Saturday, February 9, 2008

Formulas for Pricing Products & Services

Pricing isn't a mystery. It's simple math that can be done on your cell phone calculator. Once you've taken the time to think about the WHY questions behind your pricing you're ready to move on and do the REAL numbers. Or, if you need to see the real numbers before thinking about the bigger questions, here's a bunch of nitty gritty formulas to help you make sense of everything involved in pricing.

HOW TO PRICE TIME

For most freelance artists and independent contractors who need to find a value for their time, I suggest starting with your desired annual salary (before tax and benefits) and then dividing that by the job, or by the hours you'd like to work during the year in order to determine your hourly or project rate of pay. Keep in mind that a self-employed person needs to make substantially more than someone who has health insurance and retirement benefits already provided by an employer. Typically 25-30% of your income will go straight to taxes. You may need to do a little research on health and disability insurance to figure out how much of your income you'll need to set aside for those, but I'd say it's not uncommon for another 20% to go toward health insurance, and 5-10% toward retirement investments. When you add all of that up, you can see quite easily how 50% of your earnings may actually never make it to your bank account. There are some tax advantages to working for yourself, but there are also a lot of costs involved in running a business.

Example 1: Target Net Income Per Job


Example 2: Target Hourly Income


The examples above help you determine if a job is worth your time, and if there are parts of your job that would be become more profitable if someone else were to do them. For example, let's say it takes you 5 hours to color-correct a wedding. If your time is worth $33/hr, than your production cost for color-correction is $165. However, if you hired someone else to do the color-correction and let's say they're a little slow because they're still learning, so it takes them 8 hours at a rate of $10/hr, than you just reduced your costs to color-correct by half! This means that you now have more time to work on higher priority projects while someone else can work on lower priority projects at a production cost savings to you.

Example 3: Production Costs



HOW TO PRICE PRODUCTS

There are several reasons why businesses sell products:


  • Products may be the only source of income to pay employees and cover overhead costs
  • Products can help define the business brand or image
  • Products as a means of extending convenience and service to clients

Whatever reason you have for selling or not selling products, make sure you're pricing them properly by taking everything that goes into providing them into consideration.



Product Based Business

If you're running a product based business, than all of the income your business earns comes entirely from the sales of your products, and you need to include the following figures into your pricing:
- Salaries for all employees (aka production costs)
- Overhead
- Cost of products (production + materials)

Service Based Business
A service based business may sell products, but the bulk of the income comes from providing a service and the products are typically add-ons or part of serving the clients needs. This business model can separate the cost of providing the service from the cost of the products so that it can sell or not sell products. In this case, the product prices are more based on:
- Materials Cost
- Production Cost

The quick & dirty (aka lazy) method of pricing is to take your production and materials costs and multiply it by four in hopes that it will also help cover your overhead costs, salaries, and taxes. If this were the formula that Starbucks, Nike, Cable companies, and even your favorite restaurant down the street used, everything would be a whole lot cheaper! Obviously the "simple" solution is not one that can support a growing business. So, here are the numbers you need in order to determine the actual costs of offering a product:

Materials
The cost of materials should be the easiest to figure out, since you have to pay for them directly. If it's an album, it's the cost of the prints and binding. If it's a DVD, it's the cost of the DVD itself and maybe special packaging.

Production

These costs are generally time-based costs. The time it takes to create something either by you or by someone you hire needs to be factored into the price of the product. If you are currently doing the production on everything and consider this to be a "free" cost- (insert record scratch noise)- think again. If something were ever to happen to you and all of the production you're doing would need to be outsourced to someone else, this would have a VERY real cost and you would be out a LOT of money if something were to happen to you and cause a situation where you still needed to rely on that product income, but could not produce the product yourself. Do NOT take this cost for granted, it WILL bite you in the end.



Overhead


This can encompass a lot of things- hence it's ambiguous name. Basically, these are the costs associated with just staying on top of business in general, and things which a lot of freelancers who are new may fail to consider in their initial pricing structures. Here are some things that are typically included in overhead costs:


  • Rent
  • Utilities
  • Maintenance
  • Professional Memberships
  • Rental Insurance
  • Replacement Insurance
  • Liability Insurance
  • Accountant
  • Bookkeeper
  • Lawyer
  • Advertising/Marketing
  • Sample/Test Products
  • Equipment Upgrades/Depreciation
  • Software Upgrades/Depreciation
  • Education/Tradeshows


