How to Price Business Services.

The main reason you went into business selling services to customers was to make a profit. If you were giving away your services for less than cost, or just breaking even, you'd be operating a non-profit venture or a business that's likely to fail. There are a variety of components that factor into whether or not a business is profitable, including location, leadership, market demand, competition, and so on. But one of the most important decisions you need to make to determine whether you turn a profit or not is how to price your services.

Service businesses can range from a sole proprietorship consultancy to mid-sized businesses with several hundred employees, some of whom go out to customers and perform anything from cleaning homes to providing information technology expertise to large corporations. Get your pricing strategy for these services wrong and you will create a problem you may never overcome. Get it right and you will dramatically increase the likelihood of creating a business that perseveres and takes care of you financially.

The bottom line is that pricing is extraordinarily important. Doesn't matter whether you're putting out a novel you've written or providing a service through a pest control company or you're a veterinarian.

Pricing Your Services.

The good news is you have a great deal of flexibility in how you set your prices. The bad news is there is no surefire, formula-based approach you can pull off the shelf and apply in your business. Pricing services is more difficult than pricing products because you can often pinpoint the cost of making a physical product but it's more subjective to calculate the worth of your counsel, your staff's expertise, and the value of your time. You can, however, use some of the same underlying pricing guidelines to figure out your costs and operating expenses plus your target profit in setting your price for services.

Factors to consider in pricing.

When pricing services, there is a bit more leeway than pricing products. "The price of a product is more objective. The price of a service is more subjective so that there is a gray area," Toftoy says. "Pricing is both an art and a science." Here are the factors that experts say you should consider when trying to determine what price to charge for a service:

• Cost-plus pricing. This standard method of pricing in business seeks to first determine the cost of making a product or, in this case, providing a service, and then add an additional amount to represent the desired profit. To determine the cost, you need to figure out direct costs, indirect costs, and fixed costs. "With the cost-plus approach, the thing to remember is that if you're paying someone 1000 shillings an hour, you may think you should charge 1000 shillings an hour for the service they provide, but you have to factor in all your costs. Those costs include a portion of your rent, utilities, administrative costs, and other general overhead costs. When you make a deal to sell a service, you have to make sure to cover all your costs.
• Competitors' pricing. You need to be aware of what competitors are charging for similar services in the marketplace. This information could come from competitor websites, phone calls, talking to friends and associates who have used a competitor's services, published data, etc. I don't think it's a good idea for any entrepreneur to compete on price if you can avoid it. Compete on service, ambiance, or other factors that set you apart. If you have to compete on price to win a customer, you may ask yourself whether that customer will be loyal to you if they find someone offering a service at a lower price. You want to establish long-term relationships in the marketplace. You need to convince the customer that you are giving them tremendous value in terms of service and quality. However, you still need to know what your competitor is charging.?
• Perceived value to the customer. This is where a lot of the subjectivity comes in when setting a price for a service. When you have a product, you may decide to use keystone pricing, which generally takes the wholesale cost and doubles it to come up with a price to charge and account for your profit. With a service, you can't necessarily do that. To your customer, the important factor in determining how much they are willing to pay for a service may not be how much time you spent providing the service, but ultimately what the perceived value of that service and your expertise is to them. That is where pricing becomes more of an art form.

Calculating your costs.

Before you set a price for the services your company will provide, you need to understand the costs of providing these services to customers. The cost of producing any service is made up of the following three parts:

• Materials cost. These are the costs of goods you use in providing the service. A cleaning business would need to factor in the costs of paper towels, cleaning solutions, rubber gloves, etc. An auto repair business would tally up the cost of supplies, such as brake pads or spark plug, which are being installed by service people. You may want to include the material list with your estimate in bidding for a job.
• Labor cost. This is the cost of direct labor you hire to provide a service. This would be the daily wages of your cleaning crew and/or a portion of your mechanic's salary and benefits while they were providing the service for your customer.?
• Overhead costs. These are the indirect costs to your business in providing services to customers. Examples include labor for other people who run the firm, whether administrative assistants or human resources personnel. Other overhead costs include your monthly rent, taxes, insurance, depreciation, advertising, office supplies, utilities, mileage, etc. A reasonable amount of these overhead costs should be billed to each service performed, whether at an hourly rate or a percentage. One important thing to note: don't just depend on figures from last year to determine your overhead costs. You need to charge customers rates that cover your current costs, including higher salaries to employees, inflation, etc.

Determining a fair profit margin

Once you determine your costs, you need to mark up your services to ensure that you achieve a profit for your business. This is a delicate balance. You want to ensure that you achieve a desirable profit margin, but at the same time, particularly in a down economy, you want to make sure that your business doesn't get a reputation for overcharging for services. Look for resources in your industry, such as the annual statement studies on small and mid-sized business financial benchmarks from Risk Management Associates, to help you determine whether your profit margin is on target. The net profit margin for a specific industry might be 5 percent, so if I'm sitting on 2 percent I need to come up a bit. I need to sell services, give value, and make sure the firm runs a fair rate of return.

