The problem with being pocket rich is that we forget about the related bills that have to be paid. Many service businesses are seasonal in nature. This does not mean that there is no work in the slower season, but there is less. Therefore, it becomes extremely important to put away some acorns for the winter (slower season) as the saying goes.

The following discussion will give you a basis for pricing your services. I urge you to think hard about the following discussion, since your profitability relies on it.

Remember, the service business is your profession. Therefore, you should never sell yourself cheap. After all, you are providing a needed service and if it is communicated to the customer that way, you will be able to command your price…. And you deserve it!!

How much does it cost to service a customer? By understanding your costs, you can literally choose your level of profit by setting the appropriate selling price of your service. The below illustration is called break even analysis, it will give you a basis for pricing.

Definitions:

Fixed Costs - Any cost that remains constant at any volume of business (i.e. rent, advertising, utilities, etc.)

Variable Costs- Costs associated with producing one unit of a good or in our case, one unit of a service. For our purposes, one unit of a service will be one hour of service. Thus, variable costs are those costs that rise and fall based upon the number of hours that we provide service. Examples of variable costs would include: Hourly pay for you or if you get big enough for your employees, Workers Compensation Insurance, Material Costs, etc.

Gross Profit - The difference between the price charged per unit (Hour of Service) and the variable costs. For example, if we bill our service at $100 per hour and a technician gets $20 per hour and all other variable costs associated with providing that hour of service are $35, our gross profit would be $45 (Figures: $100 billed less ($20+$35) variable costs).

Once these definitions are clearly understood, we can determine our breakeven point.

Breakeven Point in units (service hours) = Fixed Costs divided by Gross Profit per Hour.

Example:

If our rent, utilities and all other fixed costs are $10,000 and if using the example above, our gross profit is $45 per hour, then our breakeven point is $222.2 hours of service at $100 per hour just to break even (Figures: $10,000 divided by $45 Gross Profit Per hour).

At 222.2 hours of service we will start making $45 per hour. You see the gross profit contributes to paying the fixed costs. Once the fixed costs are paid, the gross profit contributes to bottom line profit. This is the reason some accountants call gross profit the contribution margin.

IS IT REALLY THIS SIMPLE? YES!!! However at various sales levels certain fixed costs rise (i.e. after a certain sales level, a new piece of equipment might have to be added, thus the cost of using that piece of equipment must be added to fixed costs). Therefore, figuring your breakeven point can sometimes be confusing. The example below illustrates a real life example which demonstrates that in order to make a 5% profit; your hourly billing rate should be $76.02.

** Productive Time includes time actually spent on the job. Unproductive time would include travel time between jobs, lunch and call backs. For example in the Pest Control industry 60% Productive time would be considered good as an industry standard.

Let’s assume that we want to make a 5% profit.

** Since we know that Total Fixed Costs + Desired Profit = 47%, and we also know that total cost plus profit = 100% of selling price, then the missing 53% must be Total Variable Costs.

We know from above that total variable cost per hour is $40.29. If $40.29 is 53% of the selling price per hour then the selling price must be $76.02 per hour (40.29/53%). This would mean that a job that takes a half hour should be priced at roughly $39.00.

The above discussion is accurate in terms of pricing methodology. Some would argue that a small operator can operate at lower prices because he/she does not have the overhead of the larger companies. There is nothing further from the truth. You see the above costs may vary slightly from company to company. But over the long run the cost structure is the same for the small operator and large operator alike.

A small single person operation has the same cost structure as the bigger companies. However, the small guy can be his own technician, run his own books, and perform all of the office functions himself (By the way, this is the way that I suggest that you start). In this manner, you may think that you are saving all of that money in technician and office salaries, and that the savings is going right to your bottom line, thereby making you much more profitable.

The problem with this thinking is that you are in business hopefully to make a profit and perhaps build a business that has some value, should you decide to sell it.

You see the fact is, that you can go out and get a job as a technician, and you could get a job as an office worker at night. Working at these jobs you would get paid a fair wage. Why would you take all the risks associated with going into business if your plan didn’t include making more money than a wage earner?

You see the profit that we spoke about before is your reward for taking the risk. If you operate under the false illusion that you can cut your price because your costs are lower, you will eliminate this reward for taking the risk. In fact, you may not only wipe out your profit you may even cut into the wage portion (It may still appear that you’re making money, because there is some wage left, not all, but some!!). At this point, why be in business? You can certainly can go out and make more money as a wage earner working for someone else doing the same amount of work.

So How Do You Compete With The Big Guys?

Beat them on quality workmanship!!!

NEVER ON PRICE!!!

Dan Gordon is the owner of PC Opportunities and has spent over 12 years as an accountant and CFO for small to medium sized businesses. His services include accounting, tax preparation and operational audits. Mr. Gordon can be contacted at (908) 684-0627 for further information.