I start off by sketching the character. I wanted to create something simple. Big head, big eyes, small body. Something you can dress up as anything.
I then sketch the character in a position that I can put in a photo. I already imagine the perspective of the photo, make a sketch of the photo with the character in it, which makes taking the photo later more easy.
I then take a picture. I put a strong light on top of it to make the illusion of 3D better. Notice that the light on my hands is almost white. If you replicate this effect on the character the illusion of 3D is a lot easier to reproduce.
In Photoshop, I put the sketch over the picture to check if the angle is correct.
In Illustator, I start building up the character in outlines with the pen tool. I'm just tracing the lines of my sketch and make closed shapes out of it.
I color the character in Illustrator, just with some basic colors and some simple shading.
I put the illustrated character in Photoshop and add some noise to it to give it the some grain as the photo. I color balance the illustration to match the light in the photo. Then using the burn and dodge tool I start adding the light and shadow in the illustration.
Where the light hits the character directly, I dodge the colors to completely white, I burn the shadowsides to black.
Using the smudge tool I "push" the illustration in to create the effect of skin inefficiencies and shirt texture. I blur the edges a bit with the blur tool to create the illusion of a dept of field.
Finally I tweak the colors a bit more and make the total even darker to make it blend in more.
Aaaaaaand we're done.