Sunday, May 24, 2015

Ramblings on Pricing and Selling Time

"The successful producer of an article sells it for more than it cost him to make, and that's profit. But the customer buys it only because it is worth more to him than he pays for it, and that's his profit. No one can long make a profit producing anything unless the customer makes a profit using it. " [Samuel B. Pettengill]
Price is not cost plus desired profit. Price is the mutually agreed value of exchange between buyer and seller. Further more unless there are crazy laws in place, it is not necessary to make a profit on each item, it is the over all business which needs to make a profit. Considered another way the contents of a retail store are an assembly of components, it is the sale of this assembly which has to make a profit, not the sale of an individual component within the assembly. If a sole proprietor does not make a profit then they will not get fed: profits are their bread and butter. If a proprietary limited  (Pty Ltd) company with owner-operators does not make a profit, it does not matter as the owners are paid wages by the company which is a different entity than the owners themselves. Therefore a Pty Ltd company can operate as a zero profit company. If there are non-working shareholders then the company needs to make profits.

Desired weekly wages, annual salary or hourly pay rate, are simply numbers pulled out off a hat, they are subjective opinions, they are not a matter of science. At any point in time, there are items in the market place available at some currently defined price. Some of these things are essential to the individual for  survival, others are imposed needs by society, and still others are optional extras. Thus we can identify 3 different levels of income:

1) Survival
2) Social
3) Optional

For an individual can also identify their current level of income, this may be higher than the minimum social level but less than the desired optional level. Whilst we can calculate these levels based on prices in the market place none of these levels are fixed. The survival income for one person can be considerably different than that for another. There will also be differences between different geographical locations, and different cultures. The income levels are therefore relative values not absolute values. Further more individuals have differing capacities to adapt and improvise: so that whilst one person may struggle with a specified minimum wage, another person may flourish or at least get by comfortably. As I have mentioned many times before, once something is released to the market and environment, people will find uses for it way beyond the original intents of the designer.

In similar manner to the income levels for individuals, it is possible to work out different price levels for goods and/or services. However when working these prices out we should also give consideration to the entire assembly of goods and services, or the over all product mix, and  the over all performance of the business. Most important of all is what the buyer is willing to pay. An amount for the price which exceeds what the customer is willing to pay, isn't a price. The amount the customer is willing to pay, is an impression, a feeling, a perception of worth: something pulled out off a hat. That whimsical intangible perception of worth, is transient and can be changed.

So can work out accurately how long a job is going to take and then multiply by an hourly rate, the resultant value however is not the price unless a customer is willing to pay such amount. There should be no buts or may be's about it, the hourly rate was pulled out off a hat. Sure may have checked industrial awards for minimum rates, and checked job advertisements for market rates in excess of the minima: but at the end  of the day all the numbers were dreamed up by someone, and the numbers felt right, or they were all they could afford. Not much point conducting complex mathematical calculations with fiction.

So calculated an amount from time and hourly rate, and the customer perceives it as way too high. If the customer can perceive it is too high, then the person doing the calculation should also be equally able  to perceive that it is too high. Now could review the project, reduce feature's and thus reduce total time, or otherwise revise estimates of times for the existing features, however the real problem is that not every hour is worth the same value.

By being focused on selling time and using a constant hourly rate as a measure of self worth, proposed prices are exceeding the markets willingness to buy. If can pull a number out off a hat for desired annual salary or for hourly rate, then can also pull a number out off a hat to define a fixed price for a project.

Prices placed on goods in a retail store are an indirect negotiation with the customer. If they like the proposed prices they will buy, if they do not like the proposed prices then they will not buy. The retailer therefore has to adjust their prices in response to the market behaviour.

In a more traditional market place, there is a more direct negotiation between buyer and seller. Further more the buyers go to the sellers: there is no annoying people who are not in the market to buy. Such people have no stated need for the items, and no stated discretionary income they are willing to spend on such items, then some seller comes disturbing them: the negotiation has one major outcome no current sale and no future sale. No future sale because there is no price low enough to encourage keeping such an annoying enterprise in business.

Like a retail store, or mail order catalogue, the proposed price has to be there to be found by the potential customer. That means that potential customers need to have reason to visit the vicinity of the stores even though they have no need or intention of buying anything. Shopping malls, plaza's and precincts draw people in with regular consumable services, and whilst there, they may then become buyers of more discretionary items.

