- 1. What does the standard cost sheet include?
- 2. Which costs are fixed per SKU?
- 3. How do you put a number on each one?
- 4. Where did the missing cost come from?
- 5. What about the cost of lead time?
- 6. What should you do with the rebuilt number?
Hypothetical: $10.00. That is the margin per unit a standard cost sheet shows for the low-volume part in the worked example below, a respectable 25 percent on a $40 price. Rebuilt with the costs that actually belong to it, the same part loses $3.25 on every unit it ships. Nothing about the part changed. Only the place where its costs were written down.
What follows is a six-step method for doing that rebuild on your own products. It uses no data you do not already have, and once you have done the first SKU the rest go quickly. If you are working through a whole product line rather than one part, start with the pillar guide on how to cut a product line without losing revenue, which puts this calculation in context.
1. What does the standard cost sheet include?
Material, direct labor, and a share of overhead, usually allocated by volume or by labor hours. The overhead rate is an average across every product, so the costs that exist because you carry many SKUs sit inside it, spread evenly across high-volume products and rare ones alike.
That averaging is not an accounting error. It is a design choice that works well for pricing high-volume products and badly for judging low-volume ones, because it charges every unit the same share of costs that were never driven by units in the first place.
For one winner per category at roughly 4,000 SKUs, see my podcast episode the Costco business model.
2. Which costs are fixed per SKU?
The costs that occur because a SKU exists, whatever it sells: changeovers, safety stock, planning and purchasing time, engineering and document upkeep, quoting and system maintenance, and the premium paid for buying its material in small lots. None of them shrinks much when volume falls.
That is the whole mechanism. Most of what a low-volume SKU costs is fixed per SKU, not per unit sold. Spread over forty thousand units a year, it vanishes. Spread over four hundred, it decides the margin.
Most of what a low-volume SKU costs is fixed per SKU, not per unit sold. Spread over forty thousand units it vanishes. Spread over four hundred it decides the margin.
3. How do you put a number on each one?
Estimate each per-SKU cost for a full year, then divide by the year’s volume. Rough figures are fine. The goal is to get the costs onto the right product, not to get them to the penny, and the order of magnitude is almost never in doubt.
Hypothetical: a part selling 400 units a year at $40. It runs 12 times a year and each changeover costs about $250 in labor, scrap, and lost run time, so $3,000 a year. Its average inventory is $6,000, carried at an assumed 25 percent a year, so $1,500. Planners and buyers spend about 20 hours a year on it at $50 an hour, $1,000. Engineering and document upkeep takes about 16 hours at $75, $1,200. Quoting and system upkeep adds $300. Its material costs 5 percent more than it would in a full lot. And of the $9.00 of standard overhead, only $4.00 genuinely scales with units; the rest is replaced by the specific costs above.
| Cost per unit | Standard cost sheet | Rebuilt |
|---|---|---|
| Material | $15.00 | $15.75 |
| Direct labor | $6.00 | $6.00 |
| Overhead that scales with units | $9.00 | $4.00 |
| Changeovers | inside overhead | $7.50 |
| Inventory carrying | inside overhead | $3.75 |
| Planning and purchasing | inside overhead | $2.50 |
| Engineering and documents | inside overhead | $3.00 |
| Quoting and system upkeep | inside overhead | $0.75 |
| Total cost per unit | $30.00 | $43.25 |
| Margin per unit at $40 | $10.00 | ($3.25) |
Run the same $7,000 of per-SKU cost through a part that sells 40,000 units a year and it adds about 18 cents a unit. The costs are real in both cases. They are only visible in one of them.
4. Where did the missing cost come from?
From your other products. Total cost did not change; the rebuild only moved it. The part had been charged $5.00 a unit of overhead it did not drive, $2,000 a year, while it actually caused $7,000 of per-SKU cost. The $5,000 difference was sitting on everything else.
Put the two halves together. In the worked example, the standard cost sheet shows a $10.00 margin per unit. Rebuilt, the same part loses $3.25 on every unit, and other products were carrying $5,000 a year of its cost. Multiply that across a tail of several hundred SKUs and you have the reason a growing catalog can erode the margins of products whose manufacturing never changed.
In the worked example, the standard cost sheet shows a $10.00 margin per unit. Rebuilt, the same part loses $3.25 on every unit, and other products were carrying $5,000 a year of its cost.
5. What about the cost of lead time?
It is real, and it is left out of the table on purpose, because it does not land on the SKU that causes it. Every changeover for a rare product adds waiting time to the queue in front of every other product on that machine, and customers notice lead time long before they notice price.
At the tank liner company I owned, cutting lead times in half created a customer service advantage, and it was done while carrying more raw material inventory, not less. I have a phrase for it that I use more than I probably should: lead time is a helluva drug. Keep that in mind when the rebuild tempts you to treat all inventory as waste. Some inventory buys lead time, and lead time is often worth more than it costs to carry.
6. What should you do with the rebuilt number?
Use it to choose among four moves, not to trigger a cut: raise the price until the part covers its real cost, lower its per-SKU costs by making it to order or consolidating it, move it off the constrained machine, or retire it. The rebuilt number tells you how much each move must fix.
Which move applies depends on things a cost rebuild cannot see, chiefly who buys the part and whether its hours on your bottleneck could earn more elsewhere. The screen for that decision is in how to identify which SKUs to kill, and the question of whether your line carries too many parts in the first place is in how many SKUs is too many.
About the Stagnation Assassin
Todd Hagopian is a Fortune 500 transformation executive who has generated $3B in shareholder value across Berkshire Hathaway, Illinois Tool Works, Whirlpool, and JBT Marel, where he serves as Global VP of Product Strategy and Marketing. Known as The Stagnation Assassin, he is the author of two published books: The Unfair Advantage: Weaponizing the Hypomanic Toolbox and Stagnation Assassin: The Anti-Consultant Manifesto. His blog is published in 15+ languages and read by operators worldwide. Bring him to your stage via his speaking page or connect with him on LinkedIn.
Rebuild one SKU before you rebuild the catalog. Request a free 15-minute 80/20 Portfolio Performance Audit and I will walk the calculation through one of your tail products with you, so the method is yours to run on the rest.