[This is the third in a series of four articles on price. The previous two articles were Price Level Not Directly Related to Profits and the Case of Perfect Price. Links to all 4 articles are at the end of this post.]
Find out what something costs and then mark it up. That’s the way you price. I’ve heard that all my life. But where did it come from because that’s not the way many industries do it. Fact is, in a lot of cases, this type of thinking works against us. And then there are people on the other side yelling, “Price what the market will bear Dufus, don’t leave money on the table!” Listen to these guys too much and you end up without a price: rather a whatcha gimme situation. Problem with that is you can never raise or lower a price if there’s no price in the first place. What’s a poor printer to do? Simple. Adopt a rational price structure based on both cost and market. And, of course, that’s easier said than done but here’s a shot at it.
Let’s take the cost approach. Basically this is determining your costs using a budget hour rate, adding for direct material (and markup) and then marking up the total. “Don’t sell it for less than it costs,” is the mantra.
To keep it simple, if Joe works in a print shop by himself and wants to earn $800 each week and if the total weekly cost of rent, utilities and everything else except for direct materials is $1,200; then the total costs in the shop is $2,000 per week (wages plus overhead). Since Joe plans to work 40 hours, then an hourly rate at 100% chargeable time would be $50 ($2,000 / 40 hours). In cost parlance, however, Joe can’t possibly charge off his time to jobs at a 100% rate for he wouldn’t have time to change between jobs let alone go to the bathroom.
In this specific case, Joe has to do a lot of other things as well besides actually produce work; like take orders, answer the phone and price jobs. So, let’s reduce Joe’s time down to the amount of time he actually works on jobs (time that is chargeable). In this case, let’s say he can charge 50% of his time to jobs (or direct labor work); therefore our calculation changes.
Instead of 40 hours of labor, we have only 50% of that as direct labor or 20 hours. The payroll and overhead of $2,000 doesn’t change but it’s now $2,000 / 20 hours chargeable time = $100 per hour.
Now IF Joe charges off 50% of his time during a week in which he pays himself $800 and his overhead is $1,200 THEN we can say with 100% certainty that his cost rate per hour is $100. But IF Joe is sick one day and only has 16 hours of chargeable time (4 hours day x 4 days instead of 5 days) then his hourly rate increases because the overhead and wages Joe pays himself doesn’t change ($2,000 / 16 = $125 hour cost rate for that week).
Likewise, IF his budget for overhead is $1,200 for the week yet, it was cold and he had to run the heater a lot which increased his electric bill which increased the overhead to $2,800 ($2,000 + $800 wages) would equal $140 an hour cost assuming he worked five days. If his costs increased and he worked only four days (16 hours), then his cost per hour would increase even more to $175 per hour.
So what’s the real cost? Could have been $100, $125, $140 or $175 which is why we don’t figure the hourly rate AFTER the period ends. Rather, we figure it before by using a BUDGET. We project what our costs are going to be and then divide by the hours we budget to have available and end up with a Budget Hourly Rate.
As illustrated, the Actual Hourly Rate can be much different than the Budget Hour Rate depending on what actually happens. But, because we have to give a price before we get the job; we muse use the Budget Hour Rate and let it go at that.
Now, point is, many think it is fact and it’s not. How many budgets actually end up to the penny as being accurate?
Okay, now on the flip side is market. How do you ever know what the market prices are?
Well, the way we do it is to survey print providers.
Yea, but how do you know about my market? Well, first, it’s a matter of statistics. And, second, it’s a matter of accepting the fact that printing markets are equally as screwed up all over the country (world). Third, and finally, understand that you may not know as much about your market as you think as we deal only with a sub-set of our market anyway.
First point: Statistics
We use an array to illustrate our findings which I think is most helpful to most in understanding the results. Image you have 100 data points and stacked them up from the lowest to the highest; then count the individual data points from the bottom (lowest to highest). The 25th data point (number) would be the 25th percentile. The 50th would be the number in the middle (median) or 50th percentile (not to be confused with average) and the 75th, the 75th percentile.
Assume you have the data points of: $10, $20, $30, $50 and $900; the average would be $202 but that’s not descriptive of the data (market). What would be more descriptive of the data is throwing out the outlying numbers out which in our example loses the $900 and $10 values. Now we are left with $20, $30 and $50 which are the 25th, 50th and 75th percentile results. Thus the relevant range (effective range) for this price point is $20 to $50 with a center point of $30 as opposed to the average of $202.
So the effective range for this price point is from the 25th percentile ($20) to the 75th percentile ($50) and is typically $30 which is the range you should consider in establishing prices. Don’t be distracted by the outlying numbers.
Second Point: Equally as Screwed Up
Now this explains what you have known for years; wages, prices and costs are all equally as screwed up throughout the country (world). The trick is to separate yourself by dealing with fact not fallacy. While it is a fact that you will always be able to find someone down at the trade show to agree with you; the trick is to deal with the relevant range and not the outlying numbers.
But you know that you are right. You are beat up on pricing and your customers demand low prices and, besides, your competitors are still lower than you.
Well, this condition could exist! Yep. I’m not saying it can’t. It can.
You CAN have very price sensitive customers. And you CAN have cut-throat competitors. I saw a good example of this years ago in Tennessee. Nonetheless, the answer to this dilemma lies in understanding the next point.
Point Three: We Only Deal With Subset of our Market Anyway
Huh? We typically deal with 25 customers which give us 50-75% of our total business. Test it out yourself. Pull sales from the last year and line them up from largest to smallest. Even a real trinket business shop has some 25% of total sales in the top 25 customers (no, business cards or walk-in is not a customer).
Now pull data on the businesses within five miles of your front door. Lots of times there can be thousands of businesses. Even in rural areas there are hundreds of businesses.
What am I saying? You CAN be hostage to price-sensitive customers. You CAN have a competitor who sells only on price. But that’s a temporary condition IF you do something about it like have an ongoing selling program that reaches beyond your comfort zone into the real market.
Conclusion
What do we use, cost or market? Use both.
Calculate costs plus markup and use that as the floor for prices. Understand though that this cost plus price is based on many assumptions and is more estimate of cost than fact.
Then compare with market. Determine the range of market prices ($20 to $50 with a typical of $30 for instance) and allow your price to rise when you can.
“Takes a lot of time you say?” Yes, which is why there are price services around like mine. But still that’s the way to do it.
Tom Crouser
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Other articles in this 4 part series
Part I, Case of the Perfect Price Click Here
Part II, Price Level Not Directly Related to Profits Click Here
Part III, Price: Cost or Market? Click Here
Part IV, Pricing What We’ve Never Done Before Click Here
