Is Your Product Profitable? – Understanding Your Process Costs

The question – “Is your product profitable?” seems, on the face of it easy to answer, you either make money or you don’t!

Obvious isn’t it? Or is it?

Ask yourself the following questions:

Do you know exactly how much it costs to make and deliver your product or service to your customer?
Do you know whether this cost is stable and repeatable – costing the same for each product delivered?
How much profit are you making on each and every item that you deliver to the customer?

It is my experience over the years that many organisations do not fully understand how much each product item costs to make.

Pint of Beer Example:

I was asked to examine the operation of a working men’s club in the Midlands. They were experiencing a drop in trade and a subsequent fall of in overall profits. I suspected that they did not have a clear “handle” on their costs.

To test my suspicions one of the first questions that I asked them was “ How much does it cost you to sell one pint of beer?”

Their operations manager gave me the figure of how much they paid to their supplier for a pint of beer and explained that they added a figure of 33% to arrive at a sales price for each pint sold. The difference between the cost of the beer and the sales price being the profit margin.

An interesting conversation then ensued:

I drew a picture of a beer glass on a flip chart and we began to list all of the items that contributed to the costs of actually delivering the “pint” to the customer.

beer example of product pricing

It was only when it became apparent what costs impacted (cumulatively) on each pint of beer sold that it could be seen that their pricing strategy was too simplistic.

Only by calculating how much each item costs to deliver can an accurate unit price be arrived at.

Ultimately it was proven that the price they were charging per pint was delivering a loss per unit.

The pint of beer example demonstrates how important it is to understand your overall costs and apportion them to each product item produced.

There is one famous example that clearly demonstrates what can happen if the costs of producing your product is not calculated correctly.

THE British Motor Corporation MINI

In 1959 the Original Mini motor car was launched by BMC (The British Motor Corporation).

morris minor BMG group

Designed by Sir Alec Issigonis the Mini (Originally designated The Morris Mini-Minor and the Austin Se7en) was a revolutionary design that became a true icon. With its transversely mounted engine and gearbox alongside with innovative rubber cone suspension, the Mini became a massive seller with 5.3 million units being manufactured between 1953 and 2000.

The best-selling British car of all time!

The First Morris Mini Minor to roll off the BMC production line at Cowley in 1959 (now kept at the Heritage Motor Centre in Warwickshire). The Austin Seven was produced at the Longbridge factory in Birmingham.

(The Mini was voted the second most influential car of the 20th Century behind the Model T Ford.)

It is therefore surprising that the Mini (and BMC – which subsequently became British Leyland and then Rover Group) lost a reported £30.00 on each Mini (in all its derivative forms) from its introduction in 1959 until its withdrawal from production in 2000.

A staggering £161,635,860 !!!

The reasons for such losses were manifold but the low introductory price of the Mini did not reflect the difficulty of manufacturing, development costs, and subsequent warranty issues were thought to be the main reasons.

The Ford Motor Company purchased an early mini and deconstructed it to see if it could manufacture a vehicle to rival it. They declared that BMC would never make money on the vehicle going on to say that “Small cars make small profits” Ford went on to produce the Cortina instead!

In Conclusion

Whether you are baking bread, selling beer, writing wills or even building motor cars it is vital to understand the costs associated with making and delivering your product. Organisations of any size need to understand how to measure the cost and how to apportion it to each item.

Without fully understanding operational costs it is difficult to set a realistic selling price for your product, a fact clearly demonstrated by the brief examples shown.

Profitability does not only depend upon knowing how much each unit costs to produce and deliver to the customer. We must also understand our production process times in order to ensure adequate capacity is in place to produce the volumes required to support and grow the business.

In my next blog, we will discuss the issue of process and product velocity (the time actually working on the product compared to the time in the process “pipeline”) and its effect on costs and profitability!

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