the business of being creative with Sean Low: the nitty gritty behind pricing
Artists amaze me. How you see form, function and color is often wholly different from the way I see it. I love that. And in a perfect world, you and your creative business would just do what you do and you would magically receive enough to keep going, thriving, creating art. Unfortunately, the world is far from perfect and, to keep going, creative businesses have to be fundamentally sound creatively and as a business. For that to happen though, you have to educate yourself thoroughly on the hows and whys of what you do as a business. Specifically, you must understand the concepts of margin, risk and the difference between absolutes and percentages. Why? Because each project must be profitable on a risk-weighted basis so that you need only hope to get enough business in the door to earn the money you need. If the last sentence is Greek to you, keep reading.
Every creative business operates on a gross and net margin. Simple, gross margin is the percentage difference between what you charge and what you get to keep before overhead. Net margin is the percentage you get to keep at the end of the day. If you are a service (i.e., event planning, graphic design) you sell time as opposed to those that sell stuff (i.e., florists, stationers, etc.). Gross margin is whatever you say it is. Net margin is a function of volume and overhead expense. Overhead is what you pay even if there were no sales (i.e., what it costs to keep the lights on). If you want gross margin of 50%, then just double your cost, 25% then add 35% to your costs. However, if you want net margin of 15%, then you need to know what your overhead is and hope you generate enough volume to get there. A quick example at 50% gross margin: you do $100 in sales, so you have $50 left. If you have overhead of $35, your net margin will be $15 or 15%. Ahh, but there is the rub: If sales are different than $100, your net margin will be more less than 15%. Assuming overhead stays the same, make more than $100, then your net margin will go up, less and it will go down. Generate less than $85 in sales and you will lose money. You have to control what you can, meaning you have to make sure that your gross margins have integrity if you hope to make money in the long run. As much as you would like to control sales volume you cannot. You can do everything in your power to generate sales, but it is not up to you to say yes. But you can control your margins, although to do so you need to understand (any) risk associated with your gross margin. Risk. Bar none, the single biggest mistake creative business owners make is to ignore or undervalue the risk associated with the projects they undertake. A client changes their mind at the last minute and you have to scramble to make it happen. You do not charge any more for the (in)decision. You forgot to bring a vase (or one broke) and now you have to run back to the studio to get one. A last minute client shows up in your high season and you charge them the same price as your other clients. The connection between all of these examples is that you will get less than the gross margin you expected, meaning that you will be shocked and incredulous when you meet the sales volume you targeted but have nothing to show for it (or are completely fried from overwork. Yes, you and your staff are the raw material that gets spent in a service business).
To properly value risk, you have to understand the difference between absolutes and percentages. Absolutes and Percentages. Creative businesses make absolute mistakes, not percentage mistakes. If I lend someone money and want to earn a return on that money equal to some number but I mess up the math, I just made a percentage mistake. I will only get a 10% return instead of the 15% I hoped for. If I expect, on average, 3 rentals of a chair but get 2 or 5, again a percentage mistake. However, absolute mistakes are what they are and have very little relation to price. If you have to go back to the studio to replace the vase, it will cost you $500 whether you charged $5,000 or $5 for the centerpiece. If it takes you 5 hours to fix a client's indecision, it does not make a difference if the event is for $500,000 or $5,000, it is your 5 hours. When there are absolute mistakes, then risk explodes the smaller the project. A $5 mistake on a $10 project hurts a lot worse than a $5 mistake on a $100 project. So charging a 50% gross margin across the board is a sure way to fail. You have to account for risk so that you earn 50% on a risk-weighted basis. Either you have to remove the risk at the low-end (say good bye to custom) or charge more. At the high end, you can charge a little (but not a lot) less because the size of the project can cover your sins. The only money that comes in the door of your creative business is what you charge. Knowing that what you charge will leave enough at the end of the day to justify your (incredible) effort is the whole ball of wax.
My hope with this admittedly technical post is that you will be able to discover what your real price is for each project you undertake and will price it accordingly. Protecting yourself and the integrity of what you earn is an extension of the boundaries you create for you, your art and your creative business. When it comes to pricing, sweat the small stuff so the larger stuff will take care of itself.
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