Costing & Pricing Your Products. An introduction

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1 Costing & Pricing Your Products An introduction

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3 Contents 01 - Costing and Pricing: An introduction Costs - the basics... 6 What are Costs... 6 Types of Costs Costing Your Products Stage One Your Direct Costs Stage Two Your Indirect Costs Reducing Costs Design Modifications Production Efficiencies Managing Quality Reducing Wastage Shipping & Transport Manage Your Tax Setting Your Sales Prices Making a Profit Thinking about the Market Adding Value Discounts Negotiation Useful Links Appendix 1 Fixed - Variable Costs Our thanks go to Meghan Roberts and Audrey Seagraves for allowing us to use their work on Design Modifications and Production Efficiencies. Photo (cover page): Traidcraft / Rajendra Shaw

4 01 - Costing and Pricing: An introduction All organisations need to spend money to survive. It is important that you manage these costs, since your sales and your costs will decide whether your organisation is sustainable. You must manage your costs Costing is all about working out how much it really costs for you to make your products. If the cost is too high then you won t be able to make a profit. Controlling your costs means that you are in control of a large part of your organisation. This guide has been written for anyone who has responsibility for an organisation that makes products, particularly craft products Use this guide with the products that you make. This guide takes you through, step by step, the process of working out how to calculate the cost of making your products. It is best that you choose one of your products as this will make more sense to you. It might also be best if start with a more simple product first. We have provided two spreadsheets to help you work out some of the costs too. Costing & Pricing Page 4 of 50

5 We have also provided you with some ideas to help you reduce your costs. If you save money on some costs, you can use them elsewhere By saving money in the production of your products, you can also make sure that the people who are producing the goods receive a fair wage. Managing your costs is only one way of making sure your organisation makes a profit. You must also sell your products and the price is a big part of this. We have also provided some information on the things you need to think about when setting your prices. Information If you want to keep control of your costs then it is important that you keep good records. If your business is small and straightforward then this can be quite an easy task. Perhaps you already have someone who helps you with your accounts; they can also help you here. If your organisation is large enough, you may already have someone who looks after your records. They will be able to help you calculate your costs. If you have any queries, questions or ideas for improvement about this guide then please contact Alistair Leadbetter at alistairl@traidcraft.org Costing & Pricing Page 5 of 50

6 02 Costs - the basics All organisations have costs. It doesn t matter if you are a business, a charity or a not-for profit organisation, you will always have to spend money. If you are not spending any money then it is very hard to do anything. You can t run your organisation without costs What are Costs A cost is something that you spend money on. That means that the money is used up and cannot be used for something else. Examples of costs are the wages and salaries that you pay to workers and staff, your electricity, the raw materials you use and your telephone calls. As you can see, these costs are very important to any organisation. It is useful to know what things you spend money on are costs and which aren t Not everything you spend money on is a cost. The important part of the definition is that the money or thing you bought is used up and cannot be used for something else. Costing & Pricing Page 6 of 50

7 To understand the difference, think about these two examples: 1. Imagine that you are making wooden toys. You have bought some wood. You cut the wood up into the shapes you need to make the toy. The wood has now been made into a toy. Now you can t use that wood to make something else it has been used up. The cost of the wood you have used is part of the cost of making the toy. 2. Imagine if you buy a motorcycle for your business. You hand over your money and you receive your motorcycle. You can now use your motorcycle every day and, if you look after it, you can use for many years to come. If you decide you no longer want the motorcycle, you can sell it and get some money back. In the first example, you have bought and used the wood and it cannot be used for anything else. In the second example, you have bought the motorcycle and you can keep using it for a long time. The motorcycle is not a cost. Information In the motorcycle example, the accounting term used to describe the motorcycle is a fixed asset. An asset is something that is worth something to your business. A fixed asset is an asset that cannot be easily turned into cash. Other examples of fixed assets are buildings and machinery. Costing & Pricing Page 7 of 50

8 So costs are things that you have spent money on that cannot be used for something else or used in a different way. They are things that you have spent money on that have been used up. Your turn As you can see, there are many different types of cost. Take some time to make a list of the costs that your business has. Some examples are wages and electricity There are different types of cost and you need to know which ones are which Types of Costs We have now seen what a cost is. Now we can look at how costs work and behave. If a cost is closely linked to the products that you make e.g. the raw materials then the total cost of raw materials used will increase as you make more products. If a cost is not closely linked to the products you make, e.g. your office rent, then the number of products you make has no direct impact on the amount you pay for rent. There are some terms for the different types of costs. We will now have a look at these costs: Direct Costs are the costs you have from making your products. Direct Costs Direct costs are costs that can be directly linked with the production and delivery of the good or service. Examples of the direct costs are your raw materials or the wages that you pay to the artisans. These costs are also called variable costs because they increase or decrease as your Costing & Pricing Page 8 of 50

