Editions   North America | Europe | Magazine

WhatTheyThink

Premium Commentary & Analysis

The Five Steps to Managing Pricing—Part 2

If you are struggling with setting prices or trying to decide when it’s time to change prices, Pat McGrew offers some starting points with this two-part series on five steps for managing pricing. This second part involves looking not just as the products you sell, but the services, too, and then reviewing and executing your pricing plan.

PREMIUM CONTENT

Our mission is to provide cogent commentary and analysis about trends, technologies, operations, and events in all the markets that comprise today’s printing industry. Support our mission and read articles like this with a Premium Membership.

TO READ THE FULL ARTICLE

About Pat McGrew

Pat is a well-known evangelist for inkjet productivity. At McGrew Group, she uses her decades technical and marketing experience to lead the industry toward optimized business processes and production workflows. She has helped companies to define their five-year plans, audited workflow processes, and developed sales team interventions and education programs. Pat is the Co-Author of 8 industry books, editor of A Guide to the Electronic Document Body of Knowledge, and a regular contributor to Inkjet Insight and WhatTheyThink.com.

Discussion

By Robert Lindgren on Jul 27, 2021

Pat...
Much of what you're saying is interesting and useful. It could even more valuable if your focus moved from "margin" to "contribution." Margin is the difference between cost defined by a series of necessarily arbitrary assumptions and revenue. Contribution is simply the difference between the dollars actually expended to produce a job and the sales dollars from it.

Zeroing in on contribution enables one to grasp the reality of the situation, to see the impact on increased volume and the impact of pricing changes. It also enables to grasp the reality of where we in our business journey as we can easily keep track of contribution dollars and compare them with the total overhead dollars for the month or year. When contribution dollars exceed overhead dollars for the period, we're in profit land.

 

By Robert Godwin on Jul 28, 2021

Contribution margins are specific to a job. This pretty much assumes that these jobs must be indvidually quoted. It is gross margin that is the metric for the profitability of a business. With PSPs either using or considering an online upload and print solution, it will be fixed pricing and gross margin that are the metrics of vale. Hybrid operations (using both W2P and custom fabrication) revenue channels must be sharp about how they price products in both manufacturing workflows. Many PSPs are challenged by this 'requirement' of business management.

 

By Robert Lindgren on Jul 28, 2021

Robert...

How do you define "gross margin" and how does it differ from "contribution" which is the difference between the sales revenue from a transaction and the incremental amount spent to produce the project?

 

By Robert Godwin on Jul 28, 2021

Contribution is more a measure of a specifc product being produced and materials (goods) used to create it. E.G., you might use this metric to compare running a job on digital vs litho; variable costs being the issue in this example based on quanitity run. Gross margin is more a metric used to see how a company is doing overall. Both are important, but must be used with the knowledge of what is being measured and how to interpret those numbers. A lot of PSPs have minmla understanding of this process. That makes it a challenge to pivot to a new product line such as W2P.

 

By Robert Lindgren on Jul 28, 2021

Robert...

It seems to me that the ultimate reality is the difference between what the printer will get for producing the work (the invoice) and the amount actually expended to produce the work. That difference if the contribution. If the contribution is sufficient to cover the overhead (fixed costs) for a time period, profit is achieved in that time period.

Isn't this the ultimate measure of how the firm is doing overall? If it's not, please help understand your position.

 

By Robert Godwin on Jul 29, 2021

Well, sure. if there is money in the till at the end of the day... Contribution is so order specific it is useful mainly for 'that' job, and only 'that' job. Contribution doesn't provide enough data to assess the health of a company overall. Both metrics, gross margin and contribution are important.
More to the point I am interested in, Gross margins allow a business manager to assess the more valuable products a PSP produces and which equipment delvers the greatest potential for growth. If you will, contribution is a micro assessment, Gross margin is a macro view.
For a small shop with a single output device, contribution likely matched gross margin. For larger operations thatoffer a range products, manuel workflows and automated workflows, both metrics must be considered. Make sense?

 

By Robert Lindgren on Jul 29, 2021

Robert...

There's no doubt that contribution is a job by job measure. But, aren't the results from any particular line of business simply the sum of the contributions from that line?

My problem is that since you've still not defined "gross margin," I still can't understand why it's different and more useful than contribution.

