Direct Labor Cost Formula

Do you need to understand a Direct Labor Cost Formula?

Pricing is a critical component of marketing. So before you start envying the volume of unit or dollar sales another business is getting, you have to remember, selling a large quantity doesn’t always translate into large profits. It could be that someone is working really hard to make very little money.

The biggest mistake most online shops make is not truly taking into account the value of their labor. So before you set the price for your products, you have to understand your labor cost and what you want to pay yourself in terms of an hourly wage.

Direct Labor Cost Formula

Let’s say that you are a one-person operation and you are making iPhone covers. You decide you want to undercut everyone else in the market and charge $15 each.

Labor – If it takes you 20 minutes to produce one iPhone cover, that means you can make 3 in an hour. If you are selling each for $15, then you are essentially paying yourself $45 an hour (3 x $15). So that’s about $79,000 a year based on a 35-hour work week, and a 50-week year. But wait. This is not your true hourly wage.

Materials – Now you have to deduct your materials. Let’s say that a plain case is wholesale $1.80 each including tax. Then there is the printing charge, let’s say .40 each. You have to get it to the customer, so even if you charge for shipping, you still have packaging costs, let’s say .30 each. So the grand total for 3 iPhone cases is $7.50. These are fixed costs. In other words, no matter what price you charge, these costs stay the same.

Selling Fees – If you are selling on an online marketplace like Etsy, you now have to deduct your fees ($.95). So for the three iPhone cases that would be $2.85 total. These costs are variable, so they go down when your price goes down, and up when your price goes up.

Ok, so now your hourly wage is down to $34.65 per hour, which is $69,300 per year in theory, if you sell 24 iPhone cases a day, 5 days a week, 50 weeks a year.

Other Expenses – But what about other business expenses? Gas to drive to the printer and the post office, packaging costs, shipping materials, bank fees, business taxes, Internet use, advertising costs. You have to factor all of these costs in as well.

Now, obviously you do have to stay in line with your competition, so you can’t charge twice what they are for the exact same product, same materials, same delivery and so forth.

So, before you set your prices, start with your desired hourly wage and work backwards from there.

If you cannot come up with a pricing model that is also a viable business model, then it is not worth doing.

Can You Believe This Seller Didn’t Price for Her Labor

I’ll never forget the seller who was knitting dog leashes. She indicated that one dog leash would take her 2 hours to make and she wanted to sell the leashes for $10 each. I tried to tell her that this was a terrible business model but she just didn’t get it. So I tried to explain it another way.

I told her that if it takes 2 hours to knit one dog leash, then likely the MOST dog leashes she can make in one day is 4 (and that’s based on a 8-hour workday). If you can only make 4 leashes a day, then you can only sell 4 leashes a day because you cannot sell more than you can physically make.

Therefore, the MOST her business could ever make in one day is four leashes at $10 each = $40 gross (we still haven’t deducted any costs). Now, does it still seem like a good business idea?

Need Help with Your Business?

If you do not know how to market your business or are not making sales, ask me a question at attentiongetting@gmail.com or check out my Consulting Services and my Store.