9 production levels increase or decrease. To keep things simple, we will call these costs direct costs for the rest of this guide. Think about your raw material costs: if you make 100 products then your raw material costs will be more than if you only made 10 products. Have a look at the graph below. It shows how direct or variable costs behave as your volume (the amount you make) increases. Indirect costs are the costs you have from running the business but not from making your products. Indirect Costs Indirect costs are costs that are not directly linked to the production of your goods. An example is your bookkeeper s salary. As you know, the bookkeeper does not get involved in making your products. Indirect costs can often be called fixed costs because they are not linked to your production levels. Your bookkeeper s salary stays the same if you make 10 products, 100 products or even 1,000,000 products. These costs are often called overheads. Costing & Pricing Page 9 of 50

10 Have a look at the graph below. The cost stays the same no matter how many products you make. Information The idea of costs being fixed is only appropriate to a fairly short time period. You know that, in time, your rent will be increased by the landlord. This is only to be expected but it shows that the rent is not fixed, it is variable over time. Fixed-Variable Costs There is one more type of cost. This one is a little more complicated. It is a bit of a cross between direct and indirect costs. You can read more about it in Appendix 1 Fixed - Variable Costs You will need this information later Your turn Go back to your list of costs that you made earlier. For each cost, decide whether it is a fixed or variable cost. Costing & Pricing Page 10 of 50

11 03 Costing Your Products Use one of your own, more simple products as an example In this section we are going to look at a process you can follow to calculate how much it costs to make your different products. As we look at the process, you might find it useful to use one of your products as an example. Warning To calculate your costs you will need to have the records of what your organisation has spent. If you do not keep records of the money you spend and what you spend it on, you will not be able to work out how much it costs to make your products. Take time following the steps so that you understand them The process has two main stages: The first stage involves calculating the direct costs of making one of your products The second stage involves calculating your business s indirect costs and deciding on how much should be allocated to each product. Information Costing & Pricing Page 11 of 50

12 Remember: if your organisation is going to be sustainable then your income must be greater than your total costs. This means that all of your costs must be included when calculating cost prices. Costing & Pricing Page 12 of 50

13 Stage One Your Direct Costs As you now know, direct costs are the costs that can be directly linked to the making of your products. Common direct costs are the labour costs from making the products, the costs of the raw materials that have been used in making the product and any packaging that is used for packing the toy. Warning The packaging referred to here is the packaging that the toy is sold with rather than the packaging that is used when you transport the goods to the customer. You start managing costs before you have even started making the product Your Production Process The best time to work out how much it costs to make a product is when you are designing and developing it. This information will help you know whether you can sell the product for a price that is profitable for you and attractive to your customers. If your product is too expensive to make, then you can change the design or manufacturing process to reduce the costs. By understanding your production process, you can easily see what raw materials are needed and which people are involved at what stage. Costing & Pricing Page 13 of 50

14 For the rest of this guide, we are going to use the example of a small Indian crafts company called Dhoni Rural Crafts. They make pottery products. Don t worry if you don t know about pottery or India it s just an example. The examples can be applied to your business too. Diagrams are an easy way to communicate with many different people An easy way of understanding your production process is to draw a picture or diagram of how you make each product. You can show all of the different production stages and processes. The diagram below shows the process for making clay pots. You can see how each stage of the process is written in a box and that arrows link each stage. Idea If you don t like using boxes then you could draw pictures of each stage. Using pictures can make it easier for everyone in your organisation to take part and make a contribution. Costing & Pricing Page 14 of 50

15 Your turn Choose one of your products. While you are practicing it might be easiest at this point to choose a simple product. Draw a diagram of the production process that you need to follow to make one of these products. Slowly build up an accurate picture of what you are doing in your business and what costs are involved. Once you have drawn a picture of the production process, you can now start adding more information for each stage. The information that you need to add is: The raw materials that are needed The cost of the raw materials that you use The people (it is better to give the jobs or roles rather than give people s names) that are needed The time they spend at each stage The cost of their time Remember, the numbers that you give are for making just one item. It is not always easy to find these numbers. The next part of this guide will give you some ideas about how to do it. Raw materials can sometimes be a big investment. It is important you manage these costs. Raw Materials If you are making products, then you will be getting some raw materials from somewhere. Raw materials nearly always come at a cost. Even if the materials are free e.g. old plastic bags, you may still have to pay someone to collect them and bring them to you. Costing & Pricing Page 15 of 50

