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Determining the right pricing strategy is a challenging endeavor that requires the person determining the price of the good or service to have the know-how of associated costs, market demand/supply, competitors' offerings, customers, and more.
The way you price a service - to some degree - determines how customers perceive you, and consequently, where in the market you position your business. More importantly, pricing may well be a determining factor in the success and longevity of your business.
As such, taking the time to figure out your pricing is an essential first step that every business owner must take. In the case that you're already established as a business, a pricing strategy can help you build offers to increase demand while maintaining a healthy profit margin.
In this post, we will limit our study to strategies of pricing a service business. To start off, pricing service is dependent on a number of factors, time being the most important. The more time-consuming these jobs are, the higher the price and vice versa. The rarer the skill needed to complete the job, the higher the price per employee, and thus, the higher the price of the service.
But, how do you determine how much your time is worth? There is no easy answer to this question. In most cases, businesses have to go through trial and error to determine the value of their time - which is why we have timesheets, time tracking technology, and more. The ultimate goal is to keep note of the time taken towards a job. Ok, but how EXACTLY can time tracking help me with pricing?
Why is pricing services so hard?
Most service businesses struggle to determine a price that’s right for the market, and at the same time profitable for the business. As such, let’s first focus our attention on how you can set the right price for your service.
Unlike pricing a product, the costs associated with a service are unknown, difficult to quantity, easy to miss, and thus, making the pricing endeavor challenging for the business.
What we’re saying is that the amount you can charge a customer is not fixed. You could be charging one customer $30/hour for painting a house, and another $35/hour for a service that’s similar, if not the same. The reasoning behind these decisions comes from the fact that they are not aware of the real costs associated with offering their service - and, thus usually resort to estimated margins as a key determinant of price.
The problem with a one-size-fits-all pricing model is that not all channels will respond uniformly and the opportunity to earn greater total profit will diminish.
In short, pricing services is a tricky business. So, how can you make the pricing work in your favor? You need the right pricing strategy dedicated to service businesses.
How to price a service: A step-by-step guide
As previously mentioned, there is one size fits all pricing strategy; however, everyone will find something that is useful for their case.
Calculate your costs
Look at the market
Know your customers
Consider time invested
Come up with a fair profit margin
Charge an hourly or per-project rate
The starting point of any pricing strategy is its cost. Knowing your costs will help you determine how much revenue is needed to generate a break-even point - or the point where revenues from a service equal the costs of providing the same service.
Calculating costs
Costs are broken down into two categories: (1) Direct, and (2) Indirect costs. Adding them up will give you an estimate of the money needed to cover the delivery of the service.
Let’s refer back to the painting business to give more context into the nature of these costs.
Direct costs include all costs that are directly related to the service, including:
Direct materials: sprayers, paint brushes;
Direct labor: Employee Salaries assigned towards the project;
Manufacturing supplies: Flow coating, caulking, painter's tape, joint compound
💡Bonus Tip:
If you have an integrated time tracking tool like Atto, then calculating the exact costs of direct labor becomes a breeze. Assuming the tool is used regularly, you should have enough data to know how long it takes to offer a particular service. After that, you follow the following 3 steps to get the value of your direct labor:
1. Divide the value of salaries, benefits, and taxes by the total hours worked during a period to calculate the hourly pay rate.
2. Divide the total number of delivered services during the same period (let’s say a month) by the exact number of labor hours - you’ll end up with an average of how many hours are required to deliver that particular service.
3. Multiply the labor hourly rate by the total time needed to offer the service and you should end up with the labor cost per unit.
Indirect costs - also known as overhead costs - include all costs that can’t be tracked towards one specific service. These are essential to keep the business running and are not always factored in deriving the true cost of the service. Overhead includes:
Rent
Utilities: Electricity, Water, Heating, and more.
Equipment and maintenance
Insurance
Indirect labor (e.g., sales, HR, marketing staff)
Marketing and advertising
Study the market
Every competitor follows a unique pricing strategy that they believe helps them scale their business. On that note, you need to determine what works best for you; however, ignoring competitors, market cues, and other external market factors won’t help you break through the noise in your industry.
Therefore, we recommend conducting ‘homemade’ market research to determine which competitors are offering what price for their service. Based on that, you can start generating an idea of what your profit margin would look like - assuming you have a good grip of related costs.
Know your value by knowing your customer
No price is important if the customer is not willing to pay for it. Thus, knowing your customer will help you understand how you're perceived by them, and henceforth your perceived value towards them. The higher your perceived value, the higher you can price your service because customers will have an understanding of the quality of your service - which is reinforced by what others say about your service (referrals, reviews), the quality of the materials or labor used in providing the service and more.
Apple is a great example of how a company can use the perceived value of its brand to provide goods and services at a premium price.
Consider time invested
The one factor in pricing that most business owners forget to account for is the time they themselves invest in a project. The time you put into your business matters, too.
In addition to the risk you incur as a business owner, you also commit valuable time towards the service; whether that is getting your hand dirty on the job site, or managing employees from a remote location. In both cases, you are working for your business, and thus, that time has to be factored into your costs when determining the price of the service.
Charge an hourly or per-project rate
The last step is determining how and how much you want to charge customers. Two common ways depending on where you operate in the world are ‘hourly pricing, and per-project pricing‘
If you want to calculate your hourly rate, you need to follow 4 steps:
1. Identify billable hours for a year by subtracting non-billable time (like billing, training, bookkeeping, etc) from the total hours you plan on working for that year.
2. Determine the total annual costs by adding your overhead and labor costs for the year (which include salaries, benefits, rent, utilities, rented space, etc.)
3. Identify the initial hourly rate you need to charge to cover all expenses by dividing the total annual costs by the billable hours for the year.
4. Multiply the initial hourly rate by the profit margin and you will get your hourly service rate.
If on the other hand, you would want to charge per project, make sure to track your time correctly so you know how many hours you spend on projects. You would need this number to calculate your project base rate. This rate is essentially calculated by multiplying the hourly rate and the total number of hours needed to complete a project. Afterward, you can add additional pricing to make a profit or to take into account future costs that may come up.
To have the most accurate calculations of costs, tracking labor costs correctly will save you a lot of time and doubt. Just as if you were to track labor costs for manufacturing a product, you can use a time tracking software like Atto to track the total hours your employees spend delivering services. Especially if they’re field technicians, having exact data is crucial if you want to calculate the true cost of your services.
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