Costing Handbook

Costing & Pricing Your Products

An introduction

Contents

01 - Costing and Pricing: An introduction .......................................... 4

02 – Costs - the basics ................................................................. 6

What are Costs ...................................................................... 6

Types of Costs ....................................................................... 8

03 – Costing Your Products ......................................................... 11

Stage One – Your Direct Costs ................................................... 13

Stage Two – Your Indirect Costs ................................................. 21

04 – Reducing Costs .................................................................. 33

Design Modifications .............................................................. 33

Production Efficiencies ........................................................... 35

Managing Quality .................................................................. 36

Reducing Wastage ................................................................. 38

Shipping & Transport ............................................................. 39

Manage Your Tax .................................................................. 40

05 – Setting Your Sales Prices ...................................................... 41

Making a Profit .................................................................... 41

Thinking about the Market ....................................................... 42

Adding Value ....................................................................... 44

Discounts ........................................................................... 46

Negotiation ......................................................................... 46

06 - Useful Links ..................................................................... 48

Appendix 1 – Fixed - Variable Costs ............................................... 49

Our thanks go to Meghan Roberts and Audrey Seagraves for allowing us to use their work on Design Modifications and Production Efficiencies.

Photo (cover page): © Traidcraft / Rajendra Shaw

August 2011

Costing & Pricing of 50

01 - Costing and Pricing: An introduction

All organisations need to spend money to survive. It is

important that you manage these costs, since your sales

and your costs will decide whether your organisation is

sustainable.

You must manage

your costs

Costing is all about working out how much it really costs

for you to make your products. If the cost is too high then

you won’t be able to make a profit.

Controlling your costs means that you are in control of a

large part of your organisation.

This guide has been written for anyone who has

responsibility for an organisation that makes products,

particularly craft products

Use this guide with

the products that

you make.

This guide takes you through, step by step, the process of

working out how to calculate the cost of making your

products. It is best that you choose one of your products

as this will make more sense to you. It might also be best

if start with a more simple product first.

We have provided two spreadsheets to help you work out

some of the costs too.

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We have also provided you with some ideas to help you

reduce your costs.

If you save money

on some costs, you

can use them

elsewhere

By saving money in the production of your products, you

can also make sure that the people who are producing the

goods receive a fair wage.

Managing your costs is only one way of making sure your

organisation makes a profit. You must also sell your

products and the price is a big part of this. We have also

provided some information on the things you need to think

about when setting your prices.

Information

If you want to keep control of your costs then it is

important that you keep good records. If your business

is small and straightforward then this can be quite an

easy task. Perhaps you already have someone who

helps you with your accounts; they can also help you

here. If your organisation is large enough, you may

already have someone who looks after your records.

They will be able to help you calculate your costs.

If you have any queries, questions or ideas for

improvement about this guide then please contact Alistair

Leadbetter at [email protected]

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02 – Costs - the basics

All organisations have costs. It doesn’t matter if you are a

business, a charity or a not-for profit organisation, you will

always have to spend money. If you are not spending any

money then it is very hard to do anything.

You can’t run your

organisation

without costs

What are Costs A cost is something that you spend money on. That means

that the money is used up and cannot be used for

something else. Examples of costs are the wages and

salaries that you pay to workers and staff, your electricity,

the raw materials you use and your telephone calls.

As you can see, these costs are very important to any

organisation.

It is useful to know

what things you

spend money on are

costs and which

aren’t

Not everything you spend money on is a cost. The

important part of the definition is that the money or thing

you bought is used up and cannot be used for something

else.

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To understand the difference, think about these two

examples:

1. Imagine that you are making wooden toys. You

have bought some wood. You cut the wood up into

the shapes you need to make the toy. The wood

has now been made into a toy. Now you can’t use

that wood to make something else – it has been

used up. The cost of the wood you have used is

part of the cost of making the toy.

2. Imagine if you buy a motorcycle for your business.

You hand over your money and you receive your

motorcycle. You can now use your motorcycle

every day and, if you look after it, you can use for

many years to come. If you decide you no longer

want the motorcycle, you can sell it and get some

money back.

In the first example, you have bought and used the wood

and it cannot be used for anything else. In the second

example, you have bought the motorcycle and you can

keep using it for a long time. The motorcycle is not a

cost.

Information

In the motorcycle example, the accounting term used

to describe the motorcycle is a “fixed asset”. An asset

is something that is worth something to your business.

A fixed asset is an asset that cannot be easily turned

into cash. Other examples of fixed assets are buildings

and machinery.

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So costs are things that you have spent money on that

cannot be used for something else or used in a different

way. They are things that you have spent money on that

have been used up.

Your turn

As you can see, there are many different types of cost.

Take some time to make a list of the costs that your

business has. Some examples are wages and electricity

There are different

types of cost and

you need to know

which ones are

which

Types of Costs We have now seen what a cost is. Now we can look at how

costs work and behave.

If a cost is closely linked to the products that you make

e.g. the raw materials then the total cost of raw materials

used will increase as you make more products.

If a cost is not closely linked to the products you make,

e.g. your office rent, then the number of products you

make has no direct impact on the amount you pay for

rent.