16 When you are working out your costs, you are making your calculations for how much it costs to make just one product. You need to calculate, for each different raw material that is used, the cost of the raw material used. Wastage can be a big problem. Analyse your production process to make sure wastage is kept to a minimum. An important part of calculating raw material costs is the amount of materials that are spoilt or thrown away. This cost is called wastage. Examples of wastage are: The cloth that is left after you have cut out the patterns for the clothes that are made The glasses that fail quality checks and are destroyed The clay that is thrown away when the pots are being shaped and finished The offcuts when you are cutting and shaping wood. These materials have all been paid for and used, so you need to consider their cost when calculating your cost prices. Warning Wastage can be a big part of your costs so it is important to reduce it as much as you can. Also think about how you can use the waste raw materials such as off-cuts in other products. Some raw materials can be very difficult to work out a cost for because the cost is so small. An example of such a cost is glue. If you are just using a small amount of glue in an item then you might not be able to calculate the Costing & Pricing Page 16 of 50

17 value per item. In these cases, it might be easier to think of this type of cost as an overhead. You will learn more about overheads later in this guide. Your turn Using the diagram you drew earlier; add the information about the raw materials, the amounts used and their cost. Labour costs are sometimes the biggest cost you have in your organisation. Labour Costs The next major direct cost is the cost of the wages or salaries that you pay to your staff. Remember, at this stage you are only interested in the wages of the people who are directly involved in making the products. Some businesses pay workers on a piece rate basis. This means that each worker is paid a certain amount for completing a certain task, such as making a pot. This makes it easy for you to work out how much you are paying for labour to make your products. Warning When you are calculating your piece rates, make sure that the amounts you are paying are enough for people to earn at least the minimum wage. Preferably they will earn more than that so that they can live on the wages that you pay. Costing & Pricing Page 17 of 50

18 We will use an example of a pottery business in this guide but the lessons can be applied to any type of business. If your staff and workers are paid per week or per month, then you need to work out how much it costs for the worker to make your products. To do this, you will need to do some mathematics. We will use the following example: Anup is paid 10,000 rupees per month. He works for 8 hours every day and works 26 days per month. He is currently has a job to make clay pots. It takes him 10 minutes to make each pot. How much does it cost to have Anup make a single pot? It is often easiest to perform these calculations in short steps First, we work out what Anup s daily wage is. To do this we divide his monthly wage by the number of days he works in a normal month. 10,000 rupees / 26 days = rupees We can calculate his hourly wage by dividing his daily wage by the number of hours that he works. His hourly wage is: rupees / 8 hours = rupees Sometimes you have to estimate numbers. People work at different rates so you often need to use an average or your best guess. If Anup takes 10 minutes to make each pot then he can make six pots each hour. To find out how much it costs for Anup to make each pot we divide his hourly rate by the number of pots he makes in an hour rupees / 6 per hour = 4.01 rupees for each pot. Your turn Using the diagram you drew earlier; add the information about the labour costs of each stage of production. Costing & Pricing Page 18 of 50

19 You may not have any other direct costs. Don t worry if you can t think of any Other Direct Costs There are other costs that you might want to include in your direct costs of production. An example of this is depreciation of any machines and equipment that is used. Information Depreciation is an accounting term. It refers to the estimated cost of owning fixed assets. Think about the motorcycle example from earlier. The longer you own and use your motorcycle, the less it is worth because it is getting worn out. Depreciation is the estimated value that the motorcycle loses every year. If you don t know the value of the direct costs, then you can count them as indirect costs. There is more about indirect costs later. There are some direct costs that are very hard to measure. Think about the electricity that powers your machinery. You have probably noticed that the electricity is expensive. It is very hard to say how much electricity is being used to power your machines and how much is being to power things such as your computers and lights. In cases like this it is very hard to separate the overheads from the direct costs of making your products. The solution is to treat the cost as an overhead. If you are able to accurately calculate any other direct costs then you should add these onto your diagram now, against the relevant production stage. An example of another direct cost might be the contracting out of work. Perhaps some of the production process is contracted out, such as painting or sanding. In this case, the price you are charged per piece needs to be included in your direct costs. Costing & Pricing Page 19 of 50

20 Warning If you contract out work to other businesses or workshops, you must make sure that the workers are also paid a fair wage. Calculating Your Total You should now have created a diagram of your production that shows all of your costs. You should now total all of the costs for each stage of production and then calculate the total for all stages. This is your total direct cost of producing a single item. Information You will notice that we haven t included any costs of selling the products once you have made them. Direct costs only relate to the production of the items and any subsequent packaging. The packaging is not packaging that you use when shipping the product, but the packaging that is used as part of the product presentation. Costing & Pricing Page 20 of 50

