Pricing Using Theory of Constraints Part 6 of 6

This is the final installment on Theory of Constraints pricing. At least for now. Goldratt's Theory of Constraints, The Goal, and Throughput Accounting don't address pricing specifially. So, I tried to summarize what we do with our clients. This pricing exercise has resulted in 10 to 20% increase in profits for our clients, so I would expect the same for you. So let's summarize what we covered about pricing.

• Part 1: We discussed the importance of and how to calculate the Throughput per Constraint Unit (T/CU) for each of your current products or services.
• Part 2: We discussed how to calculate a minimum T/CU which is like the minimum price you need to charge to cover your operating expenses and make a profit.
• Part 3: We then compared the T/CU we get for each product/service to the minimum T/CU we calculated.
• Part 4: Next we discussed how to handle products/services that are priced below the calculated minimum T/CU.
• Part 5: And finally we discussed how to handle products/services that are priced above or well above the calculated minimum T/CU.

With this additional information, I hope you can determine a price that 1) will help you to achieve your financial goals; 2) meet or exceed the value perceived by the market place (will customers buy at that price?); and 3) establish the position, brand and image you desire in your supply chain.

Here's to maximizing YOUR profits and setting your prices!

"Dr Lisa" Lang

P.S. Check out our new Theory of Constraints Pricing Project! http://www.scienceofbusiness.com/Default.aspx?tabid=144

(c)Copyright 2007, Dr Lisa, Inc. All rights reserved.

Pricing using Theory of Constraints Part 5

For the products that are well above the T/CU you need to look into the following things:
- what is your close rate on these items, is it low?
- have your customers/prospects told you that you were over priced?
- do you want more of this type of business?

The products that are slightly above the T/CU you calculated are probably fine. And some of them that are well above the T/CU are probably OK too. But the ones that you would like to sell more of, but are not, due to too high pricing, these are the ones you should consider lower the price on.

...to be continued...

Here's to maximizing YOUR profits!
"Dr Lisa" Lang
(c)Copyright 2007, Dr Lisa, Inc. All rights reserved.

Pricing using Theory of Constraints Part 4

Let's look at the products that are currently priced below the mininum T/CU that you calculated. You can have some products priced below your min T/CU because the weighted average just needs to be at the minimum. To determine if this is one that should be below the minimum or raised you need to take into account the following:
- where is the competition priced?
- does selling this product, help you to land higher T/CU products with the same customer?
- typically you have more than one of your constraint -- like have multiple printing presses. Does this particular product run on one of your more loaded ones or does it run on a less loaded one?

...to be continued...

Here's to maximizing YOUR profits!
"Dr Lisa" Lang
(c)Copyright 2007, Dr Lisa, Inc. All rights reserved.

Pricing using Theory of Constraints Part 3

Compare the minimum T/CU to the T/CU for each product. You will find current prices that are too low and too high relative to the min T/CU.

Now look at your quotes and calculate the T/CU for all your quotes. What is the T/CU for the ones your winning versus the ones your losing?

...to be continued...

Here's to maximizing YOUR profits!
"Dr Lisa" Lang
(c)Copyright 2007, Dr Lisa, Inc. All rights reserved.

Pricing using Theory of Constraints Part 2

Now that we have our current T/CU for each product/service we calculate the minimum T/CU we need to cover all of our Operating Expenses plus make the profit we want. Here's how we do that:

Min T/CU = (annual OE + annual profit) divided by annual available constraint units

Operating Expenses (OE) are all the costs that don't change when you sell just ONE more of your product/service. They are all the costs not captured in the TVCs (Truly Variable Costs) and typically include rents, utilities, selling/marketing, general admin, all labor including direct, maintenance, and warehousing expenses.

To start, you can use your current annual profit, then increase it to see where you need to price to meet your profit goals.

Constraints Units (CU) are the annual number of hours or minutes you have available. So you you work one shift then use the time from one shift times about 70% which takes breaks and other misc downtime.

Now you have 1) your current T/CU for each product (see Part 1) and 2) the minimum T/Cu you need for each product.

...to be continued...

Here's to maximizing YOUR profits!
"Dr Lisa" Lang
(c)Copyright 2007, Dr Lisa, Inc. All rights reserved.

Pricing using Theory of Constraints PART 1

Deciding on pricing for your products or services tends to consume a lot of time and can even be stressful. Typically we are looking for a price that 1) will help us to achieve our financial goals; 2) meet or exceed the value perceived by the market place (will customers buy at that price?); and 3) establish the position, brand and image you desire in your supply chain.

The Theory of Constraints approach to pricing adds a slightly different perspective. When we first start working with a client we calculate the Throughput per Constraint Unit (T/CU) for each product/service. Here's how you do that.

1) List each product or category of products. If you have custom products, then use product categories. If you sell the same products multiple times, then list the individual products.
2) Calculate the Throughput(T) for each where T is the selling price minus the truly variable costs (TVCs). Typical TVCs are raw materials, sales commission, outside services, and freight.
3) Estimate how much of the constraint each product uses, how many constraint units. This is typically a time measure.
4) Divide #2 by #3 and you have T/CU for each product e.g. Throughput $ per minute.

Do this and now you have some information about your current pricing.

To be continued ...

Here's to Maximizing YOUR Profits!
"Dr Lisa" Lang

P.S. Check out our new Theory of Constraints Pricing Project! http://www.scienceofbusiness.com/Default.aspx?tabid=144