Technical Difficulty Rating: 6 out of 10
This is the second part of a two-part series looking at developing a hypothetical tracking device that incorporates Bluetooth Low Energy (BLE), GPS, an accelerometer, and a USB rechargeable lithium battery.
When deciding to develop a new hardware product you should first look at the big picture. This is what established hardware companies do, and so should you.
The best way to do this is with a preliminary production design. This is what we are covering in this series.
In part one we covered designing the system level block diagram, selecting all of the production components, and listing some of the specifications for your product after you have the critical components selected.
In this second part you’ll learn how to estimate the landed manufacturing cost, determine the suggested retail price, and estimate your profit margin.
This case study is based on a sample of my do-it-for-you Predictable Hardware Report service. You can download a sample report here. However, the goal of this article is to teach you about the preliminary design process and all of the information it provides, not to sell this service.
We’re now to the step that is one of the primary reasons for doing a preliminary production design.
Ultimately, I consider the production cost (also called manufacturing cost or Cost of Goods Sold – COGS) one of the most important things that you need to understand as early as possible.
This is because the manufacturing cost is what’s going to determine if your product can be manufactured and sold at a profit. It will determine how much profit you’re going to make, and how much you can sell the product for.
For example, if you’re planning on selling your product for $99 and you go through the exercise of calculating your production cost and you find out it will cost you $75 to manufacture, then something’s going to have to change. You’re going to need to find ways to lower the cost or increase your suggested retail price.
Or you may determine that the product isn’t worth pursuing if it’s not going to ever make a sufficient profit. But, that’s okay too. If that is the case you need to know as soon as absolutely possible so you can pivot to a new product with higher profit potential.
Manufacturing Cost Breakdown
Figure 1 – Sample of a Predictable Hardware Report showing the electronic components costs.
We’re now going to run through all the different pieces that make up the total production cost. I’m specifying the costs for volumes of 100, 1k, 10k and 100k units.
In general, for 100 and 1K units, domestic manufacturing is preferred. Then, for volumes of 10k or greater, manufacturing in China is usually the way to go.
Keep in mind that even with low volume production, you’re still better off sourcing any components that you can through Asia. Then assemble the product and do all your testing domestically.
This hybrid manufacturing strategy allows you more direct control over the assembly process, final testing, and ultimately the quality of the final product. Yet, it still provides significant cost reductions by buying components from China.
Electronic Component Costs
I’ve started off by listing all the electronic components that we’ve already selected in part one of this series, including the Bluetooth microcontroller module, the GPS, accelerometer, connectors, the battery.
Then, I specify their prices for 100, 1k, 10k and 100k units. These volumes are assuming the product is expected to be a high-volume consumer electronic product. For high-dollar niche products lower volumes are likely more appropriate.
As you increase your manufacturing volume you will get discounts for purchasing the components in higher quantities. The best way to determine your quantity discounts is by getting quotes from the suppliers.
However, if you’re just looking for a ballpark estimate, you can roughly assume that each time you jump up by a factor of 10X you’re going to get between a 10% and 25% discount.
Once you get into really high volumes of 100k units or more, you have more pricing flexibility because at those levels you can negotiate pricing with your suppliers.
Printed Circuit Board
After listing the costs for all of the various components the next cost is the fabrication of the empty Printed Circuit Board (PCB). The two main criteria that impact the empty PCB cost are the number of layers and the size of the board.
After the empty PCB is produced, the next cost is the to solder on all of the electronic components. This step is called PCB assembly.
Figure 2 – Manufacturing cost estimates for the PCB, mechanical, and other steps.
PCB assembly costs are mostly impacted by the total number of component pins to be soldered and the number of leadless or fine-pitch components. PCB assembly will usually be cheaper if you stick entirely to using surface-mount components and avoid mixing in any through-hole components.
You will learn that the cost to assemble the PCB is going to be a lot higher than the cost to fabricate the empty PCB. As a rough estimate about 25-35% of your PCB cost will be for the empty board, with the remaining cost being for the PCB assembly. Of course, this is in addition to the cost of the actual components themselves.
For most products, including our BLE tracking product example, the mechanical costs will primarily be for a plastic enclosure. In this example design I’m assuming the simplest possible enclosure which is comprised of just two pieces of plastic that form the top side and bottom side.
