NEED A WAY TO PRICE YOUR PRODUCT? TRY THIS INSTEAD.

2 of the more burning questions that we are invariably faced with at when creating a product are:

• ‘How much can I sell it for?’ 
• ‘How much many money can I make on each unit?’

You’ll often see advice to price 2.5 – 5x your BoM costs, but this overly simplistic and doesn’t take the nuances of the manufacturing and sales process into account. So that’s what we’re looking at fixing up today.

Determining the sales price of a product depends on 3 factors:

• Your sales model, and whether you are doing direct sales or indirect sales
• How much end customers are willing to pay for a product, which you will know from your customer research
• The raw cost it takes to get your product manufactured and out to customers

In this article we’re going to dive into how the specific costs associated with manufacturing you might not be aware of, as well as briefly looking at how sales models affect your profits.

If you are still in the early stages of designing and developing your product idea, you probably won’t have opened discussions with a contract manufacturer yet, so won’t know the exact cost for some of the items we’ll discuss here. Fear not if you don’t. I’ve included a few ‘rule of thumb’ estimates that I’ve used in the past for estimating certain manufacturing costs you’ll run into, which will help give you a ball park estimate to work from.

DISCLAIMER! 

Note, this information is meant as a guideline only. Please do not take this article as word-of-law. Developing and selling hardware is a dynamic and variable beast, with your own experiences most likely varying widely based on your product, the market you’re in, your competitive landscape, your customers, sales channels and more. This article is intended to give you pointers, in case you are feeling lost or stuck. If ever in doubt, just ask yourself ‘Does this fundamentally make sense for my situation?’

Onwards.

Electronics & PCB

If you’ve got to this point you should have a fairly good idea of what is going to go into your product, especially at low volume through buying components from the likes of RS, Element14, Digikey or your local electronics supplier. The low volume electronic component and PCB costings (1 off) form the basis of this pricing model. There are two main points worth noting here:

1. 70 – 90% of your product cost will come from 20 – 40% of components. This means that if you haven’t fully finalized your design yet, don’t lose sleep over trying to find a source for every single component (at least not yet), especially for sundry items like resistors and capacitors (that don’t have any special requirements). Your will have a handful of core, critical components which need to be carefully chosen to keep cost low and ensure long term supply (e.g. don’t choose something that you know is going to go end of life in a year or two). 
2. The mark ups that suppliers (such as RS, Element14, Digikey, etc) apply to components is similar to that of contract manufacturers (CM), so the price breaks (discounts at volume) that you receive from both (up until around the 10,000 mark at least) are roughly equivalent.

From my experience the price breaks you can expect relative to one-off pricing for electronic components are:

• 100 off (15 – 25% discount from one off pricing)
• 1,000 off (30 – 50% discount from one off pricing)

Once you get to 10,000 units or more of a specific component, you get into quote territory. The actual price breaks over 1 off volume vary considerably dependent on the component type and are really dependent on how well integrated a contract manufacturer’s supply chain is with its own suppliers.

Whether you are able to use a contract manufacturer’s preferred parts also makes a considerable difference to your final BoM price (hence why it’s important to get talking to your CM as soon as you've settled on a first pass design, as they’ll make some recommendations for changes which will need to be reflected in your design).

Enclosure

The next item to consider is the per unit cost of the enclosure. Enclosure costs vary significantly based on a number of factors, such as:

• Whether it is an off-the-shelf or custom designed enclosure
• Manufacturing technique (3D printing, injection moulding, rotational moulding, etc)
• Base material (aluminium, ABS plastic, etc)
• Material additives (UV stabilisers, pigments, anodising, etc)
• Enclosure complexity (physical design as well as number of parts to be assembled)
• Production volume

Given the large number of variables it is difficult to point to exact price breaks, except saying that they can be significant (e.g. a small, 10 off ABS injection moulded cases could be $3 - $5 each, whereas at volumes of 40,000 could be as cheap as 17c each).

Assembly & Functional Testing

Assembly and functional testing cost is largely dependent on the assembly complexity of the product, how well design for manufacturing principles have been applied. Whether you are using automated testing equipment (ATE, more on this below) or manual labour testing is also an influencing factor. A rough rule of thumb of 4 – 8% of hardware cost can be used to estimate this, if you haven’t had a chance to talk to a CM yet and got a quote.

Highly Accelerated Stress Screening (HASS)

HASS is essentially a post assembly stress testing method designed to incite infant mortality failure of components, through all axis vibration and rapid thermal cycling. HASS testing is carried out so that failures happen in the manufacturing environment (where they can be fixed), instead of in the field where either a recall, replacement or in-field repair would be necessary.

