How to Price Products or Services for Sustainable Profit

Pricing can be one of the hardest decisions for an independent business owner. If the charge is too little, there will be a lot of hard work but not enough revenue to cover operational costs. If the charge is too much without understanding the market or the value provided, the business will have a difficult time attracting customers.

A strong business pricing strategy starts with understanding what it actually costs to deliver your product or service, what your customers are willing to pay, and what your business needs to earn to remain sustainable.

The goal is not necessarily to have the lowest price. The goal is to set a price that covers costs, supports a healthy profit, reflects the value provided by the business, and makes sense for your market.

This guide will outline the major factors to consider when deciding how to price a product or service, including the business’s costs, its competitors, customer value, and the established target profit margin.

Why Pricing Is a Business Strategy

The price does more than determine how much money a customer pays. It affects the revenue, profit, cash flow, and ability of the business to grow.

Setting prices too low can cause problems even when sales are strong. The business may have plenty of customers but still not make enough money to keep going after all the expenses are paid. A higher price, however, is not always the answer.

Pricing can affect the ability to grow the business. If the prices do not leave enough room for expenses, unexpected costs, and profit, eventually the business may find itself unable to hire help, replace equipment, increase inventory, or invest in marketing.

Consider a small lawn care company. The owner may look at the local market and see that other companies charge around $50 for a basic mowing service. It may seem reasonable to charge $50 as well. But if that price does not cover the company's actual costs and leave enough money for profit, the business could end up working harder without becoming more financially successful.

This is why pricing should be treated as an ongoing business decision rather than a number that is chosen once and is never revisited.

A good pricing strategy considers the costs, the customers, the competitors, and the value of what the business provides.

Know the Full Cost of What Is Sold

Before deciding what to charge, a business owner needs to know what it costs to provide the product or service.

Start with the direct costs. These are costs directly connected to what is sold. For a bakery, this might include ingredients and packaging. For a retailer, it may be the wholesale cost of the products being sold. For a lawn care company, direct costs for a particular job might include fuel, materials, and the equipment involved in completing the work.

But direct costs are only part of the picture.

The business also has overhead, which includes expenses required to keep the business operating even when they are not tied to one specific sale. Rent, insurance, software, equipment, advertising, utilities, labor costs, taxes, and administrative expenses are examples.

The owner’s time matters, too. If you run a service business, do not assume that the time you spend working is free simply because you own the business.

For example, a lawn care business may spend 30 minutes mowing a customer's yard. But the job might actually require 20 additional minutes for driving, loading and unloading equipment, communicating with the customer, scheduling, and handling other tasks. The owner must also maintain equipment, pay for insurance, purchase fuel, and cover the other costs of running the company.

If the business owner only thinks about the 30 minutes spent mowing, the true cost of the job is underestimated.

Before setting a price, ask:

What does this product or service really cost from start to finish?

Cost-Based Pricing vs. Value-Based Pricing

There are several ways to approach pricing, and an owner does not have to rely on only one.

Cost-based pricing starts with the costs. Calculate what it costs to provide the product or service and then add enough to reach the desired profit.

For example, suppose a lawn care company calculates that the direct cost of completing a typical mowing job is $30. The owner might use that number as the starting point for determining a sustainable selling price.

Cost-based pricing is useful because it helps ensure that there is a clear understanding of the minimum costs before choosing a price. However, these costs are not the only thing customers consider.

Value-based pricing focuses on the unique benefit or outcome the product or service provides to the customer.

A lawn care company may provide more than simply cutting grass. Perhaps it offers reliable scheduling, professional communication, edging, cleanup, and the convenience of knowing the yard will be maintained on a consistent schedule. Those benefits can have immense value to a busy homeowner.

The same principle applies to other businesses. A service that saves a customer significant time, solves an expensive problem, or provides specialized expertise may be worth more than a price based only on the number of hours required to complete it.

The strongest business pricing strategy considers both the costs and the value the business provides.

Research the Market Without Copying Competitors

Looking at what similar businesses charge can help you understand the market, but the competitors' prices should not automatically become your prices.

Research several businesses that offer similar products or services. Look for general pricing ranges and pay attention to what is included in the price. Two businesses may appear to offer the same service but provide very different levels of quality, convenience, experience, or customer support.

Return to our lawn care example. Suppose the owner discovers that several competitors charge about $50 for a basic mowing service. It may be tempting to charge $45 simply to attract more customers.

But what if the $50 price is already barely profitable for the other businesses? Charging $45 could make the problem even worse.

Instead, the lawn care business owner should first calculate the actual cost of completing the job and determine what price the business needs to charge to earn a sustainable profit. Competitor pricing can tell the owner what customers are accustomed to seeing in the market, but it does not tell the owner what his business needs to charge.

The research should help answer questions such as: Is my price within a reasonable range for this market? What are customers receiving at different price points? What makes my offering different?

Use competitor research as one piece of information alongside the costs, target customer, and the unique value provided.

Set a Target Margin

Once basic costs are understood, the step for an owner is to consider how much profit is desired for product or service.

A profit margin shows how much of the sales revenue remains as profit after the applicable costs and expenses are accounted for. Setting a target margin can help to work backward to calculate a sustainable price.

Let's return to the lawn care company. Suppose the owner determines that the direct cost of a typical mowing job is $30 and he wants to earn a 40% gross profit margin.

