The Economics of Offering a Service

[Illusions]

I've been considering back up plans in case, once my website goes online, I don't find a full time job within a certain number of months. Although I'd have to do more research before fully considering it, one of the back up plans involved trying to freelance, while offering a non-art related service targeting a niche market. The niche market would be small businesses. Now comes the part that I don't know about due to my lack of knowledge concerning economics. The service being offered would cost almost one fifth to a tenth of what other similar services cost, but they are targeted at every size business. I'm uncertain mainly because, one if I had regular customers I'd be able to make at least what I used to make a year, two is no one else is offering this service for anywhere near this cheap, and three is google searching turns up no one offering this service at the price I would, and targeting the market I would be targeting (I could eventually expand the service to target larger businesses, while still offering the same price). Lastly, it would require a full third to half my business savings to start up, and since I'd mainly be going on word of mouth at the beginning, might not see potential clients start coming in until 2 - 3 months after startup. The cost of start up looks like it could be recouped in about 2 - 3 months of operation though.

So, people with knowledge of economics and business...what exactly am I overlooking that probably causes what would be potential competitors to offer their services at nearly 5 to 10 times what I would? Is it simply the possible scale of their business, desire for large sums of money, or naivety on my part? I'd rather not discuss what service this would be, as like I've said, I haven't found anyone offering this type of service, targeted at the size of businesses I would, at the price I'd be able to offer it at.

[Loki]

A lot of people (and businesses) associate a lower price with a lower quality of service. You need to address that in your advertising (i.e. write something like "guarantee savings by avoiding the middle man" or something of the sort). As for why, it's presumably because the person doing the job and the person getting the job might be two different people. The company needs to also make a profit, and the workers are probably getting more in benefits than you'll be giving yourself. Having said that, if you're sure others charge 5-10 times more, you might want to consider increasing your asking price as well. You'll still be the cheapest, and you won't have to worry about how your clients will react to inevitable price increases down the line.

[Dreadnaught]

What service is it?

And I agree with Loki, price does convey professionalism in most circumstances. If a service is complex and can't be done on your own, most people are going to be suspicious if something that's too cheap.

Imagine you have a row of five car garages in front of you that all offer to replace a busted car clutch. Their prices are:

Garage 1- $1000
Garage 2- $1000
Garage 3- $910
Garage 4- $850
Garage 5- $200

I suspect most people would pick Garages 3 or 4. But that most people would not pick Garage 5.

[Wraith]

So, people with knowledge of economics and business...what exactly am I overlooking that probably causes what would be potential competitors to offer their services at nearly 5 to 10 times what I would? Is it simply the possible scale of their business, desire for large sums of money, or naivety on my part? I'd rather not discuss what service this would be, as like I've said, I haven't found anyone offering this type of service, targeted at the size of businesses I would, at the price I'd be able to offer it at.

I don't know your industry well, but from the ones I do know well: People who do freelance/consultant work get much fewer hours of work than full time employees, and their income stream is unreliable. So they have to charge more to make up the difference. Or give up wasteful expenses like food. They also tend to cater to people who can't really afford FTEs to do that sort of work. Even though the freelancers charge more per hour, because they work so few hours it still usually gets the companies they work for a large savings versus hiring an FTE to do the work in-house.

It's typical in my industry for professional freelancers to charge $150-$250 an hour, or more. But even the best struggle to get 20 hours billable a month (there's also a lot of unbillable work they have to do for this), and their monthly income can fluxuate wildly, so they usually wind up making less than an FTE would doing the same sort of work.

Again though, this is mostly from my own industry, and may not be true for yours. Mine also usually has fewer skilled employees than there are positions available, which probably helps drive the price of things up. It's possible that your competitors in this arena are more 'full service' than you can be, especially if they're actual companies rather than freelancers - but you'd know if that was true better than I would.

[Illusions]

A lot of people (and businesses) associate a lower price with a lower quality of service. You need to address that in your advertising (i.e. write something like "guarantee savings by avoiding the middle man" or something of the sort).

And I agree with Loki, price does convey professionalism in most circumstances. If a service is complex and can't be done on your own, most people are going to be suspicious if something that's too cheap.

Imagine you have a row of five car garages in front of you that all offer to replace a busted car clutch. Their prices are:

Garage 1- $1000
Garage 2- $1000
Garage 3- $910
Garage 4- $850
Garage 5- $200

I suspect most people would pick Garages 3 or 4. But that most people would not pick Garage 5.

Well this part is a bit disheartening, but it makes sense and is something I apply, like in Dread's example, or when purchasing products. I would hope a valid explanation would clear up why it was so cheap, and its cheapness would be what I'd use in marketing the service, as I'd be targeting businesses that would otherwise be too small to afford using the service otherwise.

What service is it?