By looking at the overhead costs on an annual level and dividing that by the number of jobs you intend to work, or the number of products you intend to sell, you can determine exactly how much of your overhead needs to be accounted for in the price of each job or product you offer. Yes, the math is tedious, but do it now and you'll save yourself from many future headaches of wondering where all of your money went and why you don't have any income to get that new camera or computer you need, or take that vacation you cleared your schedule for. The beauty of overhead costs is that because most of them are expenses for your business, many of them are also tax deductible. I've included a sample of what overhead costs may be for a service based business that relies on 30 jobs per year, has a very reasonably priced office space or studio (maybe even in their home), has a few websites and likes to order sample products as well as special gifts for marketing, and values education and staying current in their field:

Example #4: Overhead Per Job (click to enlarge)


HOW TO PRICE THE PROJECT / JOB

The price for most service based projects or jobs involve:
- Overhead
- Production
- Product (optional)

Overhead
This is where most, if not all of the profit ends up going after production and products have been paid for. You really NEED to have a grasp on these numbers before you determine your pricing. In order for long-term success to happen, you need to have a budget for upgrades, experimentation, samples, marketing, office space, utilities, insurance, accounting, legal, and more. Maybe you're mooching health insurance off of your spouse- what if they were to suddenly lose their job and neither of you had health insurance? What if you had children? Maybe you work from home- but you still claim a room or square footage of your house as office space and you still need to furnish it to make it most productive for you. If you have kids, you still need to hire daycare or a nanny to take care of the kids so that you aren't distracted while you're in your home office. Maybe with both parents working full time, you need to hire someone to clean the house so that you can spend more quality time with your kids, or with each other, when you aren't working. Maybe you're on the road traveling and shooting so much that you would really benefit from having someone in your office answering phones, filing paperwork, setting up appointments and dealing with vendors. I could go on and on.. but these are the things you REALLY need to think about and budget for in advance in your business. I didn't even talk about an "oh shit" fund, but that should be included as well- especially in the event of a major natural disaster. No one needs to rehash how long it took insurance agencies or the government to step in and provide aid to people suffering from hurricane Katrina. Maybe it's not a huge natural disaster, maybe your camera just completely craps out on you or a $1500 lens accidentally hits the floor and becomes unusable. Is your insurance deductible low enough for you to comfortably replace it? Would you need to pay for another one immediately? Being a professional means being prepared for anything- are your finances prepared for anything?

Production

These are the people costs in your business... or the time costs to complete the project. Whether it's paying yourself for your time, or paying someone else to help you produce a product or a project, know exactly how much time (and money needed for that time) goes into producing each product or job you take on. You already know the benefits of hiring someone at a lesser rate based on Example #3: Production Costs. You already know how much you need to make from each job in order to be self-employed based on Example #1: Target Net Income Per Job. But do you know how much of your time actually goes into each of your projects? If you don't have a good grasp on this, you may need to record the time you spend on everything you do for a whole week. In fact, if you've never done this, you should definitely try it for at least a week because it can be a huge eye-opener as to where you're actually spending most of your time. Clock yourself in and out of each task you do as if someone were paying you by the hour for your work on their project. Something like this could work:
9:00 am - General Email correspondance
10:00 am - Edit Jones Photos
10:30 am - Post-Process Jones Photos
12:00 pm - Lunch
12:30 pm - General Email correspondance
12:40: pm - Create slideshow for Jones Photos
1:00 pm - Blog Jones Photos
2:00 pm - Burn & Print Jones photos to disk
2:40 pm - Package Jones photos for USPS pick-up
3:00 pm - Leave Sari Family shoot
3:30 pm - Sari Family shoot
5:30 pm - Return home & begin backing up files
6:00 pm - Back-up complete, work day ends

After a week or two of doing this, you should be able to identify how much time you spend on each aspect of a job or project. You should also be able to take a step back and see where there's room to train someone else to take care of a few tasks- even if it was something like printing and packaging orders that would just be so much more valuable for someone else to take care of even if it were just one day of the week so that you could spend your time focusing on other things that were higher priority, or maybe it would allow you to take one more client, or spend a few more hours with your friends and family. Being in business for yourself doesn't mean you have to do it all by yourself. We are infinitely more productive when we can work as a team, which allows us to focus on the things that we do best and are most productive doing.

Product
Since this is the most straight forward answer in the grand scheme of things, I won't spend much time rehashing it. Just make sure you know all of your costs involved in offering that product before putting a simple price on it. Know the raw materials, shipping, and packaging cost for each item you offer- so that it can be fully accounted for in your pricing.

