Why is charging the right price in a service-based business is so important? The right price ultimately determines your business success or failure.
In my video from last Friday, I made the statement that the “Your marketing and branding and everything you do in business, is really an expression of a promise that you make to your public that what you have to offer is more valuable than your asking price.”
That means even the price you charge for your products or services is part of your marketing strategy.
When starting a business, every entrepreneur gets to the point where they have to make a very important decision. It is one of the most important decisions, and it sets the tone for almost everything else the business does moving forward: How much to charge for a product or service.
The French economist J.B. Say, who coined the term “entrepreneur” defined it simply as, one who shifts economic resources out of an area of lower yield and into an area of higher yield.
That means if you (being your greatest resource in all business ventures) quit a 9 to 5 job making $60k a year to start your own business, but wind up working 80 hours a week and unable to generate a profit; you aren’t an entrepreneur, you are a hard-working unemployed person with a small business loan. Your marketing is just a story you tell yourself and your customers.
Until you generate a profit. That moment when the ink goes from red to black is a special private sobering and sweet moment of validation. It is in fact when a crazy, hard-working, unemployed, vision-laden person becomes an entrepreneur. It is a right of passage. To me, it is sacred. It is something few understand. You have moved yourself (again, your most precious business resource) from an area of lower yield, and into an area of higher yield.
This however, is NOT a magical or mystical thing. While it requires vision and hope, it also requires a healthy understanding of marketplace value, demand, and some basic arithmetic…
If you are giving away your services for less than cost, or just breaking even, then you aren’t operating a business, you are operating a non-profit venture. If you aren’t intending to operate a non-profit, then your business is on it’s way to failure.
“It can just destroy you if you don’t do it right. It 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. The bottom line is that pricing is extraordinarily important.” –Charles Toftoy of George Washington University School of Business
A business needs to be profitable to grow (duh). A business needs to grow in order to be able to serve more people. A profit is important, and pricing should be planned to maximize the greatest service and the best profit margin. That profit is determined by the price you charge for what your business does. When pricing there are many factors one should consider.
There are two different methods to determining the sweet-spot number. The good news is that there is a lot of flexibility on how you set prices. The bad news is there is no set formula of success. Your pricing is going to be very tailored to you and your business. Let’s discuss all the differences between 1) cost-plus pricing and 2) value-based pricing.
Cost-plus pricing “takes the cost of producing your product or service and adds an amount that you need to make a profit” for a sustainable business. (Info Entreperneurs) This is typically a percentage of the costs.
To calculate this, businesses need to determine their overhead costs, such as “telephone expenses, office equipment and furniture, rent and utilities, stationary and supplies, postage and delivery costs, clerical help, business insurance, business-related meals and entertainment, travel expenses, professional association memberships, legal and accounting fees, and advertising and marketing costs.”
While that may be a lot, businesses –or the entrepreneur him/herself– then needs to determine salaries. How much do you want to earn? Are you charging by the hour or by the service? To calculate hourly costs, you calculate the sum of labor and overhead costs + the profit you want to earn, and then divide by your total hours worked. From this you can determine your annual salary… or you can go to websites like www.salary.com to find some help.
But then you may ask, how do I determine how many hours I work? If you work 40 hours a week for 48 weeks (giving you a month off for vacation time), you would work for 1,920 hours. Lifehacker.com suggests that 20% of those hours will be non-billable, time you spend searching for new customers or filing paperwork. If that is true for you, you would have 1,152 billable hours.
Don’t forget taxes! The IRS has lots of information about the Self-Employment Tax (SE Tax) which pays for Social Security and Medicare. And there’s an income tax. All are based on your business’s net profit or loss.
Something you definitely haven’t forgotten is the profit you are trying to make. Your profit margin should be 10 to 30% of your other costs. This profit money helps build a reserve emergency fund for when business is slow and/or can be used to strengthen the business to help it grow.
