If you work for yourself or dream of working for yourself, I'm sure one of the motivating factors is to make a profit. Making a profit can depend on a lot of different factors. Some of those factors are outside of your control like the market and the competition. Then there are other factors where you have a bit of control on how you can move the needle like leadership, management, where to locate your business, the number of locations and pricing. Pricing is one of the most important factors that have a direct impact on your profit. Pricing is how much you charge for your service.
Service businesses vary from giant law firms with lawyers billing by the hour to small and scrappy IT firms who send consultants out to help solve people's tech problems. A pricing strategy is just that - a strategy and an extraordinarily important one. If you don't approach it as such, you might fumble around trying to figure out how much to charge. If you fumble long enough, you risk never recovering from it. Regardless of your industry, product or service, pricing can make or break the longevity and health of your business.
I know you care about the longevity of your business. I've never met anyone who has said, "Yeah, I want to start a little business and then slowly watch it fizzle out into nothing." Everybody building a business wants to see it grow. Let's dig into pricing 101.
Step 1. Calculate Your Costs
Whatever pricing strategy you plan to use, before you set your prices, you should figure out what your costs are. Having an understanding of your costs allows you to operate from a place of knowing. There are three types of costs to look at: the cost of materials, labor and overhead.
These are the costs that are required to provide the service. For example, Jason Markk's shoe cleaning service has material costs of the cleaning supplies they use to provide their service. Figure out how much material costs you incur for each client, customer or project.
This is the cost of the employees you hire to deliver your service. A yoga studio provides the classes as a service and the staff who runs the studio and teachers who teach the classes are all a part of the labor costs. If you're a solo shop, your hourly rate is your labor cost.
Overhead costs are the indirect costs you have running your service business. Here are some examples: office rent, liability insurance, office supplies, the utilities cost at your office, the cost of your administrative assistant, your accountant, bookkeeper and all your marketing. Most businesses have a lot of similar overhead costs, but it will depend on what service you're providing and how you run your business.
Your overhead costs need to be considered because your revenue is what you need to earn to keep your business running. If you can't make enough money to pay all the bills to keep the business machine running, the business machine will stop running! When determining your price, try your best to use current and accurate figures. I know, I know, it can be tough because overhead can change rapidly when you're company is growing. You might always be working with slightly imperfect information. If that's you, then you'll need to factor that in.
Figure out what your monthly overhead is. How many clients or customers or projects do you take on each month? If each job you did or customer you served help pay for your overhead, how much would you need to add onto your price to cover your overhead? Is it realistic? Maybe you need to take on more customers or jobs or lower your overhead?
Step 2. Considerations with Pricing
There is a lot of flexibility in how you set your prices. The downside to this flexibility is that there isn't an out-of-the-box solution or formula that you can apply to pricing in your business. Pricing products is often a function of the cost to create and manufacture the product, but with pricing services it's much more nebulous. How do you put a price on someone's past experiences? What do you bill for the mistakes you made in the past that gave you the knowledge you have today?
Even though pricing is a gray area, we can still use some of the same principles of costs, expenses and the desired profit to try to back into a price. I touched on it a bit earlier. Pricing equal parts art and science. It's the ultimate negotiation between theory and practice. And it tests the intersection of lots of different things within your business like the market you're in, the market's perception of the value you're providing and your ability to communicate that value.
The Competition's Pricing
You should know what the going rate is for a similar service. Do some research online, reach out to the competition yourself or speak to people you know who might use the service you provide. If the differentiator in your service relative to your competition is that you're a cheaper alternative, know that you're competing on price.
Competing on price is tough because you'll be sensitive to your costs. If your value is that you're cheaper, you'll need to stay competitive with labor, material and overhead costs. And as the saying goes, you get what you pay for. If there is a tech startup offering your same service with a piece of technology behind it that you don't have, chances are the many millions of dollars they've raised will allow them to offer their service (with the technology) at a cheaper price than you can and you might really want to reconsider competing on price.
Even if you don't plan on competing with price, you should still know the competition's pricing. Because when you charge more than a competitor, you'll need to communicate why you charge higher prices. Are you extraordinarily focused on results and you have a proven track record of said results? Do you create a customer experience in an industry that has never considered creating a customer experience? What value are you giving to the customer that justifies your higher prices?
No matter what pricing strategy you use, it's should be based on this. The price can be your hourly wage or the hourly wage of an employee or contractor. As mentioned above, when setting your price, you can't just charge the cost of the hourly rate. If it's an employee who you pay $15/hour, you have to also include the costs of running your business. If you're charging for your time, you still have to bake in all the other costs you incur running your business.
The beauty of cost-plus pricing, in theory, is it's relative simplicity. You can figure out your costs, then determine what you'd like your profit to be and back into a price in that way. Make sure to consider industry standards for profits and make sure the value you provide is aligned with the profit you seek to make.
The Customer's Perception of Value
You already understand the price a customer pays is not just a function of how much time and effort that was put into a service. Customers and clients are willing to pay a price based on their perception of the value you provide. That means if they perceive you to be an expert or that it's a privilege to work with you because you're one of the best in the industry, they'll pay higher fees because of how they perceive you.
