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A Perspective on Custom Manufacturing in America
By Greg Williams -
June 2008
Bidding for Market Share in the New Economy
A slowing economy often creates a buyer’s market. It
may also bring opportunities to improve both market share and profit by
changing the way your shop bids jobs and prices product. Now may be a great
time to consider throughput pricing.
The concept of throughput pricing employs the basic principles of
simplicity, consistency and transparency. The goal is not just to price jobs
more accurately, which it does well, but also to attract and contract more
work in the process.
This article will look at some of the ideas and actions commonly used to convert to throughput pricing and maximize the benefits of that
system.
Like any effort to improve throughput, the first step is to identify any
change that would eliminate or streamline steps in your current bidding or
product pricing process. One way to begin this effort is to look closely at
what your customers are telling you about your current product offering.
For example, the owner of a high end residential cabinet shop noticed that
90% of their customers were choosing a particular upgrade to the cabinet
construction. This shop had always offered this option with an upcharge, but
what
their customers had been telling them was that this “option” was actually the
standard that was expected by the market for their product. By adjusting the
basic cabinet pricing slightly, they were able to offer the popular option
transparently as a standard. This simplified the bidding process and set
them apart from competitors that were still charging extra for that type of
option.
Another strategy to accomplish throughput pricing involves looking at the
criteria that you use now to arrive at a price for a job. Does your current
method involve counting things like hinges, drawer guides, beaded frame
openings and the like? If so, you are probably using some version of a
“cost-plus” pricing method. This method is common in the industry and has
its roots back in a time when we did things like estimating, purchasing and
cut listing using only a set of prints, a note pad and a calculator. If you have invested thousands of dollars in
computers and software for your business to use then you should seriously
consider updating your process to match your current technology.
Cost-plus pricing of jobs is often not as accurate as many people would like
to believe. The problem is the numbers used as the “costs” in cost-plus
pricing are sometimes not based on actual costs calculated from job costing
data. Many cost-plus methods are home grown scenarios that arrive at an
estimated price based on a hodge-podge of markups applied to assumed or
generic costs of various items. Typically, no two shops do it quite the
same, but generally speaking the resulting price is a subjective amount
rather than a calculation arrived at by consideration of hard data and the
goals for profitability of the business.
Question: Wouldn’t the most accurate estimate of the profit you might make
on a particular type of job in the future be based on the profit you
actually made on similar jobs in the past? If so, then the logical next step
is to categorize past jobs by the criteria of major options and look at the
data in terms of average revenue and profit – and let that determine how you
bid and price product.
Put another way, the best and most effective metrics on which to base
pricing are the desired profit per dollar of revenue and the price point
that your market will sustain. In order to determine how much markup will
consistently deliver that result you should look historically at what your
profits actually were for past jobs, when records for those jobs are
categorized by things such as job type, door style, wood specie, finish,
hardware, delivery area and total dollar value of the contract.
This holistic review of the relationship between contract price, options and
profit will reveal trends that are both good and bad. It will also let you
look at pricing products and options from the perspective of what your
customers see as value, which can be quite different than what you may see
from your side of the transaction.
But what if you don’t have accurate job costing records that can be
categorized like this? If not, I would advise that you take steps to change
that situation as soon as possible, but don’t let that deter you now.
Many who successfully implement throughput pricing just go back over past
jobs and do the math required to arrive at
percentage upcharges to apply for common options such as specie, finish,
hardware and door style. After implementation of the percentage based
upcharges they track real job costs and adjust the percentages accordingly
as required. Once this system is in place it becomes possible to incentivize
high margin trends and mitigate the impact of low margin options by
structuring the markups accordingly.
Percentage based upcharges will always result in profits that are just as
consistent and usually higher than cost-plus pricing when compared over a
quarter or even a month of business. They are easier for you and your staff
to process and track, and when combined with aggressive job costing they
will help you identify weak areas in the production processes where your
business is leaking profit. They are also much easier for your customer to
understand and navigate.
When a dealer or end user can easily verify your bid and understand the cost
of the options they are considering, that level of transparency has value on
its own merits in a buyer’s market. It sets your shop apart from any
competitor that would require them to total up measurements and count parts
in order to understand how the bid was calculated.
Once trends have been incorporated into pricing and processes have been
simplified, new strategies to increase profits and market share become
easier to identify and take advantage of. Optimizing throughput becomes a
process of very subtle changes once the big constraints have been resolved.
To describe it in a snapshot, the goal of the design of your new pricing and
sales order processing system should be to attract and cultivate customers
that are the most profitable for your business.
So, why wouldn’t everyone jump on the throughput pricing bandwagon? That
question becomes one of whether or not the change is worth the pain to
realize the gain.
As Eli Goldratt points out in his book “Beyond the Goal”, the only logical
reason for bringing technology into a business process is to eliminate or
reduce restrictions that prevent greater levels of throughput. The problem
is that the processes or policies that were in place before the technology
arrived often tend to persist largely unchanged, even after the new
technology has eliminated the need for those processes. That explains how
many shops have ended up with bidding and sales order processing scenarios
that are far behind their technology.
Identifying and changing those processes is sometimes difficult because it
requires the owner or manager of the business to first step back and cut the
ties to all of the comfortable assumptions that support the status quo. That
first step can be a killer. The next step, getting buy-in across the
organization for the changes, can sometimes be equally difficult. It’s
definitely not a project for a timid or passive type of individual.
Fortunately, I haven’t met too many successful shop owners or managers that
fall into either of those categories. If you want to give throughput pricing
a try, the best way to go about it is to create the new pricing system
off-line and test it in parallel with the current system, checking it
against current work that is being priced the old way and historic jobs that
represent your target market. After some tweaking and fine tuning you should
be able to hit a level of accuracy with the new method that will merit live
testing, and then build a comfort level that will support the change.
Good luck!
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