Todd Drummond, Consultant and Lean Manufacturing expert
Todd Drummond

Let's assume you are having problems with your truck's transmission and go to the local mechanic for help. The mechanic quotes you his hourly rate for service and says parts cost extra. In other words, that hourly charge is to cover his operating expenses and create a net profit. How much the parts cost doesn't affect the hourly rate; parts are an add-on expense.

Now, what does this have to do with roof truss or wall component sales? The answer is a lot more than most of you may have considered.

If you didn't sell manufactured components, how would you maximize the gross profit for your facility? Simple: You'd rent it at the maximum dollar rate possible for the time period you choose, be it monthly, weekly, daily, or even hourly. Within reason, you don't care how the tenant uses the facility and how much he pays for the materials he uses. You just want the most you can get based on market conditions for the agreed time the lessee uses the facility.

Now, when you sell a component project to your customers, how is this so different from leasing your manufacturing facility? When you manufacture a customer’s project, the customer in effect is renting your facility.

Even though that's the case, most component manufacturers figure the selling price a different way: By adding the cost of materials with the cost of labor and then multiplying it by some number. But think back to that truck mechanic. Lumber and truss plates are like auto parts for a truck. And while truck mechanics don't use material costs when setting their hourly service rate, you in effect are with your pricing formula. The cost of auto parts has nothing to do with how much of the hourly garage time the repair will consume. The cost of parts is always a separate line item from the hourly charge.

Here's the point: Using the material cost to establish the margin rate skews the hourly rate up and down depending on the cost of material. If material costs drop, the company charges less per hour. In effect, you are giving yourself an hourly pay cut.

Here's the formula you should be using:

Material + Labor Cost + (Dollar Rate * Expected Hours) = Sales Price

Using this pricing formula will yield higher margin dollars per hour spent on projects. You will be able to view the gross-margin dollar rate per estimated hour and recognize at a glance the high- and low-margin dollar-per-hour projects. In other words, you'll know how much you spend "renting" your manufacturing assets per hour for the orders being produced--all without being skewed by material cost percentages. You will have a much better understanding of which orders are worth the effort and which ones you will pass on to your competition. You will know at a glance how much you will truly be earning on an hourly basis, so, in essence, you are giving your company an hourly raise to do business.

All of this will lead to greater net profit at the end of the new year.