bilby
Fair dinkum thinkum
- Joined
- Mar 6, 2007
- Messages
- 34,228
- Gender
- He/Him
- Basic Beliefs
- Strong Atheist
I worked for a manufacturing company here for almost 15 years; I started out unloading trucks in the goods inwards warehouse, and after a number of moves and promotions, finished as Demand Planning Manager.
At one point, I was the Inventory Manager for the manufacturing plant, and we had a number of ongoing issues with unfinished inventory building up at various parts of the process. I determined that we didn't really know what these delays cost, and so whether it was worth buying more equipment and/or adding staff to clear the bottlenecks, so the General Manager and I had a series of meetings, and decided to hire a production accountant to work with me to get a better handle on our costs at a more granular level than was then understood.
After a long and complex study, in which the two of us built a detailed cost model of the site, with each operation and machine hour costed in detail, one of the things that fell out of the analysis was that the previous cost model, which estimated production costs based on the crude number of units produced per hour, produced wildly inaccurate results; The actual cost of manufacturing some 200 of the 385 SKUs we produced was below our selling price; about 150 SKUs were priced approximately in accordance with the old model; and the remaining 15 SKUs were priced with profit margins WILDLY greater than our price setting rules suggested was appropriate.
This in a company that had been thriving and growing very fast for 30+ years. Our best selling products were being sold for FAR more than they cost to make - but the customers were used to paying that price, and our competitors generally charged a similar amount. Most of our product lines were being sold at below cost, effectively subsidised by the big ticket items.
The management response to this was to make some significant changes to our manufacturing strategy, to maximise production of the most profitable lines; And to direct the salesforce to aggressively push the most profitable items. No reductions in price were made to the high-margin items; And the price of the loss-making items was increased very little (to avoid loss of sales volume), with a view to slowly increasing the prices to bring them to profitability over ten to fifteen more years.
The lessons here are: a) Don't spook the market if you find out that your pricing policy is wildly inappropriate; b) It's not important to make a profit on every (or even most) of the lines you sell, as long as the overall operation is profitable; c) Just because you know that you are selling at the 'wrong' price, doesn't mean your best strategy is to change to the optimum price structure straight away - and it might NEVER be the best strategy; and d) If it ain't broke, don't fix it.
Our customers largely wanted a large product range from a single supplier. If we stopped selling products X, Y and Z that were losing money (or sharply raised our price on those items), then we would lose our sales of everything to that customer, including product A, which was making us a mint. This one simple and commonplace fact - customers don't want to deal with a vast number of different suppliers - totally destroys the hypothesis that "you can't set your price below what it costs to produce + a reasonable profit if you want to stay in business". Indeed, to give a more commonly seen example, you see this at fast food outlets, where drink refills are free - 'free' is certainly less than the cost of goods sold in this scenario, and yet not offering free refills would harm the business, and drive customers to the competition.
Of course, the above is just a real world example from an actual manufacturing company; I am sure you have some sound economic theory that says it would be impossible in a hypothetical economy. But it seems to be quite typical of real manufacturing facilities - they sell quite a number of products at a loss, mostly because they simply don't realize what their actual costs are - and those few who do have a handle on their actual costs don't act, because disrupting the market is generally a bad strategic move - it would show your hand to your competitors - and because their optimum sales strategy includes loss-leaders (just like the free drink refills at fast food joints).
In short, your claim here is, to my certain knowledge, false. It could be true of a manufacturer or retailer with a very small product range, and a good grasp of their actual costs, who operates in a fully mature market that has been stable in terms of both costs and demand for a considerable time (at least a quarter century); But as such circumstances are rare, it's not a useful guide to the real world.
