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Pricing Embroidery for Profit Part 1: Calculating Costs & Determining Markup

Thursday, May 21, 2015

Pricing for profit is an important task for many start-up or novice business owners. Successfully balancing fair, equitable and profitable pricing for embroidery services will set you on the path to generating consistent profit margins. Often times, start-up businesses will use competitor’s prices as a foundation for their own pricing schedules. Use caution with this approach, as you are assuming that your competitors have done their homework AND their prices are profitable. Competitors may be hoping that their low prices will attract more business, while in reality, it’s undermining their profits and putting their business at risk.

Conversely, competitor pricing will likely have some influence on your pricing model. However it should not be a primary controlling factor. When researching your competition, be aware of the following, and you will be well-equipped to make wise choices for YOUR business:

  • Competitor prices are a reflection of their product quality, service and delivery.
  • There will always be someone out there who is willing to do poor quality work, very fast and deliver it cheaper than anyone else.

Eventually these vendors will run their course and a correction will be inevitable.

Your business is unique, with a number of variables that will be different from your competition. Knowing that, it is important to create price lists tailored to your business. Developing your pricing lists is an easy task if you follow these steps:

  1. First calculate the cost of doing business.
  2. Next calculate production output.
  3. Divide stitches into cost to arrive at a cost per “production unit”.

This gives you a cost factor, enabling you to determine a competitive mark-up and final selling price. Let’s explore each of these steps in more detail:

1. Calculate the Cost of Doing Business –

All businesses have two major costs, a) Fixed costs and b) variable costs.

Fixed costs are those costs that are the same month after month, such as rent, machine payments and depreciation.

Variable costs change depending on the amount of units sold, direct labor and raw materials. As production increases, you have to hire more people and you consume more raw materials.

In order to run a successful business, you need to capture, analyze and respond to pertinent business information. This is facilitated by maintaining books on our business. Track assets, liabilities, inventories, cash flow, sales and of course expenditures. Quick Books is very helpful bookkeeping software to help track and analyze this important data, providing you with the information necessary to establish our costs on a monthly basis.

Determine an average sum of daily expenditures. Use accounting software to accomplish this task. In addition to all of your expenses generated by writing checks, there are two items that I would like to mention; overhead and depreciation.

Overhead

Home based business may be able to deduct certain expenses due to the use of your home. See IRS Form 8829 for more information. If you do not include this overhead figure in your cost basis, your cost may be lower now (offering you a competitive edge in your pricing) but will jump substantially if and when you have to move the business out of the home.

Depreciation

Since you don’t sit down and write a check each month for depreciation, you may not think of it as an expense. It is however, a very real expense. As your machinery ages, it loses value. Depreciation allows you to get a tax break on your major machinery purchases over time. When you include depreciation in your costing, you pass on the cost of your equipment to your customers.

Calculate expenses on a daily basis and total them for a month, then move on to the next step.

2. Calculating Production Output

We now have to establish a measurable unit of measure to track. Since designs are digitized in stitches, let’s use 1,000 stitches (1KSt.) as our production unit.

In order to get the most accurate production figures, it is best to track your production with a “Production Log”. In lieu of a production log, you can estimate your figures by using the following formula: Output stitches equals 50% of your machine speed. For example; if your stitching speed is 1,200 stitches per minute, 50% of that is 600 stitches per minute. This means that during an 8 hour day of production, you should be able to generate 36,000 stitches per hour (288,000 stitches per day) working full time.

Keep in mind that these output figures reflect full time production (8 hours per day). If you are a start-up business, you may not have enough production volume initially, to keep your machine running full time. By projecting full time production, you will derive a realistic and competitive cost. Even with your profit margin included you may operate under a loss for the first few months of business. You need to cover that loss with enough start-up capital to keep your business going until you are able to generate enough sales to achieve full time production status.

3. How to Figure Cost Per Unit (1KSt)

Divide your daily production output into your daily cost of doing business. For example: If your production cost per day works out to be $18 per hour ($144 per day, $4,380 per month) and your adjusted production output was 600 stitches per minute (SPM), which becomes 36,000 stitches per hour (SPH), your cost per thousand stitches would be $18/36 = $0.50 per thousand stitches.

4. Competitive Markup and Selling Price

The FTC prohibits this blog from telling WHAT to charge. That is up to you. However, there are some guidelines to help you make that decision. Let’s use two different business models as an example. The first embroidery shop has chosen to only provide embroidery services oncustomer’s own goods, while the second shop sells wearables as well as the embroidery. By nature, embellishment will usually command tight profit margins. Even though the embroidery often creates the perceived value of the garment, the customer is still buying the garment, not the embroidery. By following this first business model, in order to make a reasonable income, you will have to do a lot of volume and own a lot of production machines to make a decent profit.

If you follow the second model, you can easily make most of your margin on the garment and show a reduced margin on the embellishment. When you add the two margins together, you can make a good income as a single head shop.

Let’s talk about mark-ups (this is what creates your profit margin). In the retail industry, most large stores mark-up their garments at least 100% (50% gross profit margin). This policy is known as “keystoning”. These large retailers are able to justify this high margin because they purchase volume, in bulk and are also stuck with the task of disposing of unsold merchandise at the end of the season.

Most small embroiderers are what we call “made to order” or “custom shops”. By this we mean that a typical customer might order 13 pieces in 5 different sizes, each embroidered. You will only order 13 pieces from your distributor at a wholesale price, however, not as cheap as the big retailers. The good news is that you are not stuck trying to liquidate unsold, excess merchandise. For this reason, you may not be able to get the 100% mark-up. You will probably fall between 50% to 100%. (33% to 50% gross profit margin).

The garments are easier to price since you know your cost (don’t forget to add inbound freight charges). The embellishment can be a little more complicated since you have to first figure cost based on history (above) and also charge for digitizing or lettering set up fees. The embroidery portion of the selling price will probably only get a 50% markup (33% gross profit margin). Obviously you want to try to get the highest markup possible (what the market will bear).

This concludes part 1 of 2 our part series on Pricing Embroidery for Profit. Read Part 2: Understanding Perceived Value here.