By Jim Hingst

 

“It’s unwise to pay too
much, but it’s worse to pay too little. When you pay too much, you lose a
little money – that’s all. When you pay too little, you sometimes lose everything,
because the thing you bought was incapable of doing the thing it was bought to
do. The common law of business balance prohibits paying a little and getting a
lot – it can’t be done. If you deal with the lowest bidder, it is well to add
something for the risk you run, and if you do that you will have enough to pay
for something better.”

John Ruskin

 

 

Setting prices for your work is a
balancing game. If you price jobs too low, you won’t make enough profit to expand
your business. Priced too high and you will price yourself out of work. In a
worse-case scenario, you could go out of business.

 

In many cases, shops establish their
prices so that they are in line with the competition. Based on information from
their sales people and customers, they compile pricing information on the
competition. For example, using data from the field you can assess what other
shops are charging per square foot for digital printing.

 

You can encounter several problems, if
you set pricing based on the competitor’s prices. The first is that you are
pricing your work as if you are selling a commodity. You should not position
your shop as an apples-to-apples business or the low-cost producer. Instead,
you should emphasize your unique
selling proposition as a specialty house that designs, manufactures and
installs corporate identity programs. Your value-added is in helping other
businesses visually communicate so they can gain larger shares within their markets.

 

Problems
with Underpricing. When was the last time that you increased
your pricing during a negotiation? It NEVER happens! Low balling your
price gives you no bargaining room when faced with the customer who wants to
haggle. When you start high, you can easily come down in price – not the other
way around.

 

If you
get what you pay for, don’t you get more value when you pay more? Maybe not.
Pricing products at a premium, however, implies that you provide higher quality
products; your services are better; and you have the financial resources to
warranty your products in the event of a problem.

 

Conversely,
underpricing your products and services diminishes your brand. Low-ball pricing
suggests that your products are inferior. Selling on price is a mistake that
both novice and experienced salespeople make. It sends the wrong message to the
buyer.

 

Overpricing. Overpricing can
create as many prices for a business as underpricing. An abrupt increase in
pricing can create distress and resentment among customers. Consistency in
pricing, on the other hand, fosters trust.

The Difference Between Cost and Price. Some shop
owners underprice jobs because they have a limited understanding of how to cost a
project. What’s more, many also don’t understand the difference between cost
and price.

Cost. Costing a job involves estimating
your cost of goods sold and apportioning an appropriate amount of your overhead
to it. Cost of Goods Sold (COGS) calculates the direct costs that go
into manufacturing a job. These direct costs include raw materials, direct
labor and any other direct expenses. Overhead comprises your fixed shop and
administrative expenses. 

Cost of Goods Sold and Cost of Sales are often used
interchangeably. For a manufacturing business, such as a sign shop or a digital
printer, Cost of Goods Sold is generally used. Cost of Sales, on the other
hand, is a term typically used for a retail business.  

Overhead. In estimating jobs, you
need to allocate a portion of the overhead.  In a job shop, such as a screen printer or
sign company, overhead includes your expenses. It does not include direct
expenses, such as raw materials, labor charges and other direct costs, used in
the manufacturing of products. 

To allocate or charge a portion of indirect expenses to jobs,
overhead is often used to calculate an hourly shop rate, which may also be
referred to as a burdened shop rate.  

These expenses are usually grouped into broad categories,
including selling, general and administrative expenses, referred to as SGA. In
larger companies, manufacturing overhead used in product production is
considered as a direct expense.

In a small sign company, segregating manufacturing overhead from
other shop expenses is as fruitful as trying to determine how many angels can
dance on the head of a pin. For this reason, it is more expedient just to lump
all indirect expenses under the umbrella of “shop and administrative expense”.

In the end, your costing system needs to cover all of your direct
costs and indirect costs in the production of your products. What job cost does
not cover is profit.

Pricing. In setting your pricing, you need to cover
all of your direct costs as well as a fair share of your shop’s overhead. On
top of that, your company needs to make a profit.

The business is a separate entity from anyone who works there.
Anyone who has invested in the business deserves a return on their investment. The
business also needs profit to expand.

