The Right Price: Participant Guide—Module 3

A business must consider several factors, including competition, costs, and profit objectives, to set a price that is both competitive and profitable. Labor costs are a significant component of service business pricing, and businesses must determine the cost of work directly applied to a service, as well as indirect costs such as overhead and benefits. Material costs, which relate to the cost of materials used directly in delivering the service, are also an important consideration. Indirect costs, or operating expenses, represent the costs of doing business that are not readily identified with a direct service. Service businesses, such as doctors, lawyers, and accountants, sell time, and the price for services is usually expressed in terms of an hourly rate called the rate per service hour. To calculate the rate per service hour, businesses must determine the total costs, including labor, material, and indirect expenses, and then add a profit margin. One method for establishing the rate of professional labor is to use the proportional allocation method, which allocates a different proportion of general operating costs to different services and products depending on the proportion of sales these items are to overall revenue. This method involves calculating the percentage of revenue for each service line and then allocating indirect expenses to each line of business based on that percentage. In addition to labor and indirect expenses, businesses must also consider the cost of materials and products when pricing their services. This includes supplies used to deliver services, such as drugs, syringes, and laboratory test kits, as well as shipping and handling costs. The formula for optimal pricing involves calculating the cost of labor per half-hour, allocation of operating costs, cost of materials, and selling price. External factors, such as the price of competition, perception of the customer, purchasing power of the customer, and the economic and political climate, must also be considered when determining the optimal price for a service. By balancing these factors, businesses can set a price that is both competitive and profitable, and that meets the needs of their customers.