Very early in my career, I emailed an expert networker asking for some tips. Even though I was young and she was a friend, I knew that asking someone to provide their core services for free wasn’t a great approach and sometimes was considered offensive.
So, out of respect and for fear of ruining our relationship, I veered away from asking, “Can I pick your brain?” Instead, I asked if I could hire her and pay for her services. I was clear about my limited budget and narrowed scope, hoping she would align her pricing structure with my ask. After all, I was new to the startup game and trying to leverage my entrepreneurial skills.
Her response was friendly and business-focused. She offered me a 60-minute consultation with follow-up. But, to my surprise, her offer also included a dollar sign followed by four figures. I remember asking a colleague, “Who charges that much for that type of service?” His response was simple and concise: Someone with clients willing to pay that much for their services.
That was the day I learned a valuable lesson and one of the most important business tips. When pricing your services, charge what you’re worth. Taking it further, factor your worth into a formula that uses both a subjective and an objective pricing approach. If you simply shoot from the hip to price your services, nine times out of 10 it will backfire.
Overview: Why it’s important to have a pricing strategy
There are few things more frustrating than running a business, doing a great job, and never making money. If your product or service is reliable but you aren’t turning a profit, you have to make adjustments. The answer is not to simply work harder (you’re likely working hard enough already). It’s to learn how to work smarter, which includes evaluating your pricing structure as it relates to your expenses, offerings, and overall value.
A solid pricing strategy is all about working smarter. It provides guardrails to keep you and your business on track. It removes the guesswork from figuring out custom quotes and ensures you charge a reasonable and competitive price that makes you and your customers or clients feel good.
Money is energy. There is a flow, and when it flows with positivity in both directions, everyone benefits.
What to consider when pricing your services
Having both a subjective and objective pricing strategy will offer a balanced perspective. It will make sure you feel valued for the work you do and allow you to perform at your best and maintain a customer base. Here are a few things to consider when pricing your services.
1. How much revenue do you need to generate?
Remember that your prices need to cover more than the cost of what you’re selling. Your prices sustain you (as the owner) and your business. Your prices should be set with thought and consideration as you allow those guardrails to keep you focused on where you need to go and how you will get there.
If you don’t have a good handle on your numbers, be sure to seek assistance. You must get your accounting in order before you can really focus on pricing and profit.
2. What is the market value of your product or service?
In your market, what is the general value of what you offer? What is the going rate for your product or service, and where do you fall on the continuum? Are you an upscale option? Are you the best bargain provider? Or are you in the middle of the road, knowing that you compete on quality and not price?
3. What are competitors charging?
While the competition should not determine your price, it’s good to know what competitors are charging and how their audience may be similar or different from yours. For example, if you offer fitness classes to the same audience as your competitors, how much is everyone charging? If you’re charging more, what do you provide to show your audience value at a higher price?
It’s essential to understand these considerations from the beginning so you can feel confident knowing what you want, what you need, and how others will perceive your business.
How to correctly price your services
Let’s take the subjective viewpoint and merge it with the objective. In other words, let’s put numbers next to those feelings. While you have some specifics about what you want to charge and what you feel is fair, we know that numbers don’t lie, and, by taking a hard look, you can solidify your prices.
1. Calculate the cost of goods
What is the cost of goods sold (COGS) required to operate your business? If you have a cost-based product, these are the direct material and labor costs. If you are a service-based business or offer a business service, this is the cost of labor to provide those services. Keep in mind that this number does not factor into your overhead costs (covered next).
Some examples of COGS include:
• The cost of raw materials to produce an item or product
• The cost of labor to make the item or product
• The cost of acquiring the merchandise you may sell
If you sell merchandise, your COGS is the original price you paid to purchase the merchandise. If you manufacture a product, it includes the costs required to create that item.
COGS are considered monetary expenses incurred to run your business (and without which you wouldn’t have a business). The COGS is the foundation of your pricing strategy, and you must understand these numbers before you move forward.
