Benefiting from Costing & Pricing Tools

Printing company managers seeking profitability may understand the relationship between cost controls and pricing models that yield margins, but they may not be so clear on selecting the best methods for assessing costs and establishing prices.

The most prevalent costing tool used in the printing industry is the budgeted hour cost rate (BHR), reports professor Philip K. Ruggles of the Graphic Communication Department, California Polytechnic State University in San Luis Obispo, author of the book Printing Estimating. He explains, "A given company should base its BHRs on accounting data, labor rates, and utilization to yield for a cost per chargeable hour for a working area or cost center."

Ruggles says that the typical model for costing a printing job, sometimes called the cost estimating formula, is: (Production time hours x BHR) + material costs + outside purchases = estimated manufacturing cost.

The estimated or baseline manufacturing cost is the dollar amount it will take to do the job in the printing company, says the professor. This baseline manufacturing cost is then commonly used as one factor in setting the price for the job. Pricing the job is frequently done by adding a profit markup, which is typically a percentage added to the estimated manufacturing cost. The price is then formally given to the customer as an estimate, proposal, or quotation to do the job.

Most computer estimating systems use the cost estimating formula described by Ruggles to establish baseline manufacturing costs. To complete the pricing aspect, he says, a default profit markup, usually 35%, is added to the estimated manufacturing cost.

One tool commonly used by printing company managers to determine BHRs for equipment are the Blue Book Budgeted Hourly Cost Studies compiled by the National Association for Printing Leadership (NAPL), Paramus, N.J. The books, now also available on disk, contain hourly costing data for more than 1,400 individual pieces of equipment; each book is updated every two years.

The complete set of Blue Books includes Digital Prepress Operations; Sheetfed Press Operations; Web Press Operations; Bindery & Finishing & Mailing Operations; and Printing Operations Up to 20 Employees.

The books contain a breakdown of all items factored into hourly cost rates for each piece of equipment, allowing users to account for all the factors that determine what it costs to operate each area. A step-by-step guide lets users calculate accurate hourly rates mirrored to their circumstances.

NAPL advises that rates in its books are guidelines and are not intended as a substitute for a firm's own rates.

Still, there's a tendency for printers to rely on the cost rates in the books, rather than calculate their own rates, observes G. David Dodd, a principal of Point Balance, LLC, an executive education and management consultancy based in Nashville. He explains, "The danger is that the published rates don't reflect an individual printer's actual cost; they may be very close in some cases but pretty unrealistic in others."

BHRs should be periodically evaluated, advises Barbara Birkett, associate professor of Rochester (N.Y.) Institute of Technology's School of Print Media. She reports, "Every six months you should be looking at your BHR to make sure that things haven't changed. This is tedious, and many printers may think it's not worth doing because the market is so tight that they can't raise prices anyway. But if they don't, they won't have clear view of what is going on."

Another costing method slowly gaining support in the printing industry is activity-based costing (ABC), an approach designed to accurately assign to job costing all appropriate support or "soft" costs—for example, those traceable to customers, programs, contracts, and business-sustaining expenses. By comparison, in the BHR system, costs for administrative resources and all other non-direct expenses are put into a cost "pool" and arbitrarily allocated to cost centers in an attempt to recover these costs based on the amount of time that work is processed at a cost center.

Thus, while the BHR approach in effect buries support costs and attempts to trace all costs to one cost object, the print order, the ABC method strives to accurately assign appropriate direct and support costs to jobs while creating cost visibility of important processes.

Dodd, who co-authored a book on ABC costing, contends, "BHR costing is not a good method because the practice pools support expenses and arbitrarily allocate them across production cost centers, which distorts the true cost of a job and ultimately customer/program profitability." For example, in a BHR system, an order that requires 10 estimates and 10 sales calls is assigned the same support cost as a job that didn't require any estimate or sales call.

Also, says Dodd, while managers using BHR costing focus on allocating job costs to individual print jobs, managers using ABC systems consider such factors as the following:

• What activities are being per-formed by a company's re-sources?
• How much does it cost to perform organizational activities and business processes?
• What is needed to perform specific activities and business processes?
• How much of each activity is required to produce individual print jobs, to produce and/or deliver non-print services, and how much of each activity is required to serve specific customers?

"Many managers believe they have a good idea of their costs," notes Ruggles, "but in reality we've found that their picture is somewhat blurred." He says several factors typically obscure a printer's view of costs:

• The language of cost is complex. He says there are nuances to how BHR costs are developed and variations in cost recovery methods, terms, and measurements, making this more complex than it first appears.
• Computer systems have lured managers into a false sense of security in the cost arena.
• Cost recovery and cost analysis, which are not hot topics in themselves, must vie for a busy manager's attention.

