Pricing for profits.

Remedying some common pricing mistakes can mean the difference between profit and loss for your foundry.

Raising a customer's price, no matter how justifiable, is always an unpleasant experience. Most buyers are evaluated on the purchase price of a casting, not whether there will be a long-term, quality source of castings for the future. The foundry is simply expected to make a casting of better quality at lower cos and then pass the savings along.

However, the price of your casting should be determined by taking the accurate, comprehensive cost of producing it and adding to that the dollar amount necessary to achieve a target profit margin. Without a profit, no foundry can survive.

Last month's article focused on evaluating the true cost of your casting. This part addresses some of the traps foundries fall into while monitoring and adjusting their casting prices.

Trap No. 1: Failure to quantify the severity of a low pricing problem.

Any effective price management system should be able to calculate a minimum target price (MTP) and compare it to the current price for each casting. A foundry can base target prices on such criteria as gross dollar profit per machine shift, revenue per mold or percent gross profit--choosing one as primar criterion and using the others as secondary.

Also, a monthly report should be prepared that compares the total selling price of all below-target price shipments to their MTP. The difference will be dollar lost each month by not having those parts at or above the MTP. This is an easy but eye-opening way to find out how much inefficient pricing costs you.

Trap No. 2: Using markup over cost.

Many foundries simply take the cost of the casting and mark it up a certain percent to arrive at its selling price, evaluating each part's price by the highest percent markup. This can be misleading. For example, is it better to sell a $1 casting with a 40% markup or a $10 casting with a 30% markup?

A better way is to calculate the desired dollar profit per molding line shift based on the cost model. The cost system could then easily calculate a suggeste selling price based on the desired profit and the casting cost.

Trap No. 3: Failure to adjust prices annually.

Even if a casting is above the target price, it should get a "cost of living increase" every year. This is justified, since every foundry's costs escalate annually. Even a small increase goes directly to the bottom line and conditions the customer to small annual increases. In fact, many customers prefer a small, justifiable increase each year to a big price hike every five or six years. Remember, a missed annual price increase is lost forever.

Trap No. 4: Failure to leave a profit cushion.

When raising prices, they should be adjusted above the MTP so the part will not automatically fall below it when your cost model is updated. This cushion may translate into survival when the economy cycles down and price pressures become intense.

Trap No. 5: Failure to raise prices to market levels, even when they are alread above the MTP.

There are times when a casting is below market price, yet above your MTP. You should always be aware of the market price and be sure your minimum price is within that range. Again, this is why annual adjustments are helpful, regardles of MTP.

Trap No. 6: Failure to raise the price on customers who want special conditions

Special conditions like extended payment terms should not be simply given away. Before giving the quote, try to find out all special terms and be sure to document them. If the customer withholds special conditions until after receiving the quote, the price may have to be adjusted upward from the original

Trap No. 7: Agreeing to long-term contracts with unreasonable conditions.

High-volume foundries receive the most price pressure from customers. On long-term, high-quantity runs, many customers expect a reduction in price over time. In many cases, this is unreasonable. Those customers don't realize they are better off allowing the foundry to charge a competitive price based on efficient operation the first year--followed by small annual adjustments--than to receive an inflated initial quote designed to handle subsequent discounts.

When dealing with long-term contracts, it is imperative that an accurate cost b obtained. Of course, pricing should be done very, very carefully. Obviously, improper costing and pricing can cost you a fortune.

Trap No. 8: Allowing a long-term customer relationship to interfere with effective pricing.

All foundries need good long-term relationships with their customers. This, however, is not a legitimate reason to subsidize a customer with low-profit work. The goal should be to fill the foundry to capacity with work that is abov MTP and sold to customers that pay on a timely basis. An amiable historical relationship is of little value if these criteria aren't being met. Solid long-term relationships must be built on win-win situations.

Trap No. 9: Pricing parts on optimistically high volumes.

Many times, customers are overly optimistic about the quantities they say they will be buying. The foundry should make clear on what volume the price is based and negotiate a volume price adjustment formula to avoid future misunderstandings.

Trap No. 10: Using across-the-board price adjustment.

The easiest but perhaps the most ineffective way to adjust prices is adding a flat percent to all parts. The price of each casting should be managed separately to be the most effective and fair to the customer.

Trap No. 11: Failure to give customers price options.

If a foundry is in a position of having no choice but to raise the price of a low-margin item, then, if possible, the customer should be given several options. For example, one new price may be based on current tooling, while another might be based on an investment in new tooling.

Trap No. 12: Thinking you can lowball now and raise prices later.

There may be a business reason (such as filling capacity) to underprice a casting. However, don't assume it will be easy to raise a low price to standard levels. Some prices may be in effect for the life of the part. An effective system to continually monitor low-margin prices will ensure they are not forgotten.

Similarly, don't assume that you can sell some parts below the MTP and make tha money up with other castings later. Net pricing for any one customer may work i theory, but it requires a very sophisticated pricing system and a lot of attention.

Trap No. 13: Failure to keep customers informed.

The ability to adjust a price may depend on how well the customer is informed about market conditions, back-log demands, industry capacity, inflation and foundry cost pressures. Some foundry sales departments have found it very helpful to produce a sales newsletter to periodically mail to customers. These newsletters help to keep the customer informed on things like union contract status, new equipment and technology, customer surveys and cost-saving projects

Trap No. 14: Failure to involve the general manager in the pricing process.

Perhaps the most crucial element missing from a poor cost and price management program is the personal involvement of the president or general manager. Active involvement by top-level management is the key to a profitable costing and pricing system.

The use of cost and price monitoring systems--coupled with the involvement of top management in these processes--can help the foundry maximize profits. In today's market, profitability is essential for survival.

Costing and Pricing Traps

Costing Traps

* Failure to realize cost management will add to profits.

* Failure to use activity-based costing.

* Failure to use full absorption costing.

* Failure to use production efficiency standards to calculate costs.

* Unrealistic production levels for cost model.

* Failure to educate employees.

* Delaying upgrading standards.

* Failure to change cost data for fear of raising prices.

* Not using a cost model with future values.

* Inaccurate core room cost.

* Failure to price outside services.

* Failure to evaluate the cost of gathering data.

Pricing Traps

* Failure to quantify the severity of low pricing.

* Using percent increase over cost.

* Failure to adjust prices annually.

* Failure to leave a profit cushion.

* Failure to raise prices to the maximum, though they're above target.

* Failure to raise prices on customers with special terms.

* Agreeing to long-term contracts with unreasonable conditions.

* Pricing on optimistically high volumes.

* Using across-the-board price adjustment.

* Failure to give customers price options.

* Lowballing now to raise prices later.

* Failure to keep customers informed.

* Failure to involve top management.