I am in the process of setting up a new estimating system. I was wondering if someone could shed some light on the concept of budgeted hourly rates and markup on hourly rates. The system has me set up some services based on time (eg. press, prepress etc) where I specify an hourly rate as well as a markup on the hourly rate. I am familiar with hourly rates and I have used them when working out estimates manually in the past. I have never really considered a markup on an hourly rate though. Generally I have considered my hourly rate to be all encompassing of labour, machine costs, power, a contribution to overhead, etc.
Where exactly does the markup fit in? Should the hourly rate be a bare bones rate - labour, machine cost, etc with no overhead component?
If I do not enter a markup on the hourly rate then the gross proft margin is low...though I am in fact generating the selling price I want.
Any thoughts or info on establishing hourly rates?
If I do not enter a markup on the hourly rate then the gross proft margin is low...though I am in fact generating the selling price I want.
I suspect the estimating system you're installing considers markup a "Profit Markup." As Philip Ruggles points out in Printing Estimating, "Budgeted Hourly Rates (BHRs) are not selling prices. They represent a composite of all costs to produce work in a particular location in the plant." He goes on to say "BHRs are not selling prices because they do not include any profit markup. When properly calculated, BHRs are first multiplied by the number of estimated hours anticipated for a job. When material and buyout costs are added, management has the baseline cost of the job with no profit."
Ruggles' book gives a detailed description of how to calculate BHRs. I would highly recommend picking up a copy. The latest, 5th edition, costs $139 new at Amazon and includes estimating for digital and click charges. The 4th edition can be had for around $20, and you can buy older, used editions for as little as $0.08. Seriously! I have no idea how that works (8 cents ??? I mean, really? How can anybody sell anything for 8 cents?). Amazon.com: Printing Estimating: Principles and Practices: Philip Kent Ruggles: Books
As an aside, you're definitely looking at pricing from the right perspective when you say "generating the selling price I want." Budgeted Hourly Rates are the basis for Cost Plus Pricing, and Cost Plus should have been ditched in favor of Value-Based Pricing a long time ago. Henry Ford did it back in 1922. In his autobiography (My Life and Work), he says "We have never considered any costs as fixed. We first reduce the price to the point where we believe more sales will result. Then we go ahead and try to make the prices. We do not bother about the costs. The new price forces the costs down."
Innovative strategy, though not likely to find many advocates in the printing industry. Luckily for most printers who rely on BHRs, nearly every competitor uses Cost Plus as well. With the price of equipment, salaries, utilities and rent being generally in line with what competitors pay, Cost Plus actually works, more or less. But think about it, what other pricing system do you know where, as the sales volume goes down, the price has to go up? One of the factors for determining BHR is utilization of equipment. On page 120 of "Printing Estimating - Developing a Cost Estimating System," Ruggles cites sample BHR costs for a 1/C Komori as $75.75 at 80% utilization, $86.58 at 70%, and $101.01 at 60%.
So why do so many printers still embrace this outdated pricing method? Because doing something stupid once is just stupid. Doing it twice becomes a philosophy. That's one reason. The other is that the method is relatively easy to implement and the bean counters get to work with concrete numbers. Wrong, but concrete.
No surprisingly, all estimating software is essentially Cost Plus, too. Including Morning Flight. As much as I hate to admit it, value-based pricing, the strategy we should be using, depends largely on what the market will bear, and I haven't found a program yet that will canvass your competitors, tally their prices, find out what customers are willing to pay, and then quote accordingly. When I say "essentially" Cost Plus, the system you're installing should, at the very least, allow you to set different rates for different customers.
Sorry for the long post. As the architect of Morning Flight, I'm passionate about how to price printing without leaving money on the table. To learn more about value-based pricing in general, here are three books to add to your library:
If you want to get a more accurate view of job costs and job profitability, then you should not include most "overhead" expenses in your hourly cost rates for individual cost centers. When you include overhead expenses in base hourly cost rates, you are essentially assigning costs to jobs that have no real cause-and-effect relationship to those jobs. The better way to account for overhead expenses is through what I call a "break-even mark-up." By using a mark-up to deal with overhead expenses, you are keeping those expenses separate from true job costs.
