How to price services when starting a business
One of the major challenges for new business owners is figuring out how to charge for their services. This article provides a framework for you to use in deciding how to price services, writes Jono Healey.
You’re ready to tell the world about your new business idea.
Everything that you’ve worked for since the idea’s inception is ready for launch, but one last challenge remains. What price will you charge for these services?
As a business owner, having a sound pricing strategy in place before you take your services to market can mean the difference between ongoing success and abject failure.
Figuring out how to price services in your business will require you to consider not only how much to charge your clients or customers, but what pricing model to use that delivers the most value for everyone involved.
This is something that founder and director of HSB Government Relations, Holly Bennett learned the hard way.
“When I set up my firm I had no idea how to charge,” said Bennett.
“I chose an arbitrary price and headed along to my local Regional Business Partners office, where I was promptly told I was too cheap, and businesses wouldn’t engage me because of it.”
While this came as something of a blow, Bennett explains that she was ultimately appreciative for the no-nonsense attitude.
“Having only worked in the public sector prior to launching, I was grateful to have gotten such straight-to-the-point advice so early on.
“Looking back, I really was just taking a stab in the dark around what is one of the most important parts of your business: where the revenue comes from.”
Start by coming to terms with your service costs
Before you can think about what the market will support in terms of prices, you need to begin by taking a long look at your costs.
This may be difficult for a new business that may not have developed a comprehensive workflow that captures all costs from start to finish. But, if you’re ready to launch, then you should have a pretty good understanding of what costs you’ll incur with each new job.
These costs will fall into three main categories:
- Labour and materials – Things like employees and the tools they use fall under this category, but keep in mind that these costs will tend to be higher in the earlier stages of business and some may be minimised as you achieve economies of scale.
- Ongoing overheads – Things like rent, utilities and software subscriptions must also be accounted for, but for the most part they will shrink as you take on a higher volume of work.
- Acquisition costs – Here, sales and marketing are costs used to acquire new customers. Generally speaking, these costs will remain the same for each new customer or client.
READ: Understanding cash flow
Next, consider a target for profitability
As the business owner, you may want to factor your take-home wage into overall profit targets, in which case you’ll need to consider how much you need to support your lifestyle.
On top of that, most businesses will build in some more money into their profit targets to make sure there’s money set aside for a rainy day.
This additional buffer can be used as an emergency fund, to expand the business or accelerate development as required.
Now you’re ready to set a revenue target
By adding your projected overall costs and profit together, you’ll have an estimate for the amount of money you’ll need to bring in overall for a given period of time.
For example, if you’re aiming for an annual income of $100,000, and you want to stretch for an extra 20 percent for growth and you estimate annual costs to be roughly $60,000 dollars, you would calculate your annual revenue target like this:
$100,000 + $20,000 + $60,000 = $180,000
This should be your baseline calculation for considering how to price your services. Once this is in hand, you’ll want to begin thinking about which pricing model will best help you achieve this target, how many customers or clients you can realistically work with, as well as taking a look at what your competitors are doing.
Pricing models: Fixed-price service fees versus hourly rates
Different types of services have traditionally used different types of pricing models to draw revenue from clients and customers.
Where the amount of labour required for a job is significant and changeable (say, in trades and construction, legal and finance), hourly rates are the norm. This allows those businesses to guarantee net positive transactions on each job.
On the other hand, an increasing number of businesses are considering fixed-fee or flat-rate models in order to entice clients or customers who have a tendency to feel uncomfortable about booking a job without knowing exactly what they can expect to pay for it.
And this was the next challenge for Bennett’s fledgling operation, which sought to offer a means for New Zealand’s small business community to see advocacy through government relations.
In coming up with a new mode of government relations delivery, Bennett also needed to experiment with her pricing model.
“The biggest challenge for many SMEs remains cash flow, meaning a significant proportion of New Zealand’s business community misses out on engaging because they do not have money to pour down an unknown political engagement drain,” Bennett said.
“As well as the traditional hour-by-hour engagement, I chose to streamline my insights into a range of programs to help all New Zealanders access meaningful government relations advice.
“Our set-time, set-cost offerings are designed to encourage the biggest part of New Zealand’s business community – SMEs – to see political engagement as an opportunity, rather than an unwieldy cost.”
The downside with fixed-fee pricing is that there are likely to be cases whereby a job takes longer or is more resource-intensive than expected – in these cases the business tends to take a hit as costs eat into profitability.
If you like the sound of fixed-fee pricing, it makes sense to begin with a trial period with VIP clients or customers so that you can get a feel for what works without immediately going to the wall.
Alternatively, you could try offering different services under different pricing models, as Bennett has with HSB Government Relations.
What are competitors charging?
Taking a look at what your competitors are charging is a great way to gauge what the market will bear in terms of price.
As you should now be familiar with your own costs, you can also use a competitor’s pricing to run some calculations on how much revenue they’re bringing in, and where they may be spending most.
This isn’t necessarily a template for you to follow, but information to use as strategically as possible. Perhaps you’re targeting a boutique service to a slightly higher end of the same market and can afford to charge higher prices for a lower volume of work? Or perhaps you’ve found a way to do things more efficiently and can afford to cut your rates in order to pursue a high volume?
Either way, thorough competitor analysis will help you better place your offering for success in pricing and other facets of business.
Avoid underselling and overcommitting
It’s relatively common for new business owners to fear charging a reasonable price because they’re worried people won’t see the value in what they’re offering.
One rule of thumb is to price your offering higher than what you feel immediately comfortable with. Not only will likely find some clients and customers are willing to pay the costs for your unique attitude and approach, but also that it’s much easier to reduce your prices later on than it is to raise them.
Further, putting a price out there that is too low can be more damaging than one that’s too high. Always keep in mind that people tend to associate price with value, and if something is priced well below the accepted market rate, they may assume that’s because it’s of poor quality.
Remember: Pricing doesn’t stand still
Being ready to adapt your thinking on how to price services is something you should be prepared for from day one, as Bennett has found value in doing off the back of changing client demands.
“As people’s perceptions of my industry begin to change, the pool of people interested in political engagement and how to do it effectively has broadened significantly,” she said.
“I chose to use this as an opportunity to trial an offering costing less than the price of a KFC bucket.
“The GR Taster session – an hour-long workshop designed around the views, attitudes and experience of real New Zealanders – helps rocket real New Zealanders into the world of government relations.”
As your business grows and pivots from time to time, just like Bennett, you’ll soon see cause to adapt your pricing policy to reflect these changes.
“Eighteen months ago, I would have thought an hour-long workshop to be a preposterous proposition,” she said, “but this is the power of listening to your community: opportunities appear that you might have never seen yourself.”
Having a plan to tweak your pricing model as you go along will allow you to be agile in a changing market and make decisions quicker than competitors can, all in the knowledge that you’ll still be making a profit.