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This is the one step in the contracting process where you are the expert and we are not. Given that there are so many different types of businesses out there and so many different ways of pricing, our best advice is to be as competitive as possible.
The old stories of $200 toilet seats and $300 hammers are simply that, old history, and you better believe that you have to sharpen your pencil as much as possible in order to be competitive.
Let's add a little perspective to the "hammer" story. The last time I heard the story, the cost of that hammer was about $400. Now let's compare one $400 hammer, special made, shipped to port, to the cost of keeping an aircraft carrier in port for one day.
The ship has over 3,200 sailors, carries 85 warplanes, with support personal for them (about 2,000), along with the pilots. They will use 600,000 ballpoint pens, 1.5 million sheets of papers and 140,000 rolls of toilet paper. Each crew member will eat three meals. Even if the hammer cost $1,000, it would be cheaper to have it specially made, rather than to keep that one ship in port for one day.
The actual story is that they had a special order for a "small" amount of these special tools, if they had waited one hour, not one day, the cost to the government and the taxpayers would have made those hammers cheap at any price. So, the buyers actually got a great deal, not one that's news worthy, but in the long run, it did save the taxpayers money.
So when you are pricing your "widget" out, remember that there are usually two sides to the "story" that you keep hearing in the bars.
Common Pricing Factors. At the same time, however, you also need to make sure that you cover all of your costs and protect your profit. Here are some things to consider in determining your price.
- Pricing History: You can often get pricing history from the buying office by asking the Point of Contact identified in the contract (Block 10 if you are using Form SF 33). You can also contact a Procurement Technical Assistance Center and ask it to run a computer review of pricing history for an item. If you are bidding on a service, it becomes more difficult to get good pricing history. Ask the contracting officer to provide you with the previous contract number so you can obtain the contract. Make sure the statement of work is the same as yours so you can make a fair price comparison.
- Cost Out All Special Requirements: The buyer may ask for many costly extras. Especially watch out for packaging requirements; they can be expensive. Don't just stick on a percentage of the cost of the item to cover packaging.
- Think Carefully about Quality Requirements: Will any of the certifications and acknowledgments add on extra costs? (See our discussion of quality assurance standards.)
- Factor in Bidding Costs: Some offers are rather simple and straightforward, but as the value of the contract increases, more time and labor are usually required. As a general rule of thumb, you can estimate that the cost of putting together an offer will run three to four percent of the value of the proposed contract. Make sure current finances can handle that cost.
- Don't Forget Overhead and Profit: Make sure your profit is reasonable. Remember that the bidding process is very competitive. You are free to figure in as high a profit as you wish, but you must win the contract to enjoy it. Never bid if it doesn't make good business sense. And while making sure that your price covers your overhead costs may seem very basic and obvious, it is the pricing factor that small businesses most often get wrong, to the detriment of the company: If your cost information is not correct, you can't accurately bid a contract, be competitive, or make good decisions for your company.
Here are some simple formulas that might help you figure out what your basic costs and profit might be.
Product Pricing Formula
Material Cost + Labor Costs + Overhead Expenses / # of items produced = Cost per item.
- Figure the total cost of the raw materials used to make up a single item, OR
- Divide the material cost of a batch of items, by the number of items produced.
- Figure what you pay to employees to produce the item, whether or not you have employees.
- Assign a wage figure even if you are the only one producing the item.
- Take the weekly salary you pay someone to produce the weekly volume of items, and divide it by the number of items.
This includes items such as rent, gas, electricity, business telephone calls, cleaning, insurance, office supplies, postage, repairs, maintenance, delivery and freight charges, packaging and shipping supplies.
- If you are working from home, calculate a portion of your total rent or mortgage payment, in proportion to your workspace, or assign a reasonable figure.
- List all overhead expense items and total them.
- Divide the total overhead figure by the number of items per month. This amount will be your overhead per item.
Add an amount to the cost of each item. Check your competition for what they are charging, and work accordingly. This establishes your profit margin. Remember that just because this is a "government" contract does not mean you can add 2,000 percent profit.
Add Profit to the Cost per Item for the Total Price per Item.
Service Pricing Formula
Hourly Overhead Expense + Hourly Wage + Profit = Total Price per Hour
Calculate all the costs related to operating your business from home, and arrive at a total cost per month. Divide this by the average number of hours worked per month, to obtain your hourly expense.
Decide on a wage to pay yourself, considering background training and expertise. Compare this to industry averages.
Add a factor to your hourly wage, to provide a profit margin.Check your competition, and market demand.
I find that the simpler you can make your calculation, using all the factors above, will help you come up with some real costs.
Determine Your True Costs
Why do we say that small businesses tend to get their cost information wrong? Simply because many, if not most, small businesses don't really know what their overhead costs are.
Often, when pricing out a project, businesses will simply take their prime costs (labor and materials) and mark that figure up by some arbitrary percentage that they believe is sufficient to cover all indirect costs and give them some profit. Or they will use a single, company-wide rate applied on only one type of base, such as direct labor hours or engineering hours, for assigning indirect costs to the product or service provided. In either case, if this estimated percentage is higher than what their overhead really is, it affects their ability to be competitive. If their estimate is lower than what their costs really are, it affects their ability to be profitable.
If your business falls into one of these categories, we strongly recommend that, before you bid on a contract (or on any other project for that matter), you take the time and the steps necessary to determine your actual costs.
You might consider using some form of activity-based costing (ABC) to accomplish this. ABC, in its simplest terms, is a cost management method that allows a business to determine the actual cost associated with each product and service. With this method, you look at every item and activity in your business associated with putting out your product or service (e.g., heats, light, administrative help, sending out an invoice, doing payroll, etc.) and then attach a cost to it. In other words, you break your costs down to their least common denominator so you know what they really are.
Without knowing your true costs, you can never be sure where money is being made or lost, you can't identify moneymakers and losers (an increase in sales does not necessarily mean an increase in profit), and you can't make good strategic decisions and plans for your company.
Although ABC is geared toward a large business, a small business can adapt this philosophy and utilize a more simplified form of it. For more information on ABC, try searching the Internet or check out some of the books on the topic in your bookstore or online.
Again, we want to remind you to carefully read the solicitation and make notes on points you don't understand. Then go ask the questions. Go to the buyer or Point of Contact identified in the contract, the small business specialist at the buying office, or a Procurement Technical Assistance Center. But please ask someone! The answers could significantly affect your price, and your profit.