4 steps to align product costs profitability and pricing
Cost and profitability work hand in hand. But sometimes, it feels like they’re hard to get a handle on.
Some market variables are outside of your control, like interest rates and material costs. So, manufacturers need to manage what they can, consistently and with discipline. Then, they can set optimal pricing.
To get costs, pricing and profitability into alignment, start with these four fundamental steps:
1. Create a repeatable cost structure
Manufacturers run into trouble when they use different cost structures or apply them inconsistently.
Before setting a price, isolate the true and total costs of production. Generally, that includes all your material costs, plus overhead and labor. Keep in mind, some of the inputs are dynamic. Costs can vary based on the shift that works on a product or whether materials have to be expedited to start a job.
Identify all the cost factors, and whether they can be managed to maximize profitability. Then, determine how to consistently break down costs so they align with company goals. Typically, that’s by job or by product family.
Apply the same cost structure across every job or product family to get the most-accurate view into costs — and how to handle them.
2. Set profitability goal
Gross profit is the difference between revenue earned on a product and the costs to produce it. The math is simple enough once you’ve got an accurate accounting of production costs. But knowing the numbers is only part of the equation. Manufacturers also need profitability targets.
Understand how much profit the company needs to earn to achieve (or exceed) its goals — not just break even. Calculate the number by job or product family, so you can see the impact of every run. And make sure everyone who manages or influences costs knows the profit targets.
3. Identify cost drivers
Once you’ve identified all your costs, prioritize them. The cost driver that has the greatest impact on profitability requires the highest degree of accuracy in your calculations. You need to accurately segment and allocate activities or material losses against it.
The ranking will also help you find the highest-impact strategies to increase profitability. For example, maybe increasing throughput is the best way to lower costs. Or maybe you need to renegotiate supply contracts.
If overhead is one of your top costs, consider managing it as an independent business cost. Instead of calculating dozens of costs and allocating them across product families, focus on key drivers within a product family. As a separate project, you can delve into ways to lower overhead, which will improve bottom-line performance on every job and product family.
4. Understand the relationship between costs, profit and pricing
Pricing protects your margins and supports the company’s long-term goals. But it must be realistic. You need a complete and accurate accounting of costs and a target amount of money to bring in. If your cost and profitability figures are accurate, you can make confident decisions about pricing and maximize your returns.With accurate insight into the numbers, you can even gain some elasticity. You know how to respond if a customer pushes back on pricing — or you can reasonably charge a little more. Ultimately, pricing should generate the best revenue outcome in each business sector.
How Wipfli can help
Getting costs, profitability and pricing into alignment can feel like a balancing act. Our manufacturing specialists take the guesswork out of the exercise so you can set competitive and profitable pricing. Contact us today to discuss your company’s pricing strategy, business performance and plans for growth.
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