September 23, 2014

Small Business Advice

Price it right: Cover costs AND give good value

If you wish to prosper, let your customer prosper...

Jerry Osteryoung | 7/16/2012

"When people have learned this lesson, everyone will seek his individual welfare in the general welfare. Then jealousies between man and man, city and city, province and province, nation and nation, will no longer trouble the world." ~ Claude Frédéric Bastiat

In most cases, pricing a product is rather straightforward. If you buy a product for $10, you know you have to sell it for a higher price if you want to make a profit. When dealing with services, however, it is so much more complicated.

Jerry Osteryoung
Jerry Osteryoung

I was working with a large heating and air conditioning contractor who was having issues with low profitability. Though they sold a product occasionally, this firm was predominantly in the service business.

We started with a profitability analysis per customer and found that some customers were generating profits, but a large number were not. It would be easy to say the firm should raise prices for the clients they were losing money on, but the better question was what is the cost of providing services to these clients.

For example, one of the services they regularly provide is a routine checkup to ensure the unit is in good working order and change filters. They charged $100 every two months to provide this service. They assumed they were making money as they were paying an employee $15 an hour and it only took an hour to complete the job.

As it turned out, however, travel time to and from the client’s residence often took an hour. Added on to the time it took to complete the service itself, the job actually took more like two hours. Additionally, if they included the cost of the employee’s benefits (30%), the direct cost of the service went from $30 to $39 per visit. As for materials, the firm provided filters for an average cost of $6 since so many houses had multiple filters.

In addition to the direct cost associated with the service, there was also overhead to consider. In this case, we calculated the overhead cost of the truck and all the support staff amounted to 60 percent of the revenue.

All things considered — direct labor and benefits ($39) plus the cost of the filters and overhead ($66) — the firm was losing $5 on each service call. Clearly this is not a good place for this firm to be. They had priced this service too low to offset the cost of providing it.

When pricing your services, you must remember that, when possible, every service you provide should cover both its direct costs and its share of the overhead. After all, if each service does not pay its share of the overhead, another will have to pick up the slack.

Now go out and make sure you have a plan in place to ensure that each product or service you provide covers both its direct and overhead costs — even if this process means that you must drop unprofitable products or services. It is critical that each and every product and service has a strong profit level.

You can do this.

Go to Links Other small business advice columns from Dr. Osteryoung are here. Note: Articles older than 30 days require registration (it's quick and free).

Jerry Osteryoung is a consultant to businesses - he has directly assisted over 3,000 firms. He is the Jim Moran Professor of Entrepreneurship (Emeritus) and Professor of Finance (Emeritus) at Florida State University. He was the founding Executive Director of The Jim Moran Institute and served in that position from 1995 through 2008. His newest book co-authored with Tim O'Brien, "If You Have Employees, You Really Need This Book," is an Amazon.com bestseller. He can be reached by e-mail at jerry.osteryoung@gmail.com.

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