The investment to implement HASS testing varies from product to product, but is generally a function of complexity (and therefore cost), so it’s best to check with your CM (also to make sure they offer it. If they don’t, you can also do it yourself, but you’ll have to put a test regime in place). A useful rule of thumb is to allocate 2 – 4% of your total hardware costs.

Manufacturing Yield

Manufacturing is not a perfect process, and you’ll always get a small number of product which don’t work when coming off of the production line. Tombstoning, insufficient wetting, bridging (especially if doing reflow soldering), poor manufacturing practices and more can cause issues. Sometimes the heat profiles of automated soldering equipment induce infant mortality in components, even prior to HASS tests.

In reality yield failure can run anywhere from 0.5% through to 5% (even up to 10% in extreme cases), and depends on a variety of factors such as:

• Quality of components
• Number of components placed
• Footprint complexity of components placed (BGA vs SOIC 8 vs 0802 resistors)
• Solder quality and type (lead vs lead free)
• Quality of manufacturing processes & systems in place

A good manufacturing process should provide a high yield rate (e.g. a low failure rate), but this can vary significantly from CM to CM. As a rule of thumb, I’ve found 2 – 3% of hardware cost to be a reasonable estimate. As your own processes mature, this number should drop to ≤1%.

Reliability / In-Field Failure Rates

No product will be without failures, regardless of how well designed and stress tested post manufacturing it is. Strong reliability engineering practices during design phases and HASS during production can greatly decrease the probability of in-field failures, but never completely eliminate them.

As such it’s important to factor the probability of failure into the pricing model, but it can be difficult to do so as, again, there are a great number of variables affecting reliability. As a general rule of thumb a failure rate of 2 – 5% for electronics would be doing fairly well and therefore 2 – 5% of HW costs is a good range to allocate to your final unit pricing until you have empirical data to make a more informed decision.

Packaging

Packaging costs also vary widely depending on the quality of packing you want to wrap your shiny product in. It’s all the rage these days to go for ultra high quality packing design and materials to create a luxurious ‘unboxing’ experience. It’s my personal opinion that as a start up, your money should be spent on:

1) Validating the living heck out of your market
2) Creating a product experience so sublime that melts your customers brains into goo
3) Finding the perfect manufacturing partner
4) Promoting your product until you’re blue in the face

As you can tell from the above list, designing a 15 piece interlocking, shiny double bonded UV resistant cardboard portmanteau is not on the list. I’m not saying shouldn’t package your product beautifully (if you can do it for the right price), but I think you need to think very carefully about where your money goes. High end packaging can be anywhere from $5 – $20 per unit. Basic but respectable packing can start at $0.30 – 1.00 per unit.

Shipping

Shipping costs are another fun variable, which change considerably based on where you are shipping from, your manufacturer’s MoQ and how Just-In-Time your sales model is. In most cases it’s not feasible to use air freight (unless your volumes are still relatively low), which means you’re stuck with a combination of sea and land transport. It’s an aspect that’s often overlooked with the Asian manufacturers, as they have large MoQs (up to 3,000 – 5,000), which need to be shipped to USA / Europe in most cases (not to mention port clearance fees), weeks if not months ahead of when you think you’ll actually need the stock.

If you know the weight, dimensions and MoQ your product to be made, you can phone around and get some shipping / clearance fee estimates from shipping companies.

NRE Amortization

Here’s one I love because so many people overlook it. NREs (Non-Recurring Engineering / Expense) usually come from four main places:

• Design & development costs: Electronics, software, industrial design, mechanical tests, IP, prototypes, user research, the works. Everything it cost you (or will cost you) to get a fully manufacturable design, but isn’t part of the physical per unit cost itself.

• Manufacturing set up: Essentially the cost to get everything up and running for manufacturing, which is typically a flat fee from the manufacturer (depending on how well organised you are). It includes reviewing design files (if you have a good CM), setting up pick & place machines, getting stencils made and more. Typically put this value at $3,000 – 5,000 for a Western manufacturer, although it depends on the agreed upon conditions (e.g. it could be rolled it into the per unit cost and tied to order volumes). There is often also a smaller per-batch set up fee (to get SMT reels loaded, stencils ready, AOI files loaded, etc).

• Certifications: FCC, UL, CE, FDA, Ex, etc all add up and vary depending on your product as well as the category it falls under, whether it is designated as a medical device, has RF transmitting capabilities and more. Bog standard certifications are in the $10k – 20k range if you do them right the first time. If you use pre-approved parts (or go through some of the Asian labs), that cost can be as low as $1,000. Failing the tests and having to resubmit can drive up cost, depending on the certification being pursued.

