Out of the Crisis.Org

[Louis Altazan]

Not many people like the aspect of raising their prices, thought sometimes it is necessary. I feel prices should NOT be capriciously raised as a “fix-all” for low profit. Rather the responsibility of the shop is to contain the cost it can and work to lower the cost of production.

Gauging when a price increase is merited and when internal improvement is a better avenue is not always simple. Many people have used gross-contribution [sales minus cost of sales] and net profit as a gauge. For instance if gross contribution remains constant yet net profit falls, a price increase might be warranted.

I feel a shortcoming of this method is, a strict observation of what is cost of sales and what is expenses. For instance sales have cost associated with them. With parts sales, clearly the cost of the part. There are also the administrative time in procuring and returning parts. With service sales, the technician’s wages are certainly cost. In my opinion, so too or administrative wages, service writers and manager’s salary.

I find it also important to consider every employee of the company that draws a paycheck, including the owner, and not just production staff, as cost of sales. Viewed over time this figure can be very revealing. To me the specific number for a particular business is not as important as continual improvement over time.

For instance if the company does $1.4M in annual sales and has 7 employees, sales per employee are $200,000.00. If another service writer is added, and sales rise to $1.5M, sales per employee are now $187,500.00. I feel this indicates the cost of production has risen. A price increase would be the improper remedy, in my opinion.

If the business with seven employees operates at 19% net profit [my definition: the amount taxes are paid on] that’s $38,000.00 per employee. If the profit per employee was, $37,000.00 eighteen months ago, this company has truly lowered their cost of production. With eight employees and the same margin, profit per employee would fall to $35,625.00.

By including total employees as cost of sales, gross margin may not be as good as thought. With the re-defined gross margin, this may indicate a need to lower production cost, more than just the need for a price increase. For example, price increases will cover rising expenses, over which the business has little control (e.g., taxes, energy, insurance, etc.) Such cost are shared, relatively evenly by all businesses in a common market. If cost of production rises, combined with those cost, prices will eventually become too expensive for the market.

_________________
Louis Altazan
Owner/Manager AGCO Automotive Corporation
Baton Rouge, LA