by: Steve Meiseneheimer
“All disciplines affect each other. Mistakenly the man says, "This is the only area where I let down." Not true. Every let down affects the rest. Not to think so is naive.” Jim Rohn
“Any monkey can trim a palm tree.” I was sixteen years old when my best friend’s dad informed me of this. I had just asked him if I could trim his two palm trees for $50. “How long would it take you?” he asked. Without thinking of the reason for his question, I said about an hour. “That’s too much money for a kid your age to be making per hour.” No one had ever told me that before. How much should a kid my age be charging per hour who has invested thousands of dollars in equipment, training, and, on top of all that, employed this man’s son?
Despite the bitter taste of that conversation, the question was still a good one. How should businesspeople, regardless of age or activity, establish their fees? I have yet to meet a businessperson who was not struggling with this issue. There are a few considerations in determining where your prices belong: costs, volume, and strategy.
Costs
Costs are the most obvious. You can't, as the joke goes, “Sell below your costs, but make it up in volume.” Separating out your direct costs (expenses directly related to production or the servicing of an account like field labor, material, and commissions) from your fixed costs (expenses that remain constant regardless of how many jobs you do like office salaries, office rental, and your electric bill) is critical to determining your gross margin and break-even point, and these are essential in calculating appropriate fees.
Your fixed, or overhead, costs must be assessed against every unit or hour you sell. If you have one million dollars of fixed costs annually and you sell a million units or hours each year, it’s logical that you must add a dollar per unit or hour to cover your fixed cost, but most businesspeople either don’t know, or don’t process this information this way when setting their prices.
If you don’t have a CPA or accountant who can explain this concept in very simple language, find another accountant. Too many can't, and it’s very simple math.
Volume
Volume is the second most conspicuous component. If you are making an excellent gross profit on each product you sell (revenue minus direct costs), but you only sell a couple of them in a month, you might cover your direct costs (labor, material, etc.) but you won't cover your fixed costs. No customer will allow you to put all your fixed costs on their order alone. You spread these overhead costs over all the units or hours you anticipate selling throughout the year. Therefore, the goal is to maximize your volume and spread these costs out so they make the smallest price impact on each unit or hour sold.
Strategy
If all the companies in your industry pay similar labor rates, have similar material costs, and have similar overhead costs, will they then charge similar fees? It’s possible. But what if you offer more services, more options, and a friendlier service, can you charge more? Or, if you are faster, more efficient, and move more volume, can you charge less?
Every company’s unique strengths and resources allow it the opportunity to choose a market position that is distinct from the competition. The premium (profit) you are able to charge over your company’s cost is affected by many factors. These factors include:
• Affluence of your market niche
• Size of the niche
• Price sensitivity of your niche
• Perceived value relative to the fee
• Special demands or expectations
• Size of sale
• Existing demand for your offering
• Demand expected to be created through marketing
• Additional demand expected for replacement, support, or training
• The nature of customer’s demand (basic need or luxury item)
• Ease of accessing your niche (local, remote, global)
• Your ability to please your customers consistently
• Your ability to offer terms or financing
Often, there is very little consideration given to these three pricing factors that drive a successful enterprise. Ask yourself, “Why do I charge what I do?” Most who read this article will answer, “Because that’s (about) what my competition charges.”
Consider this rule, “Only serve niches that appreciate your company’s unique value.” When your honor this rule, you can, first, charge a premium above your costs (which drives your gross margin), and second, you will optimize the perceived value and acceptance by your market niche (which drives your volume).
Your fees, therefore, are a function of your costs, your volume, and your market position. There is simply nothing accidental about a company that grows and profits over time – and, in business, there’s simply nothing more rewarding.
Steve Meisenheimer offers practical insights into leading and managing a growing company through his books, audios, and subscription products. Learn more at http://www.MeisenheimerInc.com, or e-mail Steve at Steve@MeisenheimerInc.com.
You are welcome to reprint this article in any format as long as the author’s name and website in the previous paragraph are also included.
