Is Your Pricing Correct

When you started your business one of the first questions you should have asked, besides “Now what do I do?” should have been something like, “Can I produce a profit or a service at a profit?” 

Most business people think about profit in terms of a percentage of a price.  We often look at our competitors and assume their price is what we should charge.  Doing that means we are accepting that their product or services are exactly like ours and they have the exact same overhead as we do.  This type of price thinking is very wrong for your business.  

What is a better way?

We are going to remove the concept of price and focus on something else.  We are going to focus on the cost of time and of every task and every minute, it takes to completely make one product or complete one project.  We are going to add to that the complete direct costs that exist for one product or project.  We are going to call this, the value stream. 

A value stream, to put it simply, is every single step in the complete process of creating a product or completing a service.  These steps involve: 

  1. Order entry by customer service
  2. Ordering and receipt of supplies and materials
  3. The end-to-end cycle time to make or complete the project or product.
  4. Packaging, Labeling, and delivery to the customer.

Everything you make or sell has a value stream.  You must not only concern yourself with suppliers and their reliability but also, all the time costs to make or deliver one product or service at a profit and the cost of supplies and materials required for the job.  You must then consider how to contain or deuce those costs in order to put value into each product or service you provide for the same cost. 

The biggest challenge you will have is “How much should you sell it for?”  In reality, you should be asking yourself how much will it cost to do this?”  Let’s look at one value stream. 

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?  Never forget that regardless of what you are selling, the time involved is also being sold. 

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 must simply remember that every employee’s time is billable, no one is non-billable.  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. 

To do this, you add the following:

  • Your Time costs.  (To determine this take your company Margin (some call this Gross Profit) divide it by the number of employees directly working and then divide that by the total number of available work minutes in a month for your business.)
  • Your Indirect Labor Costs – the people you pay anyway
  • Your Business expenses – rent, utilities, vehicles, etc.
  • Your information management costs at each step in your process

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 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 benefit. 

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.