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Corporate Finance

How to Charge for Customization

How to Charge for Customization

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Alright everybody we’re ready to talk about the super sexy topic of improving gross profit margins which I think is super sexy because improves your cash flow, it improves your net profit, and it improves your overall business valuation; things that are critically important to whatever your goals might be. So how do we do that?

Well one of the best ways we can do it is by decreasing our overall costs of goods sold. What are costs of goods sold? Costs of goods sold are the costs of the goods that we sell. It’s the costs of whatever it is that we’re selling to our customers. If we’re a manufacturing firm it might be [this], if we’re a service based firm it might be me, you never know but it’s something that is being sold.

So what we’ve got to think about is how do we decrease costs of goods sold? A lot of the times, I find, and this is true across every industry, we’re pressured into customization. “Hey you know, I love your product but if you just tweak it a little bit, if you just add this little feature, you know if you would just do those 5 things for me that are outside of the other 80 things you’re doing, then I’d really appreciate it.”

In construction, they’re pretty good about this and they call that a change order. For the rest of us, a lot of us are not very good at it, in the service business or in other businesses in manufacturing, and we go ahead and we just, “oh, sure, we’ll add that little thing for you,” but what we forget to charge for it.

One of the key critical weaknesses is our discipline on costs of goods sold. If we understand that adding a product or service is going to increase our costs of goods sold we must also then add that to our price. We cannot lose gross margin for customization. And again, this applies to every business under the sun, we all get asked to do these things and it’s very important that we hold our ground; not in a negative way, but in a very positive way.

If you went to a car dealership and said “hey, what does your base model cost?” and they said, “$40,000,”  and you say, “great, I want new wheels, I want the premium stereo system, and by the way I want all the bells and whistles I can possibly get on this car,” and they say, “it still costs $40,000,” you would be pretty amazed. You expect it to cost more, your customers will expect the same thing. You have to have the discipline to ask for it.

Someone asked me about Social Security....

Someone asked me about Social Security….

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“If you could build a startup to replace social security, how would you do it? What do you think the biggest challenges would be?”

There are many problems with the social security system. The most obvious are:

  1. Funding: There’s not enough being put in to match what is coming out. This is a classic example of expenses being higher than revenues. It is partially a result of population and demographic issues. This will be somewhat alleviated by the Millennials, but continue to be exacerbated by the Baby Boomers. It is also partially due to the ineffective and wasteful administrative nature of government.
  2. Return: When I put money into social security I don’t get a rate of return on my money. This is because the government uses social security funds to spend on other things. Also, individuals (or organizations) are not able to invest their social security taxes. The government believes you are too dumb to invest your own money…at least that is what the policy leads me to believe.

So, on to my thoughts on “privatization”.

First, as much of a libertarian as I am, I don’t think it is practical to replace social security with a private enterprise (start-up). That said, I would privatize portions of it (on a fixed fee) and require bidding every five years to insure the money management and disbursements were handled in the most efficient manner possible.

Second, I would make a number of revenue and investment changes. Here they are (open for discussion and critique):

  1. Reduce payroll taxes to 10% total (5% employee and 5% employer). Payroll taxes are currently the most regressive tax in America (other than “sin” taxes), and these taxes are causing an increasing wealth gap and really hurting the lower-middle class. *This helps a number of social issues and will improve the overall economy (see the payroll tax holiday from the previous recession).
  2. Extend the payroll tax and cap the Medicare tax at $1 million of payroll rather than the current limit of $117,000. *This fixes the revenue issue.
  3. Require social security funds and Medicare funds to be set aside and separately managed by independent money management firms and administrators. *This cuts administrative costs (reducing overall expenses) and increases the overall rate of return (boosting revenue.) We should require those firms to manage these funds with 75% short-term bond funds and all other funds in highly liquid index funds with a maximum fee of .35% per year for money management and a max fee of $1.50 per participant for administration. *By the way these companies have the best automated reporting around and this bidding would be incredibly competitive.
  4. Require the government to immediately seed the fund with the amounts needed to fulfill the next 10 years (assuming a 3% rate of return).

That’s it.

Clearly, there are a lot of numbers in this that would have to be run and I am sure my percentages would have to be closely analyzed to insure stability in the system. I am completely flexible around the numbers and percentages as long as the theory remains intact; grow revenues and lower expenses by outsourcing, grow the economy and the base by lowering payroll taxes and simplifying government administration.

What do you guys think?

 

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