There are some terms for the different types of costs. We

will now have a look at these costs:

Direct Costs are the

costs you have from

making your

products.

Direct Costs Direct costs are costs that can be directly linked with the

production and delivery of the good or service. Examples

of the direct costs are your raw materials or the wages

that you pay to the artisans. These costs are also called

variable costs because they increase or decrease as your

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production levels increase or decrease. To keep things

simple, we will call these costs “direct costs” for the rest

of this guide.

Think about your raw material costs: if you make 100

products then your raw material costs will be more than if

you only made 10 products.

Have a look at the graph below. It shows how direct or

variable costs behave as your volume (the amount you

make) increases.

Indirect costs are

the costs you have

from running the

business but not

from making your

products.

Indirect Costs Indirect costs are costs that are not directly linked to the

production of your goods. An example is your

bookkeeper’s salary. As you know, the bookkeeper does

not get involved in making your products. Indirect costs

can often be called fixed costs because they are not

linked to your production levels. Your bookkeeper’s salary

stays the same if you make 10 products, 100 products or

even 1,000,000 products. These costs are often called

overheads.

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Have a look at the graph below. The cost stays the same

no matter how many products you make.

Information

The idea of costs being fixed is only appropriate to a

fairly short time period. You know that, in time, your

rent will be increased by the landlord. This is only to

be expected but it shows that the rent is not fixed, it is

variable over time.

Fixed-Variable Costs There is one more type of cost. This one is a little more

complicated. It is a bit of a cross between direct and

indirect costs. You can read more about it in Appendix 1 –

Fixed - Variable Costs

You will need this

information later

Your turn

Go back to your list of costs that you made earlier. For

each cost, decide whether it is a fixed or variable cost.

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03 – Costing Your Products

Use one of your

own, more simple

products as an

example

In this section we are going to look at a process you can

follow to calculate how much it costs to make your

different products. As we look at the process, you might

find it useful to use one of your products as an example.

Warning

To calculate your costs you will need to have the

records of what your organisation has spent. If you do

not keep records of the money you spend and what you

spend it on, you will not be able to work out how much

it costs to make your products.

Take time following

the steps so that

you understand

them

The process has two main stages:

The first stage involves calculating the direct costs of

making one of your products

The second stage involves calculating your business’s

indirect costs and deciding on how much should be

allocated to each product.

Information

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Remember: if your organisation is going to be

sustainable then your income must be greater than your

total costs. This means that all of your costs must be

included when calculating cost prices.

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Stage One – Your Direct Costs

As you now know, direct costs are the costs that can be

directly linked to the making of your products. Common

direct costs are the labour costs from making the

products, the costs of the raw materials that have been

used in making the product and any packaging that is used

for packing the toy.

Warning

The packaging referred to here is the packaging that

the toy is sold with rather than the packaging that is

used when you transport the goods to the customer.

You start managing

costs before you

have even started

making the product

Your Production Process The best time to work out how much it costs to make a

product is when you are designing and developing it. This

information will help you know whether you can sell the

product for a price that is profitable for you and attractive

to your customers.

If your product is too expensive to make, then you can

change the design or manufacturing process to reduce the

costs.

By understanding your production process, you can easily

see what raw materials are needed and which people are

involved at what stage.

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For the rest of this guide, we are going to use the example

of a small Indian crafts company called Dhoni Rural Crafts.

They make pottery products. Don’t worry if you don’t

know about pottery or India it’s just an example. The

examples can be applied to your business too.

Diagrams are an

easy way to

communicate with

many different

people

An easy way of understanding your production process is to

draw a picture or diagram of how you make each product.

You can show all of the different production stages and

processes. The diagram below shows the process for

making clay pots. You can see how each stage of the

process is written in a box and that arrows link each stage.

Idea

If you don’t like using boxes then you could draw

pictures of each stage. Using pictures can make it

easier for everyone in your organisation to take part and

make a contribution.

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Your turn

Choose one of your products. While you are practicing

it might be easiest at this point to choose a simple

product.

Draw a diagram of the production process that you

need to follow to make one of these products.

Slowly build up an

accurate picture of

what you are doing

in your business and

what costs are

involved.

Once you have drawn a picture of the production process,

you can now start adding more information for each stage.

The information that you need to add is:

The raw materials that are needed

The cost of the raw materials that you use

The people (it is better to give the jobs or roles rather

than give people’s names) that are needed

The time they spend at each stage

The cost of their time

Remember, the numbers that you give are for making just

one item.

It is not always easy to find these numbers. The next part

of this guide will give you some ideas about how to do it.

Raw materials can

sometimes be a big

investment. It is

important you

manage these costs.

Raw Materials If you are making products, then you will be getting some

raw materials from somewhere. Raw materials nearly

always come at a cost. Even if the materials are free e.g.

old plastic bags, you may still have to pay someone to

collect them and bring them to you.

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When you are working out your costs, you are making your

calculations for how much it costs to make just one

product. You need to calculate, for each different raw

material that is used, the cost of the raw material used.

Wastage can be a

big problem.

Analyse your

production process

to make sure

wastage is kept to a

minimum.

