Budgeted Hourly Rates

[bhm8hwcm]

I am in the process of setting up a new estimating system. I was wondering if someone could shed some light on the concept of budgeted hourly rates and markup on hourly rates. The system has me set up some services based on time (eg. press, prepress etc) where I specify an hourly rate as well as a markup on the hourly rate. I am familiar with hourly rates and I have used them when working out estimates manually in the past. I have never really considered a markup on an hourly rate though. Generally I have considered my hourly rate to be all encompassing of labour, machine costs, power, a contribution to overhead, etc.

Where exactly does the markup fit in? Should the hourly rate be a bare bones rate - labour, machine cost, etc with no overhead component?

If I do not enter a markup on the hourly rate then the gross proft margin is low...though I am in fact generating the selling price I want.

Any thoughts or info on establishing hourly rates?

 

[Morning Flight]

If I do not enter a markup on the hourly rate then the gross proft margin is low...though I am in fact generating the selling price I want.

I suspect the estimating system you're installing considers markup a "Profit Markup." As Philip Ruggles points out in Printing Estimating, "Budgeted Hourly Rates (BHRs) are not selling prices. They represent a composite of all costs to produce work in a particular location in the plant." He goes on to say "BHRs are not selling prices because they do not include any profit markup. When properly calculated, BHRs are first multiplied by the number of estimated hours anticipated for a job. When material and buyout costs are added, management has the baseline cost of the job with no profit."

Ruggles' book gives a detailed description of how to calculate BHRs. I would highly recommend picking up a copy. The latest, 5th edition, costs $139 new at Amazon and includes estimating for digital and click charges. The 4th edition can be had for around $20, and you can buy older, used editions for as little as $0.08. Seriously! I have no idea how that works (8 cents ??? I mean, really? How can anybody sell anything for 8 cents?). Amazon.com: Printing Estimating: Principles and Practices: Philip Kent Ruggles: Books

As an aside, you're definitely looking at pricing from the right perspective when you say "generating the selling price I want." Budgeted Hourly Rates are the basis for Cost Plus Pricing, and Cost Plus should have been ditched in favor of Value-Based Pricing a long time ago. Henry Ford did it back in 1922. In his autobiography (My Life and Work), he says "We have never considered any costs as fixed. We first reduce the price to the point where we believe more sales will result. Then we go ahead and try to make the prices. We do not bother about the costs. The new price forces the costs down."

Innovative strategy, though not likely to find many advocates in the printing industry. Luckily for most printers who rely on BHRs, nearly every competitor uses Cost Plus as well. With the price of equipment, salaries, utilities and rent being generally in line with what competitors pay, Cost Plus actually works, more or less. But think about it, what other pricing system do you know where, as the sales volume goes down, the price has to go up? One of the factors for determining BHR is utilization of equipment. On page 120 of "Printing Estimating - Developing a Cost Estimating System," Ruggles cites sample BHR costs for a 1/C Komori as $75.75 at 80% utilization, $86.58 at 70%, and $101.01 at 60%.

So why do so many printers still embrace this outdated pricing method? Because doing something stupid once is just stupid. Doing it twice becomes a philosophy. That's one reason. The other is that the method is relatively easy to implement and the bean counters get to work with concrete numbers. Wrong, but concrete.

No surprisingly, all estimating software is essentially Cost Plus, too. Including Morning Flight. As much as I hate to admit it, value-based pricing, the strategy we should be using, depends largely on what the market will bear, and I haven't found a program yet that will canvass your competitors, tally their prices, find out what customers are willing to pay, and then quote accordingly. When I say "essentially" Cost Plus, the system you're installing should, at the very least, allow you to set different rates for different customers.

