Examples of businesses that are frequently quoted to illustrate this are airlines and hotels. Once the aircraft doors are closed and it leaves any empty seats can no longer be sold. A hotel room that has not been occupied can no longer be sold. Of course you’re not actually selling the seat or the room but renting it to the customer. The problem that these businesses face is that the costs incurred in bringing their products to market (purchasing aircraft, building hotels, maintaining and staffing them) can never be recovered.
Both airlines and hotels use pricing systems using software to help them mitigate this problem. If you’ve visited airline websites to find out what the fare will be but not actually booked a flight you will notice on a later visit to their website that the price will have changed. Airlines often over book to try and fill flights but this often leads to damaging their brands. Good hotels do not do this – a hotel reception area with angry customers would lead to a future loss of business.
Airlines and hotels are not the only businesses faced with this problem. Any service business has the same problem. Whether it’s a public relations agency, a consulting firm or an electrician a day gone by without invoicing is a day that can never be sold. All the costs associated with being available on the day can never be recovered.
So what’s to be done?
You need to charge correctly and to ascertain a minimum price, you first need to calculate the total annual costs of the business. The next step is to calculate the actual days available for sale. The days available for sale is 365 minus weekends, public holidays, and the working days lost in December (in addition to the actual public holidays). You also need to deduct the days spent visiting prospective clients, preparing proposals, marketing your business, keeping abreast of developments in your industry AND your clients industries.
If you have a small business you also need to calculate the total costs of maintaining your household and add the amount of profit that you want to make.
So the total costs plus your required profits divided by the actual days available for sale is the minimum you should be charging per day. Where applicable you could work out an hourly rate.
In this type of business you also need to establish what the going rates are for the type of service you provide. If these are higher you should charge accordingly.
It is also bad practice to quote lower fees to get a ‘foot in the door’. Once clients accept your quoted fee you will, even if you are doing outstanding work, find it very difficult to increase your fees.
While I have suggested cost plus pricing above it is actually not a good thing to do. You should base your fees on the clients costs related to the problem you are solving for them. This requires that you know the clients business. Also bear in mind that clients like all consumers often believe that higher prices are also an indication of quality and value.
Competing on price is a race to the bottom. Don’t go there.