Cost-Plus Pricing Demonstrates Value to Clients Savvy clients demand pricing transparency, as they should. To the client, the practice of estimating projects using a combination of market pricing and hourly labor rates seems confusing.Ira Friedman ⋅ Feb 8, 2013 Ira Friedman is the CEO of Bay Audio, amanufacturer of custom speaker solutions.He holds an MBA from the Harvard BusinessSchool.Savvy clients demand pricing transparency, as they should. To the client, the practice of estimating projects using a combination of market pricing and hourly labor rates seems confusing. Most products listed on a proposal are foreign to the buyer, can’t be easily shopped online, and make the client question the product’s value. Then again, labor rates charged by many integrators are higher than rates that clients pay to their CPA, physical therapist, and their kid’s violin instructor. Therefore, the value proposition seems off-balance. Your penchant for choosing obscure products and creating additional labor categories frustrate the client even more. Which begs the question, “Why not increase pricing transparency, refocusing the client on the overall project and away from the price of the TV?” The cost-plus pricing method will become, in my opinion, the de facto pricing strategy in the near future. Used by network providers and interior designers, cost-plus satisfies the demand for pricing transparency and shifts the focus to engineering, installation, and service. The AV industry has enjoyed outsized product margins for years, and has used these margins to offset (and ignore) labor inefficiencies. Most integrators earn slim profits on labor, relying on product margins to float the business. Clients demand low product margins. And the market demands efficient use of labor. Surely, costplus pricing satisfies the client, but it puts pressure on labor profits, forcing management to get a grasp on labor costs, capacity, and inefficiencies. Cost-plus pricing puts the power of the purchase back in the client’s hand, resulting in larger projects with higher quality gear.The networking industry has figured how to pay its personnel well, earn slim product margins, provide high end-user value, and post a nice yearend profit. You can do it, too. By standardizing your systems, creating repeatable in-house processes, and billing for each labor hour. A Cost-Plus Strategy With cost-plus, you price products based on landed cost, plus a reasonable mark-up–typically 17 percent. For example, with MSRP pricing, a speaker sells for $300, with a $125 landed cost. That’s close to 58 points of margin. A TV sells for $3,000, with a $2,800 landed cost. That’s a seven-point margin. A system with a TV and five speakers sells for $4,500, with a net margin to the dealer of $1,085. With a 17-percent cost-plus model, the integrator would sell the speakers for $246 each, and the TV for $3,264, a combined selling price of $4,000, and a net margin of $584. “But he makes less money!” you scream derisively, “this is stupid.” And you would be right. However, the smart integrator doesn’t sell $300 speakers with the cost-plus model. Instead, he improves performance by selling $500 MSRP speakers, at $245 each. The improved package sells for $4,500, which is the client’s original budget. And the integrator earns $654. Of course this is a 40-percent drop in gross margin, and that drop needs to be made up somewhere. This is where additional product and labor charges come in. 1. Products require transportation, so each item includes a delivery cost, including the cost of getting the item from the vendor, and the cost of delivering it to the job site. Delivery may add $200 in our example.2. Cost-plus pricing means just that: every item is invoiced with a 17-percent markup, including the Apple TV, the wireless hub, and the projector.3. Cost-plus pricing is based on gross dealer cost. Count rebates, freight allowances, and spiffs as “gravy.”4. Cost-plus pricing puts the power of the purchase back in the client’s hand, resulting in larger projects with higher quality gear. High-quality products tend to require less follow-up and warranty service–areas of the business that tend to rob profits. How And When To Present Cost-Plus Pricing As a client, I like to hear about pricing policies at the start of a discussion. It’s on my mind, and I want the question settled before focusing on performance. I went to an interesting mid-priced restaurant/wine bar last week. The waiter told our four-person table that the restaurant was, in reality, a discount wine store with a high-end kitchen. He encouraged us to walk to the wine racks and choose a bottle. (The restaurant has sommeliers on staff.) We chose a $35 Riesling–a bottle selling for $70 in other restaurants. We felt we got a great deal, which meant we had no compunction having extra appetizers and dessert. When we were done, we happily walked out, having paid $200 for dinner–more than one would expect to pay at a mid-priced restaurant. Knowing a pricing policy gives a client confidence. Offering cost-plus sounds great: “We sell products at wholesale plus a nominal 17-percent mark-up to cover purchasing, warehousing, and service. Plus, our labor rates are the same as every high-quality integrator in town.” After this declaration, you can focus your presentation on the things you do best–system design, engineering, programming, installation, and service. Focusing on the labor side of your business reduces client uneasiness, and allows you to compete with something you can defend: your abilities.