21 Summary So far you have learned a process for understanding your production process and for calculating the costs associated with it. The key stages are: Draw a diagram of your production process and show details of the labour, raw materials and other costs involved Include the costs of raw materials required at each stage Include the costs of the labour involved at each stage Include any other costs that you can accurately calculate Add them all together to find the total direct costs of making one unit of this type of product. Stage Two Your Indirect Costs You must aim to make a profit. If your costs are too high, then you must find savings. One of the reasons for working out how much your products cost to make is so that you know how much you should sell your products for. You know that a business should make a profit so you know that your total sales should be greater than your total costs. This tells us that we should think about all of the costs that a business has when we work out what our sales prices are going to be. In the previous section of this guide, you saw how to calculate your direct costs for making a single item. This next part of this guide will help you think about how to calculate your indirect costs for each item that you make. Costing & Pricing Page 21 of 50

22 Remember that indirect costs are those costs that your business has that cannot be directly linked to making your products. Examples of indirect costs are the bookkeeper s salary, your marketing costs and the electricity you use. In this stage of costing your products, we will look at some different ways that you can include these indirect costs in the total cost of making each of your products. Getting Prepared If you want to do your costing properly, then you will need to records of what you spend in running your organisation. Your accountant or bookkeeper will probably have these numbers readily available. If you don t have a bookkeeper already, perhaps think about hiring one part-time or having one of your existing workers trained. Managing your costs is something that you need to do all of the time. Information Once you understand how to cost your products, you will find it useful to have a system that allows you to easily calculate and check your cost prices on a regular basis. This helps you manage costs and lets you know if increasing costs in your business are affecting your profits. You might have to increase your prices, find cheaper supplies or change the way that you make your products. Costing & Pricing Page 22 of 50

23 Allocating Indirect Costs The process of taking your indirect costs and adding them on to the direct costs is called allocation. You are allocating a percentage of the indirect costs to each of your products. It is better to start simple when introducing new systems. We have provided two templates to help you calculate your indirect costs. There are a number of ways that you can allocate your indirect costs. They range from the very simple to the very complicated. The more complicated systems are also more accurate but require more work and time to get right. It might be easiest to start with the simple system and keep improving it. This guide will give you a very simple way of calculating the indirect costs that you can allocate to each product. It will then give you the theory for more complicated systems. It is your decision about how complicated you want to be. A Simple System You should always work with your most recent figures. To calculate this, you will need a list of all of your costs. Earlier on in this guide, there was an exercise where you had to look at all of your costs and decide which ones were direct costs and which ones were indirect. You need to return to this list and get the most recent values for the costs. The best place to look might be in your most recent annual accounts. The person who prepares these reports will have prepared a report called a trial balance. Costing & Pricing Page 23 of 50

24 Information A trial balance is a report that shows the balances on all of your accounts at a certain point in time. Your bookkeeper or accountant will be able to help you identify which items are direct costs and which are indirect costs. Information There are many different types of accounts on a trial balance such as sales, bank accounts, your debtors etc. Don t worry if you are not including all of the accounts. You just need to make sure that you include all of the costs. Follow the process carefully. You will soon see how the system works. This system is based multiplying your direct costs by a number to give you an estimate of the total costs of making each product. The basic stages are: Calculate your total direct costs, your total indirect costs and your total costs Find out how many times larger your total costs are than your direct costs For each product, increase the direct costs to include all of your other business costs Costing & Pricing Page 24 of 50

25 The first stage is to calculate your total direct costs, your total indirect costs and your total costs You need to add up all of the direct costs and all of the indirect costs that you have. You should now add them together so that you have a value for total costs. You should have three totals: 1. Total Direct Costs 2. Total Indirect Costs 3. Total Costs For example, imagine that your total direct costs were $10,000 and your total indirect costs were $50,000. Your total costs are therefore $10,000 + $50,000 = $60,000 Now you can calculate how many times greater your total costs are than your direct costs You can now do this calculation: Total Costs / Total Direct Costs This tells you how much greater the total costs are than the direct costs. The total costs should always be greater than the total direct costs. Using our example, divide 60,000 by 10,000 $60,000 / $10,000 = 6 We now know that our total costs are six times greater than our direct costs. This tells us that, if we increase the direct costs for each product by this number, we have a good estimate for the total cost of making each product. Costing & Pricing Page 25 of 50

26 You will need to multiply the direct costs for making each of your products by the number you calculate. A spreadsheet can be very useful here. To work out the total estimated cost of each product, multiply the product s direct cost by the result of our calculation. Think about our clay pots and the total direct cost for making a medium blue pot is $2. 2 multiplied by 6 = $12 Our estimated total cost for making the medium blue bowl is $12. We can guess that if we sell the pot for more than $12 we should make a profit. This method is quite simple to calculate and gives you an estimate of what the total cost is. It is not very accurate though and does not really show how you spend your money. As you know, your costs change quite regularly. It is a very good idea to create a spreadsheet so you can quickly and easily check your estimate on a regular basis. Costing & Pricing Page 26 of 50

