# How to estimate the cost of a service?

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Let's say I build a service, a map for example. To build a map service costs me around \$1,000. But a service isn't a one-off investment, it's like making a product, when I sell it, I don't need consider anything. But I need to keep upgrading my service, also, other investment will be involved, for example, server, and more programmers are required.

But how can I estimate the cost? All of these things are costs, and one single user cannot front all the R&D cost in the initial development. So, how to price the service? What information I need to consider? And how to estimate more accurately?

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How to Estimate the Cost of a Service? I agree with and will paraphrase from Jeremy Parson's answer above/below: Start with an idea of the revenues you can expect from the service, then go figure out a way to create and provide the service at a price that will be self-sustaining (make a profit).

Here's my version of the same answer.

1st - Be reasonably certain of the demand (how much customers will pay) for your service, and the duration of that demand.

Each time a customer pays to use your service, the money you charge has to do three things: pay you back for the variable costs of providing the service one more time; pay a portion of fixed costs(office rent, server time, phone bills, etc) you incur whether you deliver service or not; pay a portion of the start-up costs (R&D, equipment purchases, professional fees, etc.) you incurred to create the service. Your salary (You have to eat, too, remember?) should be included in the start-up and fixed expenses. When the start-up costs are all earned back, then the "break-even" point has been reached. This can take four or five years, sometimes less. Will demand for your service last this long?

2nd - Make a plan to create, maintain, and deliver service so the break-even point can be reached as quickly as possible.

3rd - Decide if there is a high enough probability for profit and if you really want to spend the next few years of your life on this venture. Then act on your decision.

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If you are on a Startup you might be in one of the following cases:

• You have solid customers, then you follow up the advices on gross-margin
• You are new and want to gain market-share and recognition, you put the price at the lowest profitable level (that means cost+risk+basic profit)

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In short: The best price is the highest price your customer will bear to pay, depending on the value the products brings to them.

If you want a longer version, you should read up on the theory of 'elastic pricing', to understand what an optimal price vs quantity sold would be.

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You're thinking in a very natural way - but you have it upside down.

Start with the value proposition and work to a realistic range of achievable pricing you can achieve. And then look at different cost envelopes, asking the question, "how can I live within this cost?" Strange? Not at all! Even in many product markets, relatively little about cost (structure and level) is somehow a given. Then in services, typically the value to the buyer is driven significantly by the transfer of risk, which is not usually related to cost in any direct and simple way.

So your challenge becomes finding different ways to achieve a given result, which is at the heart of all entrepreneurship. The more you know the space, the more choices you will find, and the more effective you will be in making good choices.

Don't (if you'll take my steer) do it the 'natural' way round.

1. I'm going to do this
2. What does that cost?
3. What do I need to charge to make a profit?

This strategy works just fine for large players in large and stable markets, and for simple commodity transactions. And it's a big cause of failure elsewhere, because it forces you to make assumption up front, limits your options downstream, and maximizes your vulnerability to attack by any player who simply knows the market 1% better than you do.

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In ecconomics its called the margin price. This is the lowest price someone is willing to pay for something where it is still viable to sell it.

The old (300 years oldI think) story is a village with fields around. One day a farmer comes to rent a fields. There are lots of fields spare and landlords, so he pushes the price very low. This is the margin price - who would pay more.

Over time more farmers come and the fields get used up. The farmers now pay a premium (supply and demand) - however, the landlords can not ask for too much because the farmers will use less than prime land, say grass or hilly land if the cost difference (loss in income from having a less fertile/producing land) is small, zero or less. This is now the margin price.

At some point that too will be used up and now the farmers are renting scrubb land. This is now the margin price.

The farmers that have to pay too high for scrub land and can rent grassland cheaper, will move. farmers that got in early see their rent rise and maybe move to cheaper land. This movemebnt keeps the margin price fairly consistant.

Charge too much and its cost effective to go without or go elswhere - charge too little and you get too many users (and thus cost) from your profit.

You need to decide how long do you expect to be paying off the dev costs - if you can afford to stretch this out, then your price will be lower and you will attract more users. When the time comes that it is paid off, you will reep more profit from more users - as opposed to larger profit from the few that could afford/would pay for the service.

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In order to calculate costs you should first determine how your system will work, probably the bottleneck will be manpower for development, so you should consider freelancer costs or development salaries etc.

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It depends in how much you spend by hour in equipment and people. Pick this number and add the amount you want as profit and you will get the value you want by hour.

So, you have a value by hour. If it's too different compared with your market, see if your business are spending too much, or in the other case, if your services are too cheap.

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The highest price will get you all users who are willing to pay the highest price but will reject the majority who are not willing to pay it. Math 101 - you are looking for the optimal pricing such that will return you the highest amount of money by any amount of users. Think about a function that describes your pricing (users vs money) and you're looking for the point where X users will return the MAX \$)

If your product can return your investment within a year or so - then your pricing strategy is correct. I would suggest you to think about more users because they also give you an incentive to improve your product.