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4 Steps to Aligning Product Costs, Profitability, and Pricing

4 Steps to Aligning Product Costs, Profitability, and Pricing


Mar 21, 2017
Manufacturing and Distribution

 

Costs and profitability work hand in hand, but not all discrete manufacturers leverage the interdependency to improve organizational performance or set optimal product pricing. To do so requires four fundamental steps:

1.Determine a cost structure.

Cost can be a tricky calculation since not all manufacturers understand how to approach it in a consistent way, and not all manufacturers use the same structure. Isolating the true costs of production—generally boiled down to materials, overhead, and labor—and understanding which aspects of those factors you can cost-effectively manage is the first step to maximizing profitability.

Having a clear picture of that information will then help you determine how to consistently break down costs in a way that aligns with company goals, which is usually either per job or per product family (the latter is generally favored by discrete manufacturers). Applying the same cost structure across all jobs or product family will give you an accurate handle on costs.

2.Develop and measure profitability goals.

Gross profit, in simplest terms, is the difference between the revenue earned on a product and the cost to physically produce it. However, knowing that number, either based on real time or historical data, is only part of the equation when developing and measuring profitability goals. You must clearly understand how much profit your company must generate in order to meet goals or, ideally, exceed them. Like costs, it comes to running numbers either per job or per product family and, again like costs, discrete manufacturers generally focus on product family.

3.Identify cost drivers.

There really aren’t many variables beyond materials, labor, and overhead when it comes to cost drivers. However, it’s essential you prioritize which of the three requires the highest level of accuracy per product family in order to accurately segment and allocate activities or material losses against it.

It’s worth noting that overhead usually encompasses expenses outside of the strict product family—like lights and supervision—so investing a lot of time calculating and allocating it across product families could be counterproductive. It may be more effective to deal with overhead as an independent business cost and delve into ways to reduce it overall.

Throughput, a subset of labor, also impacts costs. Measured against product families as units per labor hour, throughput reflects how fast you’re moving products on the floor. The less time it takes to make and ship products translates to lower costs and higher profitability.

4.Understand the impact of costs and profitability on pricing.

Pricing supports and protects manufacturing margins. Having realistic numbers surrounding costs and profitability leads to confident B2B decision making about price elasticity that maximizes value and minimizes the risk of customer pushback. Part and parcel to value is identifying where you can reasonably charge a little more based on data you’ve gathered about your product families and making pricing improvements accordingly. Ultimately, you want to arrive at price points that generate the best revenue outcomes across each of your business sectors.

Aligning product costs, profitability and pricing is a balancing act that keeps your company competitive and profitable. Reach out to one of our manufacturing specialists today to discuss data’s role in your business decisions, performance, and growth.

Author(s)

Suzanne Koss
Suzanne Koss, CPIM
Partner
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