Happy New Year Everyone!
Are you interested in raising your prices and just don’t know how to do it? Why to do it?… Well, let’s not be Captain Obvious and say “to generate more revenue!” We are getting w-a-y better than that now 🙂 I’m hearing many people say they want to raise their prices but don’t know how or how much so I thought I would share some wisdom from one of the masters of business and encourage you to follow my tweets this week to assist with this.
I know that many don’t know much about accounting so I thought I would start out the new year with an awareness to the elusive accounting world … and share lingo and concepts to help you find the right price-points for this new year 🙂 Please Note: As usual we are going to over-simplify this topic AND I am not an accounting professional, nor do I play one on TV 🙂 If you have particular questions, I encourage you to make an appointment with your CPA to discuss specifics further. In a shorter posting next week I will share some things for you to be thinking about as you may be considering raising your prices .
I’d like to share the wisdom from “The Grandfather of Modern Business”, Peter F. Drucker, regarding what he explains as effective price-points and accounting practices for optimization. The following is a combination of direct quotes and paraphrasing from pages 370-375 of Peter Drucker’s book, “The Daily Drucker“:
Information on Cost and Value
Basic structural information is focused upon the value that is created for customers and the resources used to do so. New accounting rules (activity-based accounting, price-led costing, economic-chain costing, economic value added, and benchmarking) record transactions of what the business is and what the results of doing business are.
Activity-based costing reports all the costs of a product or service until the customer actually buys the product, and provides the foundation for integrating cost and value into one analysis (p. 370).
Traditionally, western business have determined prices in the following manner: added all costs, put a desired profit margin on top, and arrived at a price. This is price-led costing. The price of what the customer is willing to pay determines allowable costs (beginning with design costs and ending with service costs). All possible costs related to the product are accounted for – the whole economical framework focuses upon creating value for the customer while assuring the business gains a return on investment (p. 371).
Traditional costing techniques build cost from the bottom up – labor, material, overhead (often time called inventoriable costs and is relevant to manufacturing businesses). Activity-basked costing starts from the end and asks, and focuses on assuring all costs are accounted for, the focus typically lies in creating superb and enough value for your customers to justify your price-point because quality and service are part of this equation now.
Designing quality into products and service in the early stages is critical to ultimately keeping all costs down. Auto makers have these costs built into their product’s price because they are anticipating there will be some type of recall, which costs money to them, so they build this cost into their selling price (p. 372). (Yep, that’s right! You really aren’t getting anything “free” when you have your recall – it’s already bought and paid for folks!)
This includes another element to your accounting system. Economic-chain costing also includes the costing systems of your suppliers. If you are a large producer, you have much more leverage to dictate this request to you suppliers. This isn’t so relevant for most folks reading this blog, but I wanted you to be aware of what it is 🙂 The key to doing this successfully is to assure setting up the system correctly from the start and alignment between the the organizations is occurring – this is always tricky for any business (p. 373)!
EVA as a Productivity Measure
Economic Value Added Analysis (EVA) measures both the quantity and quality of all products and services to determine if the business is wealthy or not. Traditional accounting validates profit via revenue being greater than your costs; however, this may not be the best way to view wealth because you still have debt on the books. This also helps service business to assess productivity because you are typically measuring and analyzing the quality of what you offer.
A business is not considered profitable until reported profits exceed its cost of capital. Until that moment it is not truly operating at a profit at all! Until that time it is not creating wealth (p. 374) Fascinating isn’t it?
Benchmarking for Competitiveness
EVA is a good start to assess competitiveness. To truly determine if you are competitive or not, consider adding one more layer – benchmarking. Think of benchmarking as creating a certain level of standards to be met to be considered a leader. When a business is above the benchmark, they are setting the standard for others to achieve, regardless of within the same industry or not.
Benchmarking involves gathering data on your products, services, or processes of your own and from another comparable business (perhaps not always from within the industry). Why? To learn what “best performance” is and to effectively optimize the performance of individuals and the business (p. 375).
If you or your business needs rescuing on this particular topic
or any other Business Strategies we have been discussing,
please reach out to Maggie (262) 716.7750 FYI: I’m in the Central Time Zone
Blessings of Success to YOU ~
The Business Rescue Coach, Maggie Mongan
Brilliant Breakthroughs, Inc.