How to Set a Price for Your Service

What to know about setting a price for your services

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.”

Price the client, not the job

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.”

Set different prices for different clients

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.

How to price your services

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. 

1. Set a profit margin that works for you.

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:

• Add how much you want to make each month to your fixed costs
• Divide the total by your gross profit margin
• Then divide that figure by the number of hours you can bill in the month

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]

2. See what your competitors charge for their services.

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.

3. Price your services higher than you expected — but not too high.

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: 

• Quoting too low risks profits: When starting out, you might quote your services too low because you don’t have the experience and history in the business to know what to charge. However, if you quote too low, you risk missing out on profits. You may even have to sacrifice your work quality to meet your price.
• Quoting too high can lose customers: If you quote too high, you risk losing the contract or client. This risk is higher if your service is in a competitive area and customers have multiple options. If lower-priced services have similar perceived quality, your target audience will opt for them unless you lower your prices or increase your service’s perceived quality. 

4. Consider inflation when pricing your services.

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.

Justifying the value of your services to clients

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:

• Promote results: Instead of telling a client that you’ll work on their project for 40 hours, tell them that the work done will increase visitors to their website by 20 percent.
• Side-by-side numbers: Whenever you send out a quote, juxtapose the price of the quote with an estimated return on investment. On the left side, they’ll see your price and on the right side, the possible outcome of your work. They’ll do the math themselves.
• Prove your experience: This is harder when you’re starting out but try to have real-world examples of the benefits you’ve delivered to other clients, especially if you have case studies of customers that are relevant to the client you’re pitching.
• Show off your USP: Highlight what makes you different from your competitors and how that will benefit the client. That could be your experience, the system you use or the ongoing and follow-up support you offer.
• You vs. the rest: If you know who you’re up against on a quote, create a table that shows how the service you offer is better than your competitors. Help the potential client to understand where your service excels and the costs of choosing someone else. [Related article: 7 Surefire Strategies to Help You Stand Out From the Competition]
• Make your pitch specific: Spend time creating documents and presentations that answer in detail how your service addresses every pain point the customer experiences to make your solution stand out.

Types of pricing strategies to consider

Consider the following standard pricing strategies when determining your service pricing structure: 

• Dynamic pricing: Dynamic pricing is the type of pricing described earlier in this article where the cost to the customer is determined by the perceived value you deliver.
• Penetration pricing: Penetration pricing involves setting a price artificially low to gain market share and then raising the price.
• Tiered pricing: Commonly used by many business software vendors, customers unlock extra features and allowances the higher the subscription they choose.
• Price skimming: Price skimming is setting a higher price because you have some sort of competitive advantage.
• Cost-plus pricing: Common in facilities management contracts, cost-plus pricing adds a percentage rate onto the unit cost of a service (for example, the hourly pay of a cleaner and the equipment they use).
• Retainer pricing: This is when a company charges a fixed fee (normally monthly) for access to a given service every month. This method of charging is popular with human resources and law firms and you charge even if your client doesn’t use the service in a billing period.
• Hourly pricing: Hourly pricing is charging a fixed hourly rate, so the amount the customer pays depends on how much work was done. It can protect your company from low margins due to excessive customer requests for changes.
• Economy pricing: Economy pricing means keeping all costs to a minimum to give customers the best price.
• Hourly billing: Hourly billing is common among freelancers and contractors who charge for the time they spend on a particular project.
• Psychological pricing: Psychological pricing is designed to make customers respond emotionally instead of rationally.
• Promotional pricing: Promotional pricing involves discounting the cost of a service, often for a limited period of time.
• Product line pricing: Product line pricing means setting progressively high prices for various products.
• Optional product pricing: Optional product pricing involves getting customers to upgrade and spend more on other products or services you offer as an optional add-on. This model involves upselling and cross-selling. 

Mark Fairlie contributed to this article. Source interviews were conducted for a previous version of this article.