Accounting: For a service oriented company which doesn’t focus on trading, how do you define the costs of service?
Let’s start with something fundamental, costing services is far more difficult than costing products.
Factors to consider in pricing (Pricing is both an art and a science.)
- Cost-plus pricing. This standard method of pricing in business seeks to first determine the cost of making a product or, in this case, providing a service, and then add an additional amount to represent the desired profit. To determine cost, you need to figure out direct costs, indirect costs, and fixed costs.
- Competitors’ pricing. You need to be aware of what competitors are charging for similar services in the marketplace. This information could come from competitor websites, phone calls, talking to friends and associates who have used a competitor’s services, published data, etc.(Avoid this factor if you can).
- Perceived value to the customer. To your customer, the important factor in determining how much they are willing to pay for a service may not be how much time you spent providing the service, but ultimately what the perceived value of that service and your expertise is to them.
Calculating your costs
- Materials cost. These are the costs of goods you use in providing the service. A cleaning business would need to factor in costs of paper towels, cleaning solutions, rubber gloves, etc. An auto repair business would tally up the cost of supplies, such as brake pads or spark plug, which are being installed by service people. You may want to include the material list with your estimate in bidding for a job.
- Labor cost. This is the cost of direct labor you hire to provide a service. This would be the hourly wages of your cleaning crew and/or a portion of your mechanic’s salary and benefits while they were providing the service for your customer. It’s a good using a time card and clock to keep tabs on the number of hours of labor involved in providing each service for a customer.
- Overhead costs. These are the indirect costs to your business in providing services to customers. Examples include labor for other people who run the firm, whether administrative assistants or human resources personnel. Other overhead costs include your monthly rent, taxes, insurance, depreciation, advertising, office supplies, utilities, mileage, etc. A reasonable amount of these overhead costs should be billed to each service performed, whether in an hourly rate or a percentage. One important thing to note: don’t just depend on figures from last year to determine your overhead costs. You need to charge customers rates that cover your current costs, including higher salaries to employees, inflation, etc.
Determining a fair profit margin
Once you determine your costs, you need to mark up your services to ensure that you achieve a profit for your business. This is a delicate balance. You want to ensure that you achieve a desirable profit margin, but at the same time, particularly in a down economy, you want to make sure that your business doesn’t get a reputation for overcharging for services. (The last statement applies to Greece)
How to Price Business Services
- Charging an hourly rate. For many businesses, pricing services on an hourly rate is preferred. This ensures that you are achieving a rate of return on the actual time and labor you invest in servicing each customer. Hourly rates are often used when you are pricing your own consulting services, instead of pricing a service that uses labor and materials from others. Your rate should be determined by your amount of expertise and seniority; a more senior consultant will generally be paid a higher hourly rate than a less experienced or junior consultant. I also recommend that one’s travel time be included as an extra charge. Sometimes even consultants are asked to price a service on a project or contract basis.
- Charging a flat fee. In tough economic times, many businesses are concerned about keeping costs down and may agree to hire your business for services only on a fixed-rate or flat-fee basis.
Beware of not getting overbudget, If you have a customer that insists on a flat fee, you may want to see if they are amenable to putting a cap on the number of hours involved in the project or agree to pay additional fees if the project runs over that time.
- Variable pricing. In addition to determining a fair price for your services, you have to determine whether you will practice a fixed-price policy and charge all your customers the same amount or whether you want to institute variable pricing, in which bargaining and negotiation help set the price for each customer. Should you charge different customers different rates? In my opinion NO. Charging different prices to different customers will create ill will. People will talk about it and they will find out. One thing a business cannot afford to lose is its integrity and respect among customers.
Monitoring and Changing Your Price
In a service business, your biggest costs are usually your people costs — salaries, benefits, etc. If you are having a hard time selling services at an acceptable profit, the problem may be that your employee costs are too high rather than the price is too low. You may want to also re-evaluate your overhead costs to determine whether there are other cuts you can make to bring your price down and your profit margin up. «Look at your expenses and see where you can cut,»
Monitor profitability monthly
You need to understand the profitability of your company every month. By the 15th of every month, you ought to have your financial statements from the previous month. Make absolutely sure you know the degree to which every person or project you sell is contributing to your goal of making money each month.
Test the market for new services and prices
You should always be testing new prices, new offers, and new combinations of benefits and premiums to help you sell more of your services at a better and better price. Often the perfect time to do this is when quoting a price to a new customer. Raise the price and offer a new and unique bonus or special service for the customer. Measure the increase or decrease in the volume of services you sell and the total gross profit of money you generate.
Be wise about raising your prices
It’s a fact of life that you will have to raise prices from time to time as part of managing your business prudently. If you never raise your prices, you won’t in business for long. You have to constantly monitor your price and your costs so that you are both competitive in the market and that you make the kind of money you deserve to make in your business. But there are risks to raising prices, particularly when your customers are going through tough financial times.
- Do raise prices when your competitors are raising prices. If the competition has upped the ante, that is a good signal that the market can and will support a price increase for your services, too.
- Do raise prices if your customers say you’re a bargain. If your customers start commenting about what a great value your services are, that may be an indication you’re charging too low a price.
- Don’t raise prices too much all at once. In a tough economy, a big jump in prices might be too much of a jolt for your customers. Instead, raise prices in small increments of two or three price increases over the course of a year.
- Don’t raise prices across the board. Do be discreet. Customers may not notice price increases if they are only for certain services and not for others.
You need to raise prices in today’s economy where you think your customer can’t see there has been an increase.
The bottom line is: You owe it to yourself and to your business to be relentless in managing your pricing strategy. Remember, how you set the price of the services you sell could be the difference between the success — or failure — of your business.
Nickolas C. Papanikolaou