Are manufacturers accidentally overpricing easy jobs and underpricing the headaches? The traditional pricing model can often hide the true cost of complexity.
Frame and truss manufacturers commonly use this method to price components.
(Materials + Wastage + Labour + Overheads) x Markup = Sell Price
The profit is based on the combination of
A. The amount of material used in the job, and
B. The complexity of manufacturing the components required.
Using the above model, two truss jobs covering the same floor area, that are similarly priced, may not require the same amount of manufacturing effort. Profit dollars are not directly correlated with manufacturing effort.
Manufacturers can tackle this pricing inconsistency by manipulating the markup of those jobs, but that would require manager or owner oversight of all outgoing quotes. Unfortunately, that doesn’t scale.
Materials carry a cost, but the value a manufacturer provides to its customers is in the conversion of those materials into engineered building components. Here is a pricing model that captures that value creation with more transparency.
(Materials + Wastage) + ((Labour + Overheads) x Markup) = Sell Price
In this model, profit comes from the labour and overheads only. This creates a direct correlation between profit dollars and manufacturing effort
Just as an aside, I’m not saying that manufacturers should make less profit overall, just that the allocation of that profit could be more effectively spread. Pricing using the value added markup model above will generally mean the markup percentage is higher than the traditional model.
So what’s to be gained from adopting the value added markup model?
Material cost is not a proxy for complexity
the traditional pricing model assumes that material cost scales 1:1 with complexity, It is viewed as the same as labour cost. This isn’t the case. A large span, high pitch gable roof might contain significantly more timber than a smaller, complex roof with raised heels, box gutters and hip ends. This smaller, more complex job will take significantly more effort to manufacture.
You can see that using the traditional pricing model, price and profit is only loosely correlated with effort.
It improves job mix
Applying markup the traditional way and without manipulating markup percentage, manufacturers will overprice simple, high throughput jobs that move through the factory cleanly. Small, complex jobs will be underpriced, simply because the job uses smaller amounts of timber.
This has a compounding effect. It can attract unwanted long term clients that do work which might not utilise manufacturers resources in the best possible way. Applying markup to labour only means that simple jobs become more competitive, and complex jobs are priced appropriately. The price of a job more accurately aligns with the effort involved.
Price matching
The value added markup model gives manufacturers more visibility to the costs associated with matching a competitors price on a quoted job.
By removing the cost of materials from the competitors sell price manufacturers can easily work out how much they have left to account for labour and the markup associated with it.
While it doesn’t make the decision for them, the numbers are explicit and easy to work out with generic reports generated from the detailing program.
Limitations
The value added markup model is not without its constraints, after all, it is not a panacea!
Manufacturers need to have accurate labour costings with up to date timing data, and overhead allocation needs to be spot on.
While the new model applies markup only to labour, wastage still needs to be applied to the materials. factory workers will still grab a longer piece of timber than they were supposed to if it was easier to get, or if it was stacked in the wrong place.
The value added markup model also differs from the industry norm traditional pricing model significantly, so benchmarking with competitors can be difficult.
And most importantly, the market still sets the price. Builders compare the final price, not the pricing structure.
The traditional pricing model ties profit partly to material costs, while the value added model ties profit directly to effort. This can change how jobs get evaluated, what jobs you win, and how the factory performs.
More timber doesn’t always mean more effort, pricing models that assume it does can distort outcomes. aligning profit with effort produces consistent pricing that scales with the business and workloads that better reflect the production lines capacity.
Thanks for tuning in this week, I’ll be exploring this model of pricing a little more in the future as I think it bears more weight than I have talked about here. Get subscribed to make sure you don’t miss it when it comes out!
Cheers,
Ryan
