How I Determine Inflation-Based Rate Adjustments

An AI image generated by DreamStudio with the prompt "A dream of invoices and paperwork". Featuring a coffee cup and some forms on a wooden table top.

Back in 2014 I read a handful of business books and one of them had some excellent advice around price increases for small businesses. It may have been Street Smarts: An All-Purpose Tool Kit for Entrepreneurs by Norm Brodsky and Bo Burlingham. It was a long time ago so while I’d like to give credit where it’s due, I’m a bit uncertain of which book it was.

I remember clearly what I learned though. It talked specifically about how if one leaves their prices the same for five or ten years, due to inflation they are basically earning considerably less after a while. Enough so that their business may start to become insolvent. This was a book for small business owners, many of whom may not really be aware of such issues (at least when inflation is relatively low).

A business that hasn’t raised their prices in ten years is then in the unfortunate position of needing to raise their prices a lot to make up for not having done so for so long. This is a change that is difficult for the business to implement and also difficult for customers to adjust to. No customer wants to be faced with a 50% increase that becomes necessary when a business owner finally figures out that inflation has had such an impact over a long period.

The book suggested small price increases every year or two to keep up with inflation and avoid this issue.

Fast forward to 2022 and the inflation issue is one that most small business owners are almost certainly very aware of. For that matter, price increases have not escaped anyone’s attention recently.

I would like to share in a transparent, open, some-what geeky way what my approach to this is in case it is of interest to my clients or other business owners or freelancers.

Maintaining a constant relative earning power

My goal with my rate increases is just to make sure that I am maintaining a constant relative earning power. My services are valuable and if I’m not keeping up with inflation I’m basically earning less each year.

I really just want to keep my rates flat, but in order to do that the reality is that I have to account for the fact that a dollar today is not the same as a dollar ten years ago or ten years from now.

My benchmark – The Consumer Price Index for All Urban Consumers

If, for example, I had a gas station, my prices would necessarily reflect the specific fluctuations in the price of gas.

However my business is service-based. While I have a few expenses, I work hard to keep them very low. Primarily my rates go to pay my own salary (after taking out lots of money for the government in the form of gross receipts tax, self-employment tax, etc.). The important thing is that I am able to support my family.

So my benchmark for rate changes is the Consumer Price Index for All Urban Consumers (CPI-U) generated by the U.S. Bureau of Labor Statistics. This is one of the standard measurements for general inflation rates in the United States.

My rate formula

The baseline is an hourly rate of $120 for 2022. The increase for each year is calculated using the prior year’s inflation number. This is because it’s the last year with complete data when I am announcing new rates and I like to give clients advanced notice. For example my 2023 rate is calculated with an increase for inflation using the inflation rate for January 2021 to January 2022 so that I can announce changes in 2022.

Using the prior year’s number means that I’m a little behind the changes, but I don’t need to track inflation exactly. I just need to make sure that over the long run my earning power isn’t going down significantly.

I then round this number to the nearest increment of $5 just to make it easier to work with. The rounded number is used for the new rate. (I use the number from before rounding the following year for the next adjustment.)

For example inflation in 2021 was 7.5% ( $120*1.075= $129. This rounds up to $130 so rates for 2023 are $130. For calculating 2024 rates I’ll start with $129 and use the inflation rate for 2022.

Increasing the value I provide

At the same time, I am also absolutely obsessed with increasing my own skill-set and knowledge level. While I adjust rates based on inflation, I’m not at this point raising rates based on my services becoming more valuable.

Each year I know that what I provide to clients is actually a better value to them than the year before.

Note: The image from this post was AI generated using DreamStudio, which is too much fun to play around with. Here were a few of the alternatives too. I particularly like the coffee cup with two handles.