27 A More Advanced System This system is slightly more competitive but, if you go slowly, you will be OK! You saw in the above example how multiplied the direct costs for each product by a number to estimate the total cost is for making a single item of each product. In the more complicated systems, you try to divide up the indirect costs between the products you make more accurately. To do this you will need more information about your business. This system is more realistic. It allocates costs to the products which have taken up most resources such as time. The more complicated systems try to be fairer about how the indirect costs are divided between your products. For example, you work in a business where there are three products. You spend 50% of your time making product 1, 30% of your time making product 2 and 20% of your time making product 3. Is it fair to divide the costs between the products equally or should it be done another way, perhaps to show that we spend most of our time on product 1? We need to choose the basis on which we share out the costs between the products. There are many different ways we can use to divide up costs between products. Here are some examples: As you use the system more, you will see which ways are best for allocating different costs. The total number of hours spent making each of the different products Total numbers of units produced The total numbers of orders placed or shipped for different products The amount of storage space that the products take up Costing & Pricing Page 27 of 50

28 As you can probably see, some of the ways are more appropriate to some costs than others. The two most popular ways of dividing up your overhead costs are the first two in the list; the total hours spent making the goods and the total number of units produced. Information As you might have guessed, you will need some more information to use these more advanced systems. You will need to know the total hours that have been spent making each of your different products or the total numbers of units that you have produced. If you have done your calculation of direct costs accurately then you will know how many hours or minutes go into making each of your products. Your records should tell you how many of each product you have made. Have a look at this example: Notice how some information that we use is from plans and some is from historical information. As you know, Dhoni Rural Crafts make pottery. The three products (with their direct costs are): Product Direct Costs Blue Bowl $1.75 Red Jug $1.54 Green Mug $1.02 This year, they plan to spend 15,000 hours making 20,000 bowls, 10,000 hours making 25,000 jugs and 5,000 hours making 40,000 mugs. Costing & Pricing Page 28 of 50

29 They have created a budget always a good idea! Dhoni Rural Crafts think that their total annual overheads (their indirect costs) will be $50,000 Warning When you are collecting the data, you must make sure that the numbers are up to date and that they are all for the same period of time. Dhoni are going to divide their indirect costs between their products based on how much time they spend making the products. The total time spent making pottery is 30,000 hours. We can now find out how is spent in indirect costs for every hour we spend making products. Use this calculation: Cost of Overheads divided by the Number of Hours Spent making Pottery: $50,000 / 30,000 hours = 1.67 Dhoni Rural Crafts spend $1.67 of indirect costs for every hour spent making products. We spend half of our time making bowls so it seems fair that we should add half of the overheads to the costs of making the bowls If we multiply the hours making the different products by $1.67 we can see how much of the overheads are going to be allocated to each of the products: Blue bowl 15,000 * $1.67 = $25,050 Red jug 10,000 * $1.67 = $16,700 Green mug 5,000 * $1.67 = $8,350 Costing & Pricing Page 29 of 50

30 Warning You will notice that the total allocated is actually $50,100. This is due to rounding in the numbers when I calculated overhead cost per labour hour. If you use a spreadsheet to calculate your numbers then you will avoid this sort of problem because you can be more accurate. Now we divide the overheads between the individual products Now that we have these numbers, we can calculate how much of our overheads need to be added onto the direct cost of each product. We need to divide the amount of overheads per product by the number of products made. Blue bowl $25,050 / 20,000 = $1.25 Red jug $16,700 / 25,000 = $0.67 Green mug $8,350 / 40,000 = $0.21 Now we can calculate the total cost for each product This tells us that we need to add $1.25 to the direct costs for making a bowl, $0.67 to the direct costs for making a jug and $0.21 to the direct costs of making a mug. Product Total Costs Blue Bowl $ $1.25 = $3.00 Red Jug $ $0.67 = $2.21 Green Mug $ $0.21 = $1.23 Costing & Pricing Page 30 of 50

31 We now know the total costs for making each of our products. As long as the sales price for each product is greater than the cost price, you can expect to make a profit. Information We have written a spreadsheet called Advanced Total Cost Spreadsheet which you can use to help you calculate these costs Summarising Your Costs It can be useful for you to write down how much it will cost you to make each the different product types that you have. Transparency is an important part of the fair trade system. Your customers will also be keen to see how much it costs you to make your products. They like to be sure that the prices they pay allow you to pay a fair wage to your staff and workers and that you make enough profit. The summary sheet on the next page is a template you can use to help you summarise the costs you have when you make your products. You will see that you have found all of these numbers while going through the earlier exercises. Costing & Pricing Page 31 of 50