2. Figure out the overhead total and percentage
Your prices need to cover your COGS and your operating expenses. If you do not cover both of these, you will not hit a profit point, nor will your business model be sustainable. This is often why business owners get frustrated and have difficulty understanding why their profit margin is less than expected.
The total overhead cost is the total of your operating expenses. This total includes, but is not limited to:
• Rent payments
• Employee wages
• Point-of-sale software
To determine your overhead percentage (which is the percentage of your revenue allocated toward operations), you need to know two numbers:
• Annual gross sales
• Annual operating expenses (but not factor your COGS into this number)
Then plug those numbers into this formula:
Expenses ÷ Gross Sales = X
X x 100 = Overhead Percentage
Let’s use some simple math. If your annual gross sales are $100,000 and your annual operating expenses are $30,000, then your overhead percentage is 30%. This means that 30% of every sale goes toward operating expenses.
3. Determine a reasonable markup
Once you have your numbers for your COGS and operations, then you can understand your starting point for your pricing. The next step is to add the markup. The markup is the amount added to each sale to turn a profit. Your profit goes toward paying off debt, providing your paycheck, and paying taxes associated with running a small business. You want to be relentless about creating a profit large enough to help you reach your business goals.
Your markup can be added as a dollar amount or a percentage. A dollar amount is a fixed price you want to earn on top of your product costs. A percentage is a set amount that’s the difference between the product’s cost and the selling price. This can be especially helpful if you have variable prices. You can set a standard markup for one set of products and another standard markup for other products lines.
Your markup is where subjective analysis comes into play. While the COGS and overhead are based on specific numbers and formulas, your markup is where you have flexibility and where you should consider industry standards for markups, pricing based on the market value, and competitors’ prices.
4. Set a price and test
Now that you’ve completed the legwork, it’s time to set your price. The first step is to determine your baseline. This is your breakeven price, and you cannot go any lower than that for any reason.
As an example, let’s go through a hypothetical situation. Let’s say you decide to sell an at-home fitness kit that you purchase for a wholesale price. Your COGS is $10 per kit, and you add a 100% markup to the product.
Determine your baseline price using this simple formula:
$10 (Costs) + $10 (Markup Amount) = $20 (Baseline Price)
If your markup is a percentage, then use this formula:
Costs x Markup Percentage = Markup Amount
Markup Amount + Costs = Baseline Price
Now, multiply your baseline price by the overhead cost percentage to determine the overhead contribution:
$20 (Baseline Price) x 0.30 (Overhead Percentage) = $6 (Overhead Contribution)
Now add the numbers together:
$6 (Overhead Contribution) + $20 (Baseline Price) = $26 (Final Price)
Your at-home fitness kit should be priced no lower than $26 so you can cover the cost of goods and your overhead contribution, plus contribute to your profit.
5. Analyze the price and then adjust
After determining your pricing structure and your menu of costs, you want to make sure they work for your audience. This means making sure your prices are competitive and work within your market. You can test your prices and see how they perform and then adjust accordingly.
You also want to consider the following:
• Is this pricing structure sustainable?
• Will the profit allow me to get paid and reinvest in the business?
• Is there flexibility for offers and discounts (if those are part of your business strategy)?
It’s much easier to adjust your prices down than it is to raise them. However, you want to evaluate your pricing strategy yearly and adjust for the cost of living, taxes, and any other factors that may impact your business and your customers.
Know your worth and your numbers, then price for profit
A solid pricing strategy will make or break a small business. Get real about knowing your numbers and be as exact as possible when plugging digits into the formula. While you may have an idea of what you, your products, or your services are worth, make sure you know their value, what will keep you competitive, and how to make your business profitable.
The post Create a Competitive and Profitable Pricing Strategy for Your Small Business appeared first on The blueprint and is written by Jen Crompton
Original source: The blueprint