Figuring out how much to charge for products and services is a balancing act. You must balance what it costs you to provide the service or product and the profit you believe you're entitled to, with what the market is willing to pay for it.
Your pricing decision affects more than your income. It can determine how much you'll have to work to meet your goals, how big your company will grow, how many and the types of customers you attract and retain, and how they view your brand.
Small wonder, then, that independent contractors and small business owners pay so much attention to how they charge for their products and services.
We'll look at charging for services and products separately in the discussion below.
Before you can arrive at a price for your service, you must consider these four factors:
Think of your salary as the amount you want to take home for your efforts, skills, and experience. If you've left a full-time job to go out on your own, you might use the salary you were earning at your full-time job. You can also research how much others earn for similar work, using recruiting and job posting websites and professional organizations, and by talking to like-professionals.
Your pricing must cover your cost of doing business and your overhead. Whether you are working from home or from an office, the elements that comprise your costs include:
The costs you include in this calculation can take into account any tax deductions you'll be able to take (for example, the cost to rent office space and travel to meet with clients.). If you're not sure which of your overhead costs are deductible on your tax returns, check with your accountant.
Your salary is the money you take home for providing your services, sharing your expertise, and the years of experience you bring to your work. But if you take out every penny that's in the black, you won't have a cushion to fall back on if needed. Your business will be subject to the ups and downs of your industry, the economy, and other factors. Adding in a profit margin, which you may want to leave in the business as a rainy-day account, helps to mitigate these financial risks.
Independent contractors and business owners typically arrive at a profit margin by adding 10% - 20% to the total of their salary and business and overhead costs.
If you price your services too high, your customers might turn to a competitor. Price your services too low, and customers might not see the value in what you offer. By researching what the competition charges for the same or similar services you can gauge how your pricing stacks up against common market practices.
Review the information available on competitors' websites and professional associations, and talk with clients and potential clients to learn the going rate for services like yours.
Service businesses typically charge in one of three ways: by the hour, by the project, or by the day. The method you choose depends on the assignment and your client.
To arrive at an hourly rate, you'll need to first determine how many hours you'll be available for work.
If you worked a typical 40-hour workweek for 52 weeks, your annual hours would come to 2,080 hours. Realistically, though, you can't devote all those hours to paid work. You'll need to subtract vacation time, holidays, and the unpaid work you do as an independent business owner (invoicing, other administrative tasks, and pitching new business).
Let's say you want to factor in a two-week vacation each year, and the seven holidays when businesses typically close, totaling 136 hours, plus another 300 hours of unpaid administrative and business development tasks. Using this framework, you'd subtract 436 hours from 2,080 for a total of 1,644 working or billable hours per year.
Here's an example: Jane, the owner of Not-So-Plain-Jane Social Media wants to pay herself $60,000, the same salary she earned working as a social media manager. She calculates that her overhead amounts to $20,000 per year, and she wants to earn an additional 20% (or $16,000) over her salary and overhead costs as profit.
Jane plans to take one week of vacation and only five holidays off, at least for the first few years while she is building her business. She factors in another 300 hours of non-paid work to run her business, for a total of 1,700 hours of working time per year.
She divides the total of her salary, overhead, and profit margin by her annual hours to arrive at an hourly rate as follows:
$60,000 (salary) + $20,000 (overhead) + $16,000 (profit) = $96,000 ÷ 1,700 hours = $56.47 per hour
The example uses an eight-hour day, but you can also use a 7.5- or 7-hour day to account for meal breaks.
A per project rate, sometimes called a flat rate, is a set charge for delivering finished work.
You can come up with a flat rate by multiplying your hourly rate by the number of hours you estimate it will take to complete the project; or by assigning a value to your experience, time, market demand, and your costs to perform the work.
While per project rates are usually based (at least in part) on an estimate of the number of hours it will take to complete the work, you can't change the rate if it turns out the project took longer than anticipated. For this reason, flat rates are appropriate only when you are quite sure that you can complete the task in the estimated time.
Consider using a daily rate for work performed on location or when the assignment involves a predetermined amount of time, such as providing a 2-day training workshop.
You can use all of the considerations you include in your hourly or flat rate to set a daily rate, but you might want to set your daily rate somewhat higher than your hourly rate because it's likely you won't be able to take on other jobs simultaneously with a daily arrangement.
For example, let's say a freelance graphic designer works at three ongoing assignments, each paying $50 per hour. She typically spends 3 hours a day on each of those assignments for a total of $450 per day. If our designer accepts another job at a daily rate during that time, she'll want to set a rate that covers at least the $450 she earns from her other assignments. (Even though she'll likely be working a shorter, seven-or eight-hour day at a daily rate, her total daily earnings would be reduced if she considered only the hours she worked. )
Just as with services, the amount you charge for the products you sell impacts everything from the number and types of customers you attract to how big your company will grow and how customers perceive your brand.
The simplest and most common pricing model is cost-plus pricing—the cost of goods, labor and related expenses, plus a profit margin. You can also price your goods based on what others charge for similar products or the demand for your goods.
Whichever model you choose, make sure that your prices are sufficient to cover your costs.
Product costs include everything you must spend to get your product into the hands of your customer. To figure out your costs, include the overhead items listed above as well as the cost of materials, labor, packaging, and sales costs like commissions.
If you are importing the goods you sell from another country, you'll also have to include the cost to get the items from the seller to your door (known as landed costs), such as transportation fees, customs fees and duties, tariffs, and insurance.
Next, add the profit margin you want to make. Retail profit margins are typically 40%-50% over the cost of goods. You might use a higher or a lower profit margin depending on your business model.
For example, using a lower profit margin can reduce your prices compared to what others charge for similar products, and help to increase your sales volume or attract new customers.
Remember that product pricing is flexible, and you can change your prices depending on your sales goals. You might charge lower prices for a limited time to attract new customers, or higher prices when demand is higher.
For example, if you are a florist, you might charge more for roses during the Valentine's Day selling season.