 

By Robert Godwin on Jul 29, 2021

Robert, This is the best I can do without going back to grad school and getting a Phd. Formulae:
Expressed as a percent: Gross Margin = (Total Revenue – Cost of Goods Sold)/Total Revenue x 100
Gross Margin = Revenue – Cost of Goods Sold
The Gross (profit) Margin shows the income after paying direct expenses related to manufacturing a product or providing a service. It represents the portion of each dollar of revenue that the company retains as gross profit.
According to INC.COM, printing does not even register in the top 15 for net profit margins. So, knowing the gross profit margin can help making a business more efficient by identifying the processes reducing the gross (profit) margin to the lower net (profit) margin. The delta from gross to net should always be reviewed. This is critical for SMB's. If you are going to sell your company or buy another, gross margin is important to review.
For PSP's this information is used to determine what equipment to buy or skilled labor to add. If printing on a digital output device delivers 20% gross margin, and production design service delivers 50% gross margin, the choice on where investment needs to be made would be based on studying the gross margins vs. the net profit. Contribution on a job that was sold at higher-than-average price, while good, could skew the assessment of overall profitability.

 

By Robert Lindgren on Jul 29, 2021

Robert....

Thanks for that response, but I have two further questions. Does Cost of Goods Sold include fixed overhead costs? Could share a simple numerical example of how your formula works as your verbal description is unclear to me?

 

By Robert Godwin on Jul 29, 2021

I am closing out the month so I have limited. I will get something posted by tomorrow. Anything I presnet with numbers will be a model for obvious reasons

 

By Robert Godwin on Jul 29, 2021

I should have done this to start with with. LOL. They explained more simply than I did.

https://www.accountingcoach.com/blog/gross-margin-contribution-margin
What is the difference between gross margin and contribution margin?
Definition of Gross Margin
Some use the term gross margin to mean the same as gross profit, which is: net sales minus the cost of goods sold. Others use the term gross margin to indicate the gross profit as a percentage of net sales.

The cost of goods sold will consist of both fixed and variable product costs. However, selling, general and administrative expenses (SG&A) are not part of the cost of goods sold.

Definition of Contribution Margin
Contribution margin is defined as net sales minus both the variable product costs and the variable SG&A expenses. The contribution margin can also be expressed as a percentage of net sales. In that case it is often described as the contribution margin ratio.

Information for Examples
Let's assume that a company had the following amounts during the past year:

Net sales of $600,000
Cost of goods sold of $320,000 ($120,000 variable + $200,000 of fixed)
Inventories did not increase or decrease
SG&A expenses of $190,000 ($40,000 variable + $150,000 fixed)
Example of Gross Margin
The company's gross margin is: net sales of $600,000 minus the cost of goods sold of $320,000 = $280,000. The gross margin or gross profit percentage is: gross profit of $280,000 divided by net sales of $600,000 = 46.7%.

Example of Contribution Margin
The company's contribution margin is: net sales of $600,000 minus the variable product costs of $120,000 and the variable expenses of $40,000 = $440,000. The contribution margin ratio is 73.3% ($440,000 divided by $600,000).

 

By Robert Lindgren on Jul 29, 2021

Robert...

Thanks for the extended definition--that helps a lot! The problem I have with gross margin is the inclusion of fixed cost. It's not that fixed cost doesn't exist or that it isn't important it's that including it with variable cost assumes that fixed is variable, i.e. if we produce more the rent on the building becomes higher.

That why it seems to me the contribution is the key as it doesn't mix apples and oranges. We do another job or expand a line of business more contribution is produced which pays for the overhead which doesn't change. If we contemplate an action which will expand the overhead, we project the likely incremental overhead cost and see whether the resulting contribution dollars will cover it.

 

By Ken Marks on Aug 06, 2021

The Markins Group published a good guide that explains this topic in detail

"The Insomniac Converter's Handbook - Machine Hour Rates and Profit Planning Fundamentals"

Contribution = Revenue – Variable Cost
Profit = Contribution – Fixed Cost
CF = Contribution ÷ Revenue

 

By Robert Lindgren on Aug 06, 2021

These three formulas are quite useful.

A lot of this discussion becomes confused by folks who want to define profit on at the job level basis (or the business line level). Profit is only rationally definable on an enterprise basis. Thus, profit equals enterprise contribution minus enterprise fixed cost.

 

Discussion

Join the discussion Sign In or Become a Member, doing so is simple and free