On pricing structures and how to increase prices

The following observations are fairly self-evident to me, in all likelihood because I have been reading a number of books about economy and economic theory over the last few years. As it turns out, they are not obvious to everyone. Hence this post.

Some time ago, I talked to a photographer who was about to change how much she charged. Her pricing structure was a flat fee – 3000 NOK – per job, including 25 edited photos, travel, and setup. For Norway, that is very cheap indeed. Most photographers charge three to four times that, and include far fewer photos. I suggested to her that there are two ways to increase the price she charged, and asked her if she could identify both.

She agreed with me that the first one – actually increasing the amount of money charged – was obvious. The second one had her stumped, until I pointed out that she was providing not only a service, but also goods. By reducing the number of goods delivered, you not only charge more for the remaining goods, you also create the potential for added sales of goods – what’s known in retail as up-selling.

She objected that her existing customers might complain, and take their business elsewhere. To counter this, I suggested offering them – and only them – a grace period of however long she felt was reasonable – a year might very well be viewed as reasonable. I also commented that there is nothing prohibiting her from offering existing customers discounts or preferential service (more flexibility in booking times, more photos) as she wanted, regardless of pricing structure.

If your business “only” delivers services, however, differentiating on the amount of goods is not an option. Differential pricing is still possible for such things as travel (make your base fee include travel within a given area, depending on your mode of transport, and create increasing circles of added charges), setup (when applicable – moreso for photographers than support technicians), as well as offering different packages.

By different packages, I mean that you offer a base flat rate for your services. For customers who commit to buying a set number of hours, you offer another, lower rate. For customers who commit to buying a larger set number of hours, you offer a third, even lower, rate. Call these levels “Basic”, “Gold”, and “Platinum”, and you’ve got yourself a differentiated pricing structure.

How, then, do you arrive at the prices involved? I was curious about this some time ago, and performed a thought experiment. I started out with the number of working hours, less vacation, per a year (for Norway, this is 1750 hours). I deducted time for retraining (I estimated this at just north of three weeks per year, or 150 hours) Next, I took my target salary – pre tax – added in overhead costs (office space, infrastructure, licences etc.), a buffer (to make up for the possibility that I wouldn’t be able to sell all my available hours, and a budget for training, and arrived at a base rate. I then divided this by my actual number of worked hours per year, and arrived at my cost per hour (less VAT).

Crucially, this is the rate at which you offer your “Platinum” pricing. Again, this might be obvious, but the reason why is this: You offer those clients who commit to buying the most of you time the best deal, at which you break even. Clients who are not willing to make that commitment are a larger risk for you, and so they pay more. Lastly, clients who are not willing to commit at all are your largest risk, and again pay a premium for that privilege.

There are other ways to differentiate, too. Most ticket tracking tools let you define service levels right in the system. This way, you can automatically give tickets from customer A shorter response times than tickets from customer B, a privilege for which customer A pays a set amount – a retainer. I would recommend differentiating response times, too, based on the pricing tier chosen by the customer, and making the option of a shorter response time contingent on buying one of the higher tiers.