“The bottom line to pricing and creating a sustainable business model has to be accurately assessing your costs and expenses.”
If you don’t know what you are spending per month to run your business, how can you possibly come up with a price structure that works for you long-term?
I know many business owners who after doing this research realized they were charging far too little for their service and it was causing them to work much harder to get more and more customers just to cover their monthly costs.
There are traditionally three categories of expenses that make up the core of any business:
- Customer Acquisition Costs (CAC)
- Costs of Doing Business (CODB)
- On-Going or Non-Reimbursable Expenses
Let’s take a moment and talk about each group and what they include.
Note: I’d also like to mention I’m not an accountant or a licensed financial adviser, so I define these terms based on how they apply to my business model. Others might define costs differently so take this as conceptual suggestions and nothing more.
Customer Acquisition Costs (CAC)
In its simplest form this cost is the one associated with turning a prospective buyer into an actual paying customer. Often this cost is considered part of doing business or an on-going expense but in reality it needs to be calculated on its own. Advertising and marketing (i.e. what you do to drive customers to your company) is probably the largest component of CAC that gets overlooked or categorized incorrectly as an on-going expense. You must compare the costs of advertising to the customers acquired through those efforts to truly see the cost of onboarding a new customer.
Another component to CAC which is yet again overlooked, you often spend a great deal of time and effort communicating with potential customers. You will spend resources on potential customers who express interest. Some businesses put prospects into an automated marketing sequence such as email marketing or direct mail. Others will add more of a “personal touch” and do whatever they need to do in order to get the customer to sign on the dotted line. They also spend a great deal of time doing research, creating proposals, presentations, and any other efforts made towards bringing the prospect on board.
All this time and effort, even if not monetarily costing you anything, will be a major drain on your available time which is an opportunity cost you incur since time spent in one area means you cannot spend it in another.
Hence, time is money. Time has a cost and consequences based on how you choose to use it.
Costs of Doing Business (CODB)
These expenses directly relate to what it costs for you to provide a particular product or service to your customer. Often, these costs only come into play during production or with a new order. If you are not producing anything or fulfilling a new order you will not have these costs to factor into pricing. However, just about anything you sell requires some effort to deliver to the customer. So unlike CAC’s which focus more on the costs to actually acquire a customer, CODB’s are looking more at what it costs to produce whatever service or product you provide to a customer once they are acquired.
Typical Costs of Doing Business include raw materials, merchandise, freight charges paid to acquire materials needed to produce the end product, and any other costs you incur to deliver the final product or service to the customer.
Some other traditional CODB cost would be: inventory expenses, maintaining or purchasing materials or equipment for a project, contractor payments, 3rd party services or software purchases, and anything else you can tie directly to servicing a customer or finishing a project.
On-Going or Non-Reimbursable Expenses
These are expenses you incur non-related to a particular customer or project such as rent, utilities, insurance, salaries, and loans. So, for example, regardless of your company’s activity, sales, or acquisitions throughout the month you will still have to pay rent and utilities. Often the amount of work coming in or sales will dictate how much of these expenses you can afford (for example rent, if you only bring in $1000 a month in revenue you cannot afford a $5000 office space). However, once these expenses are established, they are fixed costs that do not fluctuate like CODB or CAC.
In my business, especially being a virtual agency, my largest expenses are definitely in the salaries paid to those producing and managing the products and projects we deliver or the on-going services we provide our customers. The majority of our employees are full-time. I used to only incur costs, once the project began which was paid to our production workers to build and complete the project. But, as my agency has grown, the need for full-time help and the cost benefits of keeping a fully staffed agency made sense to eliminate the “per project costs” and higher hourly costs. Managing a full-time staff who are ready, willing, and able to accomplish whatever tasks are needed has been a great move towards independence to do what I choose and how I choose with my business as my team is fully on-board to help navigate whichever direction we choose to pursue. In the past, working with mainly contractors, I found myself dealing with a large amount of frustration trying to find a contractor that actually gave a damn about the project or my client like I did. But eventually it became obvious that I was expecting too much from an hourly worker. They have no vested interest or long-term vision as they often work with many businesses in need.
Because the majority of our employees are full-time it makes tracking expenses easier and more difficult all at the same time. Easier, because regardless of the work being done, salaries are a constant month to month. So long as services needed for a project stay in house, it’s easy to estimate these expenses and project revenue. However, I say more difficult because with full-time workers its much harder to track time across multiple projects. Any one of my employees, including myself, may touch 5, 10, or even 15 different accounts on a daily basis. If we spend our day meticulously tracking how that time is spent, the amount of productivity drops considerably. When I worked with only contractors these costs were clear cut and easily identifiable. A challenge for sure.
So now that you understand the three categories of expenses involved with running your business you should be able to calculate the bare minimum you need month to month to stay out of the red. All three cost categories will greatly affect small business pricing and it is very important to include not only the costs to run and maintain the business but the costs to acquire the customer into your pricing as well. And, since the CODB and CAC costs will continue to fluctuate it will require you to forever be flexible with any pricing model you come up with.
This article is part of a 7 part series I’ve put together to help you effectively price small business services:
- Getting Rid of Limiting Beliefs About Money
- Creating a True Cost Analysis of Your Business
- Avoiding the Pricing Push (overpricing)
- Avoiding the Pull to Cheapen Your Worth (underpricing)
- Pros and Cons of Time-Based Pricing
- Pros and Cons of Value-Based Pricing
- Monitoring & Grow While Maintaining Pricing
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