Pricing is one of the most critical functions in any graphic communications company. Managers, estimators, and other employees in graphic communications firms around the world make thousands of pricing decisions every business day. The pricing process normally begins with the preparation of an estimate of the costs that the company will incur to produce a prospective job, and most companies set asking prices by applying a standard mark-up to estimated job costs. Once a company communicates its proposed price to a prospective buyer, market forces enter the picture. Today, graphic communications companies find themselves competing more and more with firms that use low prices to win business, and managers must contend with savvy customers who insist they can obtain lower prices from other printing companies. In the face of these competitive pressures, managers must decide whether, or by how much, to reduce their asking prices to get the work.

Many graphic communications companies have used some form of cost-plus pricing for decades. One major problem with this pricing system relates to the way firms calculate the estimated costs of prospective jobs. In order to make sound pricing decisions, managers must understand the economic consequences of those decisions. More specifically, when a manager is deciding whether or not to sell a job at a particular price, he or she must be able to accurately predict whether making that sale will increase or reduce company profits. Therefore, to support sound pricing decisions, a company’s cost estimating system must accurately portray how a prospective job will cause cost levels to change and how a particular selling price will impact bottom-line profitability. Today, most commercial printing companies use cost estimating systems based on budgeted hourly cost rates, or BHR’s. Unfortunately, BHR-based estimating systems are incapable of satisfying this basic requirement for rational pricing.

A traditional BHR estimating system has two structural flaws that create pricing problems. The first flaw is that BHR estimating systems treat all operating expenses as variable costs when, in reality, the vast majority of operating expenses in a modern graphic communications company are fixed costs. BHR systems assign fixed operating expenses to prospective jobs in a two-step process. In the first step, fixed operating expenses are allocated to direct production cost centers, and production work activities are linked to each cost center. In the second step, fixed operating expenses are allocated to prospective jobs based on the volume of work activities that each job will require. By allocating fixed operating expenses in this manner, BHR estimating systems essentially treat these fixed expenses as if they are variable production costs. This costing approach impairs managers’ ability to make sound pricing decisions because it presents a distorted view of cost dynamics at the company level. BHR systems do not accurately portray how a company actually incurs operating expenses or how those expenses change (or don’t change) as a result of producing jobs. Therefore, a typical BHR estimating system cannot enable managers to predict the bottom-line profit impact of their pricing decisions.