Selling on the Margin
To talk about cost and costing, we need to first talk about what it means to “Sell on the Margin”.
Selling on the Margin is an important part of knowing how to cost your products. This is key information for making sure you don’t get the raw end of a deal. So let’s jump right in.
We start by looking at that key term Margin, which is the difference between Full Cost and Profit. Then you might ask: okay, but what is Full Cost? The answer is that Full Cost = Labor Costs + Material Costs + Packaging Costs. We sometimes refer to Full Cost as Direct Cost.
Whew, that’s a lot of jargon all at once, but I promise this is going to be so helpful to understand. We’ve just got a few more terms and then we’ll get to an example that brings it all together.
One more term to define is Marginal Cost, which are all the more general costs of running your business that need to be taken into account when you are costing.
Marginal Cost includes things such as: Rent, Loan Payments, Utilities, Taxes, Transportation Expenses, Depreciation (a non-cash expense), Advertising & Promotion, and more.
The difference between Selling Price – Direct Cost = Marginal Cost +Profit
Connect it to Cost And Costing
Now we have enough context to start looking at an example.
If we keep the formula in mind, we’ll see that Selling on the Margin means you cover your Direct Cost, but you lower your Selling Price by discounting from the Marginal Costs.
One of the reasons to get away with it is it is harder to allocate the Direct Costs to everything you sell and the discounted sales add to the Margin, so it is okay.
To be honest, I am not a fan because it is a slippery slope. For Example: A restaurant comes up and wants to purchase XY Bakery Goods 6 x per week. But he will not pay retail and, “Oh, by the way, please deliver and sell on net 30 days terms.”
You, wanting to make a deal, might say, “I can give you 20% off.” But that 20% is coming from what would normally cover your Marginal Costs.
He responds, “Great! But just one more thing…if I do not sell it I will want a credit for the product and I want delivery between 7:30 and 8:30 am. And we will make adds and cuts by 6 pm the night before.”
What's so bad about that?
Let’s plug some numbers in and see how this example of cost and costing looks in practice.
Basket of Products – Regular Retail $ 100.00
His Price is $ 80.00
Delivery is 16 miles round trip and take an hour at Rush hour:
1 man + Van = $ 20 x 6 = $ 120
So now you are at – $ 60
Sales = $5 per day x 6 => that brings you to $45
But we need to factor in the Cost of Cash. Your bank loan rate is 8% his sales are $ 390 a week, you carry 4 weeks or $ 1,500.
That also costs you $ 10.00 in interest per month:
Summary: $ 100 worth per day and you end up selling it for $ 44.50. Are you many any money? Is it a huge drain on your operation?
Your Direct Cost are 65% see you are losing $ 9.50 per day of direct labor and giving away ALL of your marginal expenses and profits! This is bad in everybody’s world.
A better Way to do Cost and costing
The thing about the example above is that it’s an easy trap to fall into, if you aren’t looking closely at the numbers with an understanding of how Costing works.
Here’s an example of how I might rework the deal:
I would (1) give 10% instead of 20%, (2) require payment on pickup, and not include delivery, and (3) require that adds and cuts must be in by 2:00pm.
By holding off discounting so much on these marginal expenses, in this example now we are giving away 10% but ultimately get a return of $2520 per month. That’s a huge difference. That’s what makes cost and costing so important.
Special Cases of cost and costing
So you might ask, with Cost and Costing, is this the only way to do it? Is it ever okay to discount so heavily on the margin? This blog could have been a lot shorter if the answer was just to never give discounts, right?
Well, the answer is that sometimes there are special cases. And really what we mean there is that the product would have an extra normal profit.
For example, when Direct Cost is 35%
Imagine that new equipment allows you to increase your production from 250 units a day with 5 people to 1700 units with 3 people. That product would have a wonderful, Extra Normal Profit. In that case, increasing your sales (by discounting on the margin) in order to match production capacity is worth it.
Now, if you found this helpful, I’d recommend reading on to our Cost and Costing Part 2.