Services businesses come with a gift and a curse of sorts. Pricing. The lack of an intrinsic value to many service products leaves a huge chasm in pricing. You will find that website developers can charge anything from US$100 to US$1500. Granted all website developers are not equal but that is a large gap right there for roughly the same product. New businesses entering an existing market also struggle with pricing services. While many imagine that pricing cheaper than the existing operators is the way to get into business the evidence suggests that once you’re in, this changes and fairly quickly. So if you have a service business, how do you price your products appropriately?

Calculate your costs

As a first step, you need to know the cost of producing or delivering your product.  This is a problem I have run into with many service businesses who simply do not how much time for example goes into preparing, producing the final product and delivering it to the customer. Even if you are going to operate in an established market this information is still very important to know because it will inform you just how profitable the pricing is. Costs should include all material and labour costs.

Look at the market

If you’re in a virgin market you really have your pick of the flowers. For most though they are entering existing markets that are likely quite well developed. What that means is you can’t price as you like. The market has established pricing and the segments have price points that appeal to them. One time when I was annoyed by the question of “how much should I charge”? I retorted “80% of too much”. While it was an off the cuff comment it kind of stuck. To effectively price within the market you will need a good understanding of the market, its depth and how the different customers fit into the segments.

Know your customers

Knowing the customers also helps a great deal. I have seen service businesses get away with pricing that many would consider daylight robbery and yet customers are willing to pay that. It comes down to two things and the first is knowing your customer. Customer service is more than a polite greeting and prompt responses to emails. It stems from understanding the needs and desires of the customer deeply and catering to them. This looks most magnificent when it is done before the customer even has to ask.

Understand the problem

If there’s one thing I love to speak about its Clayton Christensen’s job theory. The father of disruptive innovation, well the academic concept of it put forward a simple theory that you will see in many service businesses. He gave the example of someone who goes to buy a drill to put a hole in the wall. The customer does not want the drill, the customer wants the hole in the wall but must buy the drill to have it. If they could get a hole in the wall through other means they would buy that if it were more convenient. Now consider this, customers are not involved with our products, our products satisfy a need in their lives. Service businesses can also look at the size of the problem they solve and this is one of the biggest paradigm shifts people experience with the transition into a business from the outside. Customers pay those ridiculous prices because of the perceived value of the problem solved. Understanding the size and severity of the problem helps you understand the value of the solution.

Keep it profitable

I have worked in a service business that had flexible pricing or at least the option to price flexibly. This was useful when customers wanted a discount for bulk services but was also a trap if the numbers were not done right. This was my job. What I had to do was make sure every deal or offer was profitable, preferably before it was communicated to the customer. In addition to this, it was also important that the deals contributed to the profitability of the business, this was the challenge. Competing on price makes things difficult but sacrificing profitability is sacrificing your business in the long run.

Services will continue to present a pricing problem because of their nature. These tips will help you see a bit more deeply into the issues you should be careful of when pricing services and written with the new entrant in the market in mind.