 30, 2015, 10:13:48 AM
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I work as a consultant in a billable hour environment. We are paid with salary, and then with a bonus that equals a percentage of our billable rate after we hit a certain threshold of our salary. For example, take these hypothetical numbers:
Salary: $100,000
Billable rate: $300/hr
Threshold: 3.5x salary
Pct of rate over threshold: 45%
After this person hits $350,000 in dollars billed (1,167 billable hours), they would accrue a bonus equaling $300 * 45% = $135 per hour billed on top of their salary.
Those are hypothetical numbers, but assume they are in the general vicinity of my situation.
The formula has been set in stone for a while, but parameters may change. There isn't a discretionary component beyond "bad year = fewer hours = lower bonus." There is no reason to believe there would be a situation in which you have a good year and don't get the bonus calculated by the formula. There is no reason to believe this will change.
The way the numbers work, an employee is often better off in good years with a lower salary, given an equal billing rate and billable hours. This was certainly the case for me this year. My total compensation by the formula would be $6k less this year if my salary were $10k higher. Essentially, some of the risk is shifted onto the employee and they reap more of the reward in good years. If the hypothetical person above billed 1500 hours, they would make more in total compensation ($45,000 bonus + $100,000 salary = $145,000) than if they had $110,000 salary ($29,250 bonus + $110,000 salary = $139,250). In fact, I know stories of people above me who have opted to keep their salary low in the past (in comparison to their billable rate) so they could reap the higher bonus and total compensation at the end of the year.
I understand the argument against discretionary bonuses in favor of guaranteed salary. I likely have a higher salary than most others at my level because I was concerned about the risk when I first came here. More salary gives you a higher minimum compensation, higher company retirement contributions (13% of income between 401k match and a not-all-that-discretionary profit sharing contribution).
The years have been good for a while, now. They could get less busy soon. It's possible but unlikely that I don't hit my hour threshold.
I can't straight up pick my salary, but they will consult me before setting it and I can give input, within reason (let's say a $10-15k range). What would you do? Lower or higher salary.
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If you leave midyear, do you get a partial payout?
My average job has only lasted 2 years, so I am a bit biased (and would take guaranteed Salary over hopefully bonus).
Your situation is interesting, and if you do plan to stick around I could see wanting to maximize your bonus a bit... but you do take risk for it. What if the company goes under before bonus? What if you get fired? What if work slows down and you can't bill enough? Generally in a situation like this I would want a pretty good return (say double) to take the risk. If a 10k salary drop gives me maybe 5k more bonus? No thanks. If it gave 20k more bonus? Cool! (Within reason, I wouldn't do 0 salary for obvious reasons).
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All very good questions. I'll try to answer them all.
If you leave midyear, do you get a partial payout?
Yes. Part of the bonus is paid in mid-year, the remainder in December. They try to pay less mid-year to avoid the risk that you top billing in the second half. Mine was about 40/60 split this year.
Your situation is interesting, and if you do plan to stick around I could see wanting to maximize your bonus a bit... but you do take risk for it.
I have been here 3 years. I plan to stay at least 6 years to hit my 401k vesting. I like it here, and I honestly plan to retire from my current profession from here (late 20's now), barring major changes.
What if the company goes under before bonus?
Doubtful. With the type of work we do, going out of business would be a slow-motion trainwreck that one would see in advance and be able to react.
What if you get fired?
I'm not all that worried about this. Very good performance reviews. Laying off/firing is very rare here. When it does happen the person is given long advance notice to start looking elsewhere. Things would have to go downhill quickly at a rate that I've never seen here before.
What if work slows down and you can't bill enough?
This is certainly the biggest risk.
Generally in a situation like this I would want a pretty good return (say double) to take the risk. If a 10k salary drop gives me maybe 5k more bonus? No thanks. If it gave 20k more bonus? Cool! (Within reason, I wouldn't do 0 salary for obvious reasons).
This year, a $10,000 salary increase for me would have resulted in $16,000 less bonus, so about -$6,000 in total compensation. I expect an increase in billable rate this next year (10-20%) which, given the leveraging of the formula, increases bonus pretty quickly since you hit the threshold faster and get a bigger percentage once you do hit it.
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How often do the parameters change? In particular, does the 'threshold' multiplier go up?