Again, I'd rather not say directly, as I haven't managed to find anyone offering it to the particular businesses I would, at the price I'd be willing to. It would be something like web hosting however, where a potential customer would pay to use some hardware for a block of time, but the hardware would still be owned by myself, maintained by myself, managed by myself, and reside with me.

Having said that, if you're sure others charge 5-10 times more, you might want to consider increasing your asking price as well. You'll still be the cheapest, and you won't have to worry about how your clients will react to inevitable price increases down the line.

Initially, if it made sense, I would offer the service as if it was in beta/trial discounted period, at the cost I would want to sell it at, and if during this trial period I have to or can adjust the price, I would do so.

I don't know your industry well, but from the ones I do know well: People who do freelance/consultant work get much fewer hours of work than full time employees, and their income stream is unreliable. So they have to charge more to make up the difference. Or give up wasteful expenses like food. They also tend to cater to people who can't really afford FTEs to do that sort of work. Even though the freelancers charge more per hour, because they work so few hours it still usually gets the companies they work for a large savings versus hiring an FTE to do the work in-house.

It's typical in my industry for professional freelancers to charge $150-$250 an hour, or more. But even the best struggle to get 20 hours billable a month (there's also a lot of unbillable work they have to do for this), and their monthly income can fluxuate wildly, so they usually wind up making less than an FTE would doing the same sort of work.

Again though, this is mostly from my own industry, and may not be true for yours. Mine also usually has fewer skilled employees than there are positions available, which probably helps drive the price of things up. It's possible that your competitors in this arena are more 'full service' than you can be, especially if they're actual companies rather than freelancers - but you'd know if that was true better than I would.

The service being offered would not be directly related to my freelance work, which I would still do on the side, but this still does apply, which is other thing I'm worried about, as while I do have experience with this service, and I can do it myself, I have no experience with how frequently other people would be willing to pay to use it.

[Ominous Gamer]

When I throw up ads on Criagslist for computer services I do better asking $40 - $50. I tried $20 once, and it wasn't so much that I didn't get replies, but the customer demographic changed completely. Went from "Best Buy wants $200, and thats bullshit" with Vista and XP machines to "theres this thingy on the TV like thingy, and its not doing its usual thingy, oh and my mom gave this to me 7 years ago". I keep the price inline with the other garage listings because I don't feel like dealing with people who can't afford to understand recent hardware.

[Dreadnaught]

Well this part is a bit disheartening, but it makes sense and is something I apply, like in Dread's example, or when purchasing products. I would hope a valid explanation would clear up why it was so cheap, and its cheapness would be what I'd use in marketing the service, as I'd be targeting businesses that would otherwise be too small to afford using the service otherwise.

It works both ways. I was recently interviewing contractors and specialists to replace my building's elevators. It's an $800k job that comes with a service package. One bidder had lower costs for the replacement, but higher monthly rates for the service package. When asked for a definition, he laid out in detail how recent changes to elevator codes (which was part of the reason we're replacing the elevators) would require more frequent inspections and compliance on more items that had to be checked. His competitors weren't able to explain their service fee numbers well at all.

The guy won our business, because he had low prices where it mattered and could justify higher ongoing service fees.

[wiggin]

Illusions - it may be that you're also underestimating how much you'll need to charge to make a decent living. Remember that self-employment tax takes a big chunk out of your earnings (though if you own a business, you can claim a lot of expenses) and you'll have to cover stuff like health benefits which can run to quite a bit. There might also be other expenses (e.g. marketing, client relations, travel, etc.) that you're underestimating.

That being said, it might just be that other operations have higher overhead and larger profit margins than you do. If you can credibly argue why your prices are lower to potential clients (and even spin it as a benefit) then you'll be doing fine.

[GGT]

Illusions, I hope your venture works out. Sounds like you've put a lot of thought and effort into the whole thing.

I read your OP a couple of times, sorry to say it was too rambling to make sense. (This, from the queen of non-sensical ramblings, yeah )

You won't name the service, but your questions DO relate to the service. If it's not currently a niche service being offered, then why not? If you can offer it at cheap rates, maybe that's because it's not really a viable service, or someone already tried and failed?

You mention back up plans and already sound a bit desperate at the outset, so here's my idea! How about going to a bank and asking for a small business loan? Even if you don't need it (you said something about your start-up costs coming from your own pocket?) it could kill a couple of birds with one stone.

1) Clear and viable business plan
2) Explaining your business model to your first "investor"
3) Getting feedback

Worst case scenario is the bank tells you about the other 500 guys who came through with the same idea and all flopped. Best case scenario is you find out your idea is indeed original with great prospects but needs some tweaking. They may even hook you up with advisors or something, if they think you need a loan, and they can profit from that.

[Illusions]

Thanks everyone for the input. I'll keep this all in mind when if I need to revisit this idea.