What happened to that cash cow?
You can make a grave error in figuring your costs. I have seen many people do
this. Let
’s set up a hypothetical scenario so that I can illustrate my point.
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The press team regularly averages 100 shirts per hour. Five people in total to
do 100 shirts per hour for a Pieces Per Labor Hour (PPLH) of 20. This is a PPLH
that is better than average (17 to 18 PPLOH is average), but poor by my
standards (Tailwind clients average 27.2).
But 20 is a good number to use here because I want to paint a picture that
depicts a plant that has better than average management and in general is
better than most.
At 3,500 shirts per week, this is a well-equipped plant that isn’t bulging at the seams. A bit more volume is possible, but the employees are
content with 35 hours per week.
A surge in business would probably not lead to overtime. Mondays and Tuesdays
are eight hour days, the remaining three days are around five hours each.
Nobody pads the time clock, employees clock out when they are done.
The employee average $10 per hour including payroll tax and associated expenses.
Gross revenue per shirt averages $2.25 each.
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Let’s assume that this plant operator is on the ball and knows these numbers. If you
asked him what his cost per shirt is, he
’d answer in a heartbeat, “Just a hair under a dollar and fifty seven cents. We make 68 cents per shirt.”
This plant has a history of good service and good quality and it is reasonably
friendly with its competitors.
A friend or quasi/competitor asks this plant owner to do his shirts wholesale.
Hmmm. Food for thought. More information is needed and sought and in the end
the proposal is as follows.
Someone who is not truly a competitor wants you to do 150 of his shirts every
day. He explains that he is at capacity, or whatever.
He offers to pay you $1.25 per shirt. You do not need to tag, wash, touch-up,
assemble or bag the shirts. The shirts will come in wet and extracted. All you
need to do is press the shirts.
What do you do?
Perhaps you reason that this is a cash cow. It takes five people to do shirts
now, but for these 150 shirts, the touch-up person, the assembler and the
washer are not needed. It costs you a mere 20 cents each to press them and you
gross $1.25 per shirt, over $900 per week. Sweet! Or is it?
On the surface, it appears clear that you don’t have to do much, or incur much expense, to process shirts that only require
pressing and nothing more. A closer look will yield an entirely different
conclusion.
More importantly, in a vast majority of these situations, the gross revenue per
shirt isn
’t anything near $1.25 per shirt. It is more like 75 cents. That sounds like a
1980s price (and it is), but the rationale is, once again, that you only pay
two people to press them. There is no washing, bagging, assembly. Nothing.
So even at that price, you nearly triple your money. You receive 75 cents to
press the shirt and pay a mere 20 cents to get them pressed. Netting a clear 55
cents per shirt, which, at 150 shirts per day for 21 business days per month,
is $1,732.50 in pure profit.
Or is it? Take a close look at the chart below and consider the following.
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This is already a problem. Now you are looking at overtime. At 100 shirts per
hour
— certainly respectable by anyone’s evaluation — that isn’t enough to curb overtime.
Supplies. The supplies costs are negligible right? Relatively, perhaps they are, but there
are supplies costs: pads and covers and hangers. Collectively, this will come
to at least 6 cents per shirt.
Labor. Here is the surprise expense. Even though you only need to press these wholesale
shirts and not touch them up, bag them or assemble the orders, it doesn
’t cost you 20 cents per shirt. It is still 50 cents!
The only way to reduce the labor expenditure to 20 cents per shirt is to get all
of your employees, aside from the pressers, to clock out during the time that
those wholesale shirts are being pressed.
That’s not going to happen. The support staff (that is, the staff members aside from
the pressers) will have it easy, because they won
’t have much to do during the 90 minutes per day that you are doing the wholesale
stuff, but you
’ll pay them anyway. And remember, there is overtime involved.
So now, your total gross payroll isn’t $1,750, it is five people at $10 per hour for 40 hours, or $2,000, plus 10
overtime hours at $15 per hour for a total of $2,150.
This raises your cost per shirt for labor from 50 cents to a little more than 50
and a half cents.
But we are trying to determine the cost of the additional shirts, not the
average cost. Therefore, the extra 750 shirts add $400 in payroll, making the
cost per shirt for labor over 53.3 cents!
This is more than two and a half times as much as you thought it would be!
This is a huge miscalculation. You thought that you could do these shirts for
less money because they cost you less, but what a surprise to learn that they
cost you more!
Utilities. I trust that there is no argument here. This is not going to go away. There may
not be any water or water heating costs so we will estimate that this comes to
30 percent of your total utility cost. It is probably far less than that.
Claims. You may have agreed that you won’t pay any claims for the wholesale guy, but you will change your mind. You will
want to protect your
“cash cow” and you will pay a marginal claim.
Repair and maintenence. The likelihood of a breakdown is absolutely proportional to how much you use
your equipment. In spite of the fact that I labeled this
“Fixed Costs,” it isn’t really.
Rent. Some will say that you need to charge space to the individual pieces, others
would disagree. Personally, I think that you should, but I
’ll leave it out. My point will be dramatic enough without adding what some may
argue are questionably entries.
Equipment depreciation. You will be using your equipment more, which means you will have to replace it
sooner. Save your pennies!
Customer service labor. You realize a savings in cost per shirt here. You will not have to increase
customer service staff by doing these discounted shirts.
Amortization. Amortization will not be affected unless, of course, doing these shirts somehow
leads to more equipment. In that case, it is possible that this line item is
affected. I
’ll leave it out.
Employee benefits. Whether or not this line item is affected depends on if and how you pay these
benefits. To keep things simple, I
’ll ignore this too.
Administration, management, office. You have taken on some potential headaches with this new venture and I am
guessing that you or your manager is going to want a raise.
Don’t say I didn’t warn you. But because I am dealing in facts, not hypothetically, I will ignore
this category. I don
’t need it to illustrate my point.
Miscellaneous, other. There is always something that we didn’t figure on. Always add a penny per shirt.
Total cost per wholesale shirt. A hair under 73 cents! That is nearly 400 percent of your original knee-jerk
reaction price! For a gross revenue of $1.25 per shirt, you do net $.45 per
shirt. This is a good margin, but you won
’t think so if you were expecting two times that much.
Cost to produce the extra 750 shirts. Remember, you were thinking 20 cents per shirt, not 73. So if you expected this
line item to read $150 (750 shirts times twenty cents), you are having a bad
day.
Remember, we are not trying to figure our average cost per shirt. We want to
figure our cost for the additional 750 shirts. There is an important difference
which must not be ignored.
If we were looking at average cost per shirt, we would be forced to compare it
to the average revenue per shirt. Average revenue per shirt used to be $2.25.
The wholesale shirts have caused that to plummet to $2.07.
This is not a testament as to whether or not you should do these wholesale
shirts, it is a lesson in figuring your costs. I have seen shirt launderers
miscalculate their costs over and over again.
“All I gotta do is press ’em and put ’em on hangers.”
They chuckle with glee as though they had just found the key to the treasure
room. I think that they weep at night though because they cannot figure out why
they aren
’t laughing all the way to the bank.
“If you do what you’ve always did, you’ll get what you always got.”
