How should you price your business services? Here are costs you have to factor into your hourly rates to run a profitable service or consulting business.
If you owned a retail store, a restaurant, or sold products online, figuring out pricing would be relatively straightforward. You’d take the price you pay for the product, add in all of your indirect overhead costs, and add in your profit margin. If you expect to make a 50% gross margin, and your total product cost is $20, the retail price would be $30. Simple, right?
But when you’re trying to set rates for selling a service, it’s different. You aren’t buying a product and reselling it. You’re not paying a set amount for something, so it’s not nearly as easy to measure your costs. Your “cost” is the value of your time and knowledge and/or your staff’s time and knowledge. That’s all well and good, but placing a value on time and knowledge and making sure you get paid what you’re worth is pretty subjective.
Understand your service business costs
Whether you’re a one-person consulting business or an IT firm with 10 or more employees, you have overhead and other costs to consider. Service industry business owners might not be so vigilant about controlling costs when it’s only small amounts of money. But the costs of doing business can be quite significant when you add them all up.
You’ll have ongoing expenses, too, for your phone service, internet access, web hosting, and office supplies. Then there’s the money you pay an employee or virtual assistant to answer your phones, send out invoices, and do other chores. And there’s also the cost of employment taxes (or self-employment taxes if you’re self-employed), health insurance, and other benefits. The monthly cost of your email marketing service and the fees for all those Chamber of Commerce and other small business associations you belong to need to be accounted for, too. Membership fees and other networking costs can add up.
Then, you might have to take clients out to dinner, upgrade your software, or have a computer repaired or replace a printer. These and other costs of running and managing your business all need to be accounted for, even though they can’t be allocated to any one job.
The bottom line is that you’re not as different from product-oriented business owners as you might think. You, too, need to keep track of and control costs.
Before you set prices, set goals
How much do you want to make annually, and how many hours do you want to work to reach that goal? This is more of an “in a perfect world” type of goal, but it will at least get you started. If you want to make $100,000 this year and you want to work 40 hours a week every week (i.e., you won’t take any time off for vacation or holidays), you only have to charge about $48 an hour to reach that goal.
Does that seem a little low? If you have specialized knowledge and charge $90 per hour and work 40 hours per week, 52 weeks per year, that’s $187,200 annually. It sounds much better until you realize that 40 hours of work doesn’t equate to 40 hours of billable work. (More about that below.)
SEE ALSO: How to Land Your First Consulting Client
Look at industry and regional trends
Every professional organization keeps detailed data on industry trends. You can find information on plenty of blogs, but if you’re in a professional business, you should belong to your industry’s professional organization. Ask them for these figures. The figures will vary by the nature of your service business, the market, and your geographic location (if you work locally). Gathering data for your type of business and your location can help you determine how to price your services in your area.
Allow for non-billable hours
If you’re charging by the hour, time is money. Non-billable hours include anything you do with your 40 hours a week that can’t be billed to your client, and therefore produces zero income. Some examples include paperwork, traveling, networking to market your business, talking to vendors or partners, etc. These non-billable activities can easily take up as much as 50% of your time or your employees’ time. If that’s the case, that $187,200 salary just got slashed to $93,600 before you account for any out-of-pocket costs for running your business.
Who are your clients?
Let’s look at two types of service-oriented entrepreneurs. The first is somebody who owns a house cleaning business. He works with busy professionals that want somebody else to clean their home instead of committing precious time to doing it themselves. Most of his clients are people slightly above the average American income.
The second type could be a corporate IT consultant who advises businesses on network security. Her clients are larger businesses that rely on her to keep their data safe.
The first entrepreneur can’t charge as much because his clientele will be more price-conscious. According tothe average national rate for house cleaning is $50 to $90 an hour. If he tried to charge $150 per hour, he would have very few clients. On the other hand, the IT consultant’s clients are people who understand that losing data is far more costly than the money spent to protect it. She can charge a lot more. Consider your client base.
Pricing Based on Your Experience
As you gain experience and recognition, your prices will go up. But when you’re just starting out, if you aren’t recognized in your industry, you may not command the best rates. Many consultants start below the target rate they want to achieve and slowly raise prices. Don’t get too greedy too soon, but don’t undercut yourself, either.
Are you selling products as well as services?
If you’re charging by the hour, the service you provide is likely your main source of income. But some service businesses and consultants upsell clients and get them to buy products as well as services. If you fall into this category and product sales are more profitable than providing your service, you might charge a lower rate on the service side to make sales on the product side.
Service-oriented people know that diversifying their offerings allows for better price control. If you’re being paid to speak at events and write books, and you’re selling products related to your service, you know what seasoned service pros already know — charging by the hour is a hard way to make money, and their hourly prices have to be higher.
Sometimes it comes down to knowing the market, knowing your competition, and falling in line with industry averages. Then, you organize your business around those rates. Each service field is different, with some fields more price-conscious than others. Know your industry, keep up with current trends, and you’ll reach your goals.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.