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The elusive concept of profit

Jun 1, 2009 12:00 AM


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When I begin a consulting assignment, I review every aspect of a client's operating and financial performance to educate myself about the company's history, reporting, and management systems, and status. Some of the figures are flat-out inaccurate in almost every case, especially in calculation of profitability by customer. That's usually the case at commercial printing companies, where the products, services, and acquisition costs vary the most from account to account.

This issue is a major industry challenge. Every few years, it receives a modicum of attention but it's not a sexy subject likely to attract a crowd at a conference and it is easily dismissed. The subject also can be a bit complicated. Let's try to simplify the discussion by starting with some basic concepts:

  • Costing and pricing are two separate issues. This column deals solely with the need to understand account-specific costs — all of them. An estimate should be nothing more than an accurate job-specific budget. Pricing is a separate issue that should consider the perceived value to the customer and should exceed estimated costs.
  • Print manufacturing costs have been driven down in recent years through more efficient equipment and production methods, improved work flow, and the digital revolution. On the other hand, customization and the notion of “1:1 marketing” have tended to increase sales, customer service, and other non-manufacturing costs commonly called “overhead.” This is particularly true in graphic arts companies that have aggressively added design and various distribution activities that have high value-added content.
  • The production standards used to estimate work might be accurate, but the logic of estimating can be misleading and inaccurate in many companies. An estimate usually assumes that only manufacturing costs are variable. Non-manufacturing costs are added on the assumption that all customers incur the same overhead costs (i.e., “averaging”).
  • I would argue that the non-manufacturing costs between accounts are much more disparate than the production costs.

Let's look at the non-manufacturing expenses that are applied equally to all accounts:

  • Price of money. Some accounts pay in 15 days. Some pay in 30 days.
  • Cash flow. Some customers supply paper.
  • Condition of files.
  • Number of estimates and quotes that are processed per awarded job.
  • Number of sales calls.
  • Customer service history.
  • Ability to schedule. Are proofs returned in a timely fashion?

By averaging non-manufacturing costs, the truly profitable customers are probably paying the freight for the unprofitable accounts, and the latter might be getting a free ride. Measurement of all these factors is known as ABC — Activity-Based Costing. It does not deal directly with pricing decisions but will provide accurate information about most or all costs on an account-specific basis.

Several of our clients have adopted Activity-Based Costing without the aid of a super-computer and a battery of PhDs. It can be done with a bit of patience and common sense. The time and effort to organize, gather, and analyze the additional information is worth it.

Many readers will have this reaction: “We already consider the non-manufacturing costs.” Perhaps an estimator makes an adjustment. Some would argue that a compensating adjustment occurs when a job is priced. I would argue that this tends to occur in only the most conspicuous cases.

My experience is that a formal measurement usually produces some surprises. A print company tends to define its “best customers” in terms of sales volume. However, Activity-Based Costing frequently reveals that extraordinary sales and service costs are greater than one realized. Conversely, figures frequently reveal a middle tier of repetitive accounts that receive little attention, demand little special handling, are “below the radar,” and incur lower costs than management realizes.

Detailed account-specific information is essential to understanding costs — all costs — and will become more important as non-manufacturing expenses increase. Averaging makes a company more competitive on work it doesn't want and less likely to win work it finds attractive. Don't wait for the Great American Software Program to implement this logic. It is better to be about right than precisely incorrect.


Dick Gorelick is president of Gorelick & Associates and the Graphic Arts Sales Foundation. He can be reached at dickgorelick@gorelickandassociates.com.