In a prior post we wrote about the critical importance of understanding the true costs of producing and delivering products and services. This knowledge is instrumental to profitably grow the top line and reduce costs without sacrificing customer expectations such as quality and on-time delivery. Whether the focus is to pursue growth, turnaround an underperforming entity or respond to market changes, the challenge is simplified when informed by the real—not believed—costs of each product, product family, and customer.
Organizations informed by such granular product level cost insight are better able to execute on their strategy. They avoid paralysis that comes with not confidently knowing where/if their costs are sustainable. In fairness, it is not easy to precisely segment the winners, stragglers and losers—just ask any senior manager. Moreover, costs are not static. They change over time adding further haziness to the financial reality.
Given the ebb and flow between fact and reality, or flat out lack of data, managers nevertheless move ahead with what they have. Unfortunately, the best of intentions sometimes fix the wrong problem. Adding to the risk is a lag in time between action and investment, and the inevitable final financial score. This makes it exceedingly difficult to adjust course within narrow competitive windows.
Where to Use True Product Costs
The following list highlights several ways that analyzing their true product costs helps companies improve their operations and financial performance.
- Re-price money losing efforts
- Profitably quote new products
- Target operational improvements and cost controls
- Reduce customer delivery backlog
- Identify insourcing/outsourcing opportunities
- Target logistics improvements
There is a lot of detail behind each of these bullets; we illustrate one. A supplier might wish to re-price product contracts in the face of weakening financials. Typically, the supplier might ask for a flat percent increase across the board. This approach can be difficult for buyers to swallow and can harm relationships.
A different tactic, enabled by true product costing, is to review the gross margin and/or net income of each product and then selectively target price increases. Let’s say a customer buys 20 different products. Rather than increasing prices for all, identify a subset of products and varying increases (can also decrease some) that meet your overall financial objectives. When the customer comes back to negotiate, you are ready with the next set of options to present to them.
This flexible repricing method, compared to an across the board lump sum, increases the number of leverage points for the seller. It also gives the buyer flexibility to differentiate where changes are more palatable—as buyers also have objectives and constraints. Thus, true product costing makes it easier to reach a win-win in negotiations.
In future posts we will explain how true product costing works and how to get started.
Adam Garfein and Anil Menawat