An important part of calculating raw material costs is the

amount of materials that are spoilt or thrown away. This

cost is called “wastage”.

Examples of wastage are:

The cloth that is left after you have cut out the

patterns for the clothes that are made

The glasses that fail quality checks and are destroyed

The clay that is thrown away when the pots are being

shaped and finished

The offcuts when you are cutting and shaping wood.

These materials have all been paid for and used, so you

need to consider their cost when calculating your cost

prices.

Warning

Wastage can be a big part of your costs so it is

important to reduce it as much as you can. Also think

about how you can use the waste raw materials such as

off-cuts in other products.

Some raw materials can be very difficult to work out a

cost for because the cost is so small. An example of such

a cost is glue. If you are just using a small amount of glue

in an item then you might not be able to calculate the

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value per item. In these cases, it might be easier to think

of this type of cost as an overhead. You will learn more

about overheads later in this guide.

Your turn

Using the diagram you drew earlier; add the

information about the raw materials, the amounts used

and their cost.

Labour costs are

sometimes the

biggest cost you

have in your

organisation.

Labour Costs The next major direct cost is the cost of the wages or

salaries that you pay to your staff. Remember, at this

stage you are only interested in the wages of the people

who are directly involved in making the products.

Some businesses pay workers on a piece rate basis. This

means that each worker is paid a certain amount for

completing a certain task, such as making a pot. This

makes it easy for you to work out how much you are

paying for labour to make your products.

Warning

When you are calculating your piece rates, make sure

that the amounts you are paying are enough for people

to earn at least the minimum wage. Preferably they

will earn more than that so that they can live on the

wages that you pay.

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We will use an

example of a

pottery business in

this guide but the

lessons can be

applied to any type

of business.

If your staff and workers are paid per week or per month,

then you need to work out how much it costs for the

worker to make your products. To do this, you will need

to do some mathematics. We will use the following

example:

Anup is paid 10,000 rupees per month. He works for 8

hours every day and works 26 days per month. He is

currently has a job to make clay pots. It takes him 10

minutes to make each pot. How much does it cost to have

Anup make a single pot?

It is often easiest to

perform these

calculations in short

steps

First, we work out what Anup’s daily wage is. To do this

we divide his monthly wage by the number of days he

works in a normal month.

10,000 rupees / 26 days = 384.62 rupees

We can calculate his hourly wage by dividing his daily

wage by the number of hours that he works. His hourly

wage is:

384.62 rupees / 8 hours = 48.08 rupees

Sometimes you have

to estimate

numbers. People

work at different

rates so you often

need to use an

average or your best

guess.

If Anup takes 10 minutes to make each pot then he can

make six pots each hour. To find out how much it costs

for Anup to make each pot we divide his hourly rate by the

number of pots he makes in an hour.

48.08 rupees / 6 per hour = 4.01 rupees for each pot.

Your turn

Using the diagram you drew earlier; add the

information about the labour costs of each stage of

production.

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You may not have

any other direct

costs. Don’t worry

if you can’t think of

any

Other Direct Costs There are other costs that you might want to include in

your direct costs of production. An example of this is

depreciation of any machines and equipment that is used.

Information

Depreciation is an accounting term. It refers to the

estimated cost of owning fixed assets. Think about the

motorcycle example from earlier. The longer you own

and use your motorcycle, the less it is worth because it

is getting worn out. Depreciation is the estimated

value that the motorcycle loses every year.

If you don’t know

the value of the

direct costs, then

you can count them

as indirect costs.

There is more about

indirect costs later.

There are some direct costs that are very hard to measure.

Think about the electricity that powers your machinery.

You have probably noticed that the electricity is

expensive. It is very hard to say how much electricity is

being used to power your machines and how much is being

to power things such as your computers and lights. In

cases like this it is very hard to separate the overheads

from the direct costs of making your products. The

solution is to treat the cost as an overhead.

If you are able to accurately calculate any other direct

costs then you should add these onto your diagram now,

against the relevant production stage.

An example of another direct cost might be the

contracting out of work. Perhaps some of the production

process is contracted out, such as painting or sanding. In

this case, the price you are charged per piece needs to be

included in your direct costs.

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Warning

If you contract out work to other businesses or

workshops, you must make sure that the workers are

also paid a fair wage.

Calculating Your Total You should now have created a diagram of your production

that shows all of your costs. You should now total all of

the costs for each stage of production and then calculate

the total for all stages. This is your total direct cost of

producing a single item.

Information

You will notice that we haven’t included any costs of

selling the products once you have made them. Direct

costs only relate to the production of the items and any

subsequent packaging. The packaging is not packaging

that you use when shipping the product, but the

packaging that is used as part of the product

presentation.

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Summary So far you have learned a process for understanding your

production process and for calculating the costs associated

with it. The key stages are:

Draw a diagram of your production process and show

details of the labour, raw materials and other costs

involved

Include the costs of raw materials required at each

stage

Include the costs of the labour involved at each stage

Include any other costs that you can accurately

calculate

Add them all together to find the total direct costs of

making one unit of this type of product.

Stage Two – Your Indirect Costs

You must aim to

make a profit. If

your costs are too

high, then you must

find savings.

