After months of silence, it was formally announced last fall that Canada and the United States had hit a recession. Challenging times for all of us, and I believe printing companies are one of the first casualties of economic downturns. Arthurs-Jones Clarke, Ward Press, Major Graphics, Quebecor World and many other firms are closing their doors, reducing staff or restructuring.
Now more than ever, then, managers and business owners need to have a firm grip on their operations and cost factors. Many companies operate using estimating and costing models that do not have any basis in true costs. There may have been a relationship between actual costs and estimates at one time, but that may not have been reviewed and validated recently.
Value added vs. full absorption
Two major costing and pricing approaches are commonly used: the traditional, fully absorbed costing model and the value-added costing model. The fully absorbed approach is a full cost-recovery model based on traditional budgeted hourly rates (BHR). The BHRs are calculated with allowances for operational overhead, factory expenses, administrative expenses, equipment depreciation, and equipment utilization all taken into consideration. This determines the estimated rate for a press—say $300 per hour. The assumption is that if you recover less than what you estimated, you will under-recover your true costs.
The value-added model, on the other hand, is based on the following model:
SSell price —Direct cost: purchases
SSell price —Direct cost: labour
SSell price = Value added
The assumption here is that anything recovered on top of the direct costs will contribute towards the costs of operating the company.
The direct labour recovery for a press with a calculated BHR rate of $100 per hour may be only $38. Therefore, any costs recovered above $38 contribute towards overhead, equipment costs, administration and selling expenses.
Pricing is actually determined by two factors: customers and competition. You may estimate your costs, but the market will determine your selling price. If you have under-recovered on one job, then you will need to over-recover on another. So your poorer customers (less profitable), who continually drive your prices down, are benefiting. Your good customers are paying the fully absorbed price or perhaps a premium for work, and are actually subsidizing your poorer customers.
In fact, it should be your good customers who get a price break—they send you large amounts of work that keeps your operation running and have earned a discount. These customers allow you to amortize your fixed costs over a wider base, thereby making larger contributions to your operation.
Let’s say that you typically operate at 75% utilization. The cost centre that has $100 per hour needs to be charged at $133 just to recover $100 per chargeable hour. If a prospect offers you the opportunity of being his or her major supplier, and you estimate that the business will require additional press time that increases your efficiency to 90%, then your BHR would come down since the fixed component is recovered over more hours.
As I said, customers and competition determine pricing. Therefore, if the price the customer is willing to pay is less than your estimated cost, you need to figure out how to reduce your costs. Try these 10 ideas:
ª Increase utilization (see chart). Offer customers volume discounts to increase equipment and plant utilization
ª Reduce the cost of paper by consolidating purchases to one paper vendor
ª Utilize customer-size paper for larger purchases
ª Explore using paper converters with less expensive options and fewer custom sheets
ª Purchase large quantities of a specific stock and promote it as a house brand at a reduced price
ª Reduce inventory and have paper delivered only as required
ª Work with your trade vendors to determine how to reduce costs in prepress, trade printing, bindery and finishing
ª Work with finishers during print-planning stages to see if they can recommend a more economical way to finish the product
ª Review the value-added contribution to your operation by each customer; consider how to convert low contributors into higher contributors, or replace them
ª Use detailed print-planning techniques. Review customer specifications and minor modifications to reduce cost. Remember to keep some of the cost savings for you.
SBudgeted Hourly Cost Rate (BHR)
S SFixed overhead
S SEquipment depreciation
S STotal fixed costs
S SEmployee benefits /taxes, etc.
S STotal variable costs
SGeneral factory expense
STotal factory costs
S SSales expense
S SAdministrative expense
S S STotal sales & admin
In recent years, companies have been trimming non-production functions to reduce costs. These functions include job-costing and analysis. Some companies that used to collect detailed costs and compared them to the estimate for every job now review only the jobs that appear to have cost overruns. However, detailed sales and contribution statistics on completed work, sorted by customer, sales rep and product type can help you know your operation and focus on profitable work.