One Part Art, Two Parts Science
By Jack Lander
Whether you plan to license or manufacture and sell your invention yourself, at some point you’ll need to determine the cost of your final product.
If you plan to go the manufacturing route, you’ll need to know in advance whether you can produce at a cost that will at least cover all of your product’s direct costs.
Of course, you’d like to make a profit. But early on, most ventures don’t make a significant profit. Profit usually comes after fine tuning manufacturing and engaging the right marketing channels.
If you plan to license, prospective licensees may ask how much your invention will cost to manufacture. And therein lies a danger.
The art and science of costing is complicated by the number of manufacturing options available and the spectrum of sub-options that must economically match the quantity you’re producing.
Sure, we can pick a method that we know. But is it optimum? Will it produce at a cost that best matches the sales volume of the product? When your prospective licensee wants to know “how much,” you had better be within, let’s say, 10% of the optimum direct cost – preferably within 5%. If in doubt, don’t discuss cost.
Suppose you decide to manufacture and sell on your own. Box 1A on the flow chart asks you to forecast your second year’s sales volume.
By the second year you should be marketing through reasonably productive channels. Unless you have a fairly broad background in manufacturing, you should consult an expert to guide you on your choices for methods and tooling that will optimize your cost.
Such an expert will need to know what kind of volume you’ll be producing in order to match it with the most appropriate process. This doesn’t mean you can’t use some low-volume methods initially.
But you must know whether you’ll make a profit when the fine tuning is done. If you’re not going to at least break even by the end of the second year, you should reconsider your venture.
The expert I refer to is an industrial designer. Ideally, you’re looking for an ID who can evaluate your design and recommend changes that will reduce cost to manufacture.
He or she also will recommend the best methods and tooling to achieve the lowest manufacturing cost for your final design. IDs come in a variety of specialties. Some work only on product appearance. Some on packaging. And some on functional design. Be sure to talk with several until you find an expert in design and manufacturing or deal with a company that has each expert on staff.
Before you consult with an industrial designer you should set your retail price. If you plan to produce on your own, set your price on the high side.
Look to competing and complementary products to get a gut feel for a price that customers may grumble about, but will still accept. One test of a high price is refund requests. Assuming that your quality is good and you haven’t deceived anyone with your offer, refunds based on customer perceived value-for-price shouldn’t go higher than about 5%. If your price is too high, you can always have a sale or even lower your price permanently.
If you plan to license, set a competitive retail price based on what you think your hypothetical licensee will want to charge.
Based on your set retail price, your forecast sales volume and the recommendations from the ID, revise your final design if necessary.
Next, decide your production quantities for each component of your product. Annual sales volume is the quantity on which to base production, but you won’t be buying a year’s supply of your most costly components.
Figure on a two to three months’ supply for the expensive items, and a full year’s supply for the inexpensive items such as fasteners. The moderately priced items will fall somewhere between two months’ and a year’s supply.
Using the production quantities you’ve decided, obtain prices from vendors for each component.
Let’s say that your estimated sales volume is 6,000 in your second year and you’ve arrived at a purchase quantity of 1,000 pieces. Ask for pricing at 500, 1,000, 3,000 and 10,000. The 10,000 quantity may be unrealistic at this point, but it indicates potential to your vendor and may help to get a better price than if you ask only for the 1,000 pieces you intend to buy.
Solicit prices from at least three vendors – better yet, five – for each component. Vendors often quote higher prices than are reasonable for a variety of reasons: They’re overloaded with work and will only take your order if they can earn exceptionally high profit; they don’t have the appropriate machinery for your work; they sense that you are a novice and may feel they can take advantage of you; they don’t have a valid system of pricing their work; etc.
Your only defense is to get several quotes. Those who have the right machinery should quote within about 10% of each other. If prices vary greatly from vendor to vendor, you probably have solicited the wrong vendors.
Now compile your total direct product cost. This includes all of your purchased components and labor for assembly and packaging.
If you intend to manufacture and sell your product, don’t consider your own time as free. If you intend to license your product, estimate the assembly and packaging time and use an hourly rate that the typical worker doing these tasks would earn. Note: overhead and miscellaneous costs are not included in direct product cost.
Here’s the critical step: multiply your direct product cost by five to arrive at an approximate minimum selling price.
Compare this price with your gut-feel retail price. Is your gut-feel retail price higher than your five times direct cost? If so, your costs are tentatively acceptable and you can proceed to either produce or license.
But if five times your direct cost is greater than your gut-feel retail price, something’s got to give. You’ve got to redesign or go back over all of the boxes in the flow chart and refine your work.
Worst case: You can’t get your costs low enough to produce at a profit or to convince a potential licensee to negotiate a contract.
But there are alternatives. If you plan to go the manufacturing route, you might lower your multiplier by four rather than five. Four is dangerously close to a permanent money loser for most products that sell for under $50.
But if you are marketing from your own website, four or even a bit less may be acceptable if you don’t have to mortgage the farm to pay for your costs of entry.
If you plan to license, you can enter negotiations and if asked about cost, answer something like this: “You fellows are the experts. I’m afraid that I’d choose the wrong manufacturing methods and find my costs too high for your taste.”
Is it really as complicated as I’ve show? Is it really essential to consult a design and manufacturing expert? You may find that your prototyper can give you some very good advice. The answer ultimately depends on your financial resources and the degree to which you are willing to risk your success.
The safest answer is always ‘yes.” But also remember that perfection is the enemy of progress. Quite often “good enough” is sufficient to start your venture. The Wright brothers, after all, built their first airplane with its tail up-front – a very unstable and risky design.
Finally, if you want a crash course in manufacturing methods, email me for my private paper #46. It’s free.
Visit www.inventor-mentor.com; contact [email protected]
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