If you’re selling a physical product you know where to start with your pricing. You’ve got your purchase/production cost, you add other expenses and then a trade markup (whatever you want to earn) and boom, you’ve got a final price.
But if you offer services, things are much more varied. If you look at multiple companies or freelancers offering a particular service, prices can vary enormously. Why does this happen? How do we choose how much to charge for our service?
That’s the question we answer today.
More specifically, we will see what are the 3 main ways we can set a price for our service, the advantages and disadvantages of each and when to choose one or the other.
Ready? Here we go!
Method #1: Neighborhood Hearsay (or Finger in the Wind)
Probably the most common method (unfortunately) is the one where we simply pick a number based on what others are asking and then simply move on.
Let’s say we hear that the industry charges X euros per hour or that for a certain service they charge Y so that’s it, that’s it, that’s what we charge.
Maybe we lower the number a bit to “be competitive”.
It’s easy to see why I don’t recommend this method and 95% of those reading this shouldn’t use it:
Disregard your service delivery costs.
What does that mean?
Maybe competitors have more people working to provide that service, so it costs them more in the end result than it does you. Or maybe it’s the other way around.
Maybe they use certain tools and software solutions and you don’t. Or maybe it’s the other way around.
Maybe they pay for rent and you don’t. Or maybe it’s the other way around.
The point is, your prices are yours and should take into account your context.
Don’t take into account the value offered.
Very often, when we talk about services, we think about time, how long it takes to do a particular thing, and we set the price based on that.
But that’s not the only thing that matters.
For example, if we at unosoft and a competitor invest 20 hours a month to provide identical marketing services, but they bring in €50,000 in sales and we bring in €100,000, should our prices be the same?
If you really want to make money in this industry, I would say no.
When does it make sense to start at a price that others are charging
But there are 1-2 contexts when it makes sense to start with a subjective price that we have heard from others or simply picked it out by lifting our finger and seeing which way the wind blows.
First, if it helps us get started.
I remember, when unosoft was in its infancy, we received a request for a quote to produce a catalog/magazine for a HoReCa company.
It was a big project and of course I got stuck on choosing the price. I didn’t want to charge too much that they wouldn’t accept, but I also didn’t want to charge too little and leave money on the table.
At one point, telling a friend who worked for a web design company about the situation I was in, he said:
“I recently overheard my boss talking to some people about an offer to create a presentation, and he said we work for 20€/hour for graphics and text“.
20€/hour – that was it!
I set the hourly rate, estimated the number of hours and sent the offer. Long story short, it was accepted and led to a really cool, long-term collaboration.
“A subjective price is better than none. Set it, but mentally tell yourself it’s temporary.”
After you’ve delivered the service draw the line and see if it was right and keep it or change it. Don’t complicate it, especially at first a wrong rate is better than none.
Second, there may be certain standard prices in our industry.
I am of the opinion that in general in services we should not care about standard prices and what others charge.
But if you want to get customers from a platform like Fiverr where you and dozens/hundreds of other providers are, it makes sense, at least for starters, to start at a similar rate to others.
These lists, centralizers and platforms set certain pricing expectations among potential customers so it’s pragmatic to take them into account.
Okay, that method covered, let’s see what other options you have.
Method #2: Set prices based on delivery costs
The second method by which we can set our prices is to start from how much it costs us to deliver that service and add a profit margin.
Although it’s probably the most common method, you’ll find that we make two huge mistakes that sometimes, even though we’ve worked hard, at the end of the month we’re left with nothing.
If you’ve ever found yourself in this situation, or want to avoid it, here’s the correct process for pricing your services based on cost:
Image taken from the Agent Pricing Calculator in our mentoring.
I say we take each step at a time, to see what exactly we need to do.
It’s an example for agencies/companies that have employees. If you’re a freelancer/working solo, replace the median salary in step 1 with the gross income (with all taxes) you want per month and don’t add the profit margin in step 5.
Step 1: Calculate the median monthly cost with the person(s) delivering the service.
The first thing we want to do is write down the full salary, with all taxes included, of the person who will deliver the service.
If you have more than one person involved, with different salaries, do an average. If you want to be even more specific, you can calculate hourly delivery costs per service (although that’s usually overkill for most of us).
In the example above, this was 10,000 lei/monthapproximately 5700 lei net.
Step 2: Divide by how many hours that person works per month to find the average cost per hour originally
It should be simple here, we just want to know how much each hour of work costs us.
The average month has 167 hours of work, so divide the full salary by 167 or how many hours that person works per month.
We have a base cost. But we don’t stop there.
Step 3: Add a markup for degree of use and billable time
Most of us stop at the previous step and think we’re done with the costing.
But this is the first mistake that leaves us at the end of the month having worked hard but not left with much.
It’s easy to play with the numbers and make everything work out. But the reality is more complicated.
In addition to the fact that no one is equally efficient in all 8 hours a day or how many they work, we also have various activities that we can’t directly bill for but need to keep track of.
Utilization rate = time spent on activities that generate revenue and are billed to the customer.
Non-utilization rate = time spent waiting or spent on activities that cannot be further billed to the customer.
Such important but often unbillable activities are:
- Answering emails;
- Internal meetings;
- Learning, documentation;
You need to keep these in mind if you want to have a real rate.
Here you must calculate how much of your working time (the 167 hours per month) is spent on billable activities (degree of use) and how much is spent on the rest (degree of non-use).
