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Decrease Cost in the Manufacturing Process

To decrease the overall manufacturing costs of your product, you need to start with a detailed understanding of the core cost drivers. Building from this foundation, you can then determine what cost reductions levers make the most sense to pull as a function of where you are in the New Product Introduction (NPI) and manufacturing process.

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Your overall costs are far more than the sum of your Bill of Materials (BOM)

To be able to model your financials, it is critical to understand the true Cost of Goods Sold (COGS), which is how much you pay the factory for each unit. On top of this cost, you also need to understand the fixed costs, which includes items such as tooling, stencils, test fixtures, Non-Recurring Engineering (NRE) (i.e. engineering services), pre-production samples, certifications and regulatory affairs, and more.

The True Cost of Manufacturing your Product

Many companies assume they can simply sum up the Bill of Materials (BOM) cost and arrive at the Cost of Goods Sold (COGS). This approach is flawed and will result in a misleadingly low COGS which can catastrophically impact a business. When calculating COGS, it’s important to include labor, scrap, factory overhead and profit as well. For large items, logistics (i.e. shipping) can also add up, especially if the products need to be air shipped to meet a schedule (including these logistics costs results in the “landed” cost).

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COGS Drivers

Design Decisions that Affect Cost of Goods Sold (COGS)

  • Material Selection (Injection Molded ABS vs Die Casted Zinc)
  • Component Selection (Arduino vs. ATmega328P)
  • Fabrication Method (Blow Molding vs. CNC Machining)
  • Manufacturing Efficiency (DFM, DFA, DFX, First Pass Yield, amount assembly labor, etc.) 
  • Product Quality (short vs. long life-time requirements) 
  • Accessories (replaceable vs. rechargeable batteries; packaging cost; spare parts, etc.) 
  • Features (Few vs. Many)
  • Consumer Market (Country of sale, global vs. domestic, consumer health vs. medical)
COGS Drivers

Manufacturing Partner Decisions that Affect Cost of Goods Sold (COGS)

  • Geographic Location (shipping, tariffs, labor rates, currency exchange rate, etc.) 
  • Factory Profit Margins (Consumer Electronic vs. Medical Factory, Original Design Manufacturer (ODM) vs. Original Equipment Manufacturer (OEM), ISO9001 vs. ISO13485)
  • Vertical Integration (in-house Surface Mounted Technology (SMT) vs. outsourced Surface Mounted Technology (SMT) that will involve an extra handling fee) 
  • Capability (waterproofing, flex Printed Circuit Board (PCB), pressure testing, conformal coating) 
  • Supply Chain (Purchasing Power, minimum order quantity (MOQ), Consigned vs Purchased components, etc.)

Example ‘Cost to Consumer’ Deconstruction

Screen Shot 2019-07-17 at 2-05-38 PM

Example of Fixed Costs

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Fixed Costs refer to one-time expenses that will be incurred to manufacture and sell a product as represented by the diagram above.

These costs do not increase in a linear relationship to volume.

The Hidden Killer: Payment Terms and Cash Flow

Once the COGS is understood, the hidden killer becomes the payment terms with both the factory and the customer.

By negotiating better terms with both parties, it is possible to significantly reduce the working capital requirements.  This means your company will have less cash tied up in manufacturing and in turn, be significantly better positioned to grow as well as protect the shareholder equity.

Component terms
When you pay your supplier

CM terms
When you pay your Contract Manufacturer

Customer Terms
When your customers pay you

Shipping
When/How your product gets to your distributor

Understanding Gross Margin in Hardware

Gross margin represents the amount of money you retain after manufacturing that can be put towards marketing, R&D and profit.

Learn More

Get Your Complete Guide to Decreasing Manufacturing Costs

Understanding your manufacturing costs will help you be successful. Know everything from Cost of Goods Sold to Gross Margin to better negotiate terms with your supplier, CM and end customer.

Read the Guide 

I'm glad we went through Dragon. They really helped with understanding all the costs associated with this product domestically and overseas. If we break MOQs for overseas manufacturing we will definitely pursue with Dragon's RFQ and PM services.

Mark Klibanov
Co-founder and Chief Product Officer, Gesture Logic

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