32 Simple Product Costing For each product, summarise: All of the different tasks that are involved in making the product, how long is spent on each and what the unit price per task is The various raw materials that you use and how much they cost per unit Any other costs that are involved in making the product (direct costs) The value of overheads that you allocate to each item When you think about the costs, please do it as if you were making a single unit of the product. Your Company Name: Name of the Product: Labour Costs Task Time Spent Pay per Unit Raw Materials Description Cost Other Costs Description Cost Total Overheads Description Total Overheads Cost Total Cost Costing & Pricing Page 32 of 50

33 04 Reducing Costs Managing costs is an important part of running any enterprise. Now that you are thinking more about costs and you have started to look at the different costs in your business, you can start to manage costs. By controlling your costs, you can increase profits and afford to pay artisans and workers more. Here are some examples of ways in which you can reduce your business costs and increase profits. At the same time, there is no impact on your product s quality and you can improve customer satisfaction! Your product design is the place where you can most easily reduce costs of production. Design Modifications Design can play an important role in your overall profits and also in the earnings of the artisan. Sometimes you can make seemingly small changes to the design of a product and, at the same time, make substantial changes to the artisan s overall earnings. Here are a couple of examples to illustrate how this works. Example: An artisan group from Guatemala was producing scarves for the export market. Each scarf was taking 9 hours to weave. When the labour information for the scarf was Costing & Pricing Page 33 of 50

34 The value of analysing your production process can be seen here analysed (using the Fair Wage Guide, see the Useful Links section at the end of this document), the artisans were earning below in Guatemala s minimum wage standard. The production process was looked at and it was found that the hand knotting on the bottom of the scarf was taking several hours and wasn t adding much value to the market price of the item. The decision was made to reduce the knotting from six inches to one inch. This also decreased the production time by about three hours, which meant that more scarves can be made. When the labour information was analysed following the design modification, the wages paid were now well above Guatemalan s minimum wage. Example Below are photos of two different coin pouches. The first is the original sample from a group in India and the second is the modified design. As you can see, the designers modified the product by decreasing the beading and also increasing the pouch size slightly. These design modifications decreased the labour time for the artisan and decreased material costs. Costing & Pricing Page 34 of 50

35 Production Efficiencies Another way to increase earnings is to find production efficiencies that can help to decrease the labour time. Example: As you can see, using technology can really help in improving efficiency and quality without taking away people s work or losing the traditional nature of your products. A Guatemalan organisation produces hand-made jewellery for the export market. Unfortunately the price was unsustainable in the market the bracelets and necklaces were too expensive, and the partner could not decrease the price of the jewellery because this would reduce the artisan s wages to well below the legal minimum wage. The importer decided to visit the group and find out why the price was so high. During the visit, they realized very quickly that the artisans were using regular needles instead of beading needles to make the necklaces. The partner immediately purchased beading needles for the group. This minor change dramatically decreased the labour time. This allowed the partner to decrease the cost of the jewellery to make it sustainable in the market without decreasing the artisans wages. The technology doesn t have to be advanced; people often just need the right tools for the work they are doing. Sometimes you have to be creative to find ways to increase artisans wages. Design modifications and finding Costing & Pricing Page 35 of 50

36 efficiencies in the production process are two methods that can be useful. These methods may not always work, but they can provide valuable information as you look at creating sustainable products. Managing Quality Maintaining high quality standards is a great way to reduce costs and improve efficiency For many businesses, not finding quality problems until it s too late is a major cost. Here s a question: When is it cheapest to find quality problems? Answer: It is cheapest to avoid the mistakes. Unfortunately, mistakes do happen. It is best to work to reduce the mistakes and find any that do happen as soon as possible. Don t waste money and time finishing products that have already gone wrong Imagine the process that you follow in making your own products. If you only check the quality of your products at the end of the production process and the problem was created at the start then there has been a lot of wasted effort and materials. Have a look at the graph below. The line shows the total cost in making a product. As you would guess, the cost rises as the item is made. This is because you have to pay people to do more and more work and you use more and more materials. If you had found the problem straight away, you would have reduced the costs of the mistake. Costing & Pricing Page 36 of 50

37 Here are some steps that can help you improve quality and reduce the costs of bad quality. Check the deliveries of raw materials when they are delivered. Do not accept any raw materials that are of poor quality Store your raw materials carefully. Don t waste money by buying good stock and letting it spoil before you can use it. Make sure your artisans understand each product that you are making, what it should look like and the quality standards you expect. Have a respected and skilled person check the quality of work and help the artisans to improve the quality of their work Introduce a quality check at every stage of production to prevent bad quality items having more work being done on them. Artisans should check their raw materials before starting work and should check their completed work Costing & Pricing Page 37 of 50