Sorry for the long post. As the architect of Morning Flight, I'm passionate about how to price printing without leaving money on the table. To learn more about value-based pricing in general, here are three books to add to your library:

Amazon.com: Pricing on Purpose: Creating and Capturing Value: Ronald J. Baker: Books

Amazon.com: The Future of Pricing: How Airline Ticket Pricing Has Inspired a Revolution: E. Andrew Boyd: Books

Amazon.com: Power Pricing: Robert J. Dolan, Hermann Simon: Books


Hal Heindel
www.morningflight.com

 

[David Dodd]

If you want to get a more accurate view of job costs and job profitability, then you should not include most "overhead" expenses in your hourly cost rates for individual cost centers. When you include overhead expenses in base hourly cost rates, you are essentially assigning costs to jobs that have no real cause-and-effect relationship to those jobs. The better way to account for overhead expenses is through what I call a "break-even mark-up." By using a mark-up to deal with overhead expenses, you are keeping those expenses separate from true job costs.

 

[David Dodd]

Luckily for most printers who rely on BHRs, nearly every competitor uses Cost Plus as well. With the price of equipment, salaries, utilities and rent being generally in line with what competitors pay, Cost Plus actually works, more or less.

Hal Heindel
www.morningflight.com

Hal,

Great post! There are several serious problems with estimating and pricing systems that are based on traditional BHR's, and you touched on some of those problems. I wholeheartedly agree that value-based pricing is the best pricing model, and value-based pricing becomes even more important when a company begins to offer more complex bundles of products and services that go beyond print manufacturing.

My only quibble with your position relates to the portion of your post I quoted above. Does cost-plus pricing really work, even more or less? Whatever pricing model a company uses (cost-plus pricing, market-based pricing, or value-based pricing), it is essential to have an accurate view of costs. If anything, having an accurate view of costs is even more important when using cost-plus pricing because cost-plus pricing simply uses a mathematical formula to convert costs into prices. If the costs are wrong, you can imagine the impact on the price. It's a classic case of "garbage in-garbage out."

The real tragedy is that many of the problems with traditional BHR's can be corrected fairly easily within the framework of most estimating software programs, including, I suspect, Morning Flight.

 

[Morning Flight]

... My only quibble with your position relates to the portion of your post I quoted above. Does cost-plus pricing really work, even more or less?

David,

I'm inclined to say yes, with reservations. Success, like beauty, is how you define it. Cost Plus works because everybody's doing it, and it doesn't work for precisely the same reason. Whenever value and price are separated, the only meaningful way left to compete is on price. Price-cutting and low-balling are rampant in this industry, to the point of being endemic. When everybody lowers prices to shore up business and the only drawback is you're not getting paid for it, and you consider that being successful, then yes, Cost Plus works.

The market parity brought about by Cost Plus has lead to over-aggressiveness in how we price. That's especially true in the digital world, where differences in quality are less discernible. As a result, profit margins in printing are now so low that the thought of closing up shop, putting the money in CDs, and soaking up the sun on an exotic beach with a Marguerita and a nice, cool beverage becomes more and more attractive. Provided that the owner has enough equity and can find a buyer for the business.

But, we do have to pick your battles. Before I can persuade Morning Flight users to abandon Cost Plus entirely, I first have to convince them to ignore BHRs - make it understood that when people go to buy grass seed, it's not the seed they care about. What they care about is their grass. Translated into printing, that means charge by the product you're delivering to your customer, not by the press you run it on. If you have to put a newsletter on the Heidelberg because the designer felt it needed 80% ink coverage, charge for that. Otherwise, forget BHR and charge for running it on the Ryobi. Morning Flight is product-centric, and it's often difficult to make the connection.

To quote from our on-line help system: "Customers have neither the time nor the curiosity to be impressed by that fancy new inkenspritzer you ran their letterheads on. They'll look right past it. What matters to them are the results delivered to their office. And they'll get vocal when a $100 letterhead you ran last month on a Multi suddenly costs $150 coming off the Heidelberg because the Multi was out of commission."

Change will come. In large part because of the "more complex bundles of products and services that go beyond print manufacturing" you mentioned. That and the maturing of Web2Print. Can you imagine a print buyer requesting a live, unattended quote from the printer's web site and having to select the press the job should be run on?

P.S. I just discovered (and ordered) your book "Throw Away BHR's: Win the Pricing Game," available from Point Balance Publishing. Thought I had read all the books on estimating printing.