Running a profitable shop is also important, so that at some point
you can sell the business and enjoy a comfortable retirement. It is
disconcerting to hear a shop owner state that they intend to work until they
die. Many of these businesses are just covering their costs. Why would any
investor buy a business that runs on a break-even basis?

You can improve your bottom line in a
number of ways. These include cutting shop and administrative costs, reducing
scrap rate and improving shop productivity. All of these activities work.
Another effective strategy which can improve profit that produces results but
causes anguish among salespeople is to raise your prices.

 

Pricing Strategies. Calculating the cost of a
product isn’t that difficult. What most people have a problem with is
determining where to set your price. Sadly, no standard pricing formula is
available. Some of these pricing strategies, which include Break-Even Pricing,
Market-Based Pricing, Cost-Plus Pricing and Value-Added Pricing are covered in
this article.

 

Break-Even Pricing. Some shops price jobs just to cover their
material costs and labor with a little extra so they can pay their bills. While
many of shop owners are pleased to break even and make a living wage, the
business isn’t making a profit. Just as you need to be paid for your hard work,
the business is an entity separate from its owners and needs to be paid.

 

While break-even pricing is not a recommended
strategy, some exceptions to this rule make sense, especially for a new
business with significant debt. Taking on major accounts on a break-even basis
can help to keep the lights on. These “overhead jobs” can cover all of your
direct expenses and a significant portion of your shop and administrative
expenses.

 

Market-Based Pricing. Basing your prices on the competitor’s
prices may not account for the differences in your business. Your overhead and
material costs may differ from other shops. You need to estimate your costs and
profit margins based on your operation, not on how another shop runs his
business.

 

You should set your pricing at whatever
the market can bear. To determine how your pricing stacks up with the
competition, incrementally increase your prices until you start to lose
business.

 

The problem is competing with competitors
who have a limited understanding of estimating. This is one reason so many of
these companies go out of business within the first couple of years. What’s worse,
is that these shops screw up the market pricing for everyone else.

 

It is difficult to contend with
ridiculously low pricing. When dealing with a new business, you can frame the
conversation by comparing your long history and financial stability with their
inexperience.

 

Blatantly slamming a competitor is generally
not well-received and usually backfires on you. Instead you can describe your
company by saying, “we are not a fly-by-night organization that just opened its doors yesterday. We have a long history of handling major graphics programs.”
Then provide examples. “We also have the financial stability to handle any problems
in the unlikely event of a graphics failure.”

 

Another
strategy in dealing with a competitive challenge is to offer your prospect with
two or three options, each priced at different levels. Other than price, each
graphics package could feature different raw materials. Instead of selling on
price, each package would offer its own advantages. Presenting a prospect with
a choice between these options often facilitates the closing process.  

 

Cost-Plus Pricing. A number of
my employers in the graphics and construction fields priced their jobs in this
manner. These companies would cover all of their raw material costs as well as
other direct outside costs and add in a fully-loaded cost for labor, which
accounts for an apportioned amount of their overhead. To that cost, the shop
would tack on a percentage for profit.

At some shops, owners would mark up jobs at a fixed rate. The
simplicity of cost-plus pricing using a fixed rate makes perfect sense. The
problem is that it does not allow you any wiggle room to negotiate in
competitive situations. It also does not account for the value that you provide
customers, for producing an outstanding product that differentiates you
business from your competitors.

Cost-plus pricing using a graduated scale makes more sense. In
this system the salesperson marks up to job based on his or her assessment of
what would close the deal. In this system, a percentage would go to the company
and the remainder would be paid to the straight-commission salesperson.

Using a graduated scale, the salesperson could mark up the job to
account for bids from other shops.  As an
example, if the rep decided to sell the job at a 40% markup, they would earn
20% in commission. On the other hand, selling a job at 25%, the rep would only
earn 10% on the job, while the shop took 15%.

This system provides reps with the flexibility to adjust prices
based on competitive pressures. It also provides reps with an incentive to sell
at a higher markup.  

