"$75/hour! Are they crazy?"

All of us have had this reaction to price at some point. Although some products/services are overpriced, most freelancers/small business owners determine price by what the time and/or materials it takes to produce an item. A number of factors go into this process.

Let's say you make pillows. All of your friends rave about your talent and suggest that you sell them. "What a great idea," you think. But, for how much? You have no idea. There are many factors to be considered to determine price, but the essential four are:

1) Manufacturing costs: Includes cost of raw materials, labor, overhead (electricity, machinery, gas, etc.).

2) Markup: The profit from each item (unit) sold. For example, if it costs $5.00 to produce a product, and you sell it for $10, your markup is 100%.

Note: To research pricing a product, consult the trade association for that industry. In our example, you would contact The National Home Furnishings Association (NHFA.org).

Call your local SBA and set up an appointment. Many of these executives have 20, 30, 40+ years experience in business and are just waiting for you to pick their brains.

3) Gross margin: The amount of money somebody pays for a product, minus what it costs to produce.

If your average investment in inventory is $100 and your gross margins are $300 (Sales of $300 and cost of goods $100), then your Gross Margin Return on Inventory Investments (GMROII) ratio would be: 3 (300 / 100).

This means you are getting 3 dollars for every 1 dollar you invest in inventory, or a 300% GMROII.

4) Market bearance: What the customer is willing to pay. No matter how cute, delicious, helpful or necessary you think your product/service is, it is only as valuable as what the customer is willing to pay for it.

For example, you consider all of your costs and decide to charge $30 for each pillow. You query your friends and they will only pay, at most, $25. The market will not support your price. It takes extensive research to determine this. Start by researching prices of similar products. SCORE can help you with this.

Now, you have to decide two things:

1) Can you actually afford to charge less for each pillow (lower your markup)?; and

2) If you can afford to charge less, is it worth your time? This is where most small business owners who are just starting out make their biggest mistake. This is particularly true of those who make their own products.

Most figure, "So, I'm not making as much off each one, but I'll do this to get going and raise my prices later." However, you may find that raising your prices causes you to lose your customer base. It's usually easier to lower prices than raise them.

Markup is your profit after each sale. This includes your time. Going to the office supply store to buy paper for invoicing; searching the Internet for fabric suppliers; calling a customer to verify an incorrect address - all of these are costs associated with producing a product.

When you're making five or six pillows a week, it might not seem like much, but think about when it's 40, 50, or 60 pillows a week, then figure out the number of hours you spend on these tasks. You may discover that you're making minimum wage. So, price your product appropriately, or you'll be sorry later.

Another factor to be considered when determining price is competition. In our pillow example, competition is intense. Major retailers can probably beat your price. So, competing on price alone won't help your sales; it could even hurt them.