Staying Alive
The struggles of a business trying to survive.
We had plenty of inquiries, but no sales in the last week of August and the first two weeks of September. Frankly, I’m a little bit nervous. Dry patches are not unheard of in this business, but three weeks is about as long as I have gone without a new order. Maybe it was just the end of summer, and decision makers weren’t around to make decisions. We could well get a clump of new business soon — we have lots of proposals sitting out there, the clients swear that the jobs are still alive, but still. Why don’t they pull the trigger? Is it fear of a recession? Or could it be our pricing? At the beginning of August, after months of good sales, I made a very slight adjustment to our pricing, adding in an extra 2 percent for the salesmen. Did that slight hike make a difference?
Back in Economics 101 we learned that there’s a direct relationship between sales (cleverly called “demand”) and pricing (cleverly called “pricing”). If you want more buyers, the theory goes, lower your price. If you raise your price, you get fewer sales. Unfortunately, this theory is pretty much useless in real life. It doesn’t take into account the idea that you should be selling your goods for more than they cost you, which sets a floor on your pricing.
Nor does it tell you what exactly will happen when you raise prices. How many clients will you lose? Lots of them or just a few? Will the increased revenue make up for the fewer transactions? It doesn’t incorporate the idea of a tipping point, the price where interest in your product entirely disappears. And it doesn’t take into account the idea that pricing that may seem reasonable in good times might be excessive when clients are scared. In my situation, where sales have been strong all year, and then suddenly stop, it tells me neither what is happening nor what to do about it.
Let’s back up a step. How do I set my prices? When I first started out, I had no particular system. I would literally make up a number that seemed reasonable. This may sound incredible, but that’s what happens when you are young, dumb, and have no access to information on competitor prices and no system for tabulating costs. After a few years I settled on a different but still dysfunctional system. I would check to see what my competitors were charging for items similar to ours and try to sell for 10 to 15 percent less. I had been in business for 10 years before I started tracking the number of hours it took us to make our products, and another 10 before I even tried to figure out what the material costs would be for each project. I know this sounds unbelievable, but that’s what I did. Now, I never made a profit in any of those years. As I have recounted in other posts, steadily growing sales volume made up for losses in day-to-day operations. Usually.
On the occasions when I tried to figure out costs for each design we made, I was stymied by the variable number of hours that different workers took to make each piece. Joe might be able to make a chair in six hours, Jane in four. What should I charge? Which number was correct? Add to that the variation that Joe and Jane both experienced, depending on their energy level and the availability of machines they needed. It was impossible to achieve consistent times, even on pieces we made over and over. Tracking the material costs wasn’t much easier. Wood comes to us in chunks that vary widely in size, and contain knots and other imperfections that greatly affect yield. The number of parts we could get out of our wood orders was not predictable. I was never able to come up with actual costs for our residential designs, so I just set prices based on my perception of their value.
When we switched to making conference tables, we were finally able to set up a system that worked better. Although our tables vary greatly in size and shape, they are composed of a limited number of types of parts. We wrote spreadsheets that took into account factors like estimated design time, size, number of top segments, woods used, number of base pedestals, type of finish, and special hardware requirements. We used factors to make predictions of the number of hours allocated to building, finishing, and packing the table. The amount of materials used was estimated by a formula that assumed certain waste factors, and we could easily choose among different types of wood. Simply amassing the pricing of every kind of material we used was a task that took months, and, frankly, we haven’t updated those costs since 2007. There hasn’t been anyone with the extra hours available to do it. We mark up the estimated materials by 48 percent, and the labor hours get charged at a shop rate of $80 per hour and then marked up an additional 9 percent. And if it’s a rush job, or I suspect we can get the client to pay more than the estimate asks for, we mark it up some more. How much extra is a straight judgment call that I make.
The best thing about our system is: it’s an actual system. Compared with the idiocy I lived with for years, it’s a dream of precision. Because the spreadsheets are detailed, we can give logical answers when our clients ask us what it costs to make a table 16 feet long, or 18 feet long, or what’s the price difference between cherry and ebony. I can look into an estimate written by either of my salesmen and see exactly how he came up with the numbers quoted to the client. I can compare the estimates with the actual build data and see whether the assumptions we made were reasonable.
