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Setting Prices for a Profitable IT Business

Setting Prices for a Profitable IT Business

When setting a price point for your IT services, you must consider market positioning, consumer psychology, and what your rate has to cover. Learn more.

Tuesday, October 28, 2014/Categories: business-development-and-sales

Setting prices for your IT services is one of the most important things you’ll do as a business owner. It’s the hinge on which the success of your business swings: set prices too low, and you won’t be able to make a living, no matter how hard you work. Set them too high, and the same thing will happen.

So how do you choose the Goldilocks price point? According to experts on this topic, there are three major factors to consider: basic knowledge of what a contractor’s hourly rate has to cover, market positioning, and consumer psychology. Read on to find out how to navigate all three to set a price that’s just right for your business.

Price Setting Part 1: What Your Fees Need to Cover

If you’ve ever broken down your annual salary at a full-time job into an hourly rate, you’ve taken the first step to making one of the most common mistakes that IT professionals make when setting prices.

According to Sean Heilweil, Cofounder and CEO of Exit Monitor, a web-based lead generation software platform, freelancers are often guilty of “not properly valuing their time and not properly accounting for time. For example, when many start out, they set an hourly rate much lower than they actually value themselves at.”

Heilweil suggests that professionals make this mistake first because of the above-mentioned salary breakdown calculation and second because they don’t believe that anyone would pay an hour rate higher than that to do business with them.

The first, he says, “is a huge mistake, because what they’re not taking into account is the fact they now need to pay things like taxes and insurance on their own.” In other words, your take-home pay is only part of what you cost to an employer. The other costs are hidden.

To identify these hidden costs, Heilweil recommends sitting down with a CPA to run the numbers: if you want to net a certain amount per hour, determine what you have to charge. That way, you’ll end up with the goal amount after paying employment taxes, health insurance, business insurance, and retirement contributions.

Heilweil acknowledges that the second mistake is a bit harder than the first to correct, but requires, in essence, that IT professionals be more confident about their services.

For many IT professionals, that confidence may come in part by exploring the market positioning part of setting prices.

Price Setting Part 2: Positioning Your Business in the Market

One of the great things about living in a digital world is that the Internet makes it easy to get an idea of what your competition is charging for work similar to yours. Rather than entering the market at the low end and working up, though, Liz Jackson of Agency Fusion, a web development, design, and branding agency, warns that it’s key to first identify what kind of business you are.

“Many entrepreneurs set their prices too low, thinking that they will ‘just start somewhere’ and that people will be thrilled to get their quality services for such a low rate,” says Jackson. “What actually ends up happening is that higher-end potential clients write them off, associating their price with how legitimate they are as an IT professional.”

So how can an IT business owner figure out how to position his or her business relative to others? Jackson recommends starting with some basic questions. “You should first ask yourself where your style of work best fits in,” she notes. “Do you like to complete projects quickly or are you very picky with your work? If you consider yourself to be one of the best in your field, and you have the skill level to back it up, you would likely want to position yourself near the top. If you are still improving your skill set or feel more comfortable working with companies on a stricter budget, a less complicated project or a more casual expectation, then positioning yourself on the more affordable end of the spectrum will be your best bet.” 

Once you’ve made that determination, she says, setting prices becomes much easier. Each level of performance has “going rates” that you can use as guidelines for your own prices. Beyond that, Jackson suggests considering your target market, your geographical area, and your experience in the industry, which will help you identify where on the price spectrum you should be.

Of course, setting prices isn’t an exact science, and understanding why we buy things at certain price points requires a little background in psychology.

Price Setting Part 3: The Psychology of Pricing

Shai Almog had a consulting business in 1999 and formed the mobile development solution startup CodeNameOne.com in 2011. In both cases, he had to set prices.

He learned a lot from the experience. “I think the basic mistake I made as a consultant was that I looked at market prices and tried to be competitive. I didn't understand that people want to pay.” You read that right: your clients want to pay you. When Almog started in ’99, he charged $70 per hour when a novice would cost about $30. He was satisfied with his rates until he formed a relationship with a larger company that resold his services at about $200 per hour.

“Initially,” says Almog, “This looked ridiculous to me. Why would someone pay that much?” But he found that the clients who paid more were much nicer, easier to work with, and more respectful. The experience taught him something valuable about the psychology of pricing: “When you want someone to do a job, you seek a low price and then treat the consultant like any other employee,” he explains. “When you want an authority figure, you seek out the high price so you can lament that you spent on the best option if something doesn’t work.”

In other words, a lot of people expect to get what they pay for.

So how can an IT freelancer switch to higher prices once they’ve started out with fees that are too low? Almog recalls a few strategies he’s used. “I used one [client] as a ‘home base’ and haggled lightly,” he explains. “For the other [clients], I’d say, ‘Look, I have company X that is buying every hour I have. I like working with them, but if the price is really good I can spare some time.’”

In another case, he started working with a client when he was just starting and his rates were too low. When the business contacted him later in need of his services, Almog explained that he was charging higher rates now, but, as part of the negotiation process, gave a modest discount over his new rate.

Of course, every situation is different, so going into negotiations confident with the value of your services helps. (See the blog post, “3 Sales Tips to Help You Avoid Becoming a Free Consultant” for more on making the sales process less painful.)

3 Steps to Setting Prices

IT businesses can find the “right” price for their services by taking the following steps:

  1. Calculating what they need to earn to pay all bills, taxes, and insurance costs and still make a reasonable profit.
  2. Identifying their position in the market to get an idea of their service offerings and price range.
  3. Understanding how psychology affects clients’ decisions when paying for highly skilled workers.

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