In my last two posts, I reviewed the basics of cost. Once you understand the basics of cost, the next step is how to use cost to create value. There are two related problems that may keep you from creating value, all connected (eventually) to cost.
Each of these is particularly applicable to small companies and startups:
1. Marketing and sales for your firm
2. Creating great value for your customers, but not much for yourself
First, being the full-time rainmaker for your startup company can be difficult, if you do not have some way of financing yourself. We know that these days getting others to invest or lend to a small company is difficult. Anyone that has been an independent consultant can tell you that working and finding work simultaneously is very difficult.
Now, you are asking me, how does that last paragraph relate to cost? Actually, it’s pretty simple. Many new entrepreneurs (and a few not so new) do not calculate their contribution to the company as part of the cost structure. This could be true whether you have a service, distribution or manufacturing company.
In the case of a service company, particularly consulting, the entrepreneur will calculate the number billable hours they hope to bill for them self and multiply that by their retail consulting rate. The resulting number looks like a good income, and that is that. The problem is, it does not work, particularly if you have others working for you.
The key is that when you are working as the sales marketing and person, you are creating value. If you do not capture that value, it will hurt your bottom line. In order to capture value it must be quantified and made part of your budget. For example, let’s say that out of 2000 hours (I know, entrepreneurs and company owners work way more!) you are going to bill for 1,000 and work on Sales and Marketing and Administrative the other 1,000 hours.
In order to capture the value of your non-billable hours you must include the cost of your compensation and benefits in the company overhead that is charged on every billable hour. This includes your own billable hours! If you are running a manufacturing and distribution company, the problem is still there but (hopefully) you will have a tendency to think about overhead more. All the same, be sure that all of your own time is included in that overhead!
The second point above, creating value for your customers but not for yourself is about pricing. Pricing of your product or service must reflect your full costs or you will not make profits. Sounds like a no-brainer, but actually pricing correctly and then getting your customers to pay that price is another story.
Consulting and other similar service companies may experience difficulty particularly in our current market conditions. I often describe the situation like this, “You can’t compete on price in a perfect market”. In economic terms, a perfect market has low cost of entry and many competitors. In our current market, there are a large number of people that usually work at jobs, but are promoting themselves as consultants at least until the job market improves. Many will work for very low rates that will be hard to compete against.
If you find yourself in this situation, you must be able to differentiate yourself so as to justify your retail price, and your retail price must reflect a realistic estimate of your true costs.
Many companies, including service, manufacturing and distribution have been hunkering down during this economic time. In order to do this well, your retail pricing must contain an accurate reflection of your true costs. You may be doing without a lot of net profits and just be in “survival mode”, and that is fine under the circumstances. However, if your true costs are not reflected, you may actually be getting behind, and that could call for deep pockets.