Let's take two examples of yoga instructors. First there is Tad McYogabooty. Tad teaches at your local yoga studio. Tad has helped celebrities implement a life-changing yoga practice in their lives, he puts out a weekly video tip and each week the tip is something valuable that helps improve your life. Tad regularly partners with Lululemon for web content or in person classes. Tad's stock might start to rise in your eyes because he's doing things that help you get to know him, like him and trust him. You have this perception about the value of Tad's services based on these things you're observing.
Now let's look at Jamie F. Magillicutty. Jamie also teaches yoga at your local studio. He comes in and does a pretty good job during his group sessions. But Jamie doesn't go out of his way to demonstrate his value other than during class. He doesn't do video tips, he doesn't do any brand partnerships and if he does help clients 1:1, he has never communicated that. Jamie is content with being a yoga instructor that teaches at the studio.
If you saw that Tad and Jamie were both offering private yoga sessions and Tad charged $200/hour, you might not think it's too crazy given how you see Tad. You know he's good because you've gone to his classes, but you've also seen through his videos, that he has a lot of value to offer. If Jamie were to charge $200/hour, you might feel like he is charging more than the value he is delivering compared to Tad. No disrespect to Jamie, but if you're going to be entrepreneurial and charge high fees, there's a lot of work that goes into communicating to your potential customers so that you can charge that fee.
This long-winded example is just to demonstrate not only the power of marketing, but the art in pricing and how it hinges on how your customer perceives the value you are delivering.
Step 3. Choose a Pricing Model
There are classic pricing models. They are the hourly rate, the flat rate and the retainer fee. Some industries, like events and interior design, have other pricing models that include a markup in addition to a classic pricing model. Make sure to do your research on what is an industry standard. If you are working as an employee now, but one day you want to run your own business, take this time to learn the business as best you can. Get paid to learn. What's the pricing model this company is using? What other pricing models are there? How many different revenue streams are there? What are the challenges you're seeing with the pricing model?
The Hourly Rate
There are instances when an hourly rate works really well. Most freelancers start out pricing this way because it's simple and straightforward. If you're charging a high enough hourly rate to cover your costs and you're working with the type of clients who can afford your rate and value your work, you're probably in a really good place. The hourly rate is working for you.
If you've become really efficient at what you do, the hourly rate might not be great for you. For example, if you're a web designer and you have a client who wants a new, simple website. She sends you all the materials you need, you charge $80/hour and you're so quick that you complete it in 2 hours. You make $160. Maybe that doesn't seem right because the value you're providing is worth more like $500 based on the quality, your experience and how it helps her generate revenue for her business. It doesn't matter that it only took you two hours. If this is where you're at, you might want to consider flat rate.
The Flat Rate / Project Rate
The flat rate could work for you if you're good at delivering projects quickly and efficiently and can manage your client's expectations of the deliverables. A flat rate could mean you work less hours and earn more money as long as you deliver the result the client wants. If you have a client who also wants to know exactly how much they'll be spending, in other words, the client wants price certainty, the flat rate is a great way to go.
There is risk though. If a project takes more time than you expected or you need to outsource a part of your project to a contractor, you might end up losing some of your profit on the project.
Charging different clients different prices can be tricky if you don't know how to communicate why your prices have changed. If you're trying to increase your rates, usually newer clients can understand an increase in price as your business grows, or you offer new or different services.
Sometimes you might charge different rates to different clients, especially if you charge on a sliding scale. For example, a therapist might charge clients based on how much their client's insurance covers and how much money the client earns. I would hope clients are sympathetic to this pricing model because the method of pricing is uniform.
Test New Prices
The price of a product or service or commodity is determined by whether or not someone will pay it. That's all the market price is. It's really that simple. If a house goes on the market at a price, an offer can made that is below or above the asking price. Whatever the house sells at, that's the price. The price is the overlap of what both the seller is willing to accept and the buyer is willing to offer.
You need to raise your rates if you're providing a lot more value to your clients then you're getting in the form of compensation. It needs to be mutually beneficial. If with each job, you learn how to be better and you deliver more value because you're constantly learning, you need to consider how and when you'll raise your rates. You may need to raise your rates now if your costs have gone up or you're killing yourself working lots of hours, but still not making enough to get by and you're risking the quality of your work suffering by taking on too much.
If that sounds like you, it's time to raise your rates. I know, you're scared. I know, "What if the client pushes back?," you ask. Well, then they push back and you tell them why you're charging what you're charging. Tell them the value you're providing, how you're always learning how to provide more value with each job you take on. Tell them how you're running a business and that you need to earn a rate that allows you to produce only great work to them.
If you are the cheap option, your clients will tell all their cheap friends to hire you and you'll stay the cheap option. If you're competing on price and you want to stay the affordable option, because you can, then be the cheap option as long as that is your intention. But don't be the cheap option because you think you don't have another way to compete. Figure out if you need to add more value to justify your prices. Then start doing it.
So if your'e reading this and feeling uncomfortable because it sounds like I'm speaking right at you, it's because I am. You knew this entrepreneurial thing meant never staying in your comfort zone, right? Go on and deliver excellent value and receive the appropriate value in return.