One of the reasons for working out how much your

products cost to make is so that you know how much you

should sell your products for. You know that a business

should make a profit so you know that your total sales

should be greater than your total costs.

This tells us that we should think about all of the costs

that a business has when we work out what our sales

prices are going to be. In the previous section of this

guide, you saw how to calculate your direct costs for

making a single item. This next part of this guide will help

you think about how to calculate your indirect costs for

each item that you make.

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Remember that indirect costs are those costs that your

business has that cannot be directly linked to making your

products. Examples of indirect costs are the bookkeeper’s

salary, your marketing costs and the electricity you use.

In this stage of costing your products, we will look at some

different ways that you can include these indirect costs in

the total cost of making each of your products.

Getting Prepared

If you want to do your costing properly, then you will need

to records of what you spend in running your organisation.

Your accountant or bookkeeper will probably have these

numbers readily available. If you don’t have a bookkeeper

already, perhaps think about hiring one part-time or

having one of your existing workers trained.

Managing your costs

is something that

you need to do all

of the time.

Information

Once you understand how to cost your products, you

will find it useful to have a system that allows you to

easily calculate and check your cost prices on a regular

basis. This helps you manage costs and lets you know if

increasing costs in your business are affecting your

profits. You might have to increase your prices, find

cheaper supplies or change the way that you make your

products.

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Allocating Indirect Costs

The process of taking your indirect costs and adding them

on to the direct costs is called allocation. You are

allocating a percentage of the indirect costs to each of

your products.

It is better to start

simple when

introducing new

systems.

There are a number of ways that you can allocate your

indirect costs. They range from the very simple to the

very complicated. The more complicated systems are also

more accurate but require more work and time to get

right. It might be easiest to start with the simple system

and keep improving it.

We have provided

two templates to

help you calculate

your indirect costs.

This guide will give you a very simple way of calculating

the indirect costs that you can allocate to each product.

It will then give you the theory for more complicated

systems. It is your decision about how complicated you

want to be.

A Simple System

You should always

work with your most

recent figures.

To calculate this, you will need a list of all of your costs.

Earlier on in this guide, there was an exercise where you

had to look at all of your costs and decide which ones

were direct costs and which ones were indirect. You need

to return to this list and get the most recent values for the

costs. The best place to look might be in your most recent

annual accounts. The person who prepares these reports

will have prepared a report called a trial balance.

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Information

A trial balance is a report that shows the balances on

all of your accounts at a certain point in time.

Your bookkeeper or accountant will be able to help you

identify which items are direct costs and which are

indirect costs.

Information

There are many different types of accounts on a trial

balance such as sales, bank accounts, your debtors etc.

Don’t worry if you are not including all of the accounts.

You just need to make sure that you include all of the

costs.

Follow the process

carefully. You will

soon see how the

system works.

This system is based multiplying your direct costs by a

number to give you an estimate of the total costs of

making each product.

The basic stages are:

Calculate your total direct costs, your total indirect

costs and your total costs

Find out how many times larger your total costs are

than your direct costs

For each product, increase the direct costs to include

all of your other business costs

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The first stage is to

calculate your total

direct costs, your

total indirect costs

and your total costs

You need to add up all of the direct costs and all of the

indirect costs that you have. You should now add them

together so that you have a value for total costs. You

should have three totals:

1. Total Direct Costs

2. Total Indirect Costs

3. Total Costs

For example, imagine that your total direct costs were

$10,000 and your total indirect costs were $50,000.

Your total costs are therefore

$10,000 + $50,000 = $60,000

Now you can

calculate how many

times greater your

total costs are than

your direct costs

You can now do this calculation:

Total Costs / Total Direct Costs

This tells you how much greater the total costs are than

the direct costs. The total costs should always be greater

than the total direct costs.

Using our example, divide 60,000 by 10,000

$60,000 / $10,000 = 6

We now know that our total costs are six times greater

than our direct costs.

This tells us that, if we increase the direct costs for each

product by this number, we have a good estimate for the

total cost of making each product.

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You will need to

multiply the direct

costs for making

each of your

products by the

number you

calculate.

A spreadsheet can

be very useful here.

To work out the total estimated cost of each product,

multiply the product’s direct cost by the result of our

calculation.

Think about our clay pots and the total direct cost for

making a medium blue pot is $2.

£2 multiplied by 6 = $12

Our estimated total cost for making the medium blue bowl

is $12. We can guess that if we sell the pot for more than

$12 we should make a profit.

This method is quite simple to calculate and gives you an

estimate of what the total cost is. It is not very accurate

though and does not really show how you spend your

money.

As you know, your costs change quite regularly. It is a

very good idea to create a spreadsheet so you can quickly

and easily check your estimate on a regular basis.

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A More Advanced System

This system is

slightly more

competitive but, if

you go slowly, you

will be OK!

You saw in the above example how multiplied the direct

costs for each product by a number to estimate the total

cost is for making a single item of each product.

In the more complicated systems, you try to divide up the

indirect costs between the products you make more

accurately. To do this you will need more information

about your business.

This system is more

realistic. It

allocates costs to

the products which

have taken up most

resources such as

time.

