The Pricing Mistake 90% of Service Businesses Make 

By Brian Keyser | Director of CFO Services at Anthem

I’ve reviewed hundreds of service business financials over the years, and I see the same service business pricing mistake over and over: They price based on what they think customers will pay, not on what they actually need to charge to be profitable. 

It’s killing their businesses slowly, one underpriced project at a time. 

Here’s what’s really happening and how to fix it. 

The Mistake: Cost-Plus Pricing Without Knowing Your True Costs 

Most service businesses do this: 

• Look at what competitors charge 

• Add up their obvious costs (labor, materials) 

• Slap on a profit margin they hope is reasonable 

• Cross their fingers and hope it works out 

What they’re missing: 

• The true cost of delivering their service 

• Overhead allocation for each service 

• Time spent on non-billable activities 

• The actual profit margin they’re achieving 

The result? They stay busy, clients seem happy, but the bank account never grows. Sound familiar? 

Why This Happens: The Hidden Cost Trap 

Service businesses think they know their costs, but they’re only counting the obvious ones. 

What they count: 

• Direct labor (the technician’s time on the job) 

• Materials or supplies used 

• Subcontractor fees 

What they forget: 

• Estimating and proposal time 

• Project management and coordination 

• Revisions and client communication 

• Administrative support 

• Sales and marketing costs 

• Insurance, licenses, and permits 

• Equipment depreciation and maintenance 

• Software and technology 

• Unbilled time and rework 

• Payment processing fees 

The shocking truth: For every hour of billable client work, most service businesses spend 30-60 minutes on unbilled activities. If you’re not accounting for that in your pricing, you’re working for half of what you think you’re earning. 

The Real Cost Formula Service Businesses Need 

Here’s how to calculate what you actually need to charge: 

Step 1: Calculate Your True Hourly Cost 

Annual overhead costs: $________ ÷ Billable hours per year: ________ (usually 1,200-1,400 for a full-time person) = Hourly overhead rate: $________ 

Example: 

• $180,000 in total overhead ÷ 1,300 billable hours = $138/hour overhead rate 

Step 2: Add Direct Labor Costs 

Employee hourly wage + benefits: $________ 

• Hourly overhead rate: $________ = True hourly cost: $________ 

Example: 

• $35/hour employee cost 

• $138/hour overhead = $173/hour true cost 

Step 3: Add Your Profit Margin 

True hourly cost: $________ ÷ (1 – desired profit margin): ________ = Minimum hourly rate: $________ 

Example: 

• $173 true cost ÷ 0.80 (for 20% profit margin) = $216/hour minimum rate 

Reality check: If you’re charging $150/hour in this example, you’re actually losing $66 per hour worked. 

The Five Hidden Costs That Kill Service Business Profitability 

1. Scope Creep Without Price Adjustments 

What happens: 

• Client asks for “just one small change” 

• You say yes to maintain the relationship 

• Small changes accumulate into hours of extra work 

• You don’t charge for any of it 

The fix: 

• Define scope clearly in every agreement 

• Track actual hours against estimated hours 

• Bill for out-of-scope work immediately 

• Use change orders for anything beyond original scope 

2. Underestimating Project Time 

What happens: 

• You quote 10 hours for a project 

• It actually takes 15 hours 

• You eat the extra 5 hours to honor your quote 

The fix: 

• Track time on every single project 

• Compare actual vs. estimated hours monthly 

• Adjust your estimating formula based on historical data 

• Add a 15-20% buffer for unknowns 

Pro tip: After 20-30 projects, you’ll have data showing you consistently underestimate by X%. Build that into your pricing model. 

3. Free Consultations That Aren’t Really Free 

What happens: 

• “Quick” consultation calls that last an hour 

• Multiple meetings before signing a contract 

• Detailed proposals that take days to create 

• You close 1 in 3, making 2 out of 3 completely unpaid 

The fix: 

• Limit truly free consultations to 15-20 minutes 

• Charge for detailed proposals or offer paid discovery phases 

• Use templated proposals that take 30 minutes, not 3 hours 

• Factor your sales time into your pricing model 

4. The “Discount to Win” Death Spiral 

What happens: 

• Competitor quotes lower 

• You drop your price to match 

• You win the job but make no profit 

• You need more jobs to cover costs 

• You discount again to win more work 

The reality: You can’t discount your way to profitability. Every time you cut your price without cutting your costs, you’re just buying yourself a job, not building a business. 