Value-Added Pricing. Optimizing prices requires you to sell
your shop’s value-added benefits rather than pricing based on a cost-plus
basis.

 

In the graphics business, value-added
means that you are positioning yourself as a business consultant, selling
solutions to a prospect’s problems. You are fulfilling unmet needs that the
competitors are not satisfying.

 

When you price according to what
competitors are doing, you are simply reacting. You raise your prices when a
competitor raises theirs. You lower your prices when they lower theirs. Does
that make pricing sense? With a value-added pricing strategy, the additional
value that you provide customers should justify higher pricing. 

 

When you price your jobs, you should
emphasize the value-added features and benefits that your company provides.
Your presentation should include:

 

• Design. An explanation of how your
design satisfies the prospect’s marketing and corporate identity objectives;

 

• Materials. A description of the
raw materials used in the job.  Quality materials,
such as the type of vinyl films used, ensure the longest service life of the
graphics. Conversely, use of cheaper materials results in failures. 

In their presentations, the 3M Company has
effectively emphasized the problems which can result when using substandard
films. In selling fleet graphics, you can provide photographs of vinyl films
channeling in the valleys of corrugation, cracking, peeling and tenting around
rivet heads.

 

• Manufacturing. How a job is
engineered and manufactured is a major factor in the service life of outdoor
graphics. Your sales presentation should emphasize any differences in product
construction, raw materials used and manufacturing processes.

 

• Installation. As part of a graphics
package, you can differentiate your proposal by including vinyl application. You
should emphasize that work is performed by a certified professional decal
installer, who has been formally trained and carries liability insurance. Professional
application provides the customer with the peace of mind that the work is done
right and is warrantied.

• Service. After-the-sale service
covers any corrective action and customer support during the service life of
the product. An outstanding service package provides the prospect with a reason
to pay more for your products.

Once you have converted prospects into
customers, after-the-sale service is the cornerstone to protecting your
business base. A reputation for reliable after-the-sales support helps build
strong customer relationships and a strong brand. In most cases, unsolicited
word-of-mouth endorsements are much more effective than any advertising
campaign you might devise.

 

Financial security. If your shop is well-established and
well-funded you can provide customers with the peace-of-mind that your business
has the financial stability to warranty its work in the event of a product
failure. In selling, you can use your experience and the financial strength of
your shop as a wedge to drive between the prospect and the incumbent graphics
provider.

 

When You Should Increase Prices. Do you have more work than
you can handle? If no one has complained that your prices are too high, your
prices are probably too low.  Getting all
of the jobs that you bid on is another indication that your prices are much
lower than your competitors. You should increase your prices until you start to
get some push back.

 

If your business is growing, your shop
and administrative expenses will also grow. To expand, you need to set your
pricing so you not only cover all of your expenses, but you have enough profits
to hire new employees, buy additional equipment, and upgrade and expand your
facilities. If your business is not generating enough profit to finance this
growth, you need to raise your prices.

 

Profitability Metrics. You can
assess the profitability of your shop using different metrics or measurements.
You can use these measurements as key performance indicators (KPIs) to gauge the progress of your business. There are three
profitability metrics that you need to track:

• Gross Margin Ratio;

• Operating Margin; and

• Net Profit Margin.

 

Here’s
how Gross Profit Margin, Operating Margin and Net Profit Ratio compare in an
Income Statement:

Gross Margin Ratio is
important for many graphics shops. After you subtract Cost of Goods Sold (often
called Cost of Sales), the difference is what you have left to pay for your
Shop and Administrative Expenses. Here is the formula:

 

(Total Revenue – Cost
of Goods Sold) ÷ Total Revenue = Gross
Margin Ratio

 

Example

($3.5 million in sales
– $1,400,000 Cost of Goods Sold) ÷ $3.5 million = 2,100,000/$3,500,000 =.6
or 60%

 

When I worked for a large
screen printer, the shop had an objective of operating at a Gross Margin Ratio
of 60%. The inverse of that ratio is a cost of sales of 40%.

