It appears to be a common practice. A business owner figures out the price of labor and materials adds an “upcharge” and VOILA – they have the price for their product or service. It is equally common for them to know that their competitor sells the product for $25 a pound and they meet that price. Or, their competitor makes a product for $25 a pound and they meet that price. No matter whether it is a product or a service the price strategy is the same…I will sell at the same rate as my competitor because that is the market. That approach will ruin your business and easily could be decreasing your profit.
Why am I saying that?
The processes above are based on not knowing enough about your business to make it as productive and profitable as possible. The business owner in the above situations doesn’t understand the impact of process, product, and cost on what they sell or make. Not understanding how their process works, what those processes cost them in time and materials, as well as other related costs, can cause your business to fail or at best not make the profits you can. If more profit isn’t your motivation, it could cause you not to be able to sell or produce at the lowest possible cost/profit and remain in business.
At one time or another, you might have heard the word “Value Stream.” A Value Stream is every single step in the end-to-end process for creating a Product or completing a Service. There is a Value Stream for each and everything you make or sell.
When you determine the value stream of your product or service, it involves every step in the making or selling of them. These steps involve:
- Order entry
- Ordering and receipt of supplies and materials
- The end-to-end cycle time to make or complete the project or product.
- Packaging, Labeling, and Delivery to the customer.
Each of these steps has a cost associated with them. While ultimately these costs will factor into your pricing, as well as ensure that you make a profit on everything you sell without artificial markups or multipliers.
How many individual steps must be performed, and completed, to fill the entire order? What quality issues, standard instructions, consistency, accountability, and information, is needed for each of these steps? How long (time) does it take for each step and all steps combined?
When you consider the time spent in producing or providing your product or service you must remember that this time includes not only the labor costs of those directly involved in the work (Cost of Goods Sold people) but also the labor costs of those who are in your office that you pay regardless of available work (Indirect labor). This even includes paid breaks and meal periods. You also must include other business expenses from rent to utilities and more. In other words, your total time inventory, plus your Cost of Goods and services, plus information costs is your profitable price for one product or service project. You then add all of that together, labor (direct and indirect), materials, business expenses, etc. to determine your cost.
All of that combined will automatically include your profit. That number will show your COST to produce 1 product or service profitably. Your marketing efforts will then tell you if the price is competitive or not. If your cost is too high, you must go back to your value stream process and determine where you can eliminate waste and error, improve efficiency, etc. to reduce your cost.
Regardless, you will then have to look at the relationship between your cost and the value seen in your product or service by your customers and make determinations regarding your cost to that value benefit. In other words, if your costs are high and your benefit high, will this make you profitable in the marketplace. If your costs are low and the value is low, what will be the benefit of that, medium costs to medium benefit, low cost to high benefit, etc.? You have to evaluate your cost in relation to the market. As you can see, Price is much more than how much you charge for your product or service.
This is a critical step for your business success. By focusing on cost instead of the price you will always know that you can make or provide one profitably. Managing those costs effectively will always lead to greater profitability. This, in turn, increases the value of your business bringing greater successes and security to you.