Do you own a service business? If so, you know it isn’t always easy figuring out how to price your services. To make sure your business is profitable, try these tips for pricing services at your small business.
Why is finding a service pricing strategy so hard?
Learning how to price a service can be difficult because your expenses are more subjective than a product-heavy company’s. How much you charge customers doesn’t always directly correlate with the amount you pay to perform services.
If you own a retail store, you buy goods at a certain price. To earn a profit, you know you need to sell the goods for more than what you paid. You determine how to price a product according to its cost.
For service industries, finding a target profit margin is not as simple. You don’t have an original price to reference. Instead, your pricing formula for services should account for the intangible aspects of running your business, such as time and value. This makes strategic pricing difficult, but ensures that it’s tailored to your business’s needs.
5 main pricing strategies for services
The good news is that since there is not a set-in-stone way for pricing services, you have flexibility. Use the following items to learn how to set prices for services:
- Hourly rate
- Fixed prices
- Time invested
- Competitor prices
- Perceived value
Calculate your hourly rate
Calculate an hourly rate to get a baseline for pricing. Follow these three steps to see how much to charge per hour.
1. Add expenses
Operating a service business doesn’t mean your company is expense-free. It’s important to understand the true cost of providing services to find your hourly rate. Take a look at your direct and overhead expenses, as well as the salary you want to earn.
As the name implies, direct costs go directly into your services. Direct expenses include the supplies you use to perform services and direct labor. If you have employees, account for wages, employment taxes, and small business employee benefits.
Overhead expenses are indirect costs that are necessary to operate. Here are some examples of overhead:
- Rent and utilities
- Equipment and maintenance
- Indirect labor (e.g. secretary or bookkeeper)
- Marketing and advertising
- Administrative functions (e.g., the cost to bill customers)
To figure out your target profit margin, also consider the salary you want to earn. Your salary is what you will use for personal expenses. If you’re quitting your job to start a business, begin with a salary close to what you currently earn.
Add all the direct costs, overhead, and salary for the total amount you must cover.
2. Determine your hourly rate
Billing at an hourly rate is another popular strategy for pricing your services. Find out the number of hours you will log during the year. For example, if you plan to work 40 hours per week, multiply 40 hours by 52 weeks. The calculation gives you 2,080 work hours for the year.
Planning to work 40 hours per week all year might not be realistic. Don’t forget about vacations, holidays, and sick days you might take off. Subtract non-work hours from 2,080 to see the actual amount of hours you will work.
After deciding on the total work hours for the year, find the billable hours. Subtract non-billable time from the total hours.
Non-billable hours include tasks that do not generate revenue, like sourcing clients and filling out paperwork. Expect about 20% of your work hours to be non-billable. So, if you plan on 2,080 work hours, 416 are non-billable.
For the hourly rate, divide your expenses by billable hours. Here’s an example:
Your business’s annual costs (including your salary) add up to $75,000. This year, you plan to work 1,920 hours.1,920 Hours X 20% = 384 Non-billable Hours
1,920 Hours – 384 Non-billable Hours = 1,536 Billable Hours
$75,000 / 1,536 Billable Hours = $48.82 per hour
Your hourly rate is $48.82.
3. Include a profit margin
First, decide what percentage you want the profit margin to be. A 10% to 30% margin is healthy for most service pricing models.
Multiply the hourly rate by the target profit margin. Add that amount to the hourly rate. Take a look at the earlier example adjusted for a profit margin:
The hourly rate is $48.82 per hour. You want a 20% profit margin.$48.82 Hourly Rate X 20% Profit Margin = $9.76
$48.82 + $9.76 = $ 58.58 Hourly Rate with Profit Margin
The rate with a profit margin is $58.58 per hour. If you wanted, you could round the dollar amount.
To charge a customer, multiply the hourly rate by the number of hours it takes to complete the service.
Charge a fixed price
As a service business, another route for setting prices for services is to charge customers by the project. Use your hourly rate and estimate how long it will take to perform the service. Multiply the time by your hourly rate. Or, you could charge a fixed price for each service.
There are pros and cons to pricing per project rather than per hour. Sometimes, you invest more time into a service than originally anticipated. The flat fee could force you to charge less than the project’s value.
But, per project fees can also be more profitable. Freelance web designer Jake Jorgovan described his experience with project-based fees in a Career Foundry article:
After the 3-hour web design project, I realized that I was doing myself a serious injustice by billing hourly. I was getting good at my craft and I was working fast. If I could start charging based on the project, and not the time I worked then I had a huge potential to earn more income in less time. And that is the beautiful thing about project-based fees.
There are a lot of gray areas when it comes to pricing strategies for services. The time you put into your business matters.
Factor in the value of your time when calculating a target profit margin. Track the amount of time it takes to complete services. The longer you spend on a project, the more you should earn.
Also, consider the number of years you’ve been in the industry. Are you new to the market or have you worked in it for many years? The more time you have under your belt, the more value you add to your company. You can charge more as an experienced person in your industry.
Don’t base your pricing for services on what competitors are doing. But, be aware of how much other companies charge.
Your competitors are playing in the same arena. Ignoring their strategies for pricing services doesn’t help you break the mold in your industry. Instead, it leaves you ignorant about what’s happening in your market.
Keeping an eye on competitor pricing reveals what sets you apart. Use your differences to market your business. Show customers the value of the unique experience your company offers.
No matter how much you charge, you won’t make money if customers are not willing to pay. You need to understand how customers perceive your business.
Use a market study to collect information from surveys, industry publications, and focus groups to see what customers think. Prove your value through brand awareness and customer experience.
Charging a fair price
There isn’t one way to approach the pricing of services. It’s up to you to decide what your offerings are worth and how they fit into the market you serve.
If you’re calculating prices for the first time, you might think the amount is too high. But, it’s important to know how to calculate profitability accurately so your business can thrive. If you do a good job and take care of customers, you shouldn’t have a problem with your fees.
Deciding on a target profit margin is a careful balance. You want to mark your prices high enough to earn a good profit margin. But, you also must avoid getting a reputation for overcharging.
Consumers are smart. Most are willing to pay a fair price for a good service. But, it doesn’t take long for customers to figure out they’re getting ripped off. Know your worth and choose a service pricing strategy that matches the value of your offerings.
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