You’re Not Charging Enough!

“What do you know?” I hear you say, “You don’t know anything about my business.”

This is true of course, I don’t know your business, but nearly every business that I have heard of or had anything to do with has had fear about raising their charges. This ranges from electrical contractors in regional towns to law firms in capital cities. In each case the argument is the same – “Ïf I raise prices to that, I will lose customers”.

 

Nowhere is this more apparent than in a business which sells services, because the temptation in most service businesses is to base pricing on time. In a future article, I will explore the appropriateness or otherwise of this strategy, but for most service-based businesses there is at least an element of time-based billing. That being the case, what we are dealing with is a finite number of units which can be delivered in a year, and so it is quite easy to work out what the pricing should be for those units, based on our desired level of profitability. When selling widgets, a strategy to increase profits could be to simply sell more widgets, but when it comes to time, we all have the same limited amount of it to sell. This can be either our own time or that of our employees, but there will only ever by 24 hours in a day and 365 (or 6!) days in a year. (Note: Leap Years are NOT an opportunity to bill more time – enjoy an extra rest day!)

When you are only going to be spending something like 60% of your time on delivery of your core service you need to ensure that that time is being charged to the customer appropriately. In the end, it just gets down to arithmetic. Let’s try a little exercise:

Amy thinks that she should be able to make $60,000 per annum out of her small business. To keep it simple let’s call it a service business, and to make it even simpler, let’s assume she has no staff. If Amy can’t make $60,000 per annum out of her full-time business, then she has no business being in business, she should go out and get a job.

In any given year, Amy can only count on working for a maximum of 1800 hours (40 hours per week for 45 weeks, the rest being taken up by holidays, and public holidays, and other time off). In fact, my experience shows that the reality is that she will probably only work for 1500 hours in a year, but to be conservative (and to take that argument off the table) let’s go with 1800.

Let’s assume that the inputs into Amy’s income are about one third (overheads like office space, stationery, direct inputs, everything – this will vary from business to business, but for the sake of the example…). So the $60,000 Amy wants to make in a year translates into a gross revenue of $90,000. (2/3 of $90000 being $60,000). On the face of it, Amy decides that $50 an hour is therefore what she needs to charge ($50 x 1800 hours = $90,000, right?) – Wrong!
Amy will likely only ever charge around 60% of the time she spends working directly to her customers. In order to generate $90,000, she needs to charge sufficient to produce that income out of 60% of 1800 hours. This is 1080 hours, and to generate $90,000 she needs to be charging a minimum of $83 per hour in the hours she is charging customers.

 

So what is she doing with the rest of her time? Well, she is running a business. Somebody needs to find new customers, somebody needs to keep the records, somebody needs to send the bills, somebody needs to be putting together the quotes and proposals, and somebody needs to take care of the filing. Of course, Amy could hire somebody else to do those things for her, thereby increasing the hours she can charge to customers, but it is never the case that 100% of your time can be billed out, at least not in my experience. The cost of the somebody else also has to be taken into account.

Now, if you haven’t got a calculator out yet, you should have. How much does Amy have to charge for her time, if the inputs are 50%? (The answer will be lower down). In fact, the exercise is similar if we are talking about selling widgets. once you know the cost of the widget, and how many you can sell in a year, you can work out how much you have to charge for them. And if you want more profit, you just sell more, right? (Sounds easier than it is).

As I’ve mentioned, this kind of exercise is really only arithmetic. If you’re a CBD lawyer and want to earn half a million, the principles are the same as if you are a suburban hairdresser who wants to earn $80,000. If it’s so simple though, then why do seemingly intelligent people struggle so?

The main issue I have found is that most business owners don’t value their time. Surprisingly, they don’t attach sufficient value to what they deliver to their customers. They don’t believe that their services are so outstanding that customers will stick with them, rather their fear is that their customers will flock to their competitor down the road based on price. If this is true, then it is a self-fulfilling prophecy. If your services are identical to those being provided by Joe next door, then you are both in trouble, because Fred from the next suburb is prepared to charge even less, and in order to hold on to what you have, you will have to undercut him. We call this a race to the bottom.

Of course, there will be times when the market for our output shifts. In nearly every business, technology is having an impact, globalisation has meant there are more players in most markets, and then there is young Chad down the road who is just starting out on his business journey and will accept any customer at any price provided they have a pulse. These are opportunities for us to further differentiate our businesses, not to join the pack selling the commoditised version of what we do. In a future article, this will be explored further.

 

In September we will be running a workshop “Setting Prices For A Service Based Business”. You can register your interest by emailing enquiry@innovusadvice.com.au, or by calling 0242580099

Look out for our next article “You are not selling your time” next week.

Oh, and if Amy’s inputs represent 50% of her selling price, she needs to charge her time at $111.

If you like this article why not share it? I appreciate your support. Be sure to visit our blog again for this and other articles. If you have any thoughts, comments are always welcome! Why not connect with me on Social Media so we can continue the conversation.

Posted on July 31, 2018 in Business

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