Putting It All Together

Here's an example of what a job might cost after factoring in the overhead, production, and product costs. You can see that there's a large chunk of each job going directly to overhead. Even if production costs were reduced by half, like if you had an associate who earns half as much, or by reducing your own salary, there's still a significant amount that goes toward the cost of simply running your own business:


Final Thoughts
Even though that was a lot to type out for you, it's really not more than a few hours of your time to sit down and actually crunch the numbers. The parts that require the most work is consistently tracking how much time you spend on each task associated with a project, and figuring out exactly how much your overhead costs are. Notice that NOTHING in this post talks about knowing what your competitors charge? That's because it doesn't really matter what they're charging- for all you know, they never even did the math to begin with and they could be out of business in two years! All that matters are the numbers you need to make your business work. Take the time to do the math now and you will save yourself loads and loads of headaches in the future. If you find yourself shocked with how much you should actually be charging per job vs. how much you're charging now, that's a good thing and it will help you better understand where you need to be in order to make the transition from part-time trap to full time passion!

Calculator

Now that you're ready to tackle the numbers, check out this awesome Rate Calculator from FreelanceSwitch.com and Cost of Business Calculator from the National Press Photographers Association.
Special thanks to Jennifer Grant for sharing that link in the comments!

Update: 11/17/08 Stacy Reeves just created an extended guide on pricing available as a free download from her blog. Check it out: http://www.stacyreeves.com/photographers-pricing-guide/


Anne Ruthmann is a lifestyle & wedding photographer from Boston, MA. She spent 10 years in the corporate & non-profit world before pursuing her passion for photography. When not behind the computer or camera, she can be found exploring the world with her husband. Follow her on Twitter.

22 comments:

  1. Awesome info, Anne! Thanks for posting all this. :)

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  2. Anne~ thank you for all the details, the spreadsheet continues to get bigger and so do my eyes..hee..hee..
    your gift of giving of your time is truly appreciated.
    thank you...thank you...thank you!

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  3. Great thoughts, great tips and it is great that you enjoy giving your time! It is much appreciated.

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  4. Anne,

    Your posts have been sooo incredibly helpful for me just starting out. I've been struggling with pricing for a while and you made it so much easier. thanks so much!

    Dennis

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  5. You are brilliant Anne with an E.

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  6. Thanks for taking the time to write this. Terrific!

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  7. i'm amazed with the time that you took to think/write all of this! amazing! YOU should be charging for this info!! hehe :) seriously, thank you and you made me realize I REALLYY need to take another look at my pricing because I'm barely making a profit with my weddings!

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  8. Seriously and CONSTANTLY amazed at you anne! WOW! This is great info, stuff that I am working through right now, but great to remember and do it the right way the first time!
    Cheerio
    -Melissa E Earle

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  9. Thank you so much for helping us all out. When I think about how much time you spend doing this, it just proves how amazing you are.

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  10. just found this and wow, thanks, you made it easy to understand!
    half way through most other pricing discussions all i hear in my head is blah blah blah.
    actually read yours twice, took notes and pow made me a new price list!

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  11. You know, now that you break it down like that, it is really easy to figure out how much to charge for the services of virtual assistants, transcriptionists and even graphic artists (although artists have some additional qualities that can add to the price).

    I have a website devoted to helping people with product creation and I think you would make a great guest on one of my teleseminars. If you would like to join me on a call, just come and register for my blog: http://productinaweekend.com and leave a comment so I can get in touch with you to plan when we could have the call.

    This would be great material for my listeners.

    Thanks,

    Micheal Savoie

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  12. Hi Anne,
    Thanks for taking the time to craft such an informative post. I have just linked to your site from my blog.
    Dave

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  13. Wow--amazing post (as usual!)

    For those wanting to jump start their numbers without opening excel, they should check out this site from The National Press Photographers Association.
    http://www.nppa.org/professional_development/business_practices/cdb/cdbcalc.cfm

    It's a quick "cost of doing business" calculator. You enter in everything, it tells you your overhead per shoot. :)

    Pretty sweet little page.

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  14. Anne,

    thank you so much for this post. It is very timely. Any recommendations on books/blogs/websites to give me some guidance on the whole startup process? I am particularly looking for information about whether/how to deduct the business expenses, such as camera and equipment, if I use them both for personal and commercial purposes.

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  15. you rock my planet! Thanks for sharing such useful information for us!

    you really know what you are talking about!!!

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  16. THANKS! This was so helpful!!

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  17. I think that having a blog like this is the most useful thing a person can do, because you reach people in ways you would never expect.

    Just the pricing formula alone is saving me hundreds of dollars in my outsourcing. In fact I just emailed my subscribers about outsourcing. I will have to include your link as a resource!

    Have an amazing day!

    Micheal Savoie
    http://ourwiz.com/likes/working-from-home

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  18. Great information thanks!
    Kristine
    www.creativetampabay.zenfolio.com

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  19. Great breakdown, I love it! Thanks!

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