The importance of Costs calculation
Nowadays, everybody is worried about selling, being “visible” and having proper marketing strategies.
In Internet you can know how many people see your website any day, and everybody like staring in front of the PC hoping that just by looking the numbers, they will increase.
This is important, of course, but always providing you are selling a product with a proper margin, or at least, with a margin at all.
You may think it is impossible to sell a product without margin, but is extremely common.
Receiving money for a product sold is not having a margin. Having a margin is taking into account correctly all the costs involved in the product sold and, even so, having certain money remaining.
As a “General rule” (not scientific at all but tends to work): if you are selling very well a product that is not “unique” (with good or better competitors) and you don’t generate much money for your expenses, you probably have a negative or zero margin.
In a normal and business-healthy situation, practically any sale is done after a “fight” between the company’s commercial, the manufacturing team and, of course, the client.
Without any doubt, one of the main important things in a business project is knowing perfectly your margins.
You may have the best marketing strategy, the best strategic planning in the world and the personal skills of a Hollywood actor, but if you are selling a product without margin, you are failing miserably.
And never forget what we said before: the market usually ends up buying the product with lower margin.
Why? Because if you were selling a product with high margin that is making you rich, then, your neighbor would quit his job tomorrow and start selling that same product… After several months, you would have to lower the price in order to compete, having then, a product without margin.
(These statements don’t include, of course, real luxury products. It is a very difficult sector to enter, not being really representative of the overall market).
* You have an open Excel Template with a generic Business Plan that integrates the products’ Costs and Margins we are about to explain, within the “Business Plan Templates” section:
- It explains in a Practical and Useful way how can you disaggregate the Costs, and link them to your Business projections.
- Also, it calculates the Margin per product and Client automatically.
Cost per Product
These costs are common for all the clients, because it is “just” what cost you to elaborate the product.
Main factors involved determining these costs:
Internal capabilities: the means you have to manufacture or develop a product.
- Your expertise.
- The resources (machinery/computers) you have.
- Your financial strength.
External capabilities: what don’t depend just on you.
- Raw material costs.
- Suppliers’ location.
- Transportation costs (includes both your suppliers’ and clients’ locations).
After realizing the implication of certain factors in the overall margin costs, you can make better choices in the manufacturing process resulting in higher margins.
Paint Company Example
3 years ago we analyzed an industrial company that employed different pigment formulations to paint a manufactured stone-based product.
In 5 products, we though the amount of pigment employed was excessive and the pigment’s price, so much expensive, so we took 2 days to stop the production (it was a pure manufacturing line) make modifications in the formulations and check the results.
The final products were almost the same as the original and the overall margins improved from a 2% to a 16%.
We told the clients we made a small modification and we lowered the prices a 3%.
So we had, in absolute terms, an 11% increase in margins with all the clients happy to have a 3% discount price.
Costs per Client
These costs include mainly:
- Transportation costs.
- Different taxes applied (if they are in different countries).
- Any customized characteristic the clients require (some clients are more demanding than others).
We recommend tracking the price per product & client.
Why? Because each client has different needs and maybe some of them buy products with higher margins than others. You have to take care about these clients.
Increasing your margins in 3 steps
There are 3 main ways of increasing your margins by analyzing your costs:
1. Selling what is better for you
Selling high margin products to high purchase-price clients:
- Seems obvious but usually, companies don’t control what they are selling and who is buying it.
By just knowing your costs and margins, you’ll be able to focus on certain clients or/and products, optimizing your overall outcome.
2. Controlling your costs
Lowering the costs you think that can be decreased without affecting your final product.
After a detailed cost analysis, it is quiet common realizing about potential changes in the composition or manufacturing process that could be made in order to increase the margins.
3. Linking your Sales
Linking your lower-margin sales to high-margin products.
* Example: Imagine that a certain client is very interested in a 1% margin product (as we said before, this is very usual) but just a little interested in other product with a 15% margin (high margin, but at a market price, not because you increased artificially the price).
You could tell him: “Ok, we’ll sell you this product at this price (giving 1% margin) but for each 3 purchases you will have to buy this other at this price (15% margin) because we have so empty the stock“.
So finally, you would have a 4,5% margin instead of just a 1% margin.
* Don’t forget visiting the “Business Plan Templates” section.
- Usually, the best-sold product is that with lower margins, so you must perfectly know all your products’ margins.
- By disaggregating your products’ costs you can check the ones that can be lowered giving a margin increase as result.
- By perfectly knowing your products’ costs you can negotiate prices with your clients linking, if necessary, low-margin sales with high-margin ones.
Don’t forget: selling without knowing your costs and margins is like driving blindfolded.