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How to set pricing for your home-based business

Heather Barnett is a freelance writer and foodie whose work has been featured in blogs, websites, magazines, and TV and radio ads. She spends her free time relaxing with her soulmate, Keith; her dog, Mosby "The Fly Slayer;" and Felix th...

Is the price right?

If you're working like a dog and still having trouble covering your expenses every month, much less having any money to splurge on yourself, you may be undercharging for your products or services.
Small business owner working at home

We have the tips to help you set the right price (and how to tell existing customers your rates are going up).

Setting prices seems like it should be easy. Just look at what everyone else charges, right? Well, no. Actually, the process involves determining your hard cost, your administrative costs and necessary profit, then balancing that against market value. Sound hard? It’s not easy, but you can get started with a little consideration, some research and a couple of easy formulas.

Determining hard cost

Tip: Don’t forget to include self-employment taxes and insurance in your hard cost. Those are things your employer would normally cover, and the goal is to be as comfortable as a freelancer as you are as an employee.

Your hard cost is the amount of money you pay to make each item or work each hour. It includes the cost of any non-direct-sellable products you need (for example, paper or fabric) and the cost of utilities and fees or other must-haves (like rent/mortgage payments, internet access, insurance, etc.). To determine your hard cost, you need to know how much your utilities and other hard costs are, and the price of any other incidental expenses you’ll have each month.

To determine your hard cost per item, you need to know how much you use for each item. So, if you make pincushions, you may know that you pay $6 a yard for all the fabric, but you’ll need to divide that yard by the number of pincushions you can get from it. So if you can make 10 pincushions from a yard of fabric, your hard fabric cost on the pincushion is 60 cents per item. Obviously, you also need to consider other incidentals (in this example, you’d also need thread and needles).

Example:

Fabric per pincushion: $.0.60
Thread per pincushion: $0.02
Total per item supply cost: $0.62

You’ll also need to know how many items you can make or hours you can spend doing your actual service in a workweek (and what you can realistically get done in that hour). Keep in mind, you need to allow for administrative duties, like answering emails and the phone, billing, marketing and more. If you don’t already know how many hours you spend doing administrative duties in a week, it’s a good idea to figure you’ll need half of your workweek for that.

Note: The numbers below are based on a 40-hour workweek. If you plan to work fewer hours, base your calculations on that where necessary. If you think you’ll probably need to work more, cap it at 40 hours anyway. If it turns out you need to work more to make the same money, you miscalculated somewhere. If you need to work more because of demand, you need to consider hiring employees or charging more (because your customers clearly think you’re worth it!).

box of receipts

For monthly utilities, fees and supplies, divide the amount you pay for each by the number of hours in a month (about 720 hours). Then multiply that number by the number of hours in a work month (about 172 hours based on 40 hours per week) to get the cost of utilities for your business total. For services you only use for business, but never for pleasure (like credit card processing fees), count all of those toward your business and simply divide them by the workweek hours (172). This will give you your total cost of running the business per hour.

Example:

Total monthly expenses (shared between business and personal): $1,500 (divided by 720 = $2.08 per hour)
Total business-only monthly expenses: $300 (divided by 172 = $1.74 per hour)
Total expense cost per hour: $3.82

Once you know this info, you can set your rate. To calculate the unit cost (C), add the amount you actually spend per item to the per-unit expenses of your business. Your unit cost is the total of the supplies (S) plus the calculation of your expense cost per hour (E) divided by the number of units you can make in one hour (U).

Formula: S + (E / U) = C
Example: $0.62 + ($3.82 / 2) = $2.53

Administrative costs

This is the good part. This is where you pay yourself! To calculate your unit costs, divide up your hours between the actual craft or service you provide (professional services) and boring administrative duties like billing, answering emails, etc. If you don’t know the breakdown, we recommend dividing them in two (for a 40-hour workweek, that’s 20 hours each).

For regular administrative duties that aren’t your specialty, figure minimum wage per hour (M). For your actual professional duties, find out what people like you get paid hourly in the U.S. or in your area (P). Just check out the U.S. Department of Labor’s Occupational Outlook Handbook to find out what someone in your position normally makes (note that these are only nationwide averages, so you may have to compromise for less, but don’t ever go less than minimum wage).

For our running example, according to the Occupational Outlook Handbook, a crafter or fine artist’s median pay in the U.S. in 2010 was about $21 an hour. In most states, minimum wage is around $8 per hour. Keep in mind that you’re breaking everything down by hour. So if you can make two items in one hour, divide both administrative and professional costs by two (on the assumption that you’ll spend half the time making it and half the time promoting, selling and billing it) to reveal the total administrative cost (A).

Formula: (M / U) + (P / U) = A
Example: (8 / 2) + (21 / 2) = $14.50

Price per unit

Are you exhausted yet? Don’t be. We’re about to tell you how much to charge per unit (remember, if you’re a service provider, your units are hours, not physical items, unless you charge per project).

Just add the administrative costs (A) to the hard costs (C) to get the price per unit.

Formula: A + C = PPU
Example: $14.50 + $2.53 = $17.03

Think that sounds crazy? Check out this $30 handcrafted cupcake pincushion on Etsy.

Putting it all together

These formulas are just the start. But as you get to understand your business better, you’ll know what adjustments need to be made. And if after using these formulas, the price still puts you well out of market range, consider these possibilities.

  • It’s time to cut costs by buying in bulk, opting for cheaper utilities or making other adjustments.
  • You’re overestimating your value or you’re working too slowly — how can you speed up production?
  • There’s a hidden cost you’re not considering or some other influence on the type of work you do that wasn’t covered here.

If you have to raise your rates based on this calculation, telling your existing customers will be difficult. It’s dangerous to simply say you’ll let them pay less, as you may be inclined to slack off on their work in favor of higher-paying clients, which could cause you to develop a bad reputation. Instead, consider these options, but accept that you may lose some clients.

  • Be honest about why you’re raising your rates, but do so in a way that makes you look great! Talk about increased demand, value for your services and other buzzwords that remind them why they hired you.
  • Allow existing clients a six-month grace period where they pay only half the increased fee or give them other value-added benefits your other customers don’t get.
  • Work for what they’re willing to pay. If you really don’t want to lose them as a client, you may have to suck it up.

More for home-based business owners

The work-at-home alpha mom
Real job opportunities for work-at-home moms
How to work from home with young kids in the house

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