The fix: 

• Compete on value, not price 

• Walk away from jobs that require unsustainable discounts 

• Calculate the break-even point and never go below it 

• Focus on ideal clients who value quality over cheapest price 

5. Not Raising Prices for Existing Clients 

What happens: 

• You price new clients at current rates 

• Long-time clients stay at rates from 3 years ago 

• Your costs have increased 15-20% 

• Your best clients are now your least profitable 

The fix: 

• Review all client pricing annually 

• Implement price increases for existing clients (5-10% annually is reasonable) 

• Communicate increases professionally with advance notice 

• Most clients will accept reasonable increases; the ones who leave probably weren’t profitable anyway 

How to Fix Your Pricing Starting Today 

Immediate Actions (This Week): 

Calculate your true costs: 

• List all annual overhead expenses 

• Determine realistic billable hours 

• Calculate your actual cost per hour 

• Compare to what you’re currently charging 

Review your last 10 projects: 

• Track estimated vs. actual hours 

• Identify patterns in underestimating 

• Calculate actual profit margin on each 

• Find which services are most/least profitable 

Set your minimum acceptable rate: 

• Use the formula above 

• This is your floor—never go below it 

• Build different rates for different service levels 

Strategic Changes (This Month): 

Create tiered service packages: 

• Basic (minimum viable service at minimum rate) 

• Standard (most clients choose this) 

• Premium (higher value, higher margin) 

Update your proposal templates: 

• Clear scope definition 

• Change order process included 

• Payment terms that improve cash flow 

• Price positioned around value, not just hours 

Audit your client list: 

• Which clients are below your minimum rate? 

• Which require disproportionate time/effort? 

• Create plan to adjust pricing or transition out 

Long-Term System (Next Quarter): 

Implement time tracking across all projects: 

• Use simple tools (Toggl, Harvest, or similar) 

• Track billable and non-billable time 

• Review weekly to spot patterns 

• Use data to refine estimates and pricing 

Build profitability dashboards: 

• Track profit margin by project 

• Monitor profit margin by client 

• Analyze profit margin by service type 

• Make decisions based on actual data 

Develop value-based pricing for premium services: 

• Price based on client results, not your hours 

• Focus on ROI and outcomes 

• Command higher rates for specialized expertise 

• Attract better clients who value results 

The Uncomfortable Conversation You Need to Have 

With yourself: “Am I running a business or buying myself a job?” 

With your team: “We need to be more profitable to grow and provide better opportunities.” 

With your clients: “We’re adjusting our pricing to reflect the true value we provide and ensure we can continue delivering excellent service.” 

With prospects: “Our pricing reflects the expertise and results we deliver. Here’s why we’re worth it.” 

What Happens When You Fix Your Pricing 

I’ve helped dozens of service businesses implement proper pricing strategies. Here’s what typically happens: 

First 30 days: 

• Some sticker shock from prospects 

• You lose 1-2 price-sensitive prospects 

• You feel uncomfortable with “higher” prices 

• Your confidence wavers 

After 60 days: 

• You land 2-3 clients at proper rates 

• You realize the right clients pay fair prices 

• Your cash flow improves noticeably 

• Stress levels decrease 

After 90 days: 

• You’re working with better clients 

• Your profit margins are actually healthy 

• You can invest in growth 

• Your business becomes sustainable 

After 6 months: 

• You’ve replaced low-margin clients with profitable ones 

• You’re making real money, not just covering costs 

• You can afford better tools, team members, or time off 

• You wonder why you waited so long to fix this 

The Bottom Line 

The service business pricing mistake that’s killing your profitability isn’t that you’re bad at business, it’s that you’re pricing based on incomplete information. 

Start with the true cost calculation today. Spend 30 minutes doing the math. You’ll either be relieved that your pricing is solid, or you’ll finally understand why you’re working so hard but not getting ahead.