Hal Heindel
www.morningflight.com

 

[pcmodem]

Before I can persuade Morning Flight users to abandon Cost Plus entirely, I first have to convince them to ignore BHRs...

Instead of abandoning Cost Plus. How about adding value-based pricing, market-based pricing, or both to the Morning Flight. This gives users flexibility and the option to change to another pricing method on their time schedule instead of yours.

 

[Morning Flight]

I couldn't agree with you more, pcmodem. But here's the problem:

Morning Flight does assign hourly rates to all presses, so there is nothing to keep you from using Cost Plus and BHRs. We just don't recommend it. On the other hand, changing from Cost Plus to Market-based or Value-based Pricing is never as easy as flipping a switch. That's because the last two are more of a Business Strategy than a pricing method. They're not easily translated into bits and bytes.

Cost Plus calculates the cost of producing the product and adds on a profit markup to arrive at the selling price. Easy to implement and computerize. Its major flaws are that it doesn't account for demand, that there's no way of finding out whether customers will buy the product at the calculated price, and that prices have to go up as volume goes down, the argument I made earlier.

Market-based Pricing has many variants but is basically what the market will bear. Value-based Pricing, also known as Dynamic Pricing, is one of those variants. That's gross oversimplification, but the two are alike in that prices are based on analysis and research compiled from the targeted market. Movie tickets, where prices are different for youngsters and seniors, and for different opening times, are one example of Market-based Pricing. So is the price of popcorn for their captive audience.

Airline tickets are Value-based Pricing taken to the limit. We all know that most passengers on any given flight paid a different price for their tickets. But did you know that ticket prices are recalculated by the airlines every 15 minutes? Airlines have completely done away with cost. Mathematical models (supported by a staff of high-salaried PhDs) look ahead at how many passengers are expected to arrive and what they're willing to pay, then set the price based on an evaluation of each seat's potential revenue contribution.

I think you can see where I'm going with this. First, few printers have as narrowly defined a product line as airlines. Second, Morning Flight was designed for small to medium size print shops. We gave it the knobs and levers that make Market-based and Value-based Pricing possible. As for the mathematical models that would need to be custom-developed for each shop, well, we couldn't afford the PhDs. Did I mention that our core estimating program is forever free?

If you can't bring yourself to put BHRs out to pasture, John Stewart, Contributing Editor at Quick Printing Magazine, has developed a BHR Calculator that can be downloaded from his web site free of charge: Downloads

Hal Heindel
www.morningflight.com

 

[PeterA]

I have been involved is setting cost rates for over 40 years - and they really are very difficult as you have to budget for a level of annual production, which is reasonably easy on printing presses but in pre press and bindery is hard - foe example if you suddenly had lots of orders for long run four colour letterheads - you would have no capacity to take work on to fill your pre press or you bindery - so you would loose money. One method which i keep coming back to is to only charge out press time. ie take the number of productive hours worked each year and divid them into your annual budget. The purists may be horified but suprisingly you soon get a feel for what is the best rate to use for cllients and its a great measure to compare clients - of course clients still pay for paper ink metal cost of plates outwork carriage and any extra costs like handwork. It may not suit you but dont dismiss it.

Peter

 

[Morning Flight]

Peter,

I've been estimating printing long enough to not dismiss any method out of hand. I take that back: Doubling the cost of paper to arrive at a total price for 1-color, and tripling it for 2-color, is absurd. Incredibly, that pricing method is still being practiced.

Other than that, any pricing system that makes you money and, by year's end, finds you still standing, is a good system. I'm down on Cost Plus, and a big fan of Market-based Pricing, but try not to be dogmatic about it.

My thoughts on your approach are more related to marketing than to pricing: Overcharging prepress for those profitable long run letterheads (little prepress per M but getting paid big), and then undercharging for profit-sapping short runs (lots of prepress per M that you're not getting paid for) could encourage the wrong product mix. Most shops have carved out a niche, with their own version of the 5-cent cigar. You could earn a reputation for being the winning bidder on exactly the kind of printing you don't make money on.

