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Are you valuing the services you provide properly?
Starting a business involves much more than coming up with a great idea. You’ll need to understand marketing, financing, customer service and more. However, pricing your offerings optimally is a crucial factor many small business owners don’t consider enough.
Pricing services is more challenging than pricing products. Service pricing is more subjective and harder to compare against similar services. Service quality and scope vary widely depending on employee training, attitude, expertise and company culture. Perceived quality is another factor affected by marketing, business reputation and more.
We’ll explain what’s involved in setting prices for your services and share tactics for pricing your services optimally to attract and retain customers.
Factors like production expenses, distribution costs and other elements influence product pricing. Service pricing, however, is a lot more nuanced and needs some careful consideration. [Related article: Expanding Distribution Channels]
“Pricing is a mix of art and science,” according to Blair Enns, author and CEO of Win Without Pitching. “For customized service firms — where each engagement is a blank slate of possibilities — it’s mostly art. For productized services, which are intended to scale to many clients or customers, there’s more science in the form of competitive analysis and audience segmentation.”
With service pricing, you should focus on the value your work delivers to the client rather than other factors such as time spent or deliverables.
Enns states that, “You should let go of the idea that any service, like designing a PowerPoint presentation, costs $X. Price the client, not the job. And base that price on value, not inputs or outputs. It’s messier than counting hours or number of slides, but it’s far more lucrative and it moves your focus from your costs to creating for your client. It’s a win-win.”
Not all clients receive the same value for the work you do for them. Some customers find the impact more beneficial than others.
For example, say your company creates PowerPoint presentations for clients, customizing them for each of their unique needs. “Different clients will and should pay different prices based on the value of that PowerPoint design to the client,” said Enns. “For example, a PowerPoint presentation for a solopreneur small business coach that would be used to pitch new clients should be priced differently than a presentation the CEO of Microsoft would use to pitch a new strategic vision to the board of directors.”
Since the presentations have specific goals that generate different outcomes, the price should reflect that rather than focus on the similarity of the service.
Ample resources are available to help business owners or service providers determine their prices. The Small Business Association offers some tips for business owners seeking to price their services fairly and accurately.
When pricing your services, consider inherent business costs. Your gross profit margin is the percentage of cash that’s left over after accounting for your material costs, overhead costs and labor costs.
Labor costs include salaries and employee benefits you provide to employees or subcontractors who perform, supervise or manage your service business. Labor costs will be higher during startup because you’ll put extensive time and energy into building the business.
To illustrate how gross profit margin affects pricing, let’s consider an example from the advertising industry. The average gross profit margin for an advertising business is 26.2 percent, according to Polymer. So, for every dollar you charge to your customer, there’s about 26 cents left over after accounting for your direct cost.
Let’s suppose that you wanted to make $10,000 a month in profit, your fixed monthly costs (the costs you’ll incur unrelated to sales) are $3,000 and you had enough work booked so you could bill 40 hours a week. At a gross margin of 26.2 percent, you’d need to charge $286.26 per hour. If you wanted to make that profit on 20 hours of billable work, you’d need to charge $572.52 per hour. [Related article: What are fixed and variable expenses?]
To apply this calculation to your own service business, take the following three steps:
Making sufficient levels of profit is key to running any business successfully because it provides you with the cash you need to invest to grow and a shield for periods when revenues are lower. [Related article: Net income vs. profit]
To keep your business competitive, conduct research to discover what your rivals are charging. Understanding competitors’ pricing can help you gauge what people are willing to pay for similar services.
Examine your competitors’ front-end, back-end and tiered pricing models. If you offer various packages, each level should carry a unique price compatible with the work involved.
You know what minimum gross margin you want to make and what your competitors are charging. That shouldn’t stop you from asking for more, though. The worst that can happen is that people won’t pay it, and you can lower your prices or negotiate with clients.
When striking the right price point balance for your services, consider the following:
During times of high inflation, you may need to raise your prices because your costs have increased. However, if costs have remained the same, you must decide whether to raise prices and make more profit or keep them the same — and keep more of your customers.
In an inflationary economy, if your customers are price-sensitive, consider keeping prices at or near the same. If customers are not price sensitive or there’s no close competition, consider raising prices to maximize profit.
The first rule of pricing is that it’s much easier to lower prices than it is to raise prices.
Many service providers often charge less than they want, especially when starting out, to generate revenue, build brand awareness and gather testimonials. If you want to raise your rates, some customers won’t stand for it. Then, it’s up to you whether you wish to continue servicing them for the price they’re used to paying or ditch them as you seek to improve profitability.
Either way, here are tips used by sales reps to explain the prices they charge to clients:
Consider the following standard pricing strategies when determining your service pricing structure:
Mark Fairlie contributed to this article. Source interviews were conducted for a previous version of this article.