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Practical Exercise for Calculating the Price of a Product
Setting the correct price for a new product is best not left to guess work or hunches. This month we lead you through an example which REAP Panhandle Business Specialist
Jerry Terwilliger created after attending a session on this topic at the Association for Enterprise Opportunity (AEO) conference in Kansas City, Missouri, last May.
Example Business Situation:
Roller Specialties is a specialty small roller manufacturer that re-manufactures hard to find rollers for sale to specialty machinery part retailers. The owner is currently preparing to introduce a new part and needs help pricing it.
The company has four employees including the owner. All perform direct labor activities. Two employees are paid $9.00/hr, one employee is paid $11.00/hr, and the owner is paid $20.00/hr. The Company averages 111 non-work days per year (365 less weekends - 52 X 2= 104, plus 7-holidays per year). On a typical workday, the employees’ average 6 1/2 hours in production-related activities and the owner averages 3 hours.
The company’s business expenses are projected to be $287,550 for the next 12 months. This includes $69,000 for direct materials and $70,009 for direct labor.
The owner has determined that one batch of rollers will require 4 person-hours of production time and will produce 160 units. Material and packaging will cost $0.73 per unit.
You Will Need this Information:
1. What is the average direct labor wage paid per hour?
Employee 1 - $9.00
Employee 2 - 9.00
Employee 3 - 11.00
Owner -
20.00
$49.00/ 4 employees = $12.25/hr
2. How many workdays are available to Roller Specialties, assuming there are 365 days in this calendar year?
Calendar days - 365
Less non-workdays -111
Total workdays available = 254
3. What is the total number of direct labor person-hours projected to be billed during the work year for the owner and employees?
Total workdays available 254
Scheduled work hours x
8
Hours available per employee
2,032
Number of employees
x 4
Total hours available 8,128
Less non-billable time *
- 2,413
Billable direct labor hours =
5,715
*Note: Each employee averages 1 1/2 non-billable hour’s per day (breaks, etc.) x 254 workdays.
Owner averages 5 non-billable hours per day x 254 workdays.
1 1/2 hrs x 254 workdays x 3 employees = 1,143
5 hrs x 254 workdays x 1 owner +1,270
Non-billable direct labor hours = 2,413
4. What is the projected overhead dollar expense for the work year?
Business Expenses for 12 months $287,550
Less:
Direct labor
-$70,009
Direct materials
-$69,000
Projected overhead expense = $148,541
5. What is the annual overhead percentage for Roller Specialties?
Annual overhead expense = Annual overhead percentage
Annual direct labor cost
$148,541 = 2.12 or 212%
$70,009
6. What will one roller cost to produce?
Average direct labor rate $12.25/person-hr
Overhead rate @ 212% + $25.97
Direct labor cost =
$38.22 1/person-hr
4 person-hours per batch = 240 minutes/ 160 units per batch = 1.5 minutes per unit
Direct labor cost/minute ($38.22 / 60 minutes) = $.64 x 1.5 minutes
$0.96
Direct material costs
+ $0.73
Per unit cost for each roller
= $1.69
7. What should the selling price be for each roller if Roller Specialties wants to receive a 25% gross margin on sales?
Margin on selling price = $1.69 / .75 = $2.25 established selling price.
Questions about pricing?
Contact Jerry Terwilliger, REAP Panhandle Business Specialist at 308.247.9926 or email him at
j414@charter.net
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REAP
Rural Business Roundtable