It obviously has been working for you all these years, so I can't say I blame you for sticking with it.

Hal Heindel
www.morningflight.com

 

[MR.G]

Hi guys,

I hope you don't mind me reopening this thread. I would just like to know if you guys have had any new ideas regarding HBR and Cost-plus pricing since you posted the above.

I am wrestling with the concepts at the moment and would like your input (if you don't mind).

The problems I see with cost plus pricing is that:
1) It does not encourage cost reduction since that would mean revenue reduction.
2) There is no simple way of incrementally increasing costs. Our customers usually expect some form of increase in prices.
3) Reduction in Raw Material prices lead to reduction of Revenue.

I'm considering using a price list with each client given his own discount structure based on volumes or something like that. Would you comment on this idea?

 

[Morning Flight]

Mr. G,

A good start and a step in the right direction. Where you go from here will depend mainly on whether you plan to publish your prices (on the internet, in your company newsletter - wherever). If you are, those prices will need to be your high water mark, the highest prices you're going to charge anyone. That's because putting prices out there for everyone to see effectively eliminates most surcharges. "We're going to charge you 10% extra because you're such a pain in the ass to work with" is not going to sit well with customers. True, you can still charge more for rush jobs and extra handling, but that's pretty much it.

Not publishing your prices increases your options. You can now price on the curve, with your base prices somewhere in the middle. I'm not advocating one strategy over the other, which, in any event, is another topic. But keeping your prices out of the public eye will let you up-price as you see fit.

Your price table could have as its baseline average prices for average sales volume, as you have suggested. Then you would factor in that "something like that" you alluded to. For starters:

1. Customer Maintenance. How demanding is the customer? How much hand-holding do you have to do? Does he or she always need the job yesterday (and then waits two weeks to pick it up)?

2. Payment History and Credit Worthiness. Is the check constantly in the mail "forever?" What are the chances of the account going belly-up? Keep in mind that most write-offs are caused not by crooks and scammers, but by honest people with poor business savvy who always meant to pay you but in the end couldn't.

3. Reruns. Regardless of who screwed it up. Seriously.

By the time you're done, you would have "low sales volume, high maintenance and high credit risk" customers at the highest price point. And "high sales volume, low maintenance and low credit risk" customers at the lowest. With the rest somewhere in between.

Glad you reactivated the thread!

Hal Heindel
Price Levels

 

[Jackie]

Completely agree with Morning Flight. Quite a few years ago when I was working In NZ my company made a list of all out clients who were excessively high maintenance, they would grind you on price and then wait nearly 3 months to send you a cheque.

The company politely informed said clients that we would no longer be their print supplier.

Best thing that ever happened. Although in these tough times it's pretty hard to turn away any business no matter how detrimental to your business they may be.

The answer would be to have the floating curve for prices that was suggested, it would encourage your good clients and eventually filter out all of the painful cases as they'd probably wander off to accept a "cheaper" quote.

Cheers
J

 

[MR.G]

Thanks so much for your reply Hal. My intial idea was to keep it (the price list) between the individual client and ourselves.

At the moment this is how things work at our company (order process if you like):
enquiry>quote by estimator>pricing by rep>accepted quote converts to Job ticket>Production manager then changes the way the job will be run based on Resource availablity>......>Deliver and invoice

This baffles me a bit since one could argue that the process from enquiry to job ticket is just a waste of effort. By using a pricelist type sytem one could change the process to look something like this:
order>production manger puts together a Job Ticket based on how it will actually be printed>...>Deliver and invoice

Any thoughts on this idea?

 

[Morning Flight]

... one could argue that the process from enquiry to job ticket is just a waste of effort.

If only it were that simple, Mr.G! What works for VistaPrint is unlikely to find traction in the typical print shop. Let's begin there, with the "typical" bit. While it would be foolish to try to make specific recommendations without knowing more about the type and size of your business, here is one, anyway: Don't let your sales rep go just yet.

