CoGS, nuts and bolts

A few times a year I get the request to create fields in DF to enter “margins”. This would be a great idea if everybody would understand “margin” the same way, but that does not seem to be the case. “Margin” in my vocabulary is that part of the revenue that was not absorbed by the Cost of Goods Sold (CoGS), expressed in a percentage. If your revenue from 100 units is 1000, and your CoGS for 100 units is 250, then your margin is 75%. You can invert the calculation to get a prediction for the future: If we multiply our CoGS for 100 units by a factor of 4 to generate the selling price, we’ll have a revenue of 1000 (always assuming we can sell 100 units :-)).Depending on whom you talk to, either the 75% or the factor 4 is called “margin”. For clarity’s sake, I would like to stick to the more classical 75%, with the CoGS making up 25% of the selling price.

Three months ago we had a request from a German company to set up a calculation algorithm for injection molding, for a scenario in which their customer owned the tooling. Given that tooling costs in injection molding are somewhat unpredictable, that seemed easy enough. The “problem” was that instead of the requested Assisted Setup, I got an explanation of how they did their calculation, with “costs” figuring very prominently. I love explanations.?

There was a row called “Gesamtkosten” (i.e. “all costs”) that said that 100 parts of 23.5 grams, would “cost” EUR 23.52. The selling price was to be EUR 32.92. So the “margin” was ~30%. So this was the first impression when represented as a bar chart:

Nothing wrong so far, until you realize that the plastic mentioned was bought at 2.7 per kilo. 100 pieces of 23.5 grams weigh 2.4 kilos. If we allow for sprues, we should make that 2.5 kilos. So raw materials including inevitable waste was EUR 6.75. Yet the header “Materialkosten” was 12.69, almost double that.?

What other variable costs should be taken into account??

-Electricity: Say the machine uses 1 kWh per kilo of plastic, that’s 2.5 kWh for 2.5 kilo. A kWh costs ~EUR 0.1, so 0.25.

-Variable labor: The file we got had labor at EUR 1.5 for 100 pieces.

-Packaging. The file stated a cost per carton of 6 EUR for 500 pieces, so 1.2 per 100.? That seems extremely expensive. Straight off the internet, a box that could contain 500 pieces would cost EUR 0.5, or 0.1 per hundred. A production company can probably get them cheaper.?

The last cost is a “tool installation cost” at EUR 3.60 per 100 pieces, based on a fixed tool installation cost of 180 and a total order of 5000 pieces. I can’t comment on that, except that EUR 180 seems high and probably reflects a worst-case scenario. I would assume two hours of labor and some nuts, bolts, and brackets, at costs since this is a side gig for a milling company. Say EUR 100 per setup. The analysis above looks like this as a bar chart:

The same data, more conventionally presented:

We're a software company and we can't tell our customers how and when to count their chickens. However, for them to be successful, it is important that they understand their cost structure. Why is that important?

1. As long as the company believes that its “costs” consume 70% of its revenue, there is relatively little incentive to look at overheads for optimization, e.g. by automation.?
2. As long as the company believes that raw material costs take up 40%? of its selling price (see above, 12.69/32.92), it will probably act too rashly in sharing raw material cost volatility with its customers. Following the company’s logic, a price increase of 25% for raw materials would lead to a price increase for their customers of 13%. Other companies that better understand their cost structure may well absorb the additional cost and make a public relations point out of it.
3. The calculation above contained a “Maschinekosten” of EUR 4.50. We assumed a variable cost of EUR 0.25 for electricity. The rest of the “machine costs” are probably assigned overheads, based on average use. The danger here is that it is not clear how more and bigger orders would allow discounts without threatening the overall result.?