This topic seems to come up often and is a critical factor in running a profitable business .
There are many fine woodworkers out there that will not be able to survive without some basic guidelines to adhere to .
The cost to the consumer and market prices varies region to region and often times in the same region . Alabama will have a different market than Chicago or Oregon vs California .
But , the actual costs to run your particular business can only be figured by you .It took help from a friend to show me the difference between labor and profit and to take a hard look at my true costs to any given job .
This is meant to be applied to those in business to earn a living not hobby shops . Here are some items to use in realizing your true costs .
Rent or portion of Mortgage applied to your shop
Liability insurance , electricity , water and any other utilities as well as your Yellow page ad and business phone service , banking service charges , check fees . License , city and state contractors ticket when applicable , a bond is usually required as well .Nowadays gasoline is a larger factor then in years past as well as maintenance on your vehicle and commercial insurance on it as well . Equipment maintenance sharpening and purchases to name a few .
Then you have supplies I charge my supplies that get used on all jobs to overhead not the individual job, such as glue , abrasives , fasteners and so on . Hinges , slides hardware and finish are used on a per job basis and can be charged accordingly .
O.K. those are some but one of the largest item that gets overlooked is time spent not being productive in the shop , looking at plans and jobs , talking to potential clients and any other time we are not making money we are spending it .So just for the sake of conversation let’s take a 40 hour week my estimate is approximately 25% or modestly 10 hours in every week are spent not being productive and may have no return .
After figuring your hard costs listed above if your hourly wage or shop fee is say $25 you need to figure 10 hours X $25 = $250 per week added to the overhead expense to correctly know what your overhead is.
Profit is what is left over and above your hourly wage and your overhead costs .
I have seen many fine wood workers fail at business because they never got a handle on their true cost to do business.
dusty
Replies
So true Dusty,
Attached is a draft word doc I use for a seminar I give on occasion.
Keep in mind this is taken from a two hour presentation,so it is just talking points.
Charles
Hi Charles , Thanks
That is a very concise and complete listing for sure .
There was one line item not familiar to me ( owners salary ) chuckle .
You must give a wonderful talk to budding entrepreneurs , if learned and followed at the earliest stages in new business , success is sure to follow .
A business savings budget plan is also a strong tool , take 10% of each paycheck and save it , well if you have enough flow and will power you will be in a strong position after years of savings .
dusty
Charles:Slide two states, "There are four basic components to pricing". And then you enumerate as:
Material Cost, Labor, Overhead and Profit.This is just plain wrong! Any modern text book on pricing typically starts from customer value, i.e., the amount that a reasonable well informed person might be willing to pay, aka economic value. Sometimes economic value can be calculated quite precisely, on the other hand, it can be very subjective and intangible (think works of art). Yet your list of basic components omits this vital, and most important, factor.Fixed costs have no place in pricing decisions because they have nothing to do with what a customer might be willing to pay. Understanding your costs is critical, but only to establish the floor price, i.e., the price at which you will lose money. The floor price is your incremental avoidable cost. It will include materials, and if you need a special tool for the job, the cost of that as well. Any price above this floor will be profitable, not necessarily desirable! Most businesses cannot survive for long at the floor price, though airlines seem to do it.The amount you can charge over the floor price is dependent upon the value that customers perceive and, inter alia, the level of competition. In fiercely competitive markets, with relatively undifferentiated products, the "value" can be bargained away, leaving everyone at the floor price - again think airlines. It may sound perverse, but capitalism abhors profit.I would encourage you to include value in your discussion about pricing. Yes it is harder to understand and is constantly influenced by many things, but without some understanding of this, your approach, which is cost-based, will lead to over pricing in weak markets and underpricing in strong ones.By starting with value, you begin to ask questions, such as, what can I offer that will increase value to cover all the costs and give an acceptable return on capital?Start with the market and work back to the shop!Regards,Hastings
Hastings,
I should clarify that what I posted is intended to educate shops on how to establish the "floor" costs.
My presentation focuses on job costing and not the selling price of the job to the end user, that is covered in a completely different set of lectures.
I totally agree that there are many factors that influence the sell price and some salesmanship skills could add to the profit dramatically. I have found (quiet painfully) that there is a great number of small shop owners that lack the basic understanding of what their basic costs are. I once had a young owner exclaim the "he had it all figured out" he went on to explain that he just made a two thousand dollar profit from a twenty-five hundred dollar built-in project. On further discussion he related that materials only amounted to five hundred dollars so of course the remainder was profit.......
Without a firm understanding of what your production costs are, success will elude the majority of the shops in the market.
I apologize that I did not explain the purpose more clearly. Thanks for bringing this to my attention.
Charles
Charles ,
That's exactly how it was brought to my attention by my old friend .
About 25 years ago I told him I just made $375 off of a bookcase , he said let's take a look , we took the materials and other direct costs and all the other overhead ones I had not begun to figure in yet and came up with a closer look .
He asked me what my hourly wage was , I said (been a long time ) like $20 an hour , then how many hours did it take . Well the bottom line was more like I made $5 an hour and no profit , hmmm ! Welcome to self employment .
