If you are reading this, you probably already have a pricing structure that you are using, but you are not satisfied with the profits your company is making. So how did you come up with the prices you've been charging? Did you create your pricing system by checking a competitors price list, then - to gain a competitive advantage - undercut the competitor? That's OK - assuming your competitor is a financial genius who lives in a forty-two room mansion, and your profit desires are appropriately smaller. But if you don't idolize the business acumen of the guy you copied, you need to consider some harsh realities: Specifically - that your only certainty in this business is that you will make less money than your competitor with every order you secure.
The US Small Business Administration (SBA) cites "Failure to price your product or service correctly" as one of the top six reasons businesses fail, and stresses that you must have a "clearly defined" pricing strategy to succeed. You need to know that your pricing system accounts for all costs involved in the manufacturing process and you need to feel secure that the prices you charge over the course of the year will leave you with a profit figure that you can be happy with. If you aren't feeling 100% secure in that department, it's time to evaluate your system.
The Objectives of a Pricing System
You may not think that creating a pricing strategy requires a lot of time spent on defining your objectives. The objective of a pricing system is to make a profit, right? That's not quite enough. A pricing structure for screen printing, embroidery, or direct-to-garment printing needs to meet these objectives:
Consistency: Your pricing structure must be made to deliver the same price each time the same job is priced, no matter who does the quoting, or when the customer asks. If a customer can call on the phone and get one price, then walk into the shop and get another, you destroy customer confidence.
Equity: Your pricing system needs to generate prices that are fair for both you and your customer, neither undercharging or overcharging when competing for business. If you charge too little, your business will not survive. If you charge too much, you may not be able to secure an adequate quantity of orders. Some people state that being "Competitive" is an objective of the pricing system, but being "competitive" is actually a function of the "equity" principle.
Logical Quantity Discounts: Discounts must be proportional to efficiencies gained as quantities rise. As customers order larger quantities, they expect discounts. That discount must be based upon a lessening of your cost per piece as quantities rise, not an arbitrary drop in price.
Profit Oriented: Each price generated must pay for materials used, labor expended, an appropriate portion of general overhead, and leave a specified profit.
Forecastability: You must be able to forecast an approximate annual profit that the system will generate.
Proportionality: Profits must be directly proportional to the amount of work performed. This is where your current pricing system probably fails miserably. If you are like most garment decorators, you use a system where profit per hour of work performed actually decreases as the complexity of the job increases.
Does your current pricing model accommodate all these objectives? If you think it does, ask yourself this: Can you generate a price for a job based upon a $60,000 annual profit goal, and then price the same job based upon a $90,000 annual profit goal? If you can't, your system fails the forecastability objective - and that usually proves fatal to businesses. I mention this because most shop owners tell me that it is impossible to price goods based upon the annual profit they want to generate. But if that were true, how do all the Fortune 500 manufacturing companies issue "guidance" to stockholders as to what they expect to achieve as a quarterly profit figure? They don't say that it's impossible to forecast profits. They just know something that you don't. Well, you don't know it yet - but you will be surprised how easy it is.
Where did we go wrong?
You can't start pricing your product the right way until you know what you are doing wrong, can you? So how do you currently price the goods you sell? Even though you probably made up your own system, it's unlikely that you created something completely unique. Roughly 70% of entrepreneurs in this industry use a system that works similar to this: Start with the cost of the garment, apply some sort of markup, then add a charge for the embellishment. Does that sound familiar? If you were pricing 24 shirts that cost you five dollars each, applying a 100% Markup (doubling the price) and then charging two dollars for printing a single color or embroidering 4,000 stitches (.50 per 1,000) your pricing computations might look like this:
But what happens when your customer decides to buy a more expensive shirt costing ten dollars? Twenty dollars? More? Most garment decorators realize that as the cost of the garment goes up, they need to reduce the markup of the garment to stay competitive. Perhaps you only markup the shirt by 50% when the cost of the garment goes above ten dollars. The new computations look like this:
While you probably decrease your markup when goods get more expensive, what should you do when the customer orders white Tee shirts that only cost you a dollar? What if the customer orders handkerchiefs that cost about thirty cents? You won't make much money if the markup only amounts to pennies, so you should probably increase your markup at that point. But how much? 200%? 300%? What if the customer supplies the goods, and you have nothing to markup? You feel pretty certain that you won't make money if you just charge two dollars for the embellishment. You need to change your markups because you're pretty sure there is a certain amount you need to charge above the cost of the shirt. While this example is overly-simplistic, when you look at your profit desires on a graph, you start to realize that your gross profit goal on each job does not fluxuate nearly as wildly as the shirt cost does:
You are probably wondering: how do we establish the right markup for every job?
The graph above is pointing out that your markup is the stumbling block in your pricing system, and once you read a few books about product pricing, you realize that the markup IS the problem. Markups are the key to a retailer's pricing system. But you are not a retailer. You are a type of manufacturer - a finisher to be exact. Manufacturers rarely use the concept of a markup. Want proof? Compare the Chevrolet Spark (starting MSRP under $13,000) with the Corvette (starting MSRP roughly $80,000). Both have a fairly similar amount of steel and other raw materials in them. Both are made by the same corporation. If General Motors used a markup of the raw materials to price these products, the price difference shouldn't be so extreme.
How do manufacturers arrive at prices for the goods they make? They use a process called Costing. They begin by determining the cost of manufacturing the entire product. In the case of a car, that includes the cost of the steel, the tires, the paint and every other component plus the cost of labor to assemble it. They also allocate a portion of their building payments, executive salaries, research & development and insurance premiums to the cost per car. Once they have gathered every cost associated with the car's manufacture - right down to the janitor's salary - into a single figure, they determine how much profit they want this car to contribute to the company's bottom line for the year, estimate how many of this car model will be sold, and tack on an appropriate profit.
You've probably already figured out where this is going. To arrive at a more perfect selling price, you could look at every order you sell, determine your cost of ink or thread, examine labor costs, allocate rents and insurance, and determine how much net profit each order must provide. That would give you a selling price that actually means something, but you'd go crazy costing orders, and your prices still would not be accurate!
It might seem illogical that costing every order you produce would render inaccurate results, but it is true. When you break down costs to such minute portions, the potential for error becomes enormous. Consider this: How many prints will a gallon of ink yield? That would depend on hundreds of factors. How many square inches of fabric will you cover? How thick will the deposit be? Did you really receive a gallon of ink in the first place? Will one shirt absorb as much ink as the next? Over the course of a 50,000 shirt order, one gallon of ink might last five thousand shirts and the next gallon will last for nearly six thousand. When converting the cost of a gallon of ink to the cost per shirt, the margin for error is enormous. There is also the human equation. One day an employee can be the perfect decorator, embroidering hundreds of perfect shirts. The next day she might ruin an entire order. How can you account for that in your costing? - The same way major manufacturers do it, and it makes the costing process easy.
Hopefully I've piqued your curiosity - so why don't you join me and click the link below to read:
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