With all of the noise out there about how to make money in creative business, charging what you are worth strategies (well, really tactics but is there really a difference ?:( ) and everyone out there with an opinion on the “right” way to do things business wise, we need to take a moment to stop and actually think.
BEFORE any conversation happens about pricing and profitability, we have to have a foundation for what the prices actually mean. Are you pricing subjective (what is between your ears), specialized labor (i.e., a master florist or draftsperson), product, and/or non-specialized labor? One size most certainly does not fit all and even if you quote your client a single number, YOU have to understand where the money goes to judge whether or not you are making what you should.
Think of foundation as the basis for strategy, the model tactics. Amateurs confuse the two and play with tactics in the hopes of adopting a new strategy. Professionals understand tactics can change at any time, strategy has to be thought through and only changed upon careful consideration for what you intend the direction of your creative business to be. Professionals are storytellers with their creative businesses, amateurs are reactionaries. Up to you to choose who you wish to be. Do the work of really understanding how to have your business tell a story or rely on the power of your art (and personality) alone. Your choice.
Yes, this is cerebral stuff for you to work on but also the very DNA of what you do. If you do not truly grasp the import of what you are charging, why should your clients? And here is the biggest point — if clients cannot understand the value underlying your price (because you do not), they will absolutely UNDER value it and you will struggle to get what you need to do the work you do.
As it relates to a project (as opposed to the leveraging of intellectual property – licensing, endorsements, appearance fees, etc. which we can address some other time), creative businesses generate revenue in only three ways, by selling ideas, time and/or product. Some creative businesses have only one of these streams (rare), others a combination, most some component of all three (even mostly service based businesses like entertainment and photography).
Ideas – as I have already talked about many times, the value of the idea is what you say it is and is wholly irrational in the sense of calculation. The only rational part of it is its relationship to the rest of what you do. If you are all about selling product, the cost of the idea will be small relative to what your client pays for the product (i.e., clients know you make most of your money from the sale of products and/or services). The opposite if originality and the power of the idea is what matters.
Time – If you provide any kind of service, what you are really selling is time. Time in the absolute sense – how long does it take to complete the task at hand; but also time in the relative sense – how efficient you are in the use of the time. Having Jeff Leatham on site for an hour is different from having a beginning floral designer, even if Jeff had previously designed what would be produced on site. The value of the difference is captured in the relative cost of time. Maybe Jeff is $500/hr., the beginning designer $50/hr.
Product– Whether through outright sale and/or rental, product is based on an idea of margin. What does the thing cost to make and/or acquire and what do you have to sell it for to achieve a desired return for your creative business.
The single biggest mistake I see all creative businesses making when it comes to pricing analysis is commingling the streams. When you just look at the whole you cannot value each piece and see what needs to be fixed. Inevitably, most creative business owners wind up chasing revenue above all else (ahem, day of planning), while leaving pricing and cash flow errors in place. Arriving at the right pricing solution means appreciating what needs to be achieved in each area, valuing risk associated with each stream and then assessing its relative importance to your creative business. Timing of cash flow then is then included as a function of risk and necessary margin not a fait accompli. So let us tear into each separately and then I will try to work in an example or two of how to bring the three together.
Valuing Ideas– Ideas are the most profitable part of a creative business. Cost of presentation is very small relative to the potential value of an idea. My rule of thumb is that Ideas should be priced at an roughly 80% margin. Yes, you keep $0.80 of every dollar you charge for ideas. The risk associated with ideas is that you cannot get to yes with your client so that you have to either keep presenting/refining beyond your 80% budget. This, of course, has a large impact on time and product if you run into constrained deadlines or are forced to re-present after approval of design (bad client management). Even if you do not necessarily have a hard deadline like an event (say interior design), delays in presentation still cost you money – worse decisions by the client in the future, extended timelines, etc. So the balance you strike when you present an idea is to see if you can attain an 80% margin and still get to an effective yes. If not, either you have to raise your price or lower your margin or both.
