Pricing when you have limited capacity

Should you charge the price that fills your diary? Not necessarily!

Here are some thoughts about optimising your pricing, using an example as an illustration: say you were thinking of being a personal trainer and wondering how much to charge:

Suppose you do a bit of estimating, maybe even experimenting, and you find that 90% will pay £15 (what’s wrong with those 10% who won’t even pay that??), 50% will pay £25, 25% will pay £35 and the richest / keenest 10% will pay £60 per hour.

So if we assume our costs are £10 per hour (you can change my numbers if you like) then the profit works out as follows:

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So you would be best to pick the price of £25 per hour which gives you half of the customers and the highest profit, of £750.

But would you ALWAYS?

Leaving aside the thought that you could earn almost as much profit by charging £5 and doing only half the work, let’s just think about one other factor: varying amounts of demand and capacity.

I have assumed that you are getting 100 enquiries, so the different pricing options get you 90 50 25 or 10 hours of work.  The 50 hours gets you the most profit.

But what if you were too busy to do 50 hours, what if you could only do 10 hours a week, and you had 100 enquiries coming in?  Then clearly you’d be better off doing 10 hours by charging £60, and making £500.  Better that than charging the “optimum” price of £25, getting more than you can handle, and doing just 10 hours at £25 and only making £150.

The same if you can only do 25 hours: charge £35 so you get 25 hours of work coming in.

So the rule is to follow the above table if you can do ANY of the amounts of work, but if the pricing might lead to too much work then you can rule those (lower) prices out – and put the price up until demand reduces to a point where your diary can just handle it.

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But always do the calculation for “what if you put the price up higher than that ‘diary full’ point?”.  For example, if your diary was nicely full when you charge £15 and sell 90 hours, you would be a fool not to go further up and charge £25 and make more profit from a half full diary.

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Summing up: If the maximum quantity you can handle is LESS than the point of maximum profit, then price so you sell that maximum quantity that you can handle (first diagram). If the maximum quantity you can handle is MORE than the point of maximum profit, move your price up to that point of maximum profit, (second diagram).

If you like a table, here is one showing your options.

You can see that if you have capacity to do 90 jobs a week, (have a look at the Cap 90 column), you shouldn’t charge £15, because although that will fill your diary, which will feel good, you’ll only be making £450, and raising your price to £25 will almost double your profit, to 750. Charging MORE than that starts to hurt you in reduced sales. The rule is to charge a price what will bring in 50% of the work, providing you can handle that much work. Never do more than 50%!

Taking the extreme opposite, if you have capacity for only 10 jobs, you should charge £60 and sell just ten. Being any cheaper will just mean that you get more more than you can cope with, at a lower price than you could have had for the ten that you can do.

and one more example, if you have capacity to do 25 jobs, charge the price that will JUST fill your diary with 25 jobs, which is £35. Any cheaper and you are selling more than you can do, for a lower price than you could have had. Any more expensive and you are losing more on sales quantity than you are gaining on price. So the rule is to fill your diary if you are capacity-limited.

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But what about recruiting??

If your optimum pricing strategy, which in my above example is to charge £25, will bring in more work than you can handle (in this case 50 customers) what about recruiting help to be able to handle the demand? That would clearly be a good idea. Say you could only serve 10 customers: we know that if it’s only you, so you really are limited to 10, then you should put the price up to £60 and serve the 10 that you get. But if you could employ 4 more people, so you and they can handle a total of 50 customers, then 50 at £25 is better than 10 at £60.

And it’s never worth going cheaper than that: 90 at £15 is never better than 50 at 25 (even before you take into account the extra cost if employing all your extra people). Even with fixed costs of employees you can’t get rid of, it’s still more profitable to do 50 jobs at £25 and to do 90 jobs at £15.

Of course in the ideal world you would charge the ‘top’ 10 people £60, the next 15 people £35, and the next 25 people £25, since they will pay that, rather than charging everyone £25, but…

a) do you know who the £60 people are?

b) will the different price customers tell each others?

c) do you have to advertise a fixed price somewhere like your website?

if the answers are yes no and no then fill your boots!

But with a fixed price the rule remains:-

Set your price at the point where it will bring in 50% of the potential business, even if it means your diary isn’t full, …and if you can’t handle the quantity that that price will bring then price higher, to the point where you just fill your diary fully.

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