How to calculate the price to quote for a service?

Is there a logical way to come up with pricing for a service such as below that my friend came up with. Are these valid ?

1. Split down the service into as many
   small steps as possible. Make sure
   to split the process in small steps
   each taking not more than 1 hour.
   Add as many details as possible.
   Calculate time for each of the step.
2. Include time to setup the system and
   environment for development for each
   step.
3. Include time for research for each
   step.
4. Remember that there will be lot of
   email exchanges in understanding
   what the client needs. Writing and
   responding to email costs a lot of
   time. Include that time. Clients
   will revert back on almost
   everything with requests for
   modifications. Assume double the
   time for fixing modifications.
5. Include cost for skills you have
   already learned. Like linux
   administration, php, js programming
   skills.
6. Remember that no one is productive
   for more than 4 hours a day. So
   double the estimates. Include
   opportunity cost.
7. Add 30% buffer on top of the final
   estimates.
8. Pricing should be more if we are
   doing this service only for this
   customer and never going to repeat
   the exact same thing in future for
   any other customer. Add 40% more
   margin for one client jobs.
9. Remember on average companies charge
   1000usd per day
10. Include time for fixing bugs, which
    will involve google research.

Finally he had this equation.

value of per day = last salary / 20
+ 50% charges for taking responsibility + 30% appreciation for
every year since your last payment

One caution, look at this from a value perspective too. Calculating number of hours and average rate per hour and all the other stuff mentioned above is fine. And if you're providing the same service as others you'll have to be competitive so that may likely be the way to go. But when possible a value-based approach sometimes makes more sense and could be better for you.

A simple example. I've done a lot of marketing consulting. I know what others generally charge per hour for similar services. So let's say that's $125/hour. If someone wants me to review their marketing plan and provide feedback however, which might take me an hour to do, the value is way beyond $125. It might be worth $500 or more. I am going to provide way more than $500 worth of value to them because of my experience and ability to provide tangible feedback that will help them better succeed. (At least that's the idea!)

So that may or may not apply here but in general terms I often see people who might be able to charge from a value perspective come at it from a cost plus perspective and sometimes that's going to not be in your best interests.

Best of luck,

I don't think that there are any concrete formulas for coming up with all kinds of pricing, but I do think there are guidelines that can help.

Structure your price with how your target customer buys. If your target is used to receiving invoices with hours billed, it would make sense to come up with an hourly number to bill them with. If your customer always purchases things upfront for a year (because they're a bigger company) present your price so that they can see it annually.

Charge the most you can. :) Unless there's only one target customer for your business (in which case you probably have other problems) you should test your pricing on each new client. If you've decided that you charge by hour, find other options that would be valuable to the customer on an hourly basis. Test, test again, and test one more time until you find out what the market can sustain.

Simpler is almost always better. I'd say its fine if you want to come up with your own complex way for generating the price but whatever you do make sure that you're giving the customer a simple pricing structure. This makes it easier for them to explain the price to others and gauge their own expectations around what a large vs. a small buy might be.

Your list is good. Another way to look at the effort is by categorizing into top level activities such as

• Discovery/requirements,
• Design/documentation/communication,
• Development/Quality
• Control/Deployment, and
• Operations/support.

Based on the project, you could define some sub-tasks and then add the mark-ups based on some of the criteria that you mentioned in the original post. If there is more than one level of communication with the client/stake holders then you need to account for the communication, presentations and revisions into your price estimates.

I have two approaches for you to set the price for your service.

Method (A) is simple and unsophisticated. Get the customer to tell you how much they'll pay, and take their offer (unless it's ridiculous). Then, raise your price somewhat and try to get another gig doing the same thing. Keep repeating the loop until people balk at the price. You've hit your optimal price.

Method (B) actually requires planning ahead of time :-) You'll want to figure out (1) How much does it cost you to provide the service, and (2) How much is the customer willing to pay.

Costs to provide the service includes everything you can think of. Your computers, rent, food, living expenses, cost of living, the cost of the coffee you drink, any software you need to buy to do this. Then amortize those costs over the amount of clients you'll be servicing. So if your costs are $3000/month and you'll be serving 10 clients a month you need to charge them at least $300/month each. Above that you are into profit.

How much is the customer willing to pay is harder. There's lots of resources on sales to help. But some simple advice is:

• how much money are they going to spend if they don't use your service
• how much money are they going to make if they do use your service
• (and what is their business revenue model)
• who is paying and what budget control do they have
• does the client prefer in advance, on completion, hourly, daily, monthly, or what.

Finding out this information is part of negotiation, but in general the best thing to do at the beginning is just ask them straight out.

This is a decent approach for a cost-based price, although I agree with other answers that you'll want to present only a very simple version to the customer. The risk is that depending on how valuable your service is to the customer, you could leave a lot of money on the table or losing the work based on your price.

Can they go to someone else to get it done? If so, you need to consider competitors' pricing. If your price comes out much higher than the competition, you need to justify why your service is better. If on the other hand you're much lower, that might be a great competitive advantage for you, or you might want to raise your price.

If on the other hand you're the only one who can perform this service (e.g., you're an ex-employee, and no one else understands the systems as well as you do), you can charge a big premium. This kind of scenario is much more rare. Even if you think you're one of a kind, you have to convince the customer too.

The bottom line is that you should do a cost-based estimate as you outline, but make sure to consider how much value you're bringing to the customer and how price will affect your chances of closing the deal.