Offer more, honestly · Every business
How to Price a Service: Cost, Value and What the Market Will Bear
A service price has to pass three separate tests, covering what the work costs you, what nearby customers expect to pay and what the result is worth to the person buying it, and most small businesses only ever run one of them.
At a glance
- Three-number pricing sets a service price by finding a floor (what a billable hour really costs, including the hours nobody pays for), a market reference (what customers can see others charging) and a ceiling (what the result is worth to the customer), then choosing a point between them on purpose.
- Rising costs of goods, services and wages were the most common financial challenge in the Federal Reserve's 2024 Small Business Credit Survey, named by 75% of employer firms.
- Averaged across nearly two dozen studies of pricing practice, 44% of firms priced mainly by watching competitors and 37% by marking up cost, while only 17% priced from what the customer gains.
- In an illustrative one-person business, counting the unbillable hours moves the true cost of a billable hour from about $44 to about $73, before any profit is added.
- Price is the strongest lever on the income statement; in a McKinsey analysis of large companies, a 1% price rise with steady volume lifted operating profit by about 8%.
Part 1 | Most prices are copied or marked up, and neither method knows what the work is worth
Ask an owner where a price came from and the answer is usually one of two sentences: We charge about what everyone else charges, or We take what it costs us and add something on top. A review of pricing research published in the Journal of Business Strategy found the same pattern across industries and countries, with competition-based pricing the most common approach and value-based pricing, the only one that starts from the customer's side of the counter, the least common.
Each method sees something real and misses something important. Copying the shop down the road assumes their costs, their customers and their hours look like yours, while a simple markup on materials ignores the fact that a service business mostly sells time, and much of an owner's time never reaches an invoice. Value-based pricing is harder because it asks what the customer would do without you, which is a question about their life rather than your spreadsheet; the three-number method below uses all three views, each for the job it does well.
Part 2 | The floor is the cost of a billable hour, which is higher than the cost of an hour
The floor is the lowest price at which a service still pays for itself, and the most common mistake in setting it is dividing the year's costs by every hour worked instead of the hours a customer actually pays for. Driving between jobs, quoting, ordering supplies, answering messages, cleaning up and doing the books are all real work, and in many small service businesses they take a large share of the week; every one of those hours has to be paid for by the hours that are billed.
The pressure on this number is not going away. In the Federal Reserve's 2024 survey of 7,653 small employer firms, rising costs led the list of financial challenges, ahead of paying operating expenses and uneven cash flow.
The worked example shows the arithmetic for a one-person business. The owner wants to pay themselves $60,000 a year and carries $24,000 of overhead for insurance, the vehicle, software, rent and supplies that are not tied to a single job; they work 48 weeks of 40 hours, and about 60% of those hours are billable.
| Owner pay target per year (Assumption) | $60,000 |
|---|---|
| Overhead per year (Assumption) | $24,000 |
| Hours worked per year (Assumption (48 weeks × 40 hours)) | 1,920 |
| Share of hours billed to a customer (Assumption) | 60% |
| Billable hours per year (Calculated (1,920 × 60%)) | 1,152 |
| Cost per hour worked (Calculated ($84,000 ÷ 1,920)) | $43.75 |
| Cost per billable hour (the floor) (Calculated ($84,000 ÷ 1,152)) | $72.92 |
| Price per billable hour with a 15% profit margin (Calculated ($72.92 ÷ 0.85)) | $85.78 |
| Two-hour job, plus $20 of materials (Calculated (2 × $85.78 + $20)) | $191.57 |
Illustrative example; replace every assumption with your own numbers.
The profit line matters as much as the floor. A business that prices exactly at cost has nothing left for a slow month, a broken tool or a raise, so the margin is set before the price, and the price is then found by dividing the floor by one minus that margin.