38 before passing it on to the next stage. Do not send anything of poor quality to your customers. This wastes money on transport and also impacts on customer satisfaction. Analyse the quality problems that you have and look at the areas where most problems occur. How can you solve these problems? Can you train people better, use different techniques, change the product design or change the production process? Reducing Wastage Wastage is the technical word for the raw materials and labour that are wasted during the production process. Examples of wastage are the pieces of cloth or wood that are left over after you have cut out the patterns you need. Waste might also include the water that you use and then pour away. Reducing waste is good for your organisation because it means that you are throwing less away (and remember that your organisation has paid for those things that are being thrown away. Reducing waste is also good for the environment Here are some ideas to help you think about how you can reduce waste in your organisation and reduce your costs: Analyse your production process and see where most of the wastage occurs. Use this information to identify where you should target your efforts. See if you can calculate the cost of wastage, remembering to think about the cost of raw materials and labour that is included in what is being thrown away. You could also include the cost of having to remake replacement items or having to deal with Costing & Pricing Page 38 of 50

39 customer complaints. This will you help you set some targets for reducing waste. Talk to your artisans, workers, supervisors and managers. Where do they see the waste occurring? What changes would they make? What can you do to reuse scrap? Can you make other products? How can you reduce scrap? Can you cut out patterns from the cloth or wood in a way that would reduce these costs? Help everyone in your business to understand the problem of waste and show them how they can be part of the solution. Why not have a competition for ideas to reduce waste? Look at how you pack your products. Packaging is a great source of waste. How can you reduce the packaging while also keeping your products well protected? Shipping & Transport Think about all the costs involved in getting your products to your customers and try to reduce them all. A major cost for craft businesses can be shipping the products to your customers. Here are a couple of good ideas to help you make the most of your container and to reduce your transport costs per item: Take care in packing your container to ensure that you can fit as much as possible in. The more empty space there is in your container, the higher the transport cost per item. Work with other organisations to share container space. It maybe that your orders are not big enough to fill a container. If you work with other organisations Costing & Pricing Page 39 of 50

40 you can still fill the container and share the cost. Manage Your Tax You can save a lot of money by keeping control of your finances and that includes tax. Tax is a very boring topic in every country of the world. It can also be very expensive. Make sure that you are managing your tax well so that you are not paying more than you have to. In some countries you can reclaim tax on exports and find other tax benefits that are available to small businesses. Make sure that you are not missing out. Tax accountants might seem expensive but they can save you more money than they cost. It is important that you keep control of your costs. This is an important part of keeping your prices down and making sure that your organisation is profitable and sustainable. You can also start controlling your enterprise and stop it controlling you Costing & Pricing Page 40 of 50

41 05 Setting Your Sales Prices Pricing is the term given to the process of setting your prices. Pricing is very important because it has a big influence on whether you sell any of your products and how much profit you make. The complicated ideas about pricing tend to be used by very large businesses. Pricing has become a very complicated world and there are many different ideas about strategies and choices. Many of these ideas are beyond the scope of this guide. Once you have started to understand your prices you may want to do some more work on your own. You now know how much it costs to make your products so you re on your way! The first point to make is that your organisation needs to bring in more money from sales than you have going out in costs. Therefore your sales prices for the things that you sell must be higher than the costs of making them. The difference between income and costs is your profit. Profit is good. Making a Profit It is easy to say that you must make more money from sales than you spend on costs. It is harder to say how much profit you should make. Costing & Pricing Page 41 of 50

42 Warning Some fair trade organisations get very nervous about profit. It is seen as a bad word. All organisations that trade must make a profit. Without profit, an organisation cannot deliver its mission. To answer these questions you need to analyse what your organisation is hoping to achieve and start to plan for the future. It is up to the organisation s managers to decide on how much profit to make but they should consider: How much money is needed for the future growth and expansion of the organisation? How much money is needed for investment in replacement machinery and equipment? How much money is needed to invest in the training and development of staff How much money is needed to be held in reserve to protect your organisation against future problems such as customers not paying or the economy being difficult These are not easy questions to answer but it is important to make sure that money is put aside for these things. All businesses need to find new customers. You can t rely on your current customers being there forever. Market research will help you understand markets and find new opportunities. Thinking about the Market It is one thing to set a price based on what your costs are and how much profit you want to make but you also have to think about what is going on the market. Your customers will probably have a number of options about where they buy their products from. Think about Dhoni Rural Crafts. There are many pottery companies, all over the world and all of them can make mugs, jugs and Costing & Pricing Page 42 of 50