Assuming your company does fall somewhere into the “typical” category, a price list will be useful for less than half of your daily quotes and orders. Much less, if my own experience is any indication. I used to be a big fan of price lists when I started my own printing company back in the early Seventies (Morning Flight Printing Estimating - Who we are). Then computers came along and our fancy price book, with the attendant paper and pencil and calculator that were still necessary to interpolate quantities and calculate any non-standard paper, was quickly retired.

Aside from the obvious drawbacks of using a price list versus a computer estimating program, your case is unique in that you would need to maintain not one list, but many. One for each customer group and price level. If you’re a specialty printer with, say, ten major accounts, that approach may be viable. Make that 200 accounts and you’re faced with a monumental effort that, in this day and age, is totally unnecessary. Simply use your estimating program to set individual price levels for each customer, then let the computer do all the work, automatically.

A footnote on allowing sales reps to adjust prices on the spot: Not really a good idea. Most reps, bless their black little hearts, are like politicians. Yes, they do care about the well-being of the company, but what they care about most is getting their commission (or, in the case of politicians, getting re-elected).

If you do give reps the authority to cut prices, establish a bottom ceiling below which they’ll need to get confirmation from management. Next, reduce the percentage of their commission by the size of the discount. More than one rep? Reward those who cut prices the least, and then only as a last resort, with a year-end bonus.

But that’s a whole other topic.

Hal Heindel

 

[pcmodem]

Morning Flight,

You bring up another good question. Markup or Markdown?

If you start out with your budgeted hourly rates (this being the break even point). Then add a small amount of markup to the cost (this being the lowest you will sell it for without management approval) Then also have a suggested price. This would allow the salesperson the flexibility for pricing without hurting the company.

 

[Keith]

Hi. My name is Keith and I'm an avid Morning Flight user. (Clap! Clap! Clap!) Thank you, thank you.

Seriously, I have been reading this thread with great interest. I like the thoughts concerning publishing prices. Since, opening my shop, I wanted to publish a big 'ole price list. Now, I'd rather not. Concerning the Cost Plus versus Value Based- I think it'd be a full time job doing all that market research for pricing! It's hard enough to run a shop. But that's why I don't see Morning Flight as an estimating program, but more like a flight recorder (). It's there to keep track of what jobs are in, who ordered it, when it's due, and what it is. If I don't enter into Morning Flight, it won't get done. Pricing is something I do, and the program does the calculating and recording. Every other job I price I will also calculate it by hand, check competitors prices and analyze my costs. I also keep a set of Franklin Estimating books on my shelf as a baseline reference or when I have no clue what to charge per/M for something odd like tipping cards inside a book.

 

[Morning Flight]

My name is Keith and I'm an avid Morning Flight user . . . I don't see Morning Flight as an estimating program, but more like a flight recorder.

Appreciate the ringing endorsement, Keith. Don't see Morning Flight as an estimating program?!? You had me going there for a minute. The answer came a few sentences down: “I do the pricing, and the program does the calculating.” Couldn’t have asked for a better definition of the role an estimating system should play in the print shop.

Pricing is, and always needs to be, a cornerstone of a company’s marketing strategy. Estimating should be looked at merely as the mechanical means of applying that strategy, using a predetermined set of pricing factors. In other words, find out how much you can afford to charge (the customer’s tipping point, based on your value proposition of quality, service, price), then synchronize your estimating program with it.

In the Morning Flight manual, I caution our users to not let the software dictate pricing:

“Some estimating systems claim to know your market's sweet spot, the exact point at which your prices are low enough to keep and attract customers, yet still high enough to earn you a profit. Their manufacturers suggest you use these miracle systems straight out of the box, abandon the prices your customers have gotten used to, and step boldly into a more lucrative unknown. What works in Brooklyn, they say, will work in every state and hamlet in the country. There's a bridge in Brooklyn you may want to keep an eye on, because what you'll be stepping into is not where, under the rosiest of circumstances, I would want to take bold steps.”

Ok, so I don’t suggest to our users that they keep a set of Franklin Estimating books on their shelf for reference as Keith does. But frankly, Keith, you could do worse. Franklin has been around literally forever, and they still produce what I consider the gold standard for “average U.S. rates.” NAQP publishes an annual Printing Industries Pricing Study that’s less comprehensive but can be put to good use when you need a second opinion (PrintImage International: News).

