Pricing a service is a lot more difficult than pricing a product.
Most business owners use a variation of cost plus pricing.
What is Cost-Based Pricing?
Cost-based pricing is the oldest and most common approach to pricing services. In this method, all the various costs are added up: direct labor costs, material costs, the overhead costs, and then an arbitrary markup for profit is added, which then becomes the price that's charged to the customer.
As much as it ensures marginal profits, this pricing method has a few drawbacks. For instance, it completely disregards the demand side of the equation and only looks at the supply side of the equation, hence it only considers the cost you incur to deliver that particular product or service to your customer.
Disregarding, to the demand side of the equation essentially results in not knowing what your customer wants, and what they are willing and able to pay for your service.
An indirect consequence of that is that you become internal focused around your costs and your delivery and less around the customer. Whereas, when you are customer focused, you know what value means to your customer and you will be able to quote a price that represents value for money.
Is there any alternative to cost-based pricing?
Value-based pricing is an alternative that places the customer's perceived value above everything else. However, it is incredibly difficult to achieve because value is highly subjective and varies from person to person. As they say, value is in the hearts and minds of the customer.
Where do I start?
There’s a couple of things you can do to start moving along this journey. The first is to your customers, certainty and choice. Certainty in what they’re going to pay, and choice in terms of options available to them, depending on what they value.
Secondly, you need to invest in your pricing function.
Currently, investments in sales and marketing functions are made, to increase the profits of businesses. However, investing in your pricing function is equally important, if not more, to increase the profitability of your business.
Getting your pricing right can literally transform the profits of your business, and will make your customers love you for giving them great value for money.