 

Here’s why Gross Margin is
important. With annual sales of $3.5 million, it meant that $2.1 million was
available to pay for an overhead of $1 million. The remainder was left to cover
interest, taxes and depreciation. Anything left was net profit.

 

Each business is different.
Smaller sign shops typically should operate at a Gross Margin Ratio of 80% or a
cost of sales of 20%.

 

Changes in Gross Margin
Ratio are a barometer which can measure the overall health of your business. These
changes can alert you to problems. If
your Cost of Goods Sold increases while sales stagnate or decline, the change probability
indicates a problem, resulting from:

 

• Poor purchasing practices;

• Failure to adjust estimating standards to account
for inflation;

• Estimating mistakes;

• Poor production planning and management;

• Inadequate sales and marketing strategy;

• Lack of sales management and training;

• Unforeseen competitive pressure; and

• Failure to hold sales personnel accountable.

Operating Margin. In addition to gross profit
margin and net margin, many analysts will look at operating margin as an
indication of your shop’s overall financial health. Operating margin is based
on profit before paying interest and taxes. It is not the same thing as EBITDA,
which also factors in depreciation and amortization.

If you are looking to secure
additional financing from your bank to expand your business, operating margin
is an important metric that the bank looks at. As a rule of thumb, a healthy operating margin above
20% signals to lenders your ability to pay back loans and that you have enough
money to pay your taxes and take care of your other financial obligations.

In computing operating margin,
the first step is to calculate your operating income:

Revenue – (COGS + Shop &
Administrative Expense) = Operating Income

Example:

$3,500,000 – ($1,400,000 + $1,020,000) =
$1,080,000

To
determine your operating margin, divide your operating margin by your revenue:

Operating Income ÷ Revenue= Operating Margin

Example:

$1,080,000 ÷ $3,500,000 = .31 or an Operating Margin
of 31%

Net Profit Margin. Gross profit margin ratio
isn’t the only benchmark for rating the performance of a shop. At the end of
the day, the effectiveness of a business comes down to the net profit margin or
bottom-line profitability. 

 

To
calculate net profit margin, subtract all of your expenses, which includes taxes and interest expense, as well as cost of goods sold and shop and
administrative expenses from your revenues or sales.

 

To
calculate your Net Profit Ratio use the following formula:

 

Net Profit (after Taxes) ÷ Revenue = Net
Profit Ratio

 

Example:

$795,000 ÷ $3,500,000 =
22.7%

 

To improve the profitability of your shop, you can
take the following steps:

 

• Review and adjust your estimating standards and
procedures;

• Increase your profit margins;

• Reevaluate contracts with your vendors to control raw
materials costs;

• Reduce your shop and administrative expenses; and

• Examine and correct your production performance and
procedures.

 

Conclusion.

When you are presenting pricing for a
graphics program, NEVER present prices for the individual components.
This gives your competitors an opportunity to pick apart your pricing and
present counter bids on the components. When making a proposal, present pricing
for the whole package including installation.

 

To effectively justify your
pricing, you must first understand the prospect’s business objectives as well
as what is important to him personally. 
This is why needs analysis is such a critical step in the sales process.
The next step is to demonstrate how your program delivers value by satisfying
those objectives and needs.

 

Positioning Your Business. Price your programs to reflect your shop’s
positioning in your market. If you are the best graphics designer in your area,
you deserve to be the highest priced shop. If your shop has produced graphics,
which have won design awards, your marketing should publicize your standing in
the industry.

 

If you are positioning your shop as an
industry leader and expect to be paid accordingly, make sure that you look like
an industry leader. You have probably heard the saying that if you want to make
a million dollars, dress like a million dollars.  This is especially true in selling graphics
packages.

 

As a graphics provider, you are in an
appearance-based business. You are selling corporate identity programs to make
other businesses look better than their rivals. In positioning your shop as the
undisputed best in visual communications, you need to play the part of an
industry consultant. The image that you project in all of your communications
is essential in commanding higher prices. 

 

As you build your brand and your reputation,
you also build demand for your services. When you are in demand, you can demand
higher prices.

 

Good Luck Selling!

 

© 2021 Jim Hingst, All Rights Reserved