Pricing applies not only to a start-up, but also to well established businesses, especially those in lower margin, highly competitive industries. The common theme with most pricing issues is risk: risk setting prices too high and you may push potential customers away; risk setting prices too low and you cut profits.
This “pricing paradox” drives most owners to default to discounting. However, risk in most cases can be eliminated by getting better information. Generally, the more you know the less risk you perceive. From that perspective, pricing is all about getting as much information as you can about your market, your customers and your own internal numbers that drive your profit.
How should you set fees or prices for your service business?
Procedures depend upon the business, but the same three elements must be considered for every service business:
- Labour and material costs
- Overheads
- Profit
These factors must be considered not only during start-up but also during growth.
Labour and Materials
Labour costs are wages and benefits you pay to employees and/or subcontractors who perform, supervise or manage your service business. If you as the owner are involved in a job, then include the cost of your labour in the total labour charge. The cost of your labour will be quite significant during start-up, when most new business owners pour lots of time and energy into their businesses.
Labour costs are usually expressed as an hourly rate. Check in your library’s reference room for government publications giving national and local salary ranges for different occupations. The editors of trade publications may also have similar information. Current rates are often cited in classified newspaper ads or may be available from your local chamber of commerce.
Labour can also be subcontracted – such workers are not on the payroll as employees. When labour is purchased for each job on a contract basis, the full cost is agreed upon in advance, which helps keep your costs fixed. The key is to carefully estimate the labour time it will take to accomplish each job on which you bid.
Profit
Profit is the amount of income earned after all costs for providing the service have been met. When calculating the price of a service, profit is applied in the same number as mark-up on the cost of a product.
For instance, if your labour costs for a job are R210, and you plan to net 21 percent before taxes on your gross sales, you’ll need to apply a profit factor of about 25 percent to your labour and overheads to achieve your goal. For example, say you have an operating costs’ subtotal of R324 and you want a profit of R81 – in this case, you quote the customer a price of R405.
If you compare the price of R405 with the cost of labour (R210) already estimated, you’ll notice that one figure is more than double the other. Some contractors use this ratio as a basis for determining price: they estimate their labour costs and then double that figure to arrive at a bid price. Pricing can be time-consuming, especially if you don’t have a knack for it.
Some contractors seem to have a sixth sense when it comes to pricing, and they “guesstimate” on what they need to quote to make a job profitable to them. If you’re just starting out, you obviously won’t have the skill of a seasoned professional.
If your quote is too low, you’ll either rob yourself of profits or be forced to lower the quality of your work to meet the price. If you estimate too high, you may lose a contract, especially if you’re in a competitive bidding situation. Make it your business to learn how to estimate labour time accurately and how to calculate your overheads properly so that when you quote a price, you can be competitive, profitable and successful as a service business.
How to increase prices without losing customers?
Are your prices currently more or less the same as your competitors? If so, you will need to add additional value in order to just increase your prices. Up sell current customers by improving your level of service or by adding a new service/product that will appeal to them.
You can also just continue offering your current service at the old rate but begin to phase it out as you move customers begin to change over to more profitable services.