Costing & Pricing 2: Factoring other important costs into your pricing Reinhard Werner &...

Costing & Pricing 2:

Factoring other

important costs

into your pricing

Reinhard Werner & Mark Kwami

Costing the labour component

• This is one of the biggest challenges for many

African Crafts companies.

• This is also because many African exporters work with external producer groups (outsourcing).

• Many agree on a piece-price for a finished or semi-finished product.

• This price is like a flat-rate which includes raw materials, production inputs, labour cost..... and possibly other factors.

Costing the labour component

• Rural producer groups often factor their inefficiencies

into such flat-rate prices

• Or they under-state their prices and may actually be producing at a loss.

• This results in them not being willing to produce repeat orders

(or they can even stop production halfway and ask for a higher price).

Costing the labour component ! If you are paying your workers on a piece-basis

make sure to link price per piece to:

1) Productivity…

i.e. How many items can the average producer

make in an 8 hour/working day ?

2) Average daily wage…

What is your target/average daily wage you want your producer to earn ? This should be comparable to a reasonable and fair average daily wage in other sectors of your economy.

Costing the labour component ! Formula for calculating the labour costs based

on Productivity and Average Daily Wage:

e.g. Cost of carving a small mask:

Target daily wage

Productivity

= Labour cost per piece

Costing the labour component ! Formula for calculating the labour costs based

on Productivity and Average Daily Wage:

e.g. Cost of carving a small mask:

Target daily wage (USD 3/day)

Productivity (10 pieces per 8hr. day)

= 30 cents labour cost

per piece

Costing the labour component ! Formula for calculating the labour costs based

on Productivity and Average Daily Wage:

e.g. Cost of carving a small mask:

Target daily wage (USD 3/day)

Productivity (10 pieces per 8hr. day)

= 30 cents labour cost

per piece

Hard working carver who makes 15/day will earn USD 4,50/day

Slow carver who only makes 5/day will only earn USD 1,50/day

Costing the labour component ! • It is important to take your time to explain this to your workers!

• It is important that they understand that if they inflate their price (labour cost), this will make it difficult to compete in the market place (especially when it comes to exports).

• Although you need to manage your labour cost in order to be more competitive, you have to be careful not to compromise on QUALITY!

Revisit Costing sheet template -Factoring in cost of labour

Factoring your overheads into your price based on

Quantities produced

Overheads/month

Number of pieces produced/month= 1,00 USD

Overheads per piece

Summary:

You have to add 1 USD per piece to your cost price to cover overheads!

E.g. Your monthly overhead costs total 1000,00 USD...

1000,00 USD

1000 pieces

Factoring Overhead Costs into your price based on financial performance of previous year:

E.g. • Total overhead costs for 2013: 12.000 USD• Total sales in 2013 including a 30% profit margin: 93.600 USD---------------------------------------------------------------------------------1) Deduct 30% profit (to do this, Divide by 1,3) 93.600 divided by 1.3 = 72.000 USD

2) Deduct absolute overheads -12.000 USD _____________

3) This gives you your Direct Cost of production 60.000 USD

In order to determine your overhead percentage, you now have to divide 12.000 by 60.000

12.000 divided by 60.000 = 0,2 x 100 = 20%

Factoring Overhead Costs into your price based on financial performance of previous year:

Formula:

Overheads of previous year

Sales of previous year minus profit margin

x 100

Revisit Costing sheet template- Factoring in overheads:

Revisit Costing sheet template- Factoring in Design Cost:

Revisit Costing sheet template- Factoring in Marketing Cost:

Factoring Overhead Costs into your price based on financial performance of previous year:

• Re-calculate this percentage at the end of each year and re-adjust

for the new year!

• You can also base this calculation on Targeted Turnover for the new year....

....especially if you are sure that your turnover is going to grow in that year. This way, you can reduce the overhead percentage and hence make your prices more competitive.

Factoring in the cost of packaging

• Many companies forget to factor in their cost of packaging!