?Different Pricing Models.

Now that you understand what it costs you to provide a service, what your competitors are charging, and how customers perceive the value of your services, it's time to figure out whether to charge an hourly rate, a per-project rate or try to negotiate a retainer for your services. This may be predetermined by your industry and the type of service pricing that predominates in your sector. For example, lawyers tend to charge hourly rates for their services, although those rates can vary. Many construction firms charge a project fee and require that one-third be paid upfront, another third be paid at the halfway point, and the remaining third be paid upon completion.

?Here are some benefits and risks associated with the following pricing models:

• Charging an hourly rate. For many businesses, pricing services on an hourly rate is preferred. This ensures that you are achieving a rate of return on the actual time and labor you invest in servicing each customer. Hourly rates are often used when you are pricing your own consulting services, instead of pricing a service that uses labor and materials from others. Your rate should be determined by your amount of expertise and seniority; a more senior consultant will generally be paid a higher hourly rate than a less experienced or junior consultant. One's travel time should be included as an extra charge. Sometimes even consultants are asked to price a service on a project or contract basis. That contract needs to factor in clerical support, computer or other services, and overhead expenses.?
• Charging a flat fee. In tough economic times, many businesses are concerned about keeping costs down and may agree to hire your business for services only on a fixed-rate or flat-fee basis. Customers want a fixed rate, Entrepreneurs want an hourly rate. It's a question of who is going to bear the risk. If I charge a flat rate, I am bearing the risk. If a project takes longer than expected to complete, you may risk losing money on the client. If you have a customer that insists on a flat fee, you may want to see if they are amenable to putting a cap on the number of hours involved in the project or agree to pay additional fees if the project runs over that time.
• Variable pricing. In addition to determining a fair price for your services, you have to determine whether you will practice a fixed-price policy and charge all your customers the same amount or whether you want to institute variable pricing, in which bargaining and negotiation help set the price for each customer. Should you charge different customers different rates? I have a hard time with that. The exception is if someone comes in and says that they will book 1,000 hours of time, you may want to give them a price break for quantity. But in general, charging different prices to different customers will create ill will. People will talk about it and they will find out. One thing a business can not afford to lose is its integrity and respect among customers.

Monitoring and Changing Your Price.

In a service business, your biggest costs are usually your people costs; salaries, benefits, etc. If you are having a hard time selling services at an acceptable profit, the problem may be that your employee costs are too high rather than the price is too low. You may want to also re-evaluate your overhead costs to determine whether there are other cuts you can make to bring your price down and your profit margin up. Look at your expenses and see where you can make the cuts.

?Monitor profitability monthly

You need to understand the profitability of your company every month. By the 15th of every month, you ought to have your financial statements from the previous month. If there is any mistake I see entrepreneurs make, it's that they don't spend enough time going over their financial statements. In some cases, no one has ever shown them how to do that. I see their eyes glaze over. In addition to understanding your monthly profitability, you need to understand the profitability (or lack of profitability) of every service you sell. Make absolutely sure you know the degree to which every person or project you sell is contributing to your goal of making money each month.

?Test the market for new services and prices

You should always be testing new prices, new offers, and new combinations of benefits and premiums to help you sell more of your services at a better and better price. Often the perfect time to do this is when quoting a price to a new customer. Raise the price and offer a new and unique bonus or special service for the customer. Measure the increase or decrease in the volume of services you sell and the total gross profit dollars you generate.

?Be wise about raising your prices

It's a fact of life that you will have to raise prices from time to time as part of managing your business prudently. If you never raise your prices, you won't in business for long. You have to constantly monitor your price and your costs so that you are both competitive in the market and that you make the kind of money you deserve to make in your business. But there are risks to raising prices, particularly when your customers are going through tough financial times. You can price too high and sell yourself out. People don't forget that they felt like you gouged them for the quality of the service you were selling.

Here are some guidelines for when and how to raise prices:

• Do raise prices when your competitors are raising prices. If the competition has upped the ante, that is a good signal that the market can and will support a price increase for your services, too.
• Do raise prices if your customers say you're a bargain. If your customers start commenting about what a great value your services are, that may be an indication you're charging too low a price.
• Don't raise prices too much all at once. In a tough economy, a big jump in prices might be too much of a jolt for your customers. Instead, raise prices in small increments of two or three price increases over the course of a year.
• Don't raise prices across the board. Do be discreet. Customers may not notice price increases if they are only for certain services and not for others. For example, a dentist can raise the price on fillings but not cleanings, a strategy that brings no customer complaints. You need to raise prices in today's economy where you think your customer can't see there has been an increase.

The bottom line is: You owe it to yourself and to your business to be relentless in managing your pricing strategy. Remember, how you set the price of the services you sell could be the difference between the success or failure of your business.

Let’s talk more about how we can scale your Service-based business!