The more complicated systems try to be fairer about how

the indirect costs are divided between your products.

For example, you work in a business where there are three

products. You spend 50% of your time making product 1,

30% of your time making product 2 and 20% of your time

making product 3. Is it fair to divide the costs between

the products equally or should it be done another way,

perhaps to show that we spend most of our time on

product 1?

We need to choose the basis on which we share out the

costs between the products.

There are many different ways we can use to divide up

costs between products. Here are some examples:

As you use the

system more, you

will see which ways

are best for

allocating different

costs.

The total number of hours spent making each of the

different products

Total numbers of units produced

The total numbers of orders placed or shipped for

different products

The amount of storage space that the products take up

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As you can probably see, some of the ways are more

appropriate to some costs than others. The two most

popular ways of dividing up your overhead costs are the

first two in the list; the total hours spent making the goods

and the total number of units produced.

Information

As you might have guessed, you will need some more

information to use these more advanced systems. You

will need to know the total hours that have been spent

making each of your different products or the total

numbers of units that you have produced.

If you have done your calculation of direct costs

accurately then you will know how many hours or

minutes go into making each of your products.

Your records should tell you how many of each product

you have made.

Have a look at this example:

Notice how some

information that we

use is from plans

and some is from

historical

information.

As you know, Dhoni Rural Crafts make pottery. The three

products (with their direct costs are):

Product Direct Costs

Blue Bowl $1.75

Red Jug $1.54

Green Mug $1.02

This year, they plan to spend 15,000 hours making 20,000

bowls, 10,000 hours making 25,000 jugs and 5,000 hours

making 40,000 mugs.

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They have created a

budget – always a

good idea!

Dhoni Rural Crafts think that their total annual overheads

(their indirect costs) will be $50,000

Warning

When you are collecting the data, you must make sure

that the numbers are up to date and that they are all

for the same period of time.

Dhoni are going to divide their indirect costs between

their products based on how much time they spend making

the products.

The total time spent making pottery is 30,000 hours. We

can now find out how is spent in indirect costs for every

hour we spend making products. Use this calculation:

Cost of Overheads divided by the Number of Hours Spent

making Pottery:

$50,000 / 30,000 hours = 1.67

Dhoni Rural Crafts spend $1.67 of indirect costs for every

hour spent making products.

We spend half of

our time making

bowls so it seems

fair that we should

add half of the

overheads to the

costs of making the

bowls

If we multiply the hours making the different products by

$1.67 we can see how much of the overheads are going to

be allocated to each of the products:

Blue bowl 15,000 * $1.67 = $25,050

Red jug 10,000 * $1.67 = $16,700

Green mug 5,000 * $1.67 = $8,350

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Warning

You will notice that the total allocated is actually

$50,100. This is due to rounding in the numbers when I

calculated overhead cost per labour hour.

If you use a spreadsheet to calculate your numbers then

you will avoid this sort of problem because you can be

more accurate.

Now we divide the

overheads between

the individual

products

Now that we have these numbers, we can calculate how

much of our overheads need to be added onto the direct

cost of each product.

We need to divide the amount of overheads per product by

the number of products made.

Blue bowl $25,050 / 20,000 = $1.25

Red jug $16,700 / 25,000 = $0.67

Green mug $8,350 / 40,000 = $0.21

Now we can

calculate the total

cost for each

product

This tells us that we need to add $1.25 to the direct costs

for making a bowl, $0.67 to the direct costs for making a

jug and $0.21 to the direct costs of making a mug.

Product Total Costs

Blue Bowl $1.75 + $1.25 = $3.00

Red Jug $1.54 + $0.67 = $2.21

Green Mug $1.02 + $0.21 = $1.23

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We now know the total costs for making each of our

products. As long as the sales price for each product is

greater than the cost price, you can expect to make a

profit.

Information

We have written a spreadsheet called Advanced Total

Cost Spreadsheet which you can use to help you

calculate these costs

Summarising Your Costs

It can be useful for you to write down how much it will

cost you to make each the different product types that

you have.

Transparency is an

important part of

the fair trade

system.

Your customers will also be keen to see how much it costs

you to make your products. They like to be sure that the

prices they pay allow you to pay a fair wage to your staff

and workers and that you make enough profit.

The summary sheet on the next page is a template you can

use to help you summarise the costs you have when you

make your products.

You will see that you have found all of these numbers

while going through the earlier exercises.

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Simple Product Costing

For each product, summarise:

● All of the different tasks that are involved in making the product, how long is spent on each and what the unit price per task is

● The various raw materials that you use and how much they cost per unit

● Any other costs that are involved in making the product (direct costs) ● The value of overheads that you allocate to each item

When you think about the costs, please do it as if you were making a single unit of the product.

Your Company Name:

Name of the Product:

Labour Costs Task Time Spent Pay per Unit

Raw Materials Description Cost

Other Costs Description Cost

Total Overheads Description Cost Total Overheads

Total Cost

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04 – Reducing Costs

Managing costs is an

important part of

running any

enterprise.