Valuing Time– Most creative businesses are way off when it comes to valuing time. Typically, time is the cost of labor pre-production. On-site labor should be considered part of production. Time is the next most valuable revenue stream of any creative business and a good rule of thumb is that it should be priced at 65% margin. If you associate 250 hours of labor to a project that costs you $30/hr., you need to charge @$80/hr. For this labor analysis, creative businesses look like traditional service businesses that charge by the hour. Think of a law firm. If a junior associate is paid $100,000 and is billed out at $200/hr. with the expectation that she will bill two thousand hours per year (i.e., generate $400,000 for the firm), the margin is 75% which is about right. Most creative businesses do not charge by the hour and/or have salaried employees. If there is a flat fee for production, the risk that a project takes longer than expected costs money. You budget ten man hours and it takes twenty with the same revenue, you made half. Risk of project slippage has to be factored into your time price. If you ridiculously efficient and effective, you can stick to 65%, if not, then margins need to go up. There is where you will meet the ire of clients. If something should take 10 hours but half the time takes 20, you need to add 32% to your margins to be priced effectively. That’s right $30/hr. labor would have to be priced at over $300/hr. if you were pricing effectively. Yeah, best to rethink cheap staff. Not to say that you do not need unskilled labor, you do. It just has to be priced much much differently than skilled, meaning the margin has to be higher for skilled labor as much as being more expensive.
Valuing Products – This is the easiest element of a creative business to price. Margins are retail margins, so need to approach 50%. If you are renting items, you need only value the item’s acquisition cost, potential for breakage, storage cost and estimated usage and multiply by two. For items sold, every component gets multiplied by two. Even on-site labor. Of course, risk of products is when your estimated cost to manufacture and/or acquire go off. Buying that last minute vase at a loss messes everything up. Again, if your systems are great, keystone works, if not then you need to price higher. But the market will push back hardest here so if you cannot produce well you need to stop producing. Clients will pay a premium for quality, but they will not for inefficient production of the same thing. This is the reason we (ok, I) decided to outsource all of Preston’s production for international events. Apart from the nightmare of producing in a distant location, we were not very good at cost effective production. Better to supervise and let specialized producers do what they do.
Putting It All Together– Ok, now we can put it all together. Say all ideas, time and products in your creative business are equal and target margins are accurate (i.e, you are pure awesomeness so there is no factor for risk), then no matter how you got there (percentage, flat fee, hourly) here is what you should make on a $45,000 fee: 80% of idea ($12,000), 65% of time ($9,750) and 50% of product ($7,500) or $29,250 before overhead (which should be @15% — remember a lot (but not all) of employee expense is absorbed in time). And there you would have it – a $22,500 profit per project in a perfect world. If you would like to earn $450,000 you would need to do 20 projects.
Now let us say you are less than awesomeness and there is a $1,000 mistake. If you were only looking at the whole, you would see only about a 3% reduction in profitability. No biggie right? But when you assess the $1,000 to each area individually, clearly its impact is felt more the lower your margin is. This means, all things being equal, the chance of your creative business not meeting its goals grows the lower your margin is. Translation: your chance of getting it right is much worse, the lower your margin. Which is where there is some counterintuitive thinking that needs to happen. Give up when you have less chance of success, stick where you do. If you have to negotiate, reduce your price on lower margin items first. Keep the good money as long as you can.
With all of the above, you are now in a position to evaluate your creative business financially. Assign your target revenue, then assess number of projects to get ideal revenue per project. Then break the revenue into idea, time and product. Now use target margins of each to see how it should all pan out.
When you compare ideal to where you are now, what you need to fix will slap you in the kisser. What most of you will find is that time and on-site labor are massively under-priced. Risk will be overvalued on higher margin and undervalued on lower margin (meaning you will be subsidizing lower margin work – whether lower priced or just lower margin with bigger or higher margin work – 80/20 issues). Last, you will probably find that your percentage of revenue in terms of idea, time and product is off from what you would like it to be. Even if you do not change your absolute cost then, you HAVE to shift the breakdown.
A word on cash flow. Most creative businesses are seasonal. The level of seasonality varies among region and type of creative business. The more seasonal, the more of risk you have to assess to everything. The reason is simple, most of us suck at managing cash in theory. If it is in the bank, it looks real. And sh-t happens. If you generate revenue of $120,000, so much better to get $10,000 per month than $120,000 up front. Yes, if you are truly seasonal your absolute prices have to be much higher than those that are not to absorb the risk of seasonality (i.e., lumpy cash flow).
We will leave the discussion of the difference between capital asset businesses (i.e., hotels and venues) vs. intellectual property businesses (i.e., you creating art for clients) for later. This post is all about intellectual property businesses so there is scarcity and NO ROOM for capital asset pricing. Yes, a project in February prices the same as a project in June.
Margin analysis really matters if you want to stand on the ground you choose instead of where someone else tells you to. I hope you choose to do the work.
