Industry Insights: Planning For Profits
Getting a true understanding of overhead and cost
structure
By
Michael MacDonald
This is a great business. We all love the romance of providing sound
systems for the top musicians in the world, world political leaders and
other luminaries. The travel is fun, the adrenalin rush is great what’s
not to like?
Well... It just seems really hard for the companies that own all this
equipment to make much money. Let’s take a hard look at pricing your services
and maybe move toward some changes. It’s vital to start thinking in terms
of “planning for profits.” But before beginning, I have good news and
bad news.
First, the good news. Because the market sets the price for the equipment
and labor that we put on the road, and competitors that have been around
for a long time have set the accepted market rates, it will take a long
time for a new company to go out of business.
Now, the bad news. If you don’t plan carefully and understand overhead
costs in your business, then you’ll go out of business. And fast. What
do I mean?
As a consultant, I spend a fair amount of time helping companies price
their products and services. Sometimes I’m working with manufacturers,
and sometimes I’m working with service providers like sound companies
the same types of companies whose staff typically reads this publication.
What I see consistently, regardless of whom I’m working with, is real
problems with pricing. Simply, most companies don’t understand it. Instead,
they rely on the market to set the price and they take a given job (or
choose to pass on it) based on an emotional rather than fiscal response.
How a sound rental company arrives at prices for its goods and services
is a very interesting proposition. As most of you are aware, the government
restricts companies from setting pricing as a group. This would be a violation
of anti-trust statutes and people do sometimes go to jail for breaking
laws along these lines.
Most sound company owners and managers lack the financial skills and experience
to understand pricing strategies, and usually resort to a “forensic accounting”
method of managing their business. That is to say, they add up all of
the expenses and revenue at the end of each reporting period and feel
good about the profit, or bad about the lack of it.
While we can’t all get into a room together and set pricing, there are
some components of setting pricing structure that are critical to profitably
running a successful business over the long haul.
Rule number 1 Allocate your overhead to the planned business
you’re expecting over the next year. Overhead is made up of all of the
costs associated with the activities in your business that are not billable
directly to the client. Rent, utilities, insurance, shop tools, indirect
labor like administrative support staff, etc. all need to be factored
into your pricing model to make sure that, at the end of the year, your
company is profitable.
Rule number 2 Develop a pricing model that breaks out the following
components each time you quote a job:
• The cost of the equipment that goes out on the project;
• The cost of the labor that is directly linked to the job;
• The overhead cost of running your business allocated to the job.
Rule number 3 Charge for the equipment that not only goes out
of the shop for tours and projects, but also for the equipment that does
not leave the shop as often. Everyone has “dog” inventory; everyone also
has “funky” equipment in inventory that only goes out once in a while.
In a perfect world, you sell off the dog inventory and never buy anything
else like it again. Likewise, funky inventory is best sold to a friendly
local company that you can rent it back from on those rare occasions when
its needed. If you have to carry inventory in these categories that doesn’t
get rented out much, the carrying cost needs to be built into your pricing
model.
Rule number 4 Old equipment that you essentially got for nothing
should be billed as if it were new. If you don’t bill the amount of the
replacement cost for this equipment, you’re charging less than you would
if you had to buy a whole new system to get the job.
In other words, as your business expands, you’re going to hit a point
where you’re locked into old system pricing but have equipment costs that
are much higher. If you don’t create a budget plan to compensate for this,
expect a lower margin for every new customer added to your client roster.
Rank your customers, and resign accounts that are less profitable in favor
of new customers willing to pay more for your company’s unique value proposition.
The three most critical issues in running a business today? Planning,
planning and planning! You must plan for each month, and review your plan
on a regular basis. If things are “going off the rail,” the sooner the
problem is seen, the sooner necessary changes can be made to fix it.
The secondary benefit is that if you meet with a bank about a short-term
loan to cover a problem, it will be a far easier task if the loan officer
sees that you have a plan. And that you manage by it!
In this case, the bottom line is indeed the bottom line. It’s imperative
to the present and future of your business to understand overhead and
cost structure. Running a sound company is hard enough you shouldn’t
have to wait to the end of the year for the outcome, like trying to finish
a really long novel. It can be particularly tough when it comes out like
a Greek tragedy!
Michael MacDonald has been involved in the professional audio industry for more than 20 years. Beginning as a freelance mixer/engineer in the ‘70s, he transitioned to working for manufacturers in the mid-’80s He has provided sound for touring acts, special events broadcast and permanent installations, and has been employed, developed products and consulted with major companies such as Yamaha and JBL Professional. Michael can be reached at mchlmacdonald@aol.com
August 2003 Live Sound International