Setting the price of services can be one of the most difficult decisions you make as a business owner. There are numerous challenges in everyday life that equate to business pricing. Let’s say you’re having a yard sale.
How do you price the items at your yard sale? You can look at the original price of the item and decide on a fraction of the original cost, based on the amount of wear and tear on the item.
You can ask friends who have held yard sales how they price similar items. Once you price your items, you may decide to to negotiate on price the day of the sale.
Even though your yard sale will not have an effect on your long-term income, you want to make sure that you price your items appropriately - not too high and not too low. And you may run into situations where a potential customer wants a lower price than you are comfortable with. You’ll have to decide on the spot if you want to accept the lower price or wait for another offer.
The yard sale isn’t your primary source of income, but your business probably is. The price you charge for your services allows you pay your employees, provide a valuable service to your clients, and -hopefully - turn a profit.
You must consider all these factors when setting your price. Many new business owners start out drastically underpricing their services, either for lack of information or out of fear of not getting the sale. If you’ve ever agonized for hours before offering a price to a potential client, only to have them accept it off the bat, you know the stress of finding the right price.
How do you avoid the pitfalls of pricing your services too low or too high? Start by gathering some critical information on your business and the market. There are several questions to answer which will help you determine how to price your services:
What are the costs associated with your business? Take into account all of the costs you incur to run your business. These types of costs are generally broken down into three categories: material costs, labor costs, and overhead costs.
If you manage a lawn care business, your material costs are any of the materials required to perform lawn maintenance - fuel, lawnmowers, tools, leaf bags, protective gear, etc. Labor costs are those associated with any staff you employ, including wages and benefits.
Overhead costs are indirect costs associated with your business, such as rent and utilities for office space, taxes, insurance for your business, marketing, office supplies, etc.
Of the costs associated with your business, which ones are fixed and which are variable? Now that you know all the costs associated with your business, take a look at each cost to determine if it is a fixed or variable cost. Fixed costs are incurred no matter the number of customers you have, such as rent and utilities for office space.
Variable costs increase or decrease based on the number of customers you serve. In the case of the lawn care business, the amount of fuel, number of lawnmowers, tools, leaf bags, and even the number of employees are variable costs based on the number of customers you have.
What are your competitors charging? Another important aspect to consider is what your competitors are charging for similar services. If you are an independent contractor and offer design, development or writing services, you may be able to get in touch with other contractors in your network and ask what they charge.
Other businesses may not be as willing to share pricing with a competitor, but you can find it either by looking on their website or calling and asking for a quote. Consider contacting a number of similar businesses so you have a wide range of price points.
Compare all the benefits of these services to your service, and think about where you want to be on the spectrum. Do you want to position your service as a high-end, expensive service with a lot of added benefits, a no-frills budget service, or somewhere in between?
What is the value of your service to your customers? Knowing all the costs of your business - both fixed and variable - gives you the information you need to charge enough to get to break even. Having an understanding of what the competition charges lets you know what is expected in your industry and in your area, if the cost of your service varies based on location.
The next step is to understand the perceived value of your service to your customer base. Let’s say that based on all the expenses associated with your lawn care business, it costs you $10 each time you mow, edge and blow leaves for a customer, given the customer has committed to service twice per month.
However, your customers believe this service is worth $50 each time you mow, edge and blow leaves off their lawn. Charging less than the perceived value could give the impression that you are cutting corners, or paying your staff less than a fair wage.
You can learn what the perceived value is asking your potential customers what they would pay for your service. You could also offer them a price higher than what you are comfortable with. When you start getting push back on the cost, you know you’ve reached your price ceiling.
What profit margin is appropriate for your industry? Your profit margin is the extra fee you build into your price on top of covering your costs. Profit margins vary widely between industries.
Your realistic profit margin may change, depending on whether you own a coffee shop with high fixed overhead costs or you’re a wedding coordinator with very little overhead. When calculating profit margins, it’s important to focus on net profit margin.
This metric looks at the overall profitability of a business, as it takes total sales minus total expenses and divides by revenue. Do a little research on the profit margins that apply to your industry. This Investopedia article will get you started.
You now have a better understanding about how your business aligns with your competitors and your industry. Before you set your pricing, consider setting your prices slightly higher than you are comfortable with.
Even if you feel that with all the information you have, you are ready to set the optimal price for your services, try pushing it 10, 15, or even 20 percent above your range. Your customers will let you know when you’ve gone too high. And if they don’t? That’s extra money in your business’s bank account - today.
Knowledge is power, so gather as much intelligence as you can to set the optimal price for your services. Look for part 2 of this series next week on how to best structure your fees.