Setting prices in small business
Setting a price for a small business can be a challenge. Cut the price too much and you loose money. Raise the price and you loose business. An article in the New York Times recounts the experience of some US small business. The basic message is that price is not everything. One business owner recounts how the quality customers gained outstrips those lost due to a perceived high price. Here’s one story
“About three years ago a computer error caused all of the prices on Headsets.com to be displayed at cost rather than retail. With the lower prices on display for a weekend, Mike Faith, the chief executive, expected sales to soar. Instead, the increase was marginal. “It was a big lesson for us,” Mr. Faith said.”
The basic lesson from this experience is that customers don’t think price is the be all and end all. The experience of a gluten free flour business showed that competitors prices may not matter as much as one thinks too. The company managed to raise its price by 20% in the first year in business by convincing customers that the product had more added value than competing flour. The most important lesson mentioned is that costs must be covered in the price charged. Seem so obvious, but I have written several pieces on this blog about breaking even.
New report on distribution of profits
The Guardian (May 1, 2011) reported on a new proposal put forward by the High Pay Commission recently. The proposal is a very simple addition to the annual financial statements. One though which is certainty aimed at stakeholders in the broadest sense, not just investors. The proposal comes about as a result of the many high salaries and bonuses of many banking and other executives which continued to be paid despite huge losses. The idea is simple. A company will have to report on how it has distributed its profit over each of the past three years. The distribution of profits as reinvestment, dividends or pay/bonuses is to be disclosed. Some of this is already in financial statements, but the latter certainty is not easy to decipher. A simple statement like that proposed would be really useful in my view, even helping people form a view on the longer term sustainability of the business. We’ll have to wait and see if this proposal becomes a reality.
Some good accounting blogs
I had a message from a fellow blogger yesterday, which I thought I’d share. The “Accounting Degree Online” blog is a US-based blog which helps people decide on the best accounting degree for them and provides some useful resources. A recent post list 50 of the top accounting blogs. Many are US-based blogs, which might not be that useful on the taxation side, but the general accounting ones are fine. Take a look.
Knowing breakeven is key for any start-up business
Anyone who has started a business from scratch knows how hard it is in the early months (or even years). Lots of businesses seem to fail too in these early times. Why? Well, there are many reasons from just bad timing, to poor marketing, poor quality and so on. There is also the possibility that the business simply did not understand its costs structure and how this relates to the volume of sales needed to make a profit.
The US Small Business Administration (and similar organisations world-wide) provide good advice for start-ups. One key concept on understanding costs and volumes is called breakeven. This simply means the output level at which your business neither makes a profit nor loss. To keep it simple, if a business knows its start-up costs and running costs for the first year, it can easily work out the level of sales required to breakeven – this output level is known as the breakeven point. To work out the breakeven point, you need to separate variable costs and fixed costs. Fixed costs remain the same regardless of how much your business sells (e.g. rent) and variable costs change as the output grows (e.g. labour costs , shipping cost, material costs). For breakeven, the sales value less the value of variable cost must be equal to fixed costs; any surplus is a profit, any deficit a loss. Doing this quick sum could save many businesses from going under. In fact, as a management accountant I would suggest a breakeven calculation is included in all business plans. I would say that, but why go into business to lose money? Or at least know when you will start to make money?
Perspectives on the meaning of “cost” – a quality management perspective
I recent read a research paper from the German “ControllerVerein” whcih I found quite interesting (controlling is the German word for management accounting by the way, and a controller is their nearest to the English term”management accounting” ). The paper is about business excellence and quality programmes. What I found interesting was the definition of “cost” from a quality perspective and well as a controlling (management accounting) perspective. I’ll do my best to translate them here.
According to the Deutsche Gesellschaft fuer Qulaitaet (DGQ or German Quality Assoc in English) costs are:
The value of physical and intangible materials, activities and other tasks which realise and subsequently recovery a product or service.
The above definition has some added notes too:
- These costs should include providing and maintaining the necessary capacity (of the product)
- Too many error and failure costs are indicators of a need for organisational and process improvement.
Now here’s the definition of costs from the Internationler Controller Verein (a leading German management accounting body):
The value of goods and services used in the creation/delivery of business activities. The cost is calculated according to management needs. Different costs may be used according to the decision being made, the type of product or the organisational structure.
So what’s the difference between these two definitions? I think the most obvious one is the time focus of each. In management accounting, we are sometimes criticised for providing too much short-term information. For example, one criticism of traditional budgeting techniques is its short-term focus. Looking at the definition of cost from the DGQ above, it clearly perceives cost as a longer-term concept. Yes, management accounting does have techniques like “life-cycle costing” which makes us consider longer-term costs of product or services, but this is a more “specialised” technique and not normally within the armaments of the typical management accountant. Although having said that, nowadays the increased focus on longer-term sustainability has focused management accountants on much broader and longer-term concepts. However, I can’t help but think if the basic definition of cost were broadened to embrace longer term thinking, like how costs are perceived by quality professionals, it would be of great benefit to us.
Just in case or just-in-time?
Just-in-time is a management concept originating from Japan. The basic idea is that everything happens “just-in-time”; materials and supplies arrive just in time for production to start, and production finishes just in time for the customer to take it. With not much room of error, if a supplier fails to deliver goods on time production is disrupted and may even cease. Normally companies that use the just-in-time philosophy have close supplier relationships and tend not to run into supply problems. The savings from reduced inventory levels are obvious. Recent events in Japan however have raised issues about how tight things can get with just-in-time. A disastrous earthquake/tsunami in March this year left parts of Japan’s east cost in ruins. Factories were destroyed and power supplies disrupted for months. An article in The Economist (March 31, 2011) mentions how global firms are re-thinking how the manage production following events in Japan. According to the article, one company that controls 90% of the market for a resin is in smartphones had ceased production. Another company which supplies 70% of the global supply of a polymer used in iPod batteries is also out of action. And, car manufacturers in Japan and America have had to cut back on production as parts are in short supply. The events in Japan have prompted some commentators to say a “just-in-case” systems is also needed, according to the Economist.
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