Pricing for profit turns the whole pricing model around. Business owners are in business make money.
They make money from:
- the profit they extract from the business whilst operating it (drawings)
- the money they make when they exit the business (which is a multiple of profits made while running the business – particularly the 3 years leading up to selling the business)
So, you can see. To record good strong profits is very important. That is why you pour your heart, sweat and tears into building your business. Otherwise, you may as well work for someone else.
With this in mind, turn the model around.
First work out how much profit you want from the business, and then work out what you need to do to get there.
A pricing for profit or profit per person per hour (PPPH) strategy is a method of setting prices to ensure profitability by focusing on the output of labor and the associated costs within a manufacturing business.
How it works:
- Calculate Costs (annual overhead – not including Production labour costs)
This involves identifying all costs associated with production:
- Labor Costs: The hourly wage or salary of employees, including super, taxes, and other expenses
- Material Costs: Raw materials and components required for manufacturing
- Overhead Costs: Fixed and variable costs, such as rent, utilities, equipment depreciation, and administrative expenses
- Determine Production Output
- Work out how many Production Hours are available per year
- Number of production staff
- X (times) 42 weeks each (52 weeks – 4 weeks annual recreation leave – 2 weeks Public Holidays – 2 weeks paid sick leave allowance)
iii. X (times) (Number of hours in the week (38 in Australia) – (minus) wasted or admin/non-productive hours per week)
- = (equals) Total number of Production Hours (TPH) available to the business to make profit
- Set a target Profit Per Year
- Work out the Profit Per Production Person Per Hour (PPPPPH) that should be charged
- Calculate annual overhead costs per hour (AOCPH), as per step 2.
- Use the annual overhead figure from step
- / (PPPPPH) from step 4
- Add the PPPPPH to AOCPH
- This gives you your labour charge out rate per person per hour (LCPPPH)
**** Note, the bigger the production team, the smaller your labour charge out rate per person per hour tends to be. As long as they are kept working, which is more likely if your rate is lower against your competitors using the other pricing methods. ****
Now, all you need to do when pricing a job, is to:
- Determine the materials to be used for a job
- Apply a smaller margin than you normally would to those materials
- Work out how many labour hours the job is expected to take to complete
- Multiply the labour hours x (LCPPPH)
**** Even easier than the above – drop me an email to [email protected] to ask me nicely for a copy of my Excel spreadsheet calculator, and I will be happy to send it to you. ****
This will help you calculate your labour charge out rate per person per hour, and also have a simplified profitability calculator you can use when pricing a job up.
Advantages:
- Hopefully win bigger jobs, lose smaller ones that tend to take as much time and effort to get moving
- Encourages you to grow a business faster – more producing hourly workers means the overhead burden is spread / carried by more people – so it can be lower than a smaller operation where the overhead costs per person per hour can be high
- Drives you to improve efficiency. Increased Profitability is directly linked to productivity improvements.
- You are clear on your numbers. Now just need to focus on returning quotes quickly, that are easily constructed, and have all of this built in. (BIG HINT: Talk to me at Fortix).
Disadvantages:
- If conditions slow, then you have a bigger workforce to keep busy (and pay for) – however, you do have the ability to drop your hourly pricing, as the overhead burden is smaller per person
The Takeaways If you and the team are working hard in manufacturing, but the effort isn’t translating into the profit that think it should, maybe look at your pricing methodology.
If all is good, maybe the balance in the business is a bit out?
Most clients who contact us have a great business, run by fantastic people, but the Systems are lacking, which throws the balance out. Poor Systems result in decreased Visibility across the business, reduced Clarity around roles, responsibilities and expectations, all resulting in People not being able to operate to their maximum Efficiency.
But that is a subject for another time……
