How Much Should I Charge?
May 12, 2010
With over a decade of coaching small business owners, I am amazed to discover how few really know how to come up with the right pricing strategy for their business. I hope this post helps. I have a LOT to say on this subject, so stay tuned!
The first question you need to ask when pricing your service is this “Am I building a business or am I just working for a paycheck?” Surely many of you that have been attending seminars around our industry have been challenged to ask this question. The difference between building a business and working a job for a paycheck is that with a job you only get paid for the work that you do. When you own a business you get paid for doing whatever work you do in the business, plus you get compensated for owning the business.
That compensation is for many things such as planning time, risk, reinvestment, retirement, as well as paying for the cost of doing business.
Therefore, when you begin to calculate how much you charge you need to think about the lifestyle that you intend your business to provide you. Do you remember the one and only reason that your business exists?
The ONLY reason your business exists as a vehicle to help you achieve your life goals!
Of course, that includes providing for your family. Think about your life. Think about why you do what you do. Is your business helping your lifestyle or hindering it? Once we know where we are going we can begin working on getting there. My good friend and world-famous sales trainer Zig Ziglar says “You cannot hit a target you cannot see!”
If you are waiting for your lifestyle and everything you are working for to happen by accident, you have a problem. Things happen by design, not by accident. You need to set clearly defined goals.
With that said, before I share how to determine what your price should be, let me mention one word of caution…
Don’t go overboard with the intense focus on lifestyle. For one thing, building a successful business is a discipline. It is a discipline that is kept based on strategies and assumptions we have made about our business. If the assumptions are correct and we are disciplined to implement the strategy, everything works. If the assumptions are wrong, then neither strategy nor discipline will work. If assumptions are correct, and you are disciplined to carry out the strategy, but the strategy is wrong, then things don’t work – but there is hope because you can always change your strategy.
I hope that wasn’t too deep. If it was, re-read it. The assumptions that we make in pricing are crucial. Let’s take a look at some possible assumptions about pricing:
“No one would ever pay that much for my service”
“People will pay almost anything for the right service experience”
“My market doesn’t have any Mercedes Clients”
“Mercedes Clients exist in every city and town, I just have to know how to find them”
“My service isn’t worth more than X amount of dollars”
“My service is worth more than any of my competitors”
“I must be competitive with other companies”
“I have no competitors other than myself”
Do you see how assumptions can sway our thinking? Now when we begin to think about strategy, we will naturally use the assumptions that exist. A strategy that is based on the assumptions that the competition is heavy and people will only pay a certain price will naturally direct you to a strategy of lower prices and more advertising.
An assumption based on the fact that there are people that are willing to pay a higher price, and that your service is worth the price you charge, and that you don’t need every Tom, Dick and Harry in town to build a profitable business and achieve your life goals will obviously direct you toward a strategy that plucks out the “cherry” clients that you want.
So make sure that your assumptions and belief systems are in line with your strategy before thinking about how much to charge.
Now, to determine how much to charge, you begin with one basic, elementary principle that must be taken into account when pricing anything whether it’s toothpicks or mold remediation.
Can you think of what it is?
Simply put, how much it costs.
Period.
Many small business owners haven’t a clue about how much it really cost to do business. And the reason is that most small business owners don’t like the “numbers”. They just like doing the technical work that they do.
To determine your cost of doing business, create a 12 month budget. I am saddened to report that most business owners I talk with do not yet have this in place. Many times these are the very people who are having difficulty making the amount of money they need to build their business.
A simple way to create a budget is to use a feature in QuickBooks:
In Quick Books, select Company, then Set Up Budgets. A window will pop up with each month of the year that is connected with the Chart of Accounts that you have already set up. Simply plug in the projected numbers for each of the upcoming 12 months (get your data from your past 12 month income statements and make the necessary adjustments).
Once you have completed this exercise, you will be able to take your assumptions into account. What happens if you raise your price 20% and you lose 10% of your volume? What happens if you hire an employee? What happens if you get more production out of existing vehicles instead of purchasing new ones?
Do you see how plugging the real numbers in can help you make decisions? Now your decisions will be made based on real data rather than feelings.
One more hint that I would like to share with you. I have been sharing this in my marketing seminars for several years now. Many of the income statements I see are missing a very important component. The component that is missing is the cost of sale, otherwise known as Cost of Goods Sold, Variable Cost, or Consumables. Experienced business owners wouldn’t even think about trying to business without this all important number, but many in our beloved industry started a business without really knowing what a business was (the author included). We simply launched out offering a service, people paid us, we paid the bills, and hopefully there was money left over. If so, it was by accident or at best intuition.
Here’s how a basic income statement is laid out:
INCOME (Revenue)
-COST OF GOODS SOLD (gas, supplies, direct labor, or anything else that is “consumed” in producing the job.
= GROSS PROFIT
- EXPENSE (Fixed expense such as rent, office supplies, administrative salaries, telephone, and marketing (marketing expense can vary greatly in many companies. Especially companies that are growing or in transition. Also, please note that you can have sub-categories for closer tracking).
= NET INCOME/LOSS (the amount left over. If you are incorporated, you are probably paying yourself a salary, so this would be your profit. If you are a sole proprietor, this may be your salary and profit.
As I mentioned before, many income statements that I see are set up without the COST OF GOODS SOLD category. In other words, the look like this:
INCOME
-EXPENSE
=NET INCOME/LOSS
Including the COGS is very important because once you realize the percentage of
cost, you can simply and quickly calculate your potential return on any investment you make in your business.
For example, let’s say your COGS are running at 50% according to your latest income statements. If you spend $2000.00 in advertising, how much would you need to get back in revenue just to pay the advertising expense? Four thousand. Actually a little more because there are hidden cost in administering the investment. Let’s say you hire someone for $3000.00 per month. How much do you have to increase sales just to pay for that person? Six thousand.
So as you can see, the COGS becomes extremely important in planning. There may be times when you make investments that don’t pay off immediately, but at least you know exactly what it is costing you.
Now that you have an outline and a 12 month projection to work with, you can run a few different “scenarios” to pick out your strategies.
Project how many clients you will serve that month at a certain price range. Project what the cost will be, and factor your fixed expense.
If your assumptions are correct, and your strategy proves out through staying disciplined to see it through, your in the money. If it doesn’t work, you review to discover whether your assumptions were incorrect or whether the strategy was flawed, or you just didn’t do what was required to implement the strategy.