• Enclosure production cost: If you are using 3D printing for small volume runs, then one off costs are less of an issue. However if you are using injection moulding for instance, then the cost of having the mould created can be significant and needs to be taken into account. Depending on the actual mould complexity and where you get them made, these can range anywhere from $3,000 to $12,000 (or more).

• Test Fixtures: You may need some sort of test fixture in order to carry out functional tests to ensure that the electronics (and mechanical bits) of your product are working before putting everything into a box to ship. These can range from simple manually operated fixtures which take a few hundred dollars (or less) to create, through to complex ATEs (Automated Test Equipment) which are essentially a full product in their own right. ATEs can range anywhere from $15,000 – 50,000 (yes, really), depending, yet again on product complexity. The more complex a product is the longer manual testing will take, which means that as volume increases there will be a cross over point where manual labour becomes more expensive than creating and using an ATE. 

The key point to remember is that these costs need to be recouped throughout production (preferably sooner rather than later), and so need to be split across the anticipated production volumes. If your total development, manufacturing, enclosure and test fixture NREs are $250,000 (hypothetically) and your anticipated annual volume is 10,000 units, the amortized NRE cost as a per unit cost would be $25 per unit ($250,000 ÷ 10,000) on top of the other per unit manufacturing costs we’ve mentioned already. Naturally you could spread this over 2 or even 3 years (although that would be pushing it a bit), which would reduce the per unit cost to $12.5 and $8.33 respectively, depending on the accuracy of your sales projections (pro tip: they don’t climb exponentially).

Profit

The last factor you need to consider in this model is profit, or more specifically how much profit you want to make.

The two biggest determining factors in my opinion on how much profit you can make on your product is dependent on:

1. How much your product costs to manufacture, minus margin / mark up
2. What the final retail price will be. 

The final retail price (e.g. what your end customers actually pay) is in turn is tied to the customer / user research you should have carried out already. By now you should know:

1. How much competing, similar or alternative products are selling for.
2. How much your customers are willing to pay based on what they’ve told you (through discussions, pre-sales, faux-presales, cost-of-issue analysis, etc).  

If you can’t answer yes to the above two questions, drop everything and go find some customers to talk to. Yes, really. I’ll wait. It’s that important.

If you know what your end retail price should be (even as a range), then you can consider the sales model you’ll be using:

• Direct Sales – you manufacture and sell directly to your customers. There are no real middle men. You are responsible for your sales channels / efforts, but can take much higher margins. Often a natural progression of this model is to sell directly to retailers, in order to reach a larger market.

• Indirect Sales – you manufacture then ship product to distributors, who in turn ship to retailers (or depending on how niche your product is, you may ship straight to retailers). Both wholesalers & retailers add mark ups to your product (cutting into your profit margin), but take responsibility for promotion of your product and are often able to reach a wider audience. 

If using indirect sales, there’s just one other major thing to remember: margins.

• Wholesalers typically have profit margins in the range of 20 - 50%.

• Retailers typically have profit margins in the range of 10 - 40%. These vary wildly depending on whether they are online retailers (e.g. Amazon), boutique physical stores or large brick-and-mortar stores (e.g. Walmart). Large retailers are a completely different ball game, so be careful. 

Both of these models have their own advantages and disadvantages, so I highly recommend spending some time getting to know the nuances so you know which one is right for you. Don’t skimp out on this. It can make or break your business, so invest some serious time here understanding which is best for your specific situation.

Margin from intermediaries need to be added on top of the profit you wish to make from your product. You need to be careful though that once everyone has taken their slice of the pie, you don’t end up with a retail price far beyond your customers’ expectations.

As a quick final note, beware the difference between profit margin and mark up. Some people like to use them interchangeably, but they are two very different things. The crux of the difference is this:

1. Profit margin is how much of your selling price (revenue) is actually profit, after to your costs (CoGS, Cost of Goods Sold) have been taken into account. Here’s some maths: Profit Margin = (Revenue – CoGS) / Revenue
2. Mark up is what percentage of your costs (CoGS) your profit is. Here’s some more maths: Mark Up = (Revenue – CoGS) / CoGS

• For example: if you sell your product directly to customers for $100, and costs $35 to manufacture and distribute, then:
• Your profit margin is: ($100 - $35) / $100 = 65%
• Your mark up is: ($100 - $35) / $35 = 185% (sounds like a lot, but it’s so-so)

Summary: So there you have it, a breakdown of where your money actually goes during manufacturing and how it affects your final retail price. The long and the short it is this:

• Keep costs low as humanely possible without damaging your product or business.
• Sell for as high as possible without damaging sales.
• Get your product out to as many customers as possible.

Written by Alan Povall on April 15, 2015