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.
Recently I received a question from one of these owners about how to price the services of their new cleaning business. Perhaps my answer to them will help you.
Don’t make the professionally fatal mistake of comparing what you charge customers to deliver a service to how much you would expect to make as an employee. Doing so, to paraphrase Mark Twain, is like comparing lightning to a lightning bug. You have to think pricing, not wages. Here’s why:
1. You’re a business now, which means you have price lists, not wage lists. And you collect revenue, which has to produce the gross profit to cover all expenses, including the salaries of the owners.
2. If you have no employees you’ll work more hours in a month than you can bill for, like time spent on 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 you 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 the 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.
Write this on a rock … When selling services think pricing, not wages.
Jim Blasingame is the author of the award-winning book, “The Age of the Customer: Prepare for the Moment of Relevance.”