How many hours are there in a bad year?
If the employment really is very stable, and you can swing it, take as low a salary as they'll pay you. At $25K salary, you can make as much as the $100K salary person working over 300 hours less.
Really odd setup you've got there. If it were my company, I'd set it up as more of a commission thing. Your salary would act as a draw, and you'd accrue some percentage on all billable hours worked. Then at some point you get paid the amount the commission exceeds the draw. Remove the perverse incentive to take less salary, work less hours, and make more money doing it.
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How often do the parameters change? In particular, does the 'threshold' multiplier go up?
How many hours are there in a bad year?
If the employment really is very stable, and you can swing it, take as low a salary as they'll pay you. At $25K salary, you can make as much as the $100K salary person working over 300 hours less.
Really odd setup you've got there. If it were my company, I'd set it up as more of a commission thing. Your salary would act as a draw, and you'd accrue some percentage on all billable hours worked. Then at some point you get paid the amount the commission exceeds the draw. Remove the perverse incentive to take less salary, work less hours, and make more money doing it.
Parameters might change this year, and it would be that the threshold goes up. This is largely due to hiring a couple more senior level people who cost money.
There are limitations to how low you can go. I doubt they would allow $25k salary for someone senior. I doubt they would allow a major swing from my salary now, but I do have some input on wiggle room.
I've heard of years where people get no bonus. My threshold this year was around 1250, and I billed around 1670. Let's assume the threshold is right around 1250 again. I missed one major consideration earlier: Over half of my billable work was for two major projects which are going away next year. I was overloaded and was pulled off of other things to work on these, so some of those lost hours will be replaced without trying too hard. That still leaves a big chunk of hours to replace though. I don't expect to be at 1600+ again, nor do want to be.
They've tried other systems, and found that this works best. There is a commission-type structure if you bring in the business, which is a percentage of all billable hours worked on that client (not just your own hours worked). Percentage is lower than the precentage over the billable hour threshold obviously, but where senior people make the most money.
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This is a pretty straight-up risk/reward calc and optimization problem. It's one of the more generous bonus programs I've seen in the consulting world. If you feel confident in your ability to bill enough hours to hit the bonus, do everything you can to minimize your salary. Your bosses will probably like this too because it means you're incented to max out your billing. You should also figure out what your minimum billing hours are without getting fired. It's probably in the 60-70% range.
Using your hypothetical numbers, at 100k salary you're making $50/h (it costs your company about 75/h for you with various overhead expenses like unemployment insurance, half of social security, and benefits). After you hit 3.5x salary in billable time you make $135/h for the same work. So here's your earnings for the year with various levels of billing. Billing under 1000 hours (50%) doesn't seem practical, in my experience anything under about 60% gets you fired pretty quickly, unless you're selling a lot of deals.
hours comp
0 100,000
1000 100,000
1167 100,000
1500 144,955
2000 212,455
As you lower your salary, your earnings improve. Here's what this looks like at 80,000 salary. The bonus kicks in at 933 hours, and you pass the 100k mark at 1081 hours. Anything over that is better at 80k salary than 100k.
hours comp
0 80,000
1000 90,395
1167 111,590
1500 156,545
2000 224,045
This just gets better the lower your salary goes. You might consider going straight 1099 and bumping the rate up over 135/h, if they'll go for it. Otherwise, tell them you're confident in hitting your billable hours and you'd like the minimum salary possible.
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Yes. I'm just wondering what others would do. To me, the benefit is pretty clear in good years and the risk seems pretty low.
I don't know how much lowering salary is possible at this point. I mentioned earlier that some kept it low on purpose. Due to the circumstances around a possible promotion this year, I probably can't go too low. It involves an outside review from others and board approval, and others who kept theirs low had to raise it at the point I'm at now. Apparently it looks bad to the reviewer/board when someone making an entry level salary is up for this particular milestone. :) (We get to set our own pay structure, and it's very different even than other offices in our company.)
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I work as a consultant in a billable hour environment. We are paid with salary, and then with a bonus that equals a percentage of our billable rate after we hit a certain threshold of our salary.
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More salary gives you a higher minimum compensation, higher company retirement contributions (13% of income between 401k match and a not-all-that-discretionary profit sharing contribution).
