The method you use to charge for your products or services is critical to how much income you can generate and the extent of profit margin that’s created.

What we are seeing:

• fixed fees that don’t cover the service delivery costs
• adopting competitor pricing that doesn’t reflect the real price
• hourly rates don’t work when you don’t record the time spent on the client/customer
• fixed-price long-term contracts becoming unviable with inflation wiping out the profits
• cutting pricing to gain market share and making losses
• reluctance to change prices causing declining profits.

These issues are not isolated to any one industry and cover the full spectrum from construction, manufacturing, retail, to even professional firms.

While no method is either correct or incorrect, each method has its advantages and disadvantages and some as a method of pricing should just be ignored. Understanding some of the most common strategies (and potential pitfalls) helps you to drive the success and sustainability of your business.

Fixed fees

Standard charges and fixed fees make life easier. There’s no need to overinvest in timesheets and more time on the job earning income is good, in theory, and can be practical provided they are managed correctly.

The issues:

1. The fixed fee not aligned with the underlying cost of the service or not being increased each year in line with business costs.
2. The fixed fee hasn’t been fully costed.
3. The fixed fee is not reflective of all the items covered. Often the same fee is applied to a range of services that vary in time and cost.
4. The fixed fee leads to scope creep when the customer thinks it’s covered and the provider finds it difficult to charge separately for the additional work.

These issues tend to lead to busy staff but poor productivity and declining profitability. When using fixed charges, it must be clear what is covered and what is not. They also need to be properly costed and maintained to ensure they will provide profitability. When costs rise, it’s critical that fixed fees are increased. It may be necessary to have a wider range of fixed prices that better reflect the services offered.

Adopting competitor pricing

While possibly the easiest way to set prices (particularly for new business owners), the risks include:

1. The competitor may not have costed correctly and could be making a loss.
2. The competitor may not be providing the same service or product, i.e. one might be standard while the other is premium.
3. The competitor may have a larger customer base or targeting a different market segment who are less price sensitive.
4. The competitor may have an unknown advantage such as strategic alliances, better wholesale buying power, own the premises from which they operate, outsourced labour, or any number of ways to reduce operating overheads or increase the lifetime value of a customer.

We come across clients who set their prices by reference to their competitors pricing only to find out this led them to making significant losses. As they hadn’t costed their services, they didn’t understand their business costs and what they needed to generate a profit. After changing how they set their pricing, they had a rapid turnaround in profit.

Another caution in adopting competitor pricing is the common practice of using Loss Leader’s. These products and services are often offered at a price that is not profitable as a means to attract new customers or provide an opportunity to up-sell.

While ensuring you’re not too far outside of the market’s price point is part of the process, it must be as a check to properly undertake price setting methods.

Hourly rates

Hourly rates are fundamental to many businesses including professional services and trades. The key issues with hourly rates are:

1. Ensuring they are correctly calculated, including, labour, overheads, and most importantly profit.
2. Ensuring your assessment of your productivity is accurate.
3. Ensuring all time is recorded accurately to reflect what’s been incurred or written off.
4. Monitoring staff productivity.

We regularly see hourly rates being calculated without factoring all business costs plus a profit margin.

Many business owners are not adequately monitoring their staff productivity, which can lead to significant lost time and poor financial performance.

Hourly rates require regular review and costs and productivity monitored to ensure the profitability is achieved.

Fixed-price, long-term contracts

When inflation was low and stable, properly costed long-term, fixed-price contracts worked well, especially for the construction industry. However, when COVID hit and prices skyrocketed, profits plummeted and many businesses closed.

The longer the contract term: the greater the risk. Contracts must reflect the greater risk with higher profit margins or the ability to pass on price increases in materials used in delivering the contract. While this may seem to go against the traditional nature of a fixed-price contract, if you go broke due to unsustainable price increases that you can’t pass on, you can’t deliver on the contract.

One option is to effectively hedge the contract by buying all materials at the contract outset (being mindful of cash-flow issues).

Market share at all costs

Undercutting competitors by underquoting is a tactic used by newcomers to the market or those chasing a greater market share to ensure a positive result in the short-term. However, it rarely leads to long-term success. This tactic can create the following issues:

1. It’s hard to be financially viable when undercutting.
2. It can become a race to the bottom with competitors undercutting each other to retain market share.
3. Quality suffers when prices are reduced, and customers move on.
4. Customers motivated by price are unlikely to appreciate the value of your offering, and can prove difficult to work with
5. If you later reposition your price to market levels, the customers often go back to their previous supplier.

Leveraging technology is a proven way to lower the price and gain market share. But building the relationship and providing better service is a better way to develop a long-term profitable customer base.

I can’t put up my price… my customers will leave!

One of the first things we get told by business clients who are making a loss or a limited profit is that they can’t put up their prices because they fear their customers will leave. We recommend regular annual price reviews and increases. By not putting up prices for several years, you can find yourself left in the position of having to increase the price significantly, and potentially creating tension with customers.

In the case of a business not making money this point is moot as going out of business or becoming insolvent is likely.

In Conclusion…

Knowing these pricing method weaknesses is key to implementing systems to ensure the profitability of your business.

Contact the team at Business Wise today to see how we can help you increase your profits and ensure the long-term viability of your business!

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Tony Muller

Chief Technology Officer

Tony has business management and information technology experience gained in the public and private sectors. He has worked with the Queensland Government Chief Procurement Office on IT tenders, and is also an Australian Institute of Management graduate.

Tony is passionate about how technology can facilitate business operations, and is always looking for innovative solutions to business requirements.