How well does this system work? On the macro level, it has been generating prices that a reasonable number of clients find acceptable, which generates sufficient cash to run the shop and leave some profit. In aggregate for this year, the number of hours that we have actually used to make our products is running 6 percent over the estimated number of hours. We were doing worse at the beginning of the year, but now that we have our splicer and sander going, we are running ahead of the estimates. Look closer, however, and the model doesn’t work so well.
On some projects we beat our estimate by a little, on some by a lot, and on some we miss by a little. And then there’s the occasional bloodbath where our hours are way, way over. There are lots of reasons for this: mistakes in the estimate, mistakes in the drawings, mistakes on the shop floor, machine failures, material defects, you name it. We do better with the materials. The big markup means that we rarely spend more for them than we charge, but we still are bedeviled by the varying yields we get from a given amount of wood. So all that I really know about the accuracy of our estimates is that the current system is not causing me to go broke. Which, in custom work, is something of a triumph.
Are my prices reasonable? Who knows? It’s very difficult for me to find out what my competitors charge. The shops that come up in Google searches do not list their pricing on the Web. As far as I can tell, we are the only shop that does this, and even so we don’t have a price on every table on our site — many of the tables have special features, invisible in photographs, that can make for shocking numbers.
We ask our clients to send us other proposals that they receive, but I have actually laid eyes on only two, and in both of those it was hard to tell whether the product was comparable to ours in build quality. I have heard that we are somewhat less expensive than one of our competitors that works primarily with architects. In reality, the product we make is extremely custom, and direct apples-to-apples comparison is not feasible. I leave that to our clients. They presumably gather a variety of proposals before they make their decisions, or maybe they don’t. Most of the people we deal with have other jobs, and buying a conference table is a very once-in-a-while thing. We do our best to make our proposals so good, and our communications so clear, and our integrity so apparent, that choosing us is the easiest thing to do. We close about 25 percent of the proposals we write. Clearly there are other choices out there, either close competitors, or much cheaper mass-produced alternatives, or doing nothing.
We ask for a client’s budget with every project, and we try to design to that number (if we get one). Even when people give me a number, I don’t know the thought process that led to it. Sometimes the requested budget is reasonable, but clients often confess that they have no idea what they expect to spend. Other clients request impossibly low numbers, and then we have to decide whether to even bother with a proposal. Once we submit a number for a particular design, we are stuck with it. If a client rejects a design/price combination, I have found, there is no good way to back down the price. For some reason this simply doesn’t work. I guess it’s because Americans are not natural hagglers. Offering a discount after trying for a higher number seems shady, I guess. If we need to retreat, we do it by simplifying the design. It is very, very rare that a client even tries to beat me down in price. More often, the transaction is simply abandoned.
We are also hampered by the small number of transactions we do and the wide variety of sizes and configurations we offer. Because we do custom work, we almost never offer the same item at different prices to different people. So we don’t have a good way to experiment with our prices to see what effect raising or lowering them might have.
I often hear the advice that if we get busy we should raise our prices. Conversely, it’s accepted wisdom that lowering prices would lead to more transactions. I am afraid to do either. The system is, broadly speaking, working. I don’t want to lower prices because I have no evidence that it would actually increase sales, and it would certainly decrease revenue. I don’t want to raise prices because I can’t tell what percentage of my clients are already at the limits of their tolerance. So I am constantly looking for more profits in other places, particularly on the shop floor. Raising productivity increases profits as effectively as raising prices.
Now that I’m no longer selling eight hours a day, I plan to start a close examination of our pricing spreadsheets and to, at the very least, update the material cost database. But pricing highly custom work is inherently complex, and I’m not sure I’ll ever be confident that my system is perfect.
How about you? Do you have trouble setting prices?
Paul Downs founded Paul Downs Cabinetmakers in 1986. It is based outside of Philadelphia.
Article source: http://feeds.nytimes.com/click.phdo?i=69a99e3445cf7d4d97474e92dcb16052
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