Now that you are thinking more about costs and you have

started to look at the different costs in your business, you

can start to manage costs. By controlling your costs, you

can increase profits and afford to pay artisans and workers

more.

Here are some examples of ways in which you can reduce

your business costs and increase profits. At the same

time, there is no impact on your product’s quality and you

can improve customer satisfaction!

Your product design

is the place where

you can most easily

reduce costs of

production.

Design Modifications

Design can play an important role in your overall profits

and also in the earnings of the artisan. Sometimes you can

make seemingly small changes to the design of a product

and, at the same time, make substantial changes to the

artisan’s overall earnings. Here are a couple of examples

to illustrate how this works.

Example:

An artisan group from Guatemala was producing scarves

for the export market. Each scarf was taking 9 hours to

weave. When the labour information for the scarf was

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The value of

analysing your

production process

can be seen here

analysed (using the Fair Wage Guide, see the Useful Links

section at the end of this document), the artisans were

earning below in Guatemala’s minimum wage standard.

The production process was looked at and it was found

that the hand knotting on the bottom of the scarf was

taking several hours and wasn’t adding much value to the

market price of the item. The decision was made to

reduce the knotting from six inches to one inch. This also

decreased the production time by about three hours,

which meant that more scarves can be made. When the

labour information was analysed following the design

modification, the wages paid were now well above

Guatemalan’s minimum wage.

Example

Below are photos of two different coin pouches. The first

is the original sample from a group in India and the second

is the modified design. As you can see, the designers

modified the product by decreasing the beading and also

increasing the pouch size slightly. These design

modifications decreased the labour time for the artisan

and decreased material costs.

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As you can see,

using technology can

really help in

improving efficiency

and quality without

taking away

people’s work or

losing the

traditional nature

of your products.

Production Efficiencies

Another way to increase earnings is to find production

efficiencies that can help to decrease the labour time.

Example:

A Guatemalan organisation produces hand-made jewellery

for the export market. Unfortunately the price was

unsustainable in the market – the bracelets and necklaces

were too expensive, and the partner could not decrease

the price of the jewellery because this would reduce the

artisan’s wages to well below the legal minimum wage.

The importer decided to visit the group and find out why

the price was so high. During the visit, they realized very

quickly that the artisans were using regular needles

instead of beading needles to make the necklaces. The

partner immediately purchased beading needles for the

group. This minor change dramatically decreased the

labour time. This allowed the partner to decrease the

cost of the jewellery to make it sustainable in the market

without decreasing the artisans’ wages. The technology

doesn’t have to be advanced; people often just need the

right tools for the work they are doing.

Sometimes you have to be creative to find ways to

increase artisans’ wages. Design modifications and finding

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efficiencies in the production process are two methods

that can be useful. These methods may not always work,

but they can provide valuable information as you look at

creating sustainable products.

Managing Quality

Maintaining high

quality standards is

a great way to

reduce costs and

improve efficiency

For many businesses, not finding quality problems until it’s

too late is a major cost.

Here’s a question: When is it cheapest to find quality

problems?

Answer: It is cheapest to avoid the mistakes.

Unfortunately, mistakes do happen. It is best to work to

reduce the mistakes and find any that do happen as soon

as possible.

Don’t waste money

and time finishing

products that have

already gone wrong

Imagine the process that you follow in making your own

products. If you only check the quality of your products at

the end of the production process and the problem was

created at the start then there has been a lot of wasted

effort and materials. Have a look at the graph below.

The line shows the total cost in making a product. As you

would guess, the cost rises as the item is made. This is

because you have to pay people to do more and more work

and you use more and more materials.

If you had found the problem straight away, you would

have reduced the costs of the mistake.

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Here are some steps that can help you improve quality and

reduce the costs of bad quality.

Check the deliveries of raw materials when they are

delivered. Do not accept any raw materials that are of

poor quality

Store your raw materials carefully. Don’t waste money

by buying good stock and letting it spoil before you can

use it.

Make sure your artisans understand each product that

you are making, what it should look like and the quality

standards you expect.

Have a respected and skilled person check the quality

of work and help the artisans to improve the quality of

their work

Introduce a quality check at every stage of production

to prevent bad quality items having more work being

done on them.

Artisans should check their raw materials before

starting work and should check their completed work

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before passing it on to the next stage.

Do not send anything of poor quality to your customers.

This wastes money on transport and also impacts on

customer satisfaction.

Analyse the quality problems that you have and look at

the areas where most problems occur. How can you

solve these problems? Can you train people better, use

different techniques, change the product design or

change the production process?

Reducing Wastage

Wastage is the technical word for the raw materials and

labour that are wasted during the production process.

Examples of wastage are the pieces of cloth or wood that

are left over after you have cut out the patterns you need.

Waste might also

include the water

that you use and

then pour away.

Reducing waste is good for your organisation because it

means that you are throwing less away (and remember

that your organisation has paid for those things that are

being thrown away. Reducing waste is also good for the

environment

Here are some ideas to help you think about how you can

reduce waste in your organisation and reduce your costs:

Analyse your production process and see where most of

the wastage occurs. Use this information to identify

where you should target your efforts.