Eyes wide open since then
regards dusty
Charles:I sometimes forget that some business owners can be woefully ignorant about the relationship between cost and profit. Your example illustrates the need for some basic understanding of cost accounting, which was your focus, rather than graduate level pricing, which was mine!Regards,Hastings
Hiya Hastings ,
What you say about customer value and the economic value or what the customer might be willing to pay imo applies more to products waiting to be bought or products already made and on the shelf .
Custom made products are imo not in the same category and the market price for the region will play some part but , only the potential client can decide if the price is in their budget or affordable .
Often times they can get one quite resonably from say Pottery Barn but it is not the same as custom made .
When we make a custom designed piece just for that client the value is much greater to them because it's special , almost everybody likes to say "I had that custom made for me " it is almost a status symbol and they feel it is better or worth more then the ones stacked up in a warehouse at least to them .
When we go to the craft fair and see stacks of boxes behind the artisan is when the " will you take $10 bucks for one attitude comes from .
So the customer value works both ways I suppose .
regards dusty
Dusty:I agree with what you say except, "what the customer might be willing to pay imo applies more to products waiting to be bought or products already made and on the shelf"You go on to say, "When we make a custom designed piece just for that client the value is much greater to them because it's special , almost everybody likes to say "I had that custom made for me " it is almost a status symbol and they feel it is better or worth more then the ones stacked up in a warehouse at least to them."In other words, there is an intangible value that customers take into account when they have something custom made. Surely, you would want to fully price to the value perceived by the customer? Now it is difficult to say precisely how much this is worth because the value is so idiosyncratic. It makes value pricing difficult, but I don't think it invalidates the fundamental point.Regards,Hastings
Agreed , it's not Black and White and certainly not a one size fits all situation .
I think that part of the difference I speak of is when you try to sell an existing product to someone it , to me seems way different then when someone comes to us because of our reputation and expertise and ability to design and cutom build we are more in the drivers seat so to speak.
regards dusty
Edited 5/31/2008 3:09 pm ET by oldusty
Well put Dusty,
To expand on what has been said.
There is a fine line between craft and business that must be balanced to gain success. I have seen more than one "savvy businessman" fail, just as I have seen a equal number of "fine craftsman" fail by losing the middle ground needed to gain balance.
This a business of woodworking.
Knowledge and experience with both the craft side as well as basic business skills are needed. Far to often I see the scale tip to far to one side or the other with disastrous results for all involved.
The best cabinetmaker in the world will starve if he is unable to sell himself and his work. On the flip side , great business skill will fail to produce income if you cant produce a sell-able product.
With all the cheep import goods and DIY explosion it is getting more difficult for the small shop to survive.
What's the answer????
(stepping off soapbox now)
Charles
I think you hit the nail on the head. You do have to decide what you can charge for a product then decide if it is worth making for that price. You can further that into how many items like that your going to make in a year and subtract the costs of materials, overhead etc. Then decide if you what to go forward.Troy
Troy ,
If you have a contract like with Costco or such to purchase X amount of units per year , then your theory comes into play .
But just knowing how much you can charge for the product and the related costs to produce it and how many you can make in a year means little without knowing how many will be sold imo .
It's pure speculation at that juncture
very dusty , from the shop
What you can charge for an item is very dependent upon how many you expect to sell at any particular price. Price and quantity sold are inversely related, though when price signals high quality that may not always hold true. Veblen rules here.
That's very true Steve ,
But how can you know how many you can sell unless you have a contract or are guaranteed your outlet will take all you make , what we call a guaranteed sale ?
Also one last factor is called diminished return , I know you know but some may not . If we make 1 item or 5 or 25 items typically the price will drop as the quantity increases until a certain point . Say after 50 or after 1,000 there will be no further savings per unit at some point typically.You certainly will increase your volume and the more units the more profit but not necessarily more profit per unit .
It also depends on the exact product , example the Master Violin maker can only produce so many per month or year , personally I can only build so many feet of cabinetry per month .We also have another business unrelated to cabinetry that involves the sales of product that we don't fabricate ourselves , there is no limit to the total dollar amount we can sell because there is no labor burden .
regards dusty
It's equally hard to know the price as to know the quantity that will clear the market. In a sense it is a duality. Since guaranteed contracts are about as rare as hen's teeth, it is just that you must make two tough estimates jointly. Pricing is a very tough problem all around.
Of course we don't care about profit per unit--in fact in a world with diminishing returns, you want to expand production until the last unit is sold at zero profit. Only in that way are total profits maximized.
At some scale, the labor burden (or what ever the limiting resource is) will effect your supplier's production so that the more you sell, the more he charges because of diminishing returns in his production.. The same principle is at work, only the scale of his production is so much larger at your current sales amounts that it seems that there is no rising supply curve.
Your right. I think my writing and communication skills need work. One thing I have noticed is that a lot of people don't factor in their time that they are not billing a client and this just eats them up. When I hear somebody talking about 30 to 50 dollars an hour for shop labor charges billed to a client this just does not work out to a profitable business in this day in age of 4.00 a gallon gas. Anyway it helps if you can charge multi thousands for chairs and more for tables:)Troy
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