Leverage Fortune 500 Business Practices: Understanding and Reducing Your Cost of Goods Sold

Regardless of how long you’ve been in business and whether you’re building your first or hundredth unit, understanding what it costs to produce your product and producing it profitably is one step in assuring your business is profitable.

Fortune 500 Companies live by the numbers. They know the optimum sales price, what it costs to produce each unit, and the profit from each sale. As an entrepreneur, borrow this practice from their playbook and be sure you understand your numbers.

You’ve no doubt done your market research to determine the optimum sales price – often the price the competition is charging for a similar product. Your costs should follow the rule of thirds: 1/3 cost of goods sold, 1/3 sales and marketing costs, and 1/3 overhead costs and profit.

It’s that first 1/3, the cost of goods sold, we’re focused on at this point. These costs are made up of labor and materials.  Even if you’re not paying yourself for your labor at this point, it goes without saying, your time is your businesses most valuable resource.

Reducing Labor Costs through Brown Paper Mapping:

When working with a Fortune 500 client one of the processes management consultants use is brown paper mapping. Using a roll of brown paper that’s typically three feet wide and the length of whatever free wall is available we affix a sheet to the wall.   We then work with the client to lay out the process sequentially and prepare it for analysis by gluing a rectangle on the brown paper for each step in the process and annotating the current time it takes for each step.

Fortune 500 companies typically have a small team of people map out the process and then bring in different groups to identify the problems and brainstorm solutions. Each idea is recorded on a post-it and affixed to the brown paper. The team then gets together and puts it into an action plan.

As a micro-entrepreneur you can replicate this by creating a brown paper of the current process, analyzing each step for problems and opportunities, and developing a plan.  For each subsequent unit select which of the process changes you’re going to implement and keep track of the time reduction as you’re building.

Reducing Material Costs by Understanding Demand:

Fortune 500 companies understand the demand for their product. They have the ability to estimate how many need to be produced to satisfy demand each week, each month, each year. They also know the peak periods and slow periods.

As a  micro-entrepreneur you might not yet have the sales history to know your long-term demand; however, you can still reduce your material costs by buying the optimum material quantity to get the lowest price possible without tying up too much of your working capital, yet insuring you have the material on hand when you need to build the next unit.

As your sales and sales channels grow you’ll have the opportunity to further understand your material and inventory demands.

Learn more about low cost business start-up strategies in $1,000 Start-Ups.