A phenomenon I see quite frequently is people underpricing themselves. They are convinced that they need to price low in order to win a contract, or convince a client to commit. This is probably true to a degree, but as a business leader or owner you still have to look at your own financials.

Let’s take a car mechanic as an example. In our example we have an independent entrepreneurial small business owner. They start drawing in customers by offering oil changes for a great price, which gets people to start coming by the shop. While performing the oil change, the mechanic spots and fixes other issues at no charge to the customer; change an air filter, refill the wiper fluid, balance tires, whatever. Over time the mechanic gets great reviews from customers and draws more and more clients. But the labor hours are not being charged. For the owner it’s manageable, they will just work more. But as the business grows the owner has to hire people to perform all the work…after all, there’s a line of cars and customers down the block! But since the oil change now includes all these other services as well, there is not enough revenue to even cover the labor costs, not to mention all the material costs of new air filters and brake pads. Even though this mechanic has five-star ratings and delights their customers, they can’t make payroll or even rent and soon go out of business.

The above example seems obvious, but unless you are watching all the right financial metrics frequently this situation is overlooked. You could easily look at the example above and see a huge number of customers, a huge number of positive reviews, and maybe even a decently-sized revenue, and think that everything is great. But their expenses outweigh their revenue, so none of it matters.

When pricing your services or bids, make sure you’ve taken the effort to think through all of the expenses, including hidden or overhead expenses. You need to include amortized capital (such as laptops or software licenses). You need to include any travel expenses. You need to include an administrative burden for when you hire someone to do your taxes at the end of the year.

Also make sure you are comfortable with your effort estimation (which admittedly is very very difficult, as I’ve talked about in the past). Make sure you build in plenty of management reserve, and again don’t forget the hidden labor costs. A common mistake I see is doing wideband delphi/planning poker for the development efforts, and not scoping in any time for design reviews, manual acceptance testing, defect remediation, or user documentation and training sessions. This is especially dangerous for firm fixed price proposals. I’ve seen people put together an FFP bid and a simple spreadsheet exercise shows that the bid will not even cover all the people needed for the calendar time.

Don’t put yourself in a bad financial situation in a misguided effort to delight your customers. Make sure you factor in ALL the costs when pricing your work, and also make sure you are tracking and monitoring all the right metrics to make sure you are poised for financial success. After all, if you go out of business then you cannot delight ANY customers.