The owner cannot simply add 40% to the $30 cost. A 40% markup would produce a $42 price, but that would not create a 40% gross profit margin.

To calculate a selling price using a target gross margin:

Selling Price = Cost ÷ (1 − Target Margin)

Using the lawn care example:

$30 ÷ (1 − 0.40) = $50

A $50 price would produce a 40% gross profit margin before other applicable expenses.

This distinction between markup and margin is important. A markup is the amount added to the cost. A margin is the percentage of the selling price that remains after the cost is deducted.

Once the lawn care owner calculates the target price, that can be compared with the local market. If $50 is reasonable for the service, the business may be in a good position. If the market will not support the price, the owner may need to look more closely at costs, service offerings, efficiency, or the value being provided.

How to Price Services and Time

Pricing a service can be more difficult than pricing a physical product because time is often one of the biggest costs.

Start by estimating how much time a service actually requires. Include preparation, travel, communication, administration, cleanup, and follow-up, not just the time spent directly with the customer.

For the lawn care business, the owner might initially think about charging based on the 30 minutes spent mowing. But if the complete job requires 50 minutes of the owner's time, plus fuel and equipment costs, plus any other employee time, then the price needs to account for the entire job.

Then consider the business expenses. The price needs to contribute toward insurance, equipment, software, marketing, taxes, and other costs of operating the business.

An hourly rate can be useful for some businesses, but it is not the only way to price a service. Some businesses charge a flat project rate or package several services together.

For example, a lawn care company might offer a monthly maintenance package instead of charging separately for every visit. A consultant might charge a project fee that reflects preparation, expertise, meeting time, and follow-up rather than simply billing for the hours a customer sees.

The important thing is to make sure the price reflects the total work and value involved, not just the time a customer sees.

When and How to Raise Prices

Many business owners hesitate to raise prices because they are worried about losing customers. But keeping prices unchanged while the costs continue to rise can eventually hurt the business.

A price review may be appropriate when supplier costs increase, operating expenses change, the services become more valuable, or the owner realizes that the current prices do not provide enough profit.

Imagine that the lawn care company's fuel, equipment maintenance, and insurance costs have increased significantly over the past year. If the owner continues charging the same price simply because that is what customers are used to paying, then the company's profit margin may gradually shrink.

A price increase does not necessarily have to be large. Consider how much the costs have changed and whether the value you provide has also changed.

Best practice is to give customers reasonable notice when possible, and make sure the new prices are applied consistently.

A price increase is not automatically a sign that a business is charging too much. Sometimes it is necessary to keep the business healthy enough to continue serving customers.

Discounting Without Destroying Margin

Discounts can help attract customers, encourage larger purchases, or introduce people to a new product or service. But a discount also reduces the amount of money the business retains from each sale.

Before offering a discount, calculate what it will do to the profit.

Suppose our lawn care company charges $50 for a service and has $30 in direct costs. The business has $20 in gross profit, or a 40% gross profit margin.

Now suppose the owner offers a 20% discount. The customer pays $40, but the direct cost remains $30. The business is left with only $10 in gross profit.

The price decreased by 20%, but the gross profit decreased by 50%.

This does not mean discounts are always a bad idea. It means you should understand the financial impact before offering one.

Instead of automatically reducing the price, consider whether you could offer additional value, create a package, set a minimum purchase, or offer a discount for a specific reason or limited period.

Common Business Pricing Mistakes

One of the most common pricing mistakes is choosing a price based only on what competitors charge. The costs and business models may be very different amongst different businesses in the same product or service line.

Another mistake is forgetting to include overhead and the owner's time. If you only count the obvious cost of materials or the hours spent completing a job, the price may not support the rest of the business.

Some business owners also confuse markup with profit margin. These numbers are related, but they are not interchangeable. Adding a certain percentage to the cost does not mean you are earning that same percentage as a profit margin.

Discounting too frequently is another common problem. A discount may generate a sale while quietly reducing the profit earned from that sale.

Finally, avoid setting the prices and never looking at them again. Costs, customer expectations, competition, and the value you provide can all change over time.

Use The Numbers to Set Better Prices

A strong small business pricing strategy starts with knowing its numbers. Before choosing a price, understand the direct costs, overhead, labor, and the value you provide to customers. Then consider the market and determine what profit margin the business needs.

The price does not have to be the lowest in the market. It needs to be sustainable for the business and reasonable for the customer.

If you are not sure whether the current prices are working, start with one of the best-selling products or services. For our lawn care company, that might mean taking the most common mowing service and calculating its true cost from start to finish.

How much fuel does the job require? How much time does it actually take? What portion of insurance, equipment, and other overhead needs to be covered? What gross profit margin does the owner want to earn? Once those numbers are clear, the owner can compare the resulting price with the market and decide whether the current price makes sense.

The same process works whether you sell lawn care, consulting, handmade products, professional services, food, or retail products.

For more help understanding how pricing affects the bottom line, read our resource on Understanding Profit. You can also explore Marketing on a Budget to learn how to reach customers without relying on constant discounts.

Take the Next Step

The prices should help the business succeed, not simply help make a sale.

Download the Pricing Decision Worksheet and test one of the top-selling products or services against its true cost and target margin. A few minutes of careful calculation can reveal whether the current price is helping the business move forward or holding it back.