How to understand pricing practices

Recovering all your costs and generating a profit from activities is vital to maintaining sustainability and continuity of service for your stakeholders, clients and their families. That is why incorporating a profit target in the financial management of your organisation is critical. Not for profit (NFP) organisations cannot, of course, distribute profits to members, but you can use them to meet your organisation’s strategic and operating plans.

Determining the ‘mark up’ is challenging for NFP’s because you don’t typically have industry benchmarks as do corporate markets, nor do you return profits to shareholders.

With a move to individualised funding and the NDIS determining price guides for service categories, it is vital that you understand the actual cost of delivering your services (refer to How to understand and calculate costs). This will allow you to price services to recover costs, including the cost of capital plus a premium for risk. It can make you aware of the gap between your target price and the achieved price that you will need to fill.

NDS and the Curtin University Not-for-profit Initiative have developed a practical learning program aimed at increasing costing and pricing skills for disability service providers across Australia. The program builds knowledge and skills in costing and pricing for financial, operational and service delivery staff. The learning materials are available in a few formats to support different learning styles and levels of skill.

As it is the responsibility and prerogative of organisations to manage their finances as they choose, each organisation needs to decide on the most appropriate costing method to suit their circumstances. Organisations are encouraged to obtain external advice if necessary, in reaching that decision.

Determine the mark up required

Your ‘mark up’ or margin should take into consideration three factors: the cost of capital, a premium for risk, and your profit target. This will allow you to meet your strategic and financial goals. The development of a longer-term financial plan that sits alongside your strategic plan should outline the financial requirements.

Pricing of individual services may differ, and you may choose to offer some services that don’t deliver much profit or allow you to recover all costs. Others may be more profitable. You will need to take a portfolio approach and understand activity levels for each service to ensure the combined outcome allows you to meet your organisation’s needs.

Pricing the cost of capital and risk

Pricing decisions should also include estimates for the annual cost of equipment or the use of working capital. If not, you risk underpricing, and the risk associated with running the service or program is increased.

There are several methods you can use on which to base the cost of capital. Simply calculating the amount, it would cost you to borrow the money, spread out over the time you expect the asset to be used, may be enough for smaller investment decisions.

By moving to pricing units of measure per use, you carry increased operational risk around service management and implementation. Whatever the methodology you adopt, incorporating the cost of capital plus a premium for the risk in the total ‘mark up’ price is a crucial component for you to achieve sustainable pricing.

Identify the target price gap

With the pricing of service groups set by the NDIA, there may be a gap between what your target price is and the amount you receive for services delivered to NDIS participants. This presents a challenge and makes it critical that you undertake both the pricing and costing exercises to understand this gap and develop other strategies to close the gap. Refer to How to understand and calculate costs for further information on costing.

If your organisation delivers services to other ‘fee for service’ clients, this may present less of a problem. However, after working through both the costing and pricing exercises based on the market segments, you will have identified your service delivery (How to develop a service delivery model). You should, therefore, have a robust understanding of both your comprehensive cost and target price gap. This will support you in developing strategies to close the gap.

Implement a regular review cycle

Many organisations like yours have already acted to improve costing, pricing and cost management practices to respond to the demands of the new funding model. Faced with the new reality, it is essential that all staff understand your organisation’s value chain; that is how you take funding inputs or revenue and deliver value to the community.

Balancing your mission and values with the reality of operating within individualised funding presents a real challenge for many organisations. Over-servicing, traditionally seen as a virtue, now comes at a cost. This will require communication to staff to ensure they understand your organisation’s goals and how over-servicing impacts viability.

Regular reviews to understand the reason behind any shortfalls in service delivery will ensure that the right decisions and actions can be taken.