So for example, the confectionery stall in a department store draws parents, with kids, into the store. If the confectionery stall is near the middle of the store, the customers then have to pass more expensive items, where upon there is potential to buy such things. The confectionery may not make much profit itself, but it is essential to the over all experience of the store which ultimately results in sale of high value items. Similarly the cafe, potentially makes less profit than the department store selling electrical gadgets and operating from the same precinct. But without the cafe, the precinct is likely to be empty and no one buying tthe electrical goods. Owners of such shopping centres should take such things into consideration before charging the shop rents which are typically seen as extortionate. Be certain as to who is generating the traffic, and who is benefiting from such traffic.

The point is, that price, cannot be calculated. Calculate expected times, give consideration to the cashflow requirements over the time frame of the project., use an hourly rate if must do, but make the final proposed price a judgement. This can be done by applying weightings either to the over all calculated price or to the components of the calculated price.

It should also be noted that whether selling goods or services, there is a component of work which is not directly attributed to the product being sold. The cost of this work needs to be recovered by applying an overhead charge to each item sold. Say for example that intend to spend 2000 hours per year, but only 1000 of those hours are directly billable. The other 1000 hours is used up on adiministration, research design and development of product made available, marketing and finding new projects to work on, learning and training to keep up to date and develop greater proficiency, and a multitude of other minor activities too small to identify or otherwise track. So every hour billed has to cover the cost of every two hours worked. if throw sick days and vacation time in, then every hour worked has to cover even more indirect costs.

That a product has to be designed before it can be made, isn't always noted by the customer, plus many products are just repetitive copies, so there is an expectation that costs of design have been recovered already. Additionally such costs of design are hidden from the customer with respect to physical goods like cars and electrical gadgets, whilst with services it is not all that apparent that design is required in the first place. So can end up formulating an hourly rate which is heavily weighted by factors which have little value to the buyer of services.

Consider a retail store again. The store sits there and people come in and either buy or don't buy the goods which are on display. At the end of the year either the shop made enough money to cover the living expenses of the owner or it didn't. One major problem for the store owner is not so much the price of the items, but the mix of the items and whether or not they are of any value to any of the people who visit the store. If have the wrong product then it won't sell at any price. If have the right product but wrong price then it won't sell.

Now goods and services are interchangeable. A product previously offered as a goods, can be converted to a service or substituted/complemented by a service. A product previously offered as a service can be changed into a physical goods. For example when lawnmowers are few and expensive, then more likely to hire someone to cut the lawn with a mower. When lawn mowers are plentiful and low cost then people more likely to cut their own lawn, if they have the time. There are thus competing  circumstances which shift the demand in favour of either the service or the dependent product.

Similarly designing a building is time consuming activity, but if design the building once and distribute the cost of design across many buildings then the cost of design per item is considerably reduced. This is essential for small buildings, as the cost of engineering is not proportional to the size of the building but to the complexity and risk involved. Small buildings with the same structural form as large buildings require the same design effort. With small buildings therefore the cost of engineering can exceed the cost of the building. With large building projects, fees are likely to be a proportion of the capital value of the project: this can be far in excess of the costs and therefore highly profitable. Whilst for the small buildings the cost exceeds the market price of the engineering: and therefore its is not a viable business to engineer small buildings on a one-off project basis. There has to be repetitious use of the engineering, in the form of documentation, so that the cost of the engineering can be recovered by the sales of multiple documents. Price is therefore intimately tied to the product definition.

Another example is the design and development of web sites, this can be a time consuming exercise and expensive. However today there are many blogging platforms, and more general purpose platforms like WordPress. Almost everyone can build themselves a website in a few minutes. The value of the services offered by the website designers/builders thus decreases significantly. The web designers can jump up and down and complain about the quality of such sites, identify flaws, wish for regulations and monopolies, talk about solutioneering and insist that custom design is a must: but at the end of the day they have to prove the value of their services. Just like architects and engineers of buildings the majority just talk about custom design for the site, they don't actually do it.