See if you can calculate the cost of wastage,

remembering to think about the cost of raw materials

and labour that is included in what is being thrown

away. You could also include the cost of having to

remake replacement items or having to deal with

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customer complaints. This will you help you set some

targets for reducing waste.

Talk to your artisans, workers, supervisors and

managers. Where do they see the waste occurring?

What changes would they make?

What can you do to reuse scrap? Can you make other

products?

How can you reduce scrap? Can you cut out patterns

from the cloth or wood in a way that would reduce

these costs?

Help everyone in your business to understand the

problem of waste and show them how they can be part

of the solution. Why not have a competition for ideas

to reduce waste?

Look at how you pack your products. Packaging is a

great source of waste. How can you reduce the

packaging while also keeping your products well

protected?

Shipping & Transport

Think about all the

costs involved in

getting your

products to your

customers and try to

reduce them all.

A major cost for craft businesses can be shipping the

products to your customers. Here are a couple of good

ideas to help you make the most of your container and to

reduce your transport costs per item:

Take care in packing your container to ensure that you

can fit as much as possible in. The more empty space

there is in your container, the higher the transport cost

per item.

Work with other organisations to share container

space. It maybe that your orders are not big enough to

fill a container. If you work with other organisations

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you can still fill the container and share the cost.

Manage Your Tax

You can save a lot of

money by keeping

control of your

finances and that

includes tax.

Tax is a very boring topic in every country of the world.

It can also be very expensive. Make sure that you are

managing your tax well so that you are not paying more

than you have to.

In some countries you can reclaim tax on exports and find

other tax benefits that are available to small businesses.

Make sure that you are not missing out. Tax accountants

might seem expensive but they can save you more money

than they cost.

It is important that you keep control of your costs. This is

an important part of keeping your prices down and making

sure that your organisation is profitable and sustainable.

You can also start controlling your enterprise and stop it

controlling you

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05 – Setting Your Sales Prices

Pricing is the term given to the process of setting your

prices. Pricing is very important because it has a big

influence on whether you sell any of your products and

how much profit you make.

The complicated

ideas about pricing

tend to be used by

very large

businesses.

Pricing has become a very complicated world and there

are many different ideas about strategies and choices.

Many of these ideas are beyond the scope of this guide.

Once you have started to understand your prices you may

want to do some more work on your own.

You now know how

much it costs to

make your products

so you’re on your

way!

The first point to make is that your organisation needs to

bring in more money from sales than you have going out in

costs. Therefore your sales prices for the things that you

sell must be higher than the costs of making them.

The difference

between income and

costs is your profit.

Profit is good.

Making a Profit It is easy to say that you must make more money from

sales than you spend on costs. It is harder to say how

much profit you should make.

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Warning

Some fair trade organisations get very nervous about

profit. It is seen as a bad word. All organisations that

trade must make a profit. Without profit, an

organisation cannot deliver its mission.

To answer these

questions you need

to analyse what

your organisation is

hoping to achieve

and start to plan for

the future.

It is up to the organisation’s managers to decide on how

much profit to make but they should consider:

How much money is needed for the future growth and

expansion of the organisation?

How much money is needed for investment in

replacement machinery and equipment?

How much money is needed to invest in the training

and development of staff

How much money is needed to be held in reserve to

protect your organisation against future problems such

as customers not paying or the economy being difficult

These are not easy questions to answer but it is important

to make sure that money is put aside for these things.

All businesses need

to find new

customers. You

can’t rely on your

current customers

being there forever.

Market research will

help you understand

markets and find

new opportunities.

Thinking about the Market It is one thing to set a price based on what your costs are

and how much profit you want to make but you also have

to think about what is going on the market.

Your customers will probably have a number of options

about where they buy their products from. Think about

Dhoni Rural Crafts. There are many pottery companies, all

over the world and all of them can make mugs, jugs and

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bowls.

By keeping an eye on who your customers are, what

products they are offering and what the prices are for

products similar to yours, you can make sure your products

are competitively priced.

Idea

Take time to research the market and watch your

competitors are doing. What are the products that are

selling well and what are the trends in the countries

where you sell your products? You have to do market

research but it doesn’t have to be expensive.

For simple products, it is often the case that you are

competing mainly on price. The levels of service and

quality that you offer to customers will help convince

them to buy from you, but price is very important.

Customers make

decisions based on

many factors. Price

isn’t always the

most important but

it does tell people a

lot about the

products.

What does the price tell the customer? If you are competing on price, remember not keep

reducing your price. Products that are too cheap can

make customers very nervous.

Think about your own experiences. If you decide to go

shopping and you see a product that is very, very cheap

what do you think? Do you think “Wow! There’s a bargain”

or do you think “That’s surprising. Why is the product so

cheap? What’s wrong with it?”

The same goes for products that seem very expensive.

Potential customers look for what justifies the high price.

The product must offer something special, something that

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makes it worth paying that extra money. If the value is

clear then they might buy your product. If not, they will

choose a different product.

Idea

Make sure that you understand your product and where

it fits in the market. Its price must compete well with

other products like it in the market. When you are

looking at the market and competition, keep an eye on

the prices.

Now that you know how much your products cost to make

and now you know how much products like yours are sold

for, what do you do?

