A project is proposed. Most projects have an return-on-investment (ROI) associated with them to help sell the idea. The ROI lists out the benefits of completing the project. The project gets approved. People work on it until it is completed…hopefully. Congratulations are given on good work. People move on to the next project. The End.
Notice anything missing? Arguably the most important part?
No one goes back to verify if the project produced the benefits that were stated in the ROI.
How does the organization know if the investment was a good one? A bad one? Or a great one?
Checking the benefits isn’t the “sexy” part of the project, but it is the rewarding part of the project.
Why don’t people go back and check the benefits? Is it because it is a month to a year after the project is complete before they are seen and people forget? Is it because people put inflated benefits on the ROI statement and they don’t want to get called out on it? Is it because putting a value to some of the benefits is extremely difficult?
Whatever the reason, it can’t stop you from checking the actual value realized from a project. What if you didn’t reach the realized value stated? Can something be done to increase the realized value. What if you exceeded it? Don’t you want to celebrate it? Use the learnings to sustain the extra value realized. The learning from verifying the realized value is immense.
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?