Millions of small businesses sell personal services like consulting, website development, or janitorial services, instead of something tangible like a computer or a kumquat.
Unfortunately, pricing a service is not as intuitive as a tangible product. Consequently, service businesses too often don’t charge enough to sustain themselves profitably because of how they think about what they sell to customers.
Don’t make the professionally fatal mistake of comparing what you charge customers to deliver your product — a service — to how much you would expect to make per hour as an employee. Doing so, to paraphrase Mark Twain, is like comparing lightning to a lightning bug. You must think like a business, not an employee. You have to think pricing, not wages. Here’s why:
1. You’re a business now, which means you offer customers a price list, like you would see on a wholesale catalog or a restaurant menu, not a wage list. And you collect revenue, which is what businesses produce to create the gross profit that pays expenses, including the salaries, taxes and benefits of employees — and owners.
2. If you have no employees you’ll work more hours in a month than you can bill for, like time spent on business development — marketing, selling — and administrative tasks. Consequently, your business must collect enough revenue to cover the time and expenses of performing or outsourcing those tasks.
3. Until you have employees, you’re a 100% extension of yourself, which means your only revenue leverage is the hours you can bill multiplied by your hourly rate.
Use this pricing logic to get started: Determine all monthly expenses, including paying yourself as an employee. If you’re home-based, include a reasonable office overhead factor and don’t forget payroll taxes. Then, divide that total by the number of billable hours you have the capacity to perform in a month (not the hours you actually perform). That quotient is your breakeven rate.
But in order to sustain your business long-term, you have to make a profit, so the rate you charge customers is somewhere between breakeven and the impact of three more factors:
1. What the market will bear (competitive pressure)
2. How much you need to make a sale (badly at first)
3. The commitment a customer is making to you (customers who sign annual contracts get discounts)
This method should cover most variables you’ll face when proposing to a prospect. Plus it will help you see the negative impact when you deliver less than capacity, or the dynamic effect of adding employees.
Finally, when should you increase pricing? The best indicator is when demand for your services increases. In this case, think like an apartment complex manager who knows if he’s 100% occupied, his rents are too low.
Write this on a rock … Your pricing strategy in summary: Think like a business, not a laborer; think price, not wages; cover costs and produce a profit; raise prices as demand increases.