Luckily for most printers who rely on BHRs, nearly every competitor uses Cost Plus as well. With the price of equipment, salaries, utilities and rent being generally in line with what competitors pay, Cost Plus actually works, more or less.
Great post! There are several serious problems with estimating and pricing systems that are based on traditional BHR's, and you touched on some of those problems. I wholeheartedly agree that value-based pricing is the best pricing model, and value-based pricing becomes even more important when a company begins to offer more complex bundles of products and services that go beyond print manufacturing.
My only quibble with your position relates to the portion of your post I quoted above. Does cost-plus pricing really work, even more or less? Whatever pricing model a company uses (cost-plus pricing, market-based pricing, or value-based pricing), it is essential to have an accurate view of costs. If anything, having an accurate view of costs is even more important when using cost-plus pricing because cost-plus pricing simply uses a mathematical formula to convert costs into prices. If the costs are wrong, you can imagine the impact on the price. It's a classic case of "garbage in-garbage out."
The real tragedy is that many of the problems with traditional BHR's can be corrected fairly easily within the framework of most estimating software programs, including, I suspect, Morning Flight.
... My only quibble with your position relates to the portion of your post I quoted above. Does cost-plus pricing really work, even more or less?
David,
I'm inclined to say yes, with reservations. Success, like beauty, is how you define it. Cost Plus works because everybody's doing it, and it doesn't work for precisely the same reason. Whenever value and price are separated, the only meaningful way left to compete is on price. Price-cutting and low-balling are rampant in this industry, to the point of being endemic. When everybody lowers prices to shore up business and the only drawback is you're not getting paid for it, and you consider that being successful, then yes, Cost Plus works.
The market parity brought about by Cost Plus has lead to over-aggressiveness in how we price. That's especially true in the digital world, where differences in quality are less discernible. As a result, profit margins in printing are now so low that the thought of closing up shop, putting the money in CDs, and soaking up the sun on an exotic beach with a Marguerita and a nice, cool beverage becomes more and more attractive. Provided that the owner has enough equity and can find a buyer for the business.
But, we do have to pick your battles. Before I can persuade Morning Flight users to abandon Cost Plus entirely, I first have to convince them to ignore BHRs - make it understood that when people go to buy grass seed, it's not the seed they care about. What they care about is their grass. Translated into printing, that means charge by the product you're delivering to your customer, not by the press you run it on. If you have to put a newsletter on the Heidelberg because the designer felt it needed 80% ink coverage, charge for that. Otherwise, forget BHR and charge for running it on the Ryobi. Morning Flight is product-centric, and it's often difficult to make the connection.
To quote from our on-line help system: "Customers have neither the time nor the curiosity to be impressed by that fancy new inkenspritzer you ran their letterheads on. They'll look right past it. What matters to them are the results delivered to their office. And they'll get vocal when a $100 letterhead you ran last month on a Multi suddenly costs $150 coming off the Heidelberg because the Multi was out of commission."
Change will come. In large part because of the "more complex bundles of products and services that go beyond print manufacturing" you mentioned. That and the maturing of Web2Print. Can you imagine a print buyer requesting a live, unattended quote from the printer's web site and having to select the press the job should be run on?
P.S. I just discovered (and ordered) your book "Throw Away BHR's: Win the Pricing Game," available from Point Balance Publishing. Thought I had read all the books on estimating printing.
Before I can persuade Morning Flight users to abandon Cost Plus entirely, I first have to convince them to ignore BHRs...
Instead of abandoning Cost Plus. How about adding value-based pricing, market-based pricing, or both to the Morning Flight. This gives users flexibility and the option to change to another pricing method on their time schedule instead of yours.