A general principle is to introduce no more than 20% of the total features as new, novel and original. These 20% of the features will take 80% of the time. The implication is that if we therefore know 80% of the features or characteristics with certainty then we can calculate the total time for the project: however doing so is likely to generate an unacceptable time frame and unreasonable price if we resort to selling time.

Rather what it tells us, is that the time for 80% of the characteristics is relatively certain, and that it effectively defines a fixed product with a fixed price. The other 20% of the characteristics involve a high level of uncertainty, and therefore a highly variable cost and consequently unknown ultimate price to the buyer. I would contend that the majority of people want to buy off-the-shelf exactly what they want. They do not want the uncertainty of custom design at the point in time they seek suitable product to satisfy their needs. Designers and makers therefore need to be pro-active and make product available for selection. Concept documents are easier to produce than full production documentation, and documentation is easier than actual manufacture of physical object. When it comes to computers and digital products then production and distribution are relatively low costs.

A society built around selling time is going to be in big trouble when production times are cut to near zero. Whilst time may be a measure of an employees work, it is not a measure of the employees contribution to the income of the business. People become self-employed so that they get a greater share of the income that they perceive their work actually generates: though without all the resources of their previous employer the usual result is that the self-employed person earns less but possibly with less pressure. Some employees have to generate income to cover wages of other employees: employees who do not produce directly billable or saleable work.

If don't sell time then what do you sell? In the main sell expertise and know how, and willingness to do the work required. For example the person selling lawn mowing services could charge by the hour or sell at a fixed price. They have a willingness to do work that the home owner may not be interested in, further more they can develop expertise in grass and weeds, they can turn a weed ridden patchy lawn, into a well manicured lawn. Household lawns have relatively similar sizes therefore all take similar time to complete, so a fixed fee would be possible. However different lawns irrespective of the size may require different amounts of work to maintain depending on the environment, and depending on whether in a poor state needing improvement or a good state needing maintenance. This may therefore suggest having hourly rates and selling time. I suggest this is a bad idea.

To start with most things have a minimum fee. So for example say that decide want $30/hour and determine that the time required for the job is 0.5 hours, therefore the fee for the job is $15. From a perspective of convenience however people are likely to have more $20 dollar notes in their wallets than fives and tens, at a sale price of $15 the supplier needs a ready supply of $5 dollar notes to provide change to the customers. The hourly rate was a desired rate, its not an absolute. Does $20 seem unreasonable for the work? Note that people go into stores and hand over a lot more than that, for physical goods, in a few minutes.

Take from another perspective the job takes 2 hours and therefore the fee would be $60, does that seem reasonable and is it convenient to pay? Would it be better if the fee was dropped back to $50? Similarly is an hourly rate of $29.95 a sensible rate to have? It may mislead some people into working with blocks of 20 instead of 30, which is roughly the marketing objective of such prices: however the customer is not going to be happy with the final price if they believe they have been misled.

Note that it is the seller setting the buyer up with perceptions of price. A seller should have some awarenesss of average incomes, and disposable portion of income, for their market sector. Also if accept cheques or credit cards then the inconvenience of various denominations is removed, but then again there are minimum fees which are acceptable.

Given that in an industrialised nation less than 10% of population is involved in agricultural, can assume that the majority of the population is attempting to grab a share of the disposable portion of peoples income, that portion not required for food or other essentials. Assuming that with time all the other essentials also only requires a small portion of the population: housing for example, once it is built it can last for 50 to 100 years possibly longer: so with the bulk of the housing existing already do not expect many people involved in housing construction. So have a relatively small percentage of population supplying essentials, and rest trying to find something to supply.

Time isn't really something that people want to buy, especially if the output of the work effort is lower quality than they could produce themselves, and their own hourly pay rate is less than that of the service purchased. The funds available to the buyer are an important aspect of how they perceive value. For example say that a person can put $50 away each week, then they can save $2600 per year. Then chances are they are not going to be impressed paying some $1800 for a weeks worth of design producing a few drawings and some calculations: if the perception concerns selling and buying time and the report they get turns out to be defective relative to their needs but otherwise what they asked for. The longer it takes to save the money the more discerning the buyer is likely to be about the purchases they make: on the other hand they may lack adequate knowledge to make a proper selection of suitable supplier.

{... lost my track.}

However, just because should avoid selling time, doesn't mean shouldn't measure time.