Service Pricing for Small Business Owners: How to Price Your Services
Being a successful service business owner isn’t always straightforward. Your success is dependent on a number of factors: competition, location, market demand, personnel, finances, marketing, and more.
But one of the most important factors is your service pricing.
The way you price out your services impacts your cash flow. If done incorrectly, it can undercut your business. That’s why it’s crucial to get strategic about your pricing and set up a sustainable formula to ensure you get paid and generate a healthy profit.
Here’s a step-by-step guide for how to price your services, complete with some commonly used definitions of service pricing terms.
What is service pricing and why is it so hard?
Service pricing is the strategy you put in place to price out your services so they’re fair for your customers, but also profitable for your business.
Although in practice, service pricing isn’t always that simple. There isn’t a “one size fits all” solution for service businesses.
With retail store product pricing, you have a clear starting point. For example, the product costs $2.00 to manufacture and you paid $3.00 to buy it from a vendor. All you have to do is apply your markup, overhead, and profit margin and you’re done.
When it comes to pricing your service business services, the lines aren’t so clear.
You’re dealing with variable labor costs for your employees. And, each job might require a unique set of supplies. Accurate job quotes are crucial for your business.
For example, if you own a residential cleaning business, one home might have plenty of windows requiring a lot of window cleaner (extra material). Or, the client might own a couple of cats, which would require extra vacuum time (extra labor).
As labor and material costs change in the market, so should your service prices.
A formula for service pricing can help remedy some of the pricing problems you’re facing.
Service pricing: Commonly used terms to know
Value-based pricing is determined by the perceived value of the service you’re providing to a customer, rather than the desired profit-margin or competitor influence.
An alternate strategy to value-based pricing. With cost-plus pricing, the price is determined by adding a specific markup to a product’s unit cost. This strategy often takes a profit-margin goal into consideration.
An alternate pricing method. It’s most beneficial to your client and it is often based on value. Your budget is set from the start, regardless of how many materials were used or how much time was spent on the job once it was completed.
A pricing strategy where you charge clients per hour of work. The success of this method is dependent on accurate time-tracking on the job.
Read more: Fixed pricing vs. Hourly billing
Profit margin is the net amount of money your business has made after subtracting all your expenses. In order to price a job to ensure a healthy profit margin, you need to mark up the cost of the job.
Profit is the number you get after subtracting all business expenses.
Overhead is indirect, background expenses such as office rent, marketing costs, vehicle insurance, etc. You need to pay to keep your business running or operational.
Markup is how much more money you charge (in a dollar amount or percentage) for a product or service after costs so you’re ensured a stable profit.
Pricing formula for services: Step-by-step guide
These steps are only a guide for your service pricing. Remember to tailor each formula to your business. Your pricing formula should be flexible!
We’ll be following a cost-plus pricing strategy for this model.
1. Calculate your costs
First, you need to determine how much your labor, materials, and overhead will cost you:
1. Labor and materials: Figure out the labor you need for the job and the materials. If you’re a landscaping business you’ll estimate the employee hourly wages, sod, grass seed, and fertilizer you’ll need to complete a job.
2. Overhead: These are indirect costs related to running your business, such as your office rent, software subscriptions (for business tools like Jobber), advertising, administration staff wages, etc. You include a portion of these costs in the price of each of your jobs.
Even if your labor and materials are straightforward to calculate, it’s worth consulting your bookkeeper or accountant to get an accurate picture of your costs to determine pricing. This is especially true if your business experiences seasonal surges.
Don’t price based on your gut — do the math when you can.
Green industry business consultant Jason Creel suggests that when including labor in your price, you should consider how much effort is required per person.
“When I say $60 per hour, I’m talking about the rate per person. So if you have a two-man crew, you’re looking at $120 per hour. If you have a three-man crew, $180 per hour. If I’ve got a two-man crew and we’re cutting grass and it took us 30 minutes to cut, that’s a $60 lawn.”
2. Assess your competitors and the market
Market-based or competitor-based pricing can be tricky! You shouldn’t base all of your pricing decisions on what your competitors are doing, but you should be mindful of them.
Although this pricing strategy is not competitor-based, it’s important to know what your competitors are charging. This can help you set an appropriate baseline for your pricing model, or showcase pricing differences and how you come out on top
For example, if you’re charging more than your competitors, you can show your customers what your unique selling proposition (USP) is. What really sets you apart from the competition? Why should they choose you?
If you discover you’re not charging enough, you can look at reasonably increasing your prices to compete with other businesses in your city.
Consider how much your average customer is really willing to pay for your service.
3. Come up with a reasonable profit margin
You should base your markup on your pricing formula on your desired profit margin. Remember that you should charge a fair and reasonable price that also helps you see a profit.
Refer to this table to roughly determine the markup and profit margins that works for your business goals:
4. Add up your costs
This is where you put all of your insights together and do your cost-plus pricing calculation.
Add up:Material costs + labor costs + overhead
Then, you have to apply your standard markup to that total.
Based on the markup table above, let’s say you want to apply a 30% markup to all of your services to get your desired profit margin.
Before you set this as your pricing formula, consider applying it to a few business cases to understand how it works in practice. Take the total material, labor, and overhead costs and multiply this amount by (1 + 0.30) to get your service price.
Keep in mind that with this pricing strategy, there’s a risk that your services are priced too high in some cases, or in comparison to your competitors. So, you may have to adjust your formula based on circumstance.
Having a firm enough understanding of your business numbers to know how much you can adjust your pricing for each job will help you fully understand your pricing formula inside and out.
Industry-specific service pricing guides
Check out these job-pricing resources for your industry: