My wife saw a post by a shop owner on Etsy this week that just drove us both absolutely crazy. The shop owner posted how you should determine your wholesale and retail pricing.
The first step was to determine your costs. What are your costs of materials? Even what is the cost of your time? While I agree with that logic, the cost of my time can be very subjective, but it makes sense. There was a exhaustive list of what to include in determining the cost of a product. A very large portion of it we agreed with.
After this is when it got interesting.
According to the shop owner, your wholesale pricing should be double your costs. Your retail pricing should be double your wholesale pricing.
The shop owner was very firm that this is the only way to price.
Based on this logic, you are entitled to a 75% profit margin when selling it in retail and a 50% margin when you are selling wholesale.
So why are people going out of business?
Because, this is not correct at all. The price is set by the consumer. If the consumer, sees value in your product at that price then they will pay for it. If they don’t, they won’t.
As a shop owner, it is your responsibility to control your costs to help control your profit. If your costs are low and the market is willing to pay a very high price then you will get a large profit margin, but if the opposite is true then you may lose money.
If everyone deserved a 75% profit margin then no one would be going out of business. Just because you are in business does not mean you deserve a profit. If you want a profit…earn it. Know your market. Set the price appropriately and then control your costs.
This is the heart of entrepreneurship.
It amazes me how companies will setup an accounting system this is designed to drive bad decisions.
Recently, I have been working with a client on improving an internal process to the team. During the direct observation with the order writer something very interesting surfaced.
The order writer can write orders to be processed one of two ways. The order writer said that method A costs $400 and only takes 1.5 hours to write the order. While method B costs $30 and takes 2 days to write the order.
I asked where the costs came from because the orders are processed by another internal group. The order writer said it is the cost of systems and labor time for that group and they charge back the order writing team the cost of each order.
The internal order processing group is managed as a Profit and Loss center. They are treated like a company.
Sadly, I have seen this accounting set up quite a bit. Even the support groups like IT, HR, etc… are setup as P&L centers.
This drives decisions to be made that are not in the best interest of the company.
In this case, the order writer is considered value added because they are changing the order to get product to customers. They help generate revenue. Half of order processing is non-value added (entering all the information they get from the order writers) while half is value added (executing the order).
Because the business gets charged back over 10 times more the cost per order for the more automated order, the value added order writers are asked to take 2 days write an order which then adds actual hard dollar cost because it takes more order writers to get the orders written and submitted.
What is wrong with being a support center, knowing it and accounting for it? Why does everything have to be a P&L center to “prove” it’s value?
The places who treat support areas like support areas and don’t worry about P&L centers for everything don’t typically make decisions like the one above. They understand how a supporting area adds value and don’t feel the need to quantify it in a P&L statement.
Have you encountered this in your work?
Have you ever seen your company play with budget numbers? Cut in one area but pay out of another area and name it something different?
Well the Pointy-Haired Boss is playing the game to perfection in this Dilbert Cartoon by Scott Adams.
My favorite part of the cartoon is the Pointy-Haired Boss saying, “If we reduce the training budget this year, we’ll get less next year.”
If I had a dollar for every time I have run up against that statement I would have enough to fund the Pointy-Haired Boss’ Contract Employee budget!
People shouldn’t be given less money just because they used less one year. That may have been good for that year but it may not be even close to what is needed for the next year based on the current circumstances.
In the end, it all comes out of the same pocket. Companies still don’t realize they are spending a lot of time managing minute details of their finances. Sometimes it is just best to take a step back and take a look at a bigger picture.
I try to imagine my own finances. There isn’t a detailed budget for every line item money could be spent on. Groceries, gas, cable, electric, etc… It is cut into bigger slices like Food/Entertainment. That could be eating out, groceries, going to the movies, etc… Each item is budgeted in detail. It is known this is the amount and how it is spent among the line items can vary from month-to-month.
Why can’t companies say this is how much will be spent on Research and Development. R&D can decide if that is on salaries, contractors, equipment, etc… But what the money they have is all the money they have so use it wisely.
Be smart with the money and always manage costs appropriately. In the end, what is best for the company needs to be done before anything else. In Dilbert’s case, it is paying the contract employee.
A couple of weeks ago there was an article in the Hartford Business Journal talking about more offshore outsourcing that was returning to the U.S. The article sums up why companies are returning the best:
The argument goes: when total cost is considered, production is cheaper locally; there is less concern about quality and intellectual property theft when dealing with a domestic company; and with new lean practices, more streamlined production lowers domestic costs.
“Company after company has learned by keeping things closer together, that leads to a stronger overall value chain,” said John Shook, chairman and CEO of the Lean Enterprise Institute, based in Cambridge, Mass. “I see a lot of companies bringing things back.”
This is a hard lesson for companies to learn. As mad as I would like to get over companies making the choice to chase cheap labor, I have to remind myself they were playing with the rules as they understood them. Ten plus years ago, value stream accounting was not known. The only system most people knew was the standard costing system. This view did not take into account the quality and lead time aspects of chasing cheap labor.
Value Stream accounting is now more widely known, thanks to efforts like the Lean Accounting Summit. If companies continue to chase the cheap labor costs, I really don’t have any sympathy for them. The article lists other reasons Arcor sees offshoring as not a good idea:
Arcor has advantages over offshore companies when competing for local work, Francoeur said. Particularly when a client is developing a new product, there’s a lot of back and forth between Arcor and the customer, which would be slowed significantly if the client had to wait days for a project to be shipped from an offshore company.
New products tend to be more sensitive to copying and intellectual property concerns, and clients trust local companies more when dealing with sensitive information, Francoeur said.
With more and more companies learning total cost is better the more local you are to your market, no matter where in the world you are located, hopefully, it will be come the norm to stay local. We have to continue to talk about total costs and keep pushing the topic with leaders in our companies. We can use the companies that left and came back as examples and eventually we will get there
About a year ago I posted a blog about transparency being crucial to employee engagement (post here). I have seen companies be transparent and get great gains from it. Add another company to that list. Last week I found a blog post (here) about Tasty Catering using transparency in order to keep their employees engaged in the company’s improvement and operation.
After hearing CEO Tom Walter share how he drives engagement with his employees through transparency and shared decision-making, it became apparent how Tasty Catering has received so many awards.
Starting off his talk, Walter said he isn’t concerned with modern technology or tweeting. “I’m concerned about people and communicating with them. I want to connect with their values,” he said.
It sounds like Walter understands communication is a two-way street. It is not about just putting something out where someone can read it on twitter or facebook or the company newsletter. It is about connecting with the individuals and having a meaningful dialogue.
Walker feels that if his managers don’t understand it, they don’t really understand how employees think. He sees the”Love and Belonging” rung of the hierarchy as the communications piece. ”We share the risk, and then we share the rewards,” Walter said.
In addition to having meaningful dialogues, Tasty Catering also publishes the financial results every month as part of the newsletter, called “Inside the Dish.” They don’t make it looks slick. They present the facts.
Newsletters are usually thought of as slick, four-color publications with articles and graphics. But that”s not what “Inside the Dish” is at all. Picture this:
- Several sheets of paper stapled together at the corner
- Absolutely no photos or graphics
- 10pt Arial font in black with single-line spacing
- Every section chock full of financials, including profits and losses (P&L) and other data such as sales and operations numbers
I would ask why no pictures or graphs to help illustrate the point. With lean, we prefer visual management and part of that is trying to make the numbers easy to understand by representing them graphically somehow or show a process throw a process map.
Financial information can be difficult to understand and Walter knows that.
You may be wondering how all of Tasty Catering’s employees understand the financial data because they aren’t all accountants. Walter is so committed to making sure his employees understand where the company stands, he has the CFO conduct one-hour sessions each month with every team.
From a lean lens, I see these meetings as a large amount of waste. Lean accounting would say to create plain English financial statements that are easy to understand. This way the CFO doesn’t have to waste a day or more of his time just explaining the numbers. This would allow him more time to be able to look for ways to improve the business instead of talk about the past performance.
How has this transparency paid off into employee engagement? Here is one example:
During the recession, Tasty Catering was really struggling. To keep the company afloat, Walter was planning to institute a 10% pay reduction and let five hourly staff members go. When he proposed this solution, one employee suggested an alternate solution. She said to ask everyone to drop down to 25 hours a week. They could survive on that until the company recovered.
Walter also offered discounts on food from the company inventory during this time to help out as well as low interest loans to be paid back when they could.
Tasty Catering may not claim to be a lean company, but they seem to act like one. The transparency shows respect for the people allowing them to want to be engaged in the company’s direction and decisions. Sounds like a company doing the right things.
I was perusing some random older Dilbert comic strips and stumbled upon this one. What a great example of traditional accounting gone wrong.
(Click on image for a larger view)
I couldn’t pass posting this Dilbert cartoon. How many times as lean change agents do you have work halted or the value not seen because of the way the accounting system calculates standard costing or budgeting? How many times have you made an improvement that required less people for that area. The people were reassigned (showing respect for people by not laying off due to improvement), but accounting system claims a labor savings. At the end of the year, management is asking where is all the savings that was promoted throughout the year? It’s not hitting the bottom line.
This is always one of my favorites to explain. How about you?