I couldn't agree with you more, pcmodem. But here's the problem:
Morning Flight does assign hourly rates to all presses, so there is nothing to keep you from using Cost Plus and BHRs. We just don't recommend it. On the other hand, changing from Cost Plus to Market-based or Value-based Pricing is never as easy as flipping a switch. That's because the last two are more of a Business Strategy than a pricing method. They're not easily translated into bits and bytes.
Cost Plus calculates the cost of producing the product and adds on a profit markup to arrive at the selling price. Easy to implement and computerize. Its major flaws are that it doesn't account for demand, that there's no way of finding out whether customers will buy the product at the calculated price, and that prices have to go up as volume goes down, the argument I made earlier.
Market-based Pricing has many variants but is basically what the market will bear. Value-based Pricing, also known as Dynamic Pricing, is one of those variants. That's gross oversimplification, but the two are alike in that prices are based on analysis and research compiled from the targeted market. Movie tickets, where prices are different for youngsters and seniors, and for different opening times, are one example of Market-based Pricing. So is the price of popcorn for their captive audience.
Airline tickets are Value-based Pricing taken to the limit. We all know that most passengers on any given flight paid a different price for their tickets. But did you know that ticket prices are recalculated by the airlines every 15 minutes? Airlines have completely done away with cost. Mathematical models (supported by a staff of high-salaried PhDs) look ahead at how many passengers are expected to arrive and what they're willing to pay, then set the price based on an evaluation of each seat's potential revenue contribution.
I think you can see where I'm going with this. First, few printers have as narrowly defined a product line as airlines. Second, Morning Flight was designed for small to medium size print shops. We gave it the knobs and levers that make Market-based and Value-based Pricing possible. As for the mathematical models that would need to be custom-developed for each shop, well, we couldn't afford the PhDs. Did I mention that our core estimating program is forever free?
If you can't bring yourself to put BHRs out to pasture, John Stewart, Contributing Editor at Quick Printing Magazine, has developed a BHR Calculator that can be downloaded from his web site free of charge: Downloads
I have been involved is setting cost rates for over 40 years - and they really are very difficult as you have to budget for a level of annual production, which is reasonably easy on printing presses but in pre press and bindery is hard - foe example if you suddenly had lots of orders for long run four colour letterheads - you would have no capacity to take work on to fill your pre press or you bindery - so you would loose money. One method which i keep coming back to is to only charge out press time. ie take the number of productive hours worked each year and divid them into your annual budget. The purists may be horified but suprisingly you soon get a feel for what is the best rate to use for cllients and its a great measure to compare clients - of course clients still pay for paper ink metal cost of plates outwork carriage and any extra costs like handwork. It may not suit you but dont dismiss it.
I've been estimating printing long enough to not dismiss any method out of hand. I take that back: Doubling the cost of paper to arrive at a total price for 1-color, and tripling it for 2-color, is absurd. Incredibly, that pricing method is still being practiced.
Other than that, any pricing system that makes you money and, by year's end, finds you still standing, is a good system. I'm down on Cost Plus, and a big fan of Market-based Pricing, but try not to be dogmatic about it.
My thoughts on your approach are more related to marketing than to pricing: Overcharging prepress for those profitable long run letterheads (little prepress per M but getting paid big), and then undercharging for profit-sapping short runs (lots of prepress per M that you're not getting paid for) could encourage the wrong product mix. Most shops have carved out a niche, with their own version of the 5-cent cigar. You could earn a reputation for being the winning bidder on exactly the kind of printing you don't make money on.
It obviously has been working for you all these years, so I can't say I blame you for sticking with it.
I hope you don't mind me reopening this thread. I would just like to know if you guys have had any new ideas regarding HBR and Cost-plus pricing since you posted the above.
I am wrestling with the concepts at the moment and would like your input (if you don't mind).
The problems I see with cost plus pricing is that:
1) It does not encourage cost reduction since that would mean revenue reduction.
2) There is no simple way of incrementally increasing costs. Our customers usually expect some form of increase in prices.
3) Reduction in Raw Material prices lead to reduction of Revenue.
I'm considering using a price list with each client given his own discount structure based on volumes or something like that. Would you comment on this idea?
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