Sunday, October 3, 2010

Make sure you include overhead in your pricing!

“Profit and morality are a hard combination to beat.” ~Hubert Humphrey

So many of the business owners we help have difficulty dealing with pricing. The question of where to set their prices is a critical one for every company. If set too high, the firm will not pick up much business. If set too low, they will have sales volume but no profits.

Just because a business is maximizing sales does not necessarily mean they are making money. Having revenue coming in is not the same as making a profit, but many business owners confuse the two, especially in a tight economy.

We were helping a very neat company, the owners of which really care about the community. It is important to them to do all they can to make their community a better place to live. They are constantly volunteering for so many activities, and as a result, they have added a great deal of value to the local community. In the process, they have also earned quite a bit of notoriety for their company.

While these entrepreneurs have done an enormous amount of good for the community, their business was not doing so well. They were not taking much of a salary even though the company has been in business for more than five years and is well-established. Although a tad flat, their revenues were okay, but they were not generating sufficient profits. Their net profit margin continuously hovered around one percent after paying themselves their miniscule salary

Being a service business, they were charging by the hour. They were taking just about every piece of business that walked through the door so long as they were able to cover their direct labor expenses and generate a 10 percent profit.

What they forgot to account for in their pricing model is their overhead. Fixed expenses such as rent, office salaries and utilities, to name just a few, have to be paid regardless of the amount of revenue. In the end, they were having to divert about 50 percent of their revenue to cover overhead costs.

By failing to account for overhead in their pricing model, they seriously underestimated the true cost of their services. If each customer is not assigned a fair and equal share of the overhead, one must shoulder the entire burden – or the owner loses a lot of money.

We were able to get this point across to the owners, but they still had reservations about adjusting their pricing model to include the overhead. They feared many of their customers would think their rates were too high. We suggested that the way to overcome this was to price by the job instead of by the hour. This would allow them to charge the fees they need to cover the overhead and still be competitive.

The jury is still out on this business, but the owners now have a plan for profitability that will allow them to grow and be successful. Even more importantly, they can now start taking a salary that fairly compensates them for their efforts.

Now go out and make sure the pricing model you set for your products and services is sufficient to cover all of your costs, including the overhead. If you cannot charge a high enough price to cover your direct costs, overhead and profits, you need to find another way to ensure those expenses are covered.

You can do this!

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