Strategies for Setting Prices for Your Services
There are many ways to price your services, and all of these methods fall into two large categories:
Category 1: Pricing from the bottom up, which includes all pricing methods that start with cost and add a profit margin.
Category 2: Pricing from the top down, which includes all methods that start by determining client value.
Here is a brief look at each category of pricing and some tips on how to price the most effectively.
If you can accurately estimate your costs, then it’s always a good idea to compute a total cost number before setting your price. New entrepreneurs often underestimate their overhead expenses, so it’s critical to create an annual budget of projected costs such as computers, telephone, Internet, equipment, accounting, legal, marketing, office supplies, rent, utilities and all the other expenses it takes to run a business.
Here is a simplified example for a sole proprietor. Let’s say that your overhead is $20,000 per year, not including your salary and benefits. Let’s also say you want to pay yourself a salary of $50,000 per year and you are able to bill 1,200 hours per year. Assuming payroll taxes and benefits are 30% of your salary, your costs include $50,000 (your salary) + $15,000 (benefits and payroll taxes) + $20,000 (overhead) = $85,000. You can now easily divide: $85,000 / 1,200 = $71 hourly rate to charge clients.
Hours Worked vs. Hours Billed
A common mistake in pricing employees based on a cost-plus method is to overestimate how many hours they will be able to bill the customer. Not all hours worked generate value for a customer and are billable. Tasks that take away from billable hours include administrative duties, sick and vacation time, mistakes, training, and downtime between jobs. This means that if you bill less than 1,200 hours, as in our example, you will need to raise your price or your overhead allocation in order to make your desired numbers.
You can also set top-down pricing by starting with total client savings or the perceived value of the project. One of the easiest examples of this in the QuickBooks® consulting world is when you acquire a client who needs to downsize his or her accounting system. Let’s say the owner is paying $20,000 per year for the current accounting system. You find that QuickBooks Enterprise Solutions is perfect for them. If you bill the client $10,000 for software, customization and training, the client is saving $10,000 the first year, and closer to $15,000 each year in the second and subsequent years. If your bottom-up pricing for this project is $6,000, you can then price between $6,000 and $10,000 (or higher) to complete the job.
With top-down pricing, as with bottom-up pricing, it’s important to stay on top of your competitors’ pricing jobs. But, don’t be fooled: you may be delivering far better service, a higher competency of training or just a friendlier personality. Many intangibles factor in your client’s decision as to whether you have the best deal for them.