Service Pricing Part 2

January 28, 2004

By: Matt Michel

This is part of a continuing series of New Year’s Resolutions aimed at helping your company become “fiscally” fit. In this series, we will walk through the marketing mix of product, price, promotion, and placement. This Comanche Marketing tip focuses on service pricing.

There are various schools of thought on the proper way to handle material mark ups and frankly, seldom does much thought go into it. Often companies use their material mark up to help cover company overhead and keep their service rates low. They create a mark up schedule with the mark ups decreasing as the material cost increases.
I follow a different school of thought. I prefer to apply all overhead against labor hours. Labor is perishable. You cannot put a direct labor hour on the truck bin and use it later. With material you can.

I like to mark up the material enough to cover direct material costs (i.e., carrying costs), plus a targeted net profit. Direct material costs include the cost of money, inventory and handling costs, shrinkage, and so on. The old rule of thumb I was taught from a factory environment is that the carrying costs for inventory is usually around 33%. It’s probably a little less for a service company.

Ideally, you or your accountant will perform a detailed examination of your carrying costs annually. That’s the ideal. In reality, few do, which explains the presence of rules of thumb. Mark up a dollar of material by your carrying cost and you’ve got your true cost. If you determine your carrying cost to be 25%, then $1.25 is the true cost of a dollar of inventory.

Once you know your true cost, you must factor in a profit. Divide the true cost of a dollar of inventory by one minus your targeted net profit before taxes to arrive at an across the board mark up. For example, if your “before tax” profit target is 20% (this may sound like a lot, but it’s not, especially after Uncle Sam and your governor take their cut), you would divide the true material cost by one minus 20%, or 80%.

If the true material cost of a dollar of inventory is $1.25, dividing this by 80% yields $1.56. This becomes the material mark up… 1.56.

Pricing should have a nuance or two. Pick up a circular for a big box retailer and they will prominently promote 60 to 90 SKUs. The pricing on these circulars is loooow. Once, I lived in a town where big box A sent its employees to big box B to buy diapers because the big box B was selling them for less than big box A could buy them.

Hmmm. What’s going on?

The diapers were one of those products on the circular. The big box heavily promoted them and they became a signal to the public that prices were great at that store. However, if you were walk into the bowels of the big box, you would find other back shelf SKUs that are less of a bargain.

Try it. Go to a Home Depot and compare the prices for some of the less promoted items with the price you get from a supply house. There’s a big difference between the pricing for those items and the signal prices on the circular.

The big boxes and other retailers flex some prices up and other prices down. If something is easy to compare, they flex the price low. If not, they flex the price up. They have a targeted net profit as well, but the target is the overall average. Some items are more profitable and some are less profitable.

You can play this game too. You can flex the prices for some visible repairs down and the price for others up. If nothing else, it will drive your competitors nuts. Remember though, the objective is to achieve the targeted net profit.

Source: Comanche Marketing. Reprinted by permission.
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Copyright © 2003 Matt Michel

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