Factoring in the cost of packaging

• You have to distinguish between

Retail Packaging

Export Packaging

Factoring in the cost of packaging

• Simple formula:

Cost of box divided by number of units = cost of box / unit

Cost of box: 1 USD divided by 10 Units = 0,10 USD/unit

Developing packaging units

• Introduction of standardized Export Cartons

• Allows you to easily calculate cost of cartons / item

• Also allows you to precisely calculate shipping volumes/weight and freight charges

• Allows you to purchase in larger quantities

Revisit costing sheet- Factoring in cost of packaging

You are an exporter who sub-contracts production to an external carving group.

In the past you have been paying a piece-price of $2,00 for a mask.

How can you realize a lower price while ensuring that both you and your carvers make a profit?

Practical exercise 1 (Group work - approx. 10mins):

Now that you have negotiated a lower price with your

producers, how do you factor in the following costs:

(We are looking for your calculation method. There can be

more than one solution for each cost item)

1. Cost transporting masks to your premises

2. Packaging

3. Rent of your premises

3. Marketing costs

Practical exercise 2 (Group work approx. 10mins):

Review the costing sheets of your companies in your groups.

1) Indicate areas where these can be improved

2) Are there any common flaws?

3) Each group presents their findings.

Practical exercise 3 (Group work approx. 15 mins) :

Fixed Costs

Variable Costs

Profit

Your Price

Price negotiations

Buyers Price

?

Fixed Costs

Variable Costs

Profit

Your Price

Price negotiations

Min. Profit margin

Break even

Danger zone

Negotiating margin

F.O.B

Fixed Costs

Profit

Fixed Costs

Variable Costs

Profit

Variable Costs

Your buyers

Wholesale or retail price

Your buyers

Costs

Your Costs

Everyone has to make a profit!

F.O.B

Fixed Costs

Profit

Fixed Costs

Variable Costs

Profit

Variable Costs

Your buyers

Cost plus price Market Price

Range

Buyers cost-plus price higher than market

price!

Profit

Fixed Costs

Variable Costs

Your buyers

Cost plus price Market Price

Range

Fixed Costs

Variable Costs

F.O.B

Profit

Buyer trying to meet his market price range at the

expense of your profit range

Fixed Costs

Variable Costs

Profit

Your Price

Min. Profit margin

Break even

Danger zone

Negotiating margin

If you know your bottom-line, you know how far to negotiate

downwards!

If you do agree to eat into your profit margin, review costs to

see where you can cut costs so as to regain profitability

NO!

Setting your minimum Profit Margin: NO!

Summary

• It is important that you understand the basics of costing and pricing!

• This is key to running a profitable business!

• Having control over your costing and pricing, gives you theconfidence and the basis to negotiate with buyers....

...and it lets you know when to say NO!

• Note! Costing and pricing is not done in isolation.

• You need to be aware of market prices, prices of your competitors etc.

Thank You!

Thank You!

The Supply Chain

• What do we mean by Supply Chain?

“A supply chain describes all the activities that are involved When transforming / processing a raw material

into a finished product and delivering it to the end customer.”

Mapping the Supply Chain of a wood carving business:

Forest

Transport to your

workshop

Chain saw operators

Transport

Saw Mill

Timber market

Raw Material Supply Chain

Manufacturer?

Whole saler? / Importer

Retailer

Production

Carving

Drying

Packaging

Loading of Container

Export Wholesaling Retailing

Transport to Port

Finishing

Transport to shipper

Production Supply Chain

Sale to end customer

Delivery to or Collection by

retailer

Raw Materials storage/distribution

Sales

Purchse by end customer

Sale to Retailer

Transport to Warehouse of

Importer

Sale to wholesaler

Product finds place in customers

home

Export/Import Supply Chain

Shipping

Sea/Air

The Value Chain

• What do we mean by Value Chain?

The Value Chain

• A chain of activities within a company that each add value to the product being produced.

(First developed in 1985 by Michael Porter Professor at Harvard Business School. Leading authority o company strategy and competitiveness of

Nations and Regions)

The Value Chain Diagram

The Value Chain Diagram

• The idea is that each activity within your company should seek to add value to the product!

• Value Chain Analysis and management has become an important tool for businesses!

Why is it important that we understanding the supply/value chain?

• It helps you better understand your business

• It helps you better identify/understand all the factors (both internal and external) that affect your business and the value of your product

• It helps you identify problem sources

• It helps you improve efficiency and quality

• It helps you optimize processes and cut costs