Wouldn't be right if I didn't confess that I, too, keep a little Franklin book on my shelf. Titled “Estimating Hints for Printing” and written by by R.T. Porte, it’s not a Franklin book per se, having preceded the Franklin Printing Catalog by some years.

For those of you who have ink running through your veins, Roy Trewin Porte was born in 1876. His love of press work came to him as a child when he prepared small printing jobs on a hand press in his mother's home. He became a printer and editor of various papers. In 1916, he moved his family to Salt Lake City, Utah, to assume the position of secretary of the Ben Franklin Club. He published the first edition of the Price List which became well-known as The Franklin Printing Catalog. In 1924, Porte established the Porte Publishing Company to continue publishing the catalog.

Interesting observation from Chapter 1:

“The cost system was at first hailed as the corrector of all such evils, but it was soon discovered that results from cost systems varied twenty-five percent on the same work when reproduced at intervals in the same office.”

So much for the validity of BHRs. Remember, this was written in 1919, before any of us ever laid eyes on a printing press. Porte travelled widely throughout the West to collect price data for his Franklin Printing Catalog. His message was simple: Don't charge what it costs you to print a job, but charge what other printers are charging for the same "class" of work, then try to produce the job at lower cost. That's pretty much the premise of any pricing guide to this day.

And no, I didn’t buy the book new.

Hal Heindel
http://www.morningflighthelp.com

 

[David Dodd]

I thought I would add a little more to the historical perspective offered by Hal Heindel. Several years ago, I was able to acquire two books by Spencer A. Tucker. I had been told that Tucker was, in many ways, the "father" of budgeted hourly rates. The first book was Cost-Estimating and Pricing with Machine-Hour Rates written in 1962. This book described how to calculate "machine-hour rates." While not specifically about printing, Tucker's machine-hour rates look a lot like BHR's.

The second book by Tucker was Creative Pricing in the Printing and Allied Industries written in 1975. In this book, Tucker offered the following comments about cost-plus pricing.

"Commercial printers who use formula-based costs and formula-type pricing are engaging in exercises which do not strengthen either their knowledge or profit. In the first instance, "full" or total costs are computed using varions methods which are equally defensible but not objective or traceable to the specific jobs being manufactured and sold. Therefore, each method produces a different cost result. Then, regardless of the specific mark up applied, management gets the notion of a unit profit developing if he sells his product at the formula price. This notion is highly illusionary in view of the arbitrary allocation of common or joint costs associated with a multiproduct company. The mark up on a printer's costs denies the existence of competition and market forces. It fails to take into account the buyer's needs and willingness to pay and what prices competitors are offering. For a printing business to grow and prosper, management must not blindly follow competitors' prices, nor slavishly follow rigid cost methods or inflexible pricing formulas. There is no single cost figure for any one product upon which management can erect its selling price. Even in one were found, management could have no assurance that the mark up to the selling price figure would be acceptable."

The more things change . . .

 

[Morning Flight]

Several years ago, I was able to acquire two books by Spencer A. Tucker. I had been told that Tucker was, in many ways, the "father" of budgeted hourly rates.

I have both of the books you mentioned, David, along with a third: "Pricing for Higher Profit," written by Tucker in 1966.

If Spencer's machine-hour rates look suspiciously like BHR's, and I'll agree with you that they do, R.T. Porte predates him by four decades. On page 43 of Estimating Hints for Printing, he states under Hour Selling Rates:

"The modern way, developed through a cost finding system, is to find out what it costs for each productive hour in each department of a printing plant, this cost per hour to bear every so-called 'overhead' burden and in addition a margin for profit."

Who knows, hourly rates may have originated in Marx's Labor Theory of Value . . . with a socialistically unacceptable profit tacked on! What's inexplicable is why printing is the only industry where BHRs still dominate. Googling on "Budgeted Hourly Rates" is a real eye-opener.

Hal Heindel

 

[craiglpress]

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