Definition: To establish a selling price for a service
How should you set fees or prices for your service business? Procedures depend upon the business, but the same three elements must be considered for every service business:
- Labor and material costs
- Overhead
- Profit
These factors must be considered not only during startup but also during growth.
Labor and Materials
Labor costs are wages and benefits you pay to employees and/or subcontractors who perform, supervise, or manage your service business. If you as the owner are involved in a job, then include the cost of your labor in the total labor charge. The cost of your labor will be quite significant during start-up, when most new business owners pour lots of time and energy into their businesses.
Labor costs are usually expressed as an hourly rate. Check in your library's reference room for government publications giving national and state salary ranges for different occupations. The editors of trade publications also might have similar information. Current rates are often cited in classified newspaper ads or available from your local chamber of commerce.
Labor can also be subcontracted--such workers are not on the payroll as employees. When labor is purchased for each job on a contract basis, the full cost is agreed upon in advance, which helps keep your costs fixed. The key is to carefully estimate the labor time it will take to accomplish each job on which you bid.
Profit
Profit is the amount of income earned after all costs for providing the service have been met. When calculating the price of a service, profit is applied in the same number as markup on the cost of a product. For instance, if your labor costs for a job are $210, and you plan to net 21 percent before taxes on your gross sales, you'll need to apply a profit factor of about 25 percent to your labor and overhead to achieve your goal. For example, say you have an operating costs' subtotal of $324 and you want a profit of $81, so you quote the customer a price of $405.
If you compare the price of $405 with the cost of labor ($210) already estimated, you'll notice that one figure is more than double the other. Some contractors use this ratio as a basis for determining price: They estimate their labor costs and then double that figure to arrive at a bid price. Pricing can be time-consuming, especially if you don't have a knack for it. Some contractors seem to have a sixth sense when it comes to pricing and they "guesstimate" on what they need to quote to make a job profitable to them.
If you're just starting out, you obviously won't have the skill of a seasoned pro. If your quote is too low, you'll either rob yourself of profits or be forced to lower the quality of your work to meet the price. If you estimate too high, you may lose a contract, especially if you're in a competitive bidding situation. Make it your business to learn how to estimate labor time accurately and how to calculate your overhead properly so that when you quote a price, you can be competitive, profitable, and successful as a service business.
See also "Pricing a Product."