The magical equation to calculate your rate is below:
Salary + Taxes = Total Salary
$45,000 + (we’ll say 15% taxes = $6,750) = $51,750
(Total Salary + Overhead Costs) / Billable Hours
If you work for yourself, it would be the number above. If not, the salaries of everyone in your business. We’ll say that the overhead costs are $12,000.
($51,750 + $12,000) / 1,152 hours = $55.34 hour
But don’t forget the profit margin. If it’s 20%, then the profit would be $11.07.
Hourly rate + Profit Margin = Total Rate
$55.34 + $11.07 = $66.41 or $66 per hour
If you want to charge by the project, estimate the time spent on the project and multiply that by the hourly rate. (Example from lifehacks.com)
But there is more to think about when setting the price then just making a profit and covering costs. The problem with cost-push pricing is that this ignores the marketing image your business is trying to publicize. That is why we consider value-based pricing along with cost-based pricing.
Value-based pricing “focuses on the price you believe customers are willing to pay, based on the benefits your business offers them.” (Info Entrepreneurs)
“You never price your product in a vacuum.” –Marie Forleo
You must understand that there is the cost, the amount it costs to make your product or provide your service, price, financial recompenses for providing your product or service, and value, what customers believe it is worth to them. How do they perceive your product or service?
Forleo shares the “Mattress Method” to determining price. When she went to buy a mattress, there was a very expensive one that she was wondering if she should spend all the money to get. The salesman told her that she does spend one third of her life in bed. Then he continued, explaining that the mattress quality impacts productivity, health, and good looks. Is that worth the money? When you can translate your product or service value into even money, time, health, or love for your customers, you show value. Depending on the product or service you can charge different prices to different customers.
Another example of value from Forleo: Imagine that you have a two-week program to help spouses to stop fighting and ultimately save their marriage. Can saving a marriage be priced? Actually, yes. When spouses see a therapist they often charge $200 a session for 24 sessions over a 6-month period. That’s over $4,800. And if you think about it, if your program really works, you could be helping them avoid a $20,000 divorce. Not relating to the cost-push pricing method, you can make establish a great deal of value.
Don’t forget your competitors!
“If nobody is competing in your space, there’s a very good chance the market you’re going into is too small” — Ben Yoskowitz
There are four strategies to deal with your competitor: pure parity, dynamic parity, premium pricing strategy, or discount pricing strategy. “In pure parity, your price always equals that of your competitor: they set the price and you match it. Dynamic parity happens when you pick a competitor and keep the gap between their price and yours the same. Premium pricing is higher than the competitors, but you gain a position of higher perceived benefits. In discount pricing, you always keep the price cheaper than that of competitors.” (Dana Griffin of Chron Small Businesses) The most common strategy for businesses to use is discount pricing.
Determining your pricing is critical to the success and survival of your business. There are many ways to price your products or services, and many things to consider. Take the time to thoroughly consider all factors. Figure out both cost-push pricing method and value-based pricing methods. This is a good practice in finding your business’ unique sweet spot for success.
“When it comes to friends and family I definitely have a “Friends and Family Policy”: Full price, every day of the year.” –Sean Burrows
I don’t give discounts, or provide work for free for those closest to me. They are the ones that know me, love me, and should thus value my contributions to the world the most. Of course it is often the expectations of those closest to us that they can get some sort of deal. My experience has taught me that giving into this is almost always a bad idea and not only strains relationships, but also sucks away time and money and resources away from your most valued use of those resources.
The young lady that cuts my hair (and does an amazing job) works at a high-end salon. Last week I asked her what she does when friends and family ask for a haircut, because it seems to me that those closest to her would take advantage. She didn’t skip a beat and simply answered, if they want to have me cut their hair, they can book an appointment with me jus like anyone else. I don’t give haircuts at home. I don’t even have a pair of scissors or clippers at home. That’s my secret to happiness!” And then we both laughed.
Content Source: https://medium.com/@SeanBurrows/why-charging-the-right-price-is-life-or-death-bcd624a1c8dc