43 bowls. By keeping an eye on who your customers are, what products they are offering and what the prices are for products similar to yours, you can make sure your products are competitively priced. Idea Take time to research the market and watch your competitors are doing. What are the products that are selling well and what are the trends in the countries where you sell your products? You have to do market research but it doesn t have to be expensive. For simple products, it is often the case that you are competing mainly on price. The levels of service and quality that you offer to customers will help convince them to buy from you, but price is very important. Customers make decisions based on many factors. Price isn t always the most important but it does tell people a lot about the products. What does the price tell the customer? If you are competing on price, remember not keep reducing your price. Products that are too cheap can make customers very nervous. Think about your own experiences. If you decide to go shopping and you see a product that is very, very cheap what do you think? Do you think Wow! There s a bargain or do you think That s surprising. Why is the product so cheap? What s wrong with it? The same goes for products that seem very expensive. Potential customers look for what justifies the high price. The product must offer something special, something that Costing & Pricing Page 43 of 50

44 makes it worth paying that extra money. If the value is clear then they might buy your product. If not, they will choose a different product. Idea Make sure that you understand your product and where it fits in the market. Its price must compete well with other products like it in the market. When you are looking at the market and competition, keep an eye on the prices. Now that you know how much your products cost to make and now you know how much products like yours are sold for, what do you do? If the market price is higher than your cost price and you can make a good profit then great! Start selling! It s not always that easy though what can you do if your cost price is higher than the price you can sell your products for? There are two things that you need to look at: 1. Reducing the costs you have in your business [have a look at some of the ideas above for reducing waste and improving quality] 2. Increasing the value that customers see in your products. Adding Value When you add value to your products, it means that you increase the value that customers see in what you have to sell. The idea is that your product is made to look more Costing & Pricing Page 44 of 50

45 interesting and valuable than your competitors products and at little cost to yourself. Here are some ideas that you can use or adapt to make your product worth more: Packaging & Presentation: Think about how you can make your products appear more valuable and attractive by the way that that they are presented. Would an attractive box or a cloth bag make the product look more interesting? Labels and Stories: Many of the products in the world of fair trade have a story behind them. By attaching a label that introduces the person or people involved in making the product, you can give the product an identity that customers find interesting. You are on the way to building a relationship with the customer and that s a great way for getting repeat sales. Sell Products Together: By designing products as part of a range and then selling products together, you can provide customers with a more complete product offering. E.g. by selling a matching necklace, earrings and ring you can encourage customers to buy more. You can keep building on some ranges to keep customers coming back for more such as ranges of pottery. Think about the products that you have and how they can be sold together to create bundles of products, perhaps as gift sets. Offer Guarantees: Offer guarantees such as Money Back if not 100% Satisfied to encourage customers to buy from you. If customers have not bought from you before, then there may be some resistance that you need to overcome. A guarantee can give that reassurance. Costing & Pricing Page 45 of 50

46 Dedicate Staff to Look After Your Customers: If you are selling to retailers, let the retailer the name and the direct line of the person who will handle any queries or questions about their orders. Then make sure that that person is always available to handle calls and s. Think about making sure that the person is in the office when your customers are in theirs. Service is a difficult feature to sell until customers have experienced it but it can make a difference when they decide whether to come back. Discounts When you are setting prices, it can be useful to set prices according to the quantities that people buy. If people place large orders then you can encourage them to buy by offering discounts. Even if you don t publicise the discounts you should be ready to negotiate as buyers will often expect it and it always looks better if you are prepared. Negotiation You should always be ready to negotiate on price. This is common practice in business and you should be prepared for it. One common reason for negotiating is discounting prices based on the quantity bought, but people may just want to negotiate anyway. You should be aware of how much your products cost to make. Therefore you know that that s your minimum price. Your business probably can t afford to make many sales that bring in zero profit so it is always best to make some profit. Costing & Pricing Page 46 of 50

47 Warning Some businesses have what they call loss leaders. These are products they sell at a loss to encourage customers into their stores to buy other, more profitable items. The total profits cover the losses from the loss leader products so it doesn t matter. This is a risky strategy when you are not selling through your own shops. You need to decide what markets you are trying to sell to and then work out what your marketing strategy is. This strategy will require you to understand your customers and your competitors and what prices are being paid in the market. You can then set your prices and start selling! Costing & Pricing Page 47 of 50

48 06 - Useful Links Here are some useful sites on the internet that can help you further The Fair Wage Guide is a very useful tool that you can use to help calculate costs and make sure that the artisan is being paid a fair wage for their labour. You will also get access to the minimum and poverty level wage information for where you live. If you are interested in improving quality, then a good place to start is the Chartered Quality Institute. They have a wide variety of tools and resources that you can use. Business Link is a UK government project with a lot of great information about running a business. The link is to Pricing, but there s other good information available &r.l2= &r.s=tl&topicId= Costing & Pricing Page 48 of 50