If the market price is higher than your cost price and you

can make a good profit then great! Start selling!

It’s not always that easy though – what can you do if your

cost price is higher than the price you can sell your

products for?

There are two things that you need to look at:

1. Reducing the costs you have in your business [have

a look at some of the ideas above for reducing

waste and improving quality]

2. Increasing the value that customers see in your

products.

Adding Value When you add value to your products, it means that you

increase the value that customers see in what you have to

sell. The idea is that your product is made to look more

August 2011


interesting and valuable than your competitors’ products

and at little cost to yourself. Here are some ideas that

you can use or adapt to make your product worth more:

Packaging & Presentation: Think about how you can

make your products appear more valuable and attractive

by the way that that they are presented. Would an

attractive box or a cloth bag make the product look more

interesting?

Labels and Stories: Many of the products in the world of

fair trade have a story behind them. By attaching a label

that introduces the person or people involved in making

the product, you can give the product an identity that

customers find interesting. You are on the way to building

a relationship with the customer and that’s a great way

for getting repeat sales.

Sell Products Together: By designing products as part of

a range and then selling products together, you can

provide customers with a more “complete” product

offering. E.g. by selling a matching necklace, earrings and

ring you can encourage customers to buy more. You can

keep building on some ranges to keep customers coming

back for more such as ranges of pottery. Think about the

products that you have and how they can be sold together

to create “bundles” of products, perhaps as gift sets.

Offer Guarantees: Offer guarantees such as “Money Back

if not 100% Satisfied” to encourage customers to buy from

you. If customers have not bought from you before, then

there may be some resistance that you need to overcome.

A guarantee can give that reassurance.

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Dedicate Staff to Look After Your Customers: If you are

selling to retailers, let the retailer the name and the

direct line of the person who will handle any queries or

questions about their orders. Then make sure that that

person is always available to handle calls and emails.

Think about making sure that the person is in the office

when your customers are in theirs’. Service is a difficult

feature to sell until customers have experienced it but it

can make a difference when they decide whether to come

back.

Discounts When you are setting prices, it can be useful to set prices

according to the quantities that people buy. If people

place large orders then you can encourage them to buy by

offering discounts.

Even if you don’t publicise the discounts you should be

ready to negotiate as buyers will often expect it and it

always looks better if you are prepared.

Negotiation You should always be ready to negotiate on price. This is

common practice in business and you should be prepared

for it. One common reason for negotiating is discounting

prices based on the quantity bought, but people may just

want to negotiate anyway.

You should be aware of how much your products cost to

make. Therefore you know that that’s your minimum

price. Your business probably can’t afford to make many

sales that bring in zero profit so it is always best to make

some profit.

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Warning

Some businesses have what they call “loss leaders”.

These are products they sell at a loss to encourage

customers into their stores to buy other, more

profitable items. The total profits cover the losses

from the loss leader products so it doesn’t matter. This

is a risky strategy when you are not selling through your

own shops.

You need to decide what markets you are trying to sell to

and then work out what your marketing strategy is. This

strategy will require you to understand your customers and

your competitors and what prices are being paid in the

market. You can then set your prices and start selling!

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06 - Useful Links

Here are some useful sites on the internet that can help

you further

The Fair Wage Guide is a very useful tool that you can use

to help calculate costs and make sure that the artisan is

being paid a fair wage for their labour. You will also get

access to the minimum and poverty level wage information

for where you live.

http://www.fairtradecalculator.com/

If you are interested in improving quality, then a good

place to start is the Chartered Quality Institute. They have

a wide variety of tools and resources that you can use.

http://www.thecqi.org/Knowledge-Hub/

Business Link is a UK government project with a lot of great

information about running a business. The link is to

Pricing, but there’s other good information available.

http://www.businesslink.gov.uk/bdotg/action/layer?r.l1=1

073861169&r.l2=1073858848&r.s=tl&topicId=1073899859

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Appendix 1 – Fixed - Variable Costs

There is one more type of cost. This one is a little more

complicated. It is a bit of a cross between direct and

indirect costs.

It is not so

important that you

understand this cost

Think about a workshop. A worker in the workshop can

produce a maximum of 50 products a day and the worker’s

salary is 300 rupees per day. Whilst production levels stay

below 50 products per day, you only need to employ one

worker and the labour costs are fixed. Once you decide to

make even one more product per day then you need one

more worker. So your labour costs vary according to

production levels. To maintain efficiency and get the

most from the money you spend, it’s best to have your

workers operating at near to optimum levels.

Look at the labour costs per unit.

If you make 50 products per day then the labour cost per

product is 300 / 50 = 6 rupees

If you make 51 products per day you need two workers so

the labour cost per product is 600 / 51 = 11.76 rupees

To keep the labour cost as low as possible you can see that

it’s best to manufacture products in multiples of 50 per

day. This means that you are as efficient as possible and

there is no wasted labour cost.

The graph for fixed-variable costs looks like:

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Basically, over time, all costs are variable. You can only

think of costs in terms of being fixed or variable for quite

short term periods and for certain production levels.

Costing Handbook

Documents

Transcript of Costing Handbook