It’s worth investing the time to look at your business/company to see the current situation. I did this exercise with several agencies and freelancers and sometimes the take-up was only 40-50%. The rest was going on useless meetings, non-value added activities etc.
Anyway, this is not a management article, so let’s get back to it.
In general I have noticed that most have a ~70-80% utilization rate, so if you don’t have time to calculate now you can start here.
The next step in our price calculation process is to increase the base cost by a percentage equal to the unused/unbillable time.
In this case, 30% (70% usage rate / 30% non-usage rate).
Quick tip, you can calculate the percentage increase of a number by multiplying by 1.x (x being the percentage). For example, you want to increase a number by 30%, multiply it by 1.3. Want to increase it by 50%? Multiply it by 1.5. Want to decrease it by 19%? Multiply it by 0.81
Continuing the calculation:
59.88RON (base cost) * 1.3 = 85.54RON/hour adjusted cost.
Hold on, I’m not done yet:
Step 4: Add other costs you still have
Do you pay rent? Do you use different software platforms and applications? Do you have subscriptions to marketing courses?
These are costs that allow you to function and do your job better. So you should take them into account when setting your prices.
Calculate what % of your total expenses these are and add to the total.
In general for service providers these are between 10-30% depending on the field of activity.
Let’s say we have 20%, so multiply the above cost by 1.2.
85.54 RON (adjusted cost) * 1.2 = 102.65 RON/hour actual delivery cost.
Phew, let’s have some calculations.
But let’s see what happened in the meantime:
We went from 59.98RON/hour original cost (which many consider real) to 102.65RON/hour actual cost.
If we also add a profit margin that we want, say 30%, we arrive at a price of 133.44RON/hour cost of sales.
102.65RON (adjusted cost) * 1.3 = 133.44RON/hour cost of sale
This is the cost you MUST charge. Below it, you don’t make a profit, or not the profit you wanted.
Now that we have the hourly rate, estimate how many hours the project will take you in total or per month and multiply that and bam!
|(1) Service||(2) Hours||(3) Cost per hour||(3*4) Offer price|
Remember to specifically itemize services to make sure you don’t forget to budget for things you’ll be doing.
This is the second reason why we work but at the end of the month or project we are left with nothing. We miss things that add up and eat up all the profit we would have had.
Important! If you work solo and have no employees, instead of employee salary put the gross income target you want to have monthly (i.e. take taxes into account). The rest stays the same.
This is the correct way to calculate your rates from costs.
But don’t go away, because we still have more:
Method #3: Pricing based on value offered
“People want cheap” is a hard statement to argue with.
If you offer services, you’ve probably gone through a situation where clients told you they chose someone else because they were cheaper.
Not pleasant, especially if you made an offer based on your delivery cost.
That may make us generalize that people always want cheaper. Which on the one hand is true, we like cheap.
But “cheap” doesn’t necessarily mean the lowest cost in money.
Because, there are other things valuable to us.
There is time.
There is opportunity cost (what else could you have done at that time/with that money).
There are opportunities we may miss because we don’t have a certain thing.
These are the reasons why people pay amounts that may seem excessive to us, but make sense to them and even seem like a bargain.
Let’s take an example to see exactly what I mean:
I recently moved. On a lunch break I went scouting around the area to see where I could buy some food.
I came across a shaormerie called Amir and fell in love with their falafel after the first bite.
After a week or so I stop by again and get another one.
So far, so good. I’m really thinking of giving other items on the menu a shot.
But the next time I go, towards the end of August, I see it’s closed for repairs.
“What to do to her” they tell me. “Maybe next time. It’s good that I’m investing in the business“.
About a week later, I’m making my way there again, but still under repair.
Long story short, it’s November 4th as I write this and the place is still closed for repairs!
I don’t know their background and what their plans were, but from my perspective that place loses money every day it’s not open.
If I were a repair/painting service provider, I’d hold this idea very close.
And maybe when I go out and make the offer, I can do a calculation like the customer:
|(1) Price Services||(2) Execution time||(3) Normal daily sales||(4) Sales lost due to works (2*3)||(5)Total cost (1+4)|
|Competitor||10.000 RON||8 weeks||5000||40.000 RON||50.000 RON|
|I||15.000 RON||2 weeks||5000||10.000 RON||25.000 RON|
The amount in the “lost sales” column is the number of days the location is closed multiplied by the average daily revenue. How much we could sell if we were open during that period.
And look how sometimes we’re too poor to buy the cheap stuff.
The first thing you have to do is figure out what value you’re offering.
No matter what services you offer, beyond the deliverables themselves, there are certain extra benefits you bring to the customer (extra revenue, time saved, less stress) or risks and losses you help them avoid (decreased sales, fines, business closure).
Once you’ve identified the value you offer, you need to quantify it. Be able to measure it in black and white.
Here’s an example from my personal calculator that I use to make estimates for clients:
The moment we put the numbers in black and white, we noticed that if we hit our goals we bring in sales we bring in a 3x increase in profit.
The difference between the cost of delivery (what we did in the previous section) and this extra value we bring in is the range in which we can juggle prices.
Value-based pricing is indeed harder to master, which is why in the Agency Accelerator mastermind we have specific modules aimed at this topic.
But you can start simple.
If you do you’ll be able to charge rates and sell at prices that allow you to focus 140% on the value you’re offering. It’s better for you and the customer.
If you internalize this and learn to understand how to quantify value in the minds of your customers, a whole new world will open up to you.
I hope this article was helpful.
If you have any more questions, suggestions, comments (or praise) we can continue the discussion on Facebook.
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