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What would you do? Lower or higher salary.
Don't understand the definition of "income" (as in "13% of income between..."), so that isn't included below. Including it could change things. Having said that, assume:
BR = Billable Rate, $300/hr
F = Full compensation
H = Hours billed
P = Percentage of billable rate, 45%
S = Salary
T= Threshold multiplier, 3.5
F = P*(BR*H - S*T) + S
dF/dS = 1 - P*T. For the numbers given, 1 - 45% * 3.5 = -0.575. In other words, full compensation goes down by 57.5 cents for every dollar salary goes up.
Calculation above is missing the stipulation that F can never be less than S. So, how many billable hours are needed if S = 0 to provide some minimum value of F? When S=0, F = P*BR*H so H = F/(P*BR).
For the numbers given, getting full compensation of $100K when S=0 requires H = 100000 / (45% * 300) = 741 hours.
If I was very confident of billing at least enough hours to meet some minimum full compensation, I'd ask for a salary of $0.
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Thanks for the input everyone.
The 13% is our 401k match which is matched on salary only (not bonus) so more salary = more match. Meaningful, but less impactful than the bonus consideration.
I understand the calculation (I am an actuary after all), I was mostly looking for people's input on the risk/reward tradeoff, to make sure I wan't crazy for wanting to keep salary low. In most situations that you'll see around, salary is preferable to bonus. This is a unique situation. (Unique enough that I didn't really believe them when they brought me on.)
As it is, I probably can't ask for a salary of $0 or even reduce it that much. I won't be asking to increase the salary though. If any year would be the year I'm worried about hitting threshold, it's this one with those big projects coming off this year.
Sorry for not giving all of the pertinent info in the original post. It's hard to give all the relevant details without an even longer post.
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In your shoes, I'd avoid-pursing/try-to-duck-if-offered further raises. I can certainly understand that it'd be unfeasible to try to negotiate for a lower salary.
How much variability, if any, is there in billable rates in your field? Could you push to having your time billed out at a higher hourly rate in lieu of future raises?
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I understand the calculation (I am an actuary after all)...
Ok, didn't realize I was carrying coal to Newcastle. :)
I was mostly looking for people's input on the risk/reward tradeoff, to make sure I wan't crazy for wanting to keep salary low.
Nope, not crazy, just confident. And while I'm in an idiomatic mood, faint heart ne'er won fair lady so good luck!
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I understand the calculation (I am an actuary after all)...
Ok, didn't realize I was carrying coal to Newcastle. :)
Haha, no problem. I was purposely withholding information in case someone I knew/worked with could recognize me. I've given out enough info now that they would though. Might as well come out with it.
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In your shoes, I'd avoid-pursing/try-to-duck-if-offered further raises. I can certainly understand that it'd be unfeasible to try to negotiate for a lower salary.
I think that's the plan right now.
How much variability, if any, is there in billable rates in your field? Could you push to having your time billed out at a higher hourly rate in lieu of future raises?
Certainly. That's a good part about the setup. If I want to negotiate a raise, I don't have to do it in the traditional way that involves asking my boss (the owner) to pay me more. Instead, I have to convince her that the market will pay more for my services. If she agrees and the market agrees (they don't raise a fuss when the bill comes in), I essentially got a raise in the form of a higher billing rate. She benefits too, since the billable rate is higher so that's more revenue per hour.
In fact, I had that conversation a couple weeks ago, and it went well. She agreed with my arguments, and I expect an increase when the rates are finalized in the next few days.
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To follow-up and give you all closure on this issue, the results are in.
I mentioned that I had a discussion to negotiate the billing rate higher. That negotiation was successful. My rate increased by 16%, which is worth about an additional $25k if I bill the same number of hours as this year.
As far as salary, I was given roughly a $12,000-wide range to choose from. My boss and I discussed it. We landed at something towards the bottom end of that range, a bit higher than my current salary. We did this because I wanted to retain that leveraged upside that I'm getting with the higher billing rate, but not all the way at the bottom so we could show some salary progression to the external reviewers for that potential promotion I mentioned earlier.
I feel good about the outcome. It's a pretty big jump overall (or a reduction in time for the same pay, however you want to look at it). Thanks to everyone here who participated and helped me talk through it!