Part 3 | The market sets the reference, and the customer's alternative sets the ceiling
What the market will bear is less a single number than a range customers carry in their heads, built from prices they have paid before and prices they can see. Research on fairness published in the American Economic Review found that people judge a price against those reference points and against the seller's reasons: in telephone surveys, 79% of respondents (101 people) found it acceptable for a grocer to pass on a higher wholesale cost, while 82% (107 people) found it unfair for a hardware store to raise snow shovel prices simply because a storm had raised demand. For a service business, that suggests a price above the local reference holds up best when the customer can see the reason for it, such as a longer appointment, a licensed specialist, a warranty or a same-day slot.
The ceiling is the value of the result to the customer, which a standard pricing text describes in two parts: the cost of the customer's next-best option, plus the worth of whatever you do differently. For a homeowner, the next-best option to a same-day repair might be two days without heat and a hotel; for a client booking a color correction, it might be a second correction somewhere else. Writing down that alternative in dollars, even roughly, gives the owner a ceiling that has nothing to do with what competitors charge.
With all three numbers on one page, the decision becomes a placement rather than a guess. A price below the floor loses money on every job however busy the calendar looks, a price far above the market reference needs a reason the customer can see, and a price near the ceiling suits work where the business is clearly different and the customer's alternative is expensive.
How you compare
- Your method: in the research averaged above, only 17% of firms priced from customer value. Writing down the customer's next-best alternative for your three most common services already puts a business in that smaller group.
- Your billable share: the 60% in the example is an assumption; tracking one ordinary week of billed versus unbilled hours gives your own figure, and every point that share moves changes the floor.
- Your costs: if rising costs are on your list, you are in the company of three quarters of small employers surveyed by the Federal Reserve; the useful comparison is your floor this year against the price you are charging now.
Questions to ask this week
What did a billable hour cost us last year? Add owner pay and overhead, then divide by hours a customer paid for, not hours worked.
Which service is priced below its floor? Check the services that take longest or need the most travel or preparation first, since these are the most often underpriced.
What would a customer do without us? Put a rough dollar figure on the next-best option for your most common job.
Can the customer see why we cost what we cost? List the differences (time, licensing, warranty, speed) and check whether your menu or quote names them.
The next step is to fill in the worked example with last year's figures for your own business and set the result beside your current price list.
About this research: This article draws on a review of pricing practice in the Journal of Business Strategy (confirmed from a published summary of the paywalled original), the Federal Reserve Banks' Small Business Credit Survey, research on fairness and prices in the American Economic Review, a McKinsey analysis of company income statements and a standard pricing textbook for the value framework. The McKinsey figure comes from large companies and shows direction rather than an exact result for a small business. The worked example is illustrative.
Sources
- Hinterhuber, A. Customer Value-Based Pricing Strategies: Why Companies Resist. Journal of Business Strategy 29(4), 2008. Average of nearly two dozen studies of pricing practice, 1983 to 2006.
- Federal Reserve Banks. 2025 Report on Employer Firms: Findings from the 2024 Small Business Credit Survey. 2025. 7,653 employer firms.
- Kahneman, D., Knetsch, J. L. and Thaler, R. Fairness as a Constraint on Profit Seeking: Entitlements in the Market. American Economic Review 76(4), 1986. Telephone surveys; 101 and 107 respondents for the questions cited.
- Marn, M. V., Roegner, E. V. and Zawada, C. C. The Power of Pricing. McKinsey Quarterly, 2003.
- Nagle, T. T. and Müller, G. The Strategy and Tactics of Pricing, 6th edition. Routledge, 2018.
Related reading: How to Calculate Profit Per Service in Five Minutes · What a Discount Really Costs You, Shown in Margin Math · How to Raise Prices Without Losing Customers, Based on the Research · Flat Rate or Hourly: Which Pricing Fits a Service Business?
Work with osNOVA on pricing your services
We help owner-run service businesses work out what each service really costs, where their prices sit against the local market and what their customers value most, then rebuild the price list and the way it is presented, so that a full calendar also means steadier cash and a margin that covers the slow months.
Email hello@osnovaops.com about your business
Or leave your email and we will reach out
Tell us what kind of business you run and what you want more of.
Not ready to talk? osNOVA runs free live events for owners.