Ruggles concludes, "Accurate cost estimating is driven by careful collection of all the job details upon which the estimate is based. Getting accurate job specifications, usually accomplished by the sales representative, is frequently problematic."

The sad fact is that printers never know the true cost of the job, says Joe Becker, principal of Becker and Company, Lanham, Md., an accounting, tax, and consulting firm serving the graphic arts industry. He says, "Hourly rates are only an estimate of costs and are not accurate because these rates are based on averages—and workloads vary. One day you can be running over capacity and another day below capacity, which affects the value of your hourly rate."

He says printers should know their value-added, that is, the sales price minus materials costs; as Becker puts it, "What's left over to pay your bills and make a profit is often referred to as contribution."

Consultant William K. Marrinan says that printing managers also need to consider capacity utilization levels when thinking about their basic cost and expense patterns. "Costs differ depending on the volume of capacity being utilized," says Marrinan, president of Marrinan Associates Inc., Raleigh, N.C., which offers printers such services as strategic business planning, turnaround management, and mergers and acquisitions.

In Ruggles's view, costing is anything but a static process. He says, "Job costing requires managers to continually assess whether jobs are making or losing money. Cost accuracy is assured only when companies accurately cost estimate before the job is done, and then accurately job cost after the job has been finished."

Furthermore, Ruggles adds, too many printing managers mistakenly believe that computer estimating provides accurate cost estimates.

"Computer estimates, while mathematically flawless, are only as accurate as the information used to generate them," he says. "Inaccuracy enters the costing process at many points: BHRs that are out of date, job specifications that are incomplete, misalignment between estimated and actual workflow, materials that are improperly specified or estimated, and so on."

Ruggles observes that while many managers wholeheartedly try to develop a core knowledge of their costs, they rarely pin them down with any accuracy. "Generally speaking," he says, "printers recover costs on jobs at perhaps an accuracy level of 85%. But the remaining costs falling through the cracks diminish bottom-line profitability."

Job costing information is important for other reasons. Says Dodd, "While cost information is helpful in making sure that the estimating process is accurate, it also should be used to measure profitability of individual customers and certain kinds of work."

The other side of the profitability equation revolves around price, which, compared to the science of costing, is seen more as an art.

"The really exceptional companies don't let costs drive prices; instead, their profit objectives do," declares Gregg Van Wert, principal of the Haven Group, a consulting firm located in Oakland, N.J. "The work these firms accept and reject is determined by their profit objectives."

Adds Dodd, "In most cases printers are establishing initial offer prices on the basis of cost estimates, and adjusting those prices based on what a customer seems to be willing to pay. Printers need to develop effective pricing strategies that capture a fair share of the value they create."

Notes Ruggles, pricing methods in printing companies largely tend to be a mystery. "While costs are openly discussed," he says, "the methods for coming up with a price tend be sensitive and secretive. In seminars I conduct on pricing print, audiences are strangely subdued."

Ruggles identifies four common pricing models:

• Price by what the market will bear.
• Price by what the competition is charging.
• Price using a baseline markup, where 35% over cost is common.
• Current price is based on past price for like goods and services.

"Of these, the most popular approach is pricing by what the market will bear because it allows prices to continuously shift as technology, workflow, costs, and other important cost drivers change," Ruggles explains.

Marrinan suggests that printers adopt incremental pricing, in which they accept a portion of discounted work to cover fixed costs, based on the volume of capacity utilized. As he explains, "All basic pricing patterns can be adapted or modified for the difference in expected volumes."

Marrinan, who reports that some of his clients striving to boost work during slow months have used incremental pricing to prepare marketing campaigns offering special incentives, says, "This pricing strategy must be preplanned, controlled, and monitored monthly, because printers who overbook their shop with discounted work won't have the capacity available when more profitable work comes into their grasp."

Becker advises that printing company managers should appoint a pricing administrator or pricing executive to make key decisions. "That person needs to truly understand the company's entire operation, including the financials, production, sales, and marketing," Becker asserts. "However, he or she doesn't need to make a decision about the price for every job; for a $10 million printer, I'd say that person would make decisions on every job over $5,000."

Price alone is not the only factor in procuring work, says Ruggles. "While print buyers are concerned about price, they are also very concerned about meeting deadlines, product quality, the ease of doing business with a printer, and numerous other factors," he reports.

He says buyers also appreciate having an open and honest discussion about price and value, but at the same time don't want a pat or glossed-over response justifying a price.