The main drivers on the cost for your enclosure are going to be the dimensions of the part that you’re making, what type of plastic you choose, how much plastic each part requires, and the number cavities in your injection mold.
You’ll want to always start with a single cavity mold which means it can produce only one part at a time.
As you increase your manufacturing quantity then you will want to transition to multi-cavity molds which can produce multiple copies of the same part with each injection. Multi-cavity molds significantly decrease the manufacturing cost for custom plastic parts.
Don’t forget to take into account the retail package you will need. A lot of people forget this step when they’re trying to figure out the approximate cost of their product.
With sales through your website or Amazon, the package mainly needs to protect the product. Since you are selling directly to the consumer through a website, it’s not as critical to have the absolute best packaging possible. In that situation the website is what sells the product, not the product package.
That being said, you don’t want people to get your product in the mail and immediately have a bad impression because the packaging looks boring or cheap.
Packaging becomes much more critical (and expensive) in a retail environment, where people don’t have a website and a description of your product to look at. They just have your packaging to help them decide to buy.
You will definitely need to put a lot more thought into the appearance and message of your packaging when you’re selling in retail. Be aware that really fancy full-color retail packaging (especially retail boxes) is going to be expensive so you absolutely need to account for that cost in your manufacturing cost estimate.
Final Product Assembly
Next, we need to add in the cost to assemble the final product. Don’t confuse this step with the PCB assembly. The PCB assembly step is only to solder on all of the electronic components on to your circuit board.
On the other hand, final product assembly is the cost to fully assemble your finished product which includes packaging the product.
The assembly cost mostly involves the cost of labor, since you have factory workers putting your product together. Fully automatic robotic assembly only begins to make financial sense for very high manufacturing volumes (millions of units).
The best method to estimate your final assembly cost is by timing how long it will take to fully assemble your product. Then, based on the average hourly rate for factory workers where you manufacturer is located, you can accurately estimate your final product assembly cost.
The more you can do to simplify your product assembly process, the more money you’re going to save on assembly. So optimizing your assembly process should always be a priority.
Quality Testing, Defects, and Returns
The next set of costs involves testing your product and accounting for any defective and returned units.
Figure 3 – Estimates for defects, returns, logistics, and import duties.
You obviously don’t want to just assemble your product and sell it without testing it beforehand. There are various ways to do this. You can choose to assemble the full product and then test it. Or you can choose to test pieces of the product individually before you put them together.
Any units that fail testing will need to be marked as defective and scrapped or recycled. Early on assume a defective scrap rate of 10%. As your manufacturing process continues to ramp up this scrap rate will become lower. Eventually, you will should aim for around a 1-2% defective rate.
You also need to factor in customer returns of your product. Regardless of how great a product is, there will always be customer returns. Some returns will happen because of product defects, and others for any number of reasons.
As with the defective rate, the customer return rate can usually be assumed to be around 10% initially. As you improve your product quality and customer support the return rate will also decrease over time.
Shipping, Warehousing, and Duties
If your product is manufactured in China, it will need to be trucked from the factory to the boat dock for shipping by sea cargo.
Then, it will take about three weeks to cross the Pacific Ocean, where it will most likely land at a port in California. Shipping by air is much more expensive so should only be used when absolutely necessary.
You will also have additional domestic trucking expenses depending on where your warehouse is located.
If your port of entry and your warehouse are in Los Angeles, for example, then the trucking cost to get your product from the port to your warehouse is going to be very minimal.
If you’re warehousing the product instead in Boston, then you’re going to have to truck the product all the way across the country, adding extra trucking costs.
Make sure to also include the cost of warehousing your product. Most of the time you’re going to have an order shipped to your warehouse. Then you will sell and ship multiple smaller orders from your warehouse inventory.
However, you can eliminate warehousing costs entirely if you obtain a large enough order to have the product shipped directly from the port to the retailer. If you have a customer that wants to purchase say 10,000 units, then there’s no point in shipping the product to your factory or warehouse.
Most of the time however, and especially when you’re just starting out, you’re going warehouse or store the product yourself.
Also factor in any duties and tariffs for importing your product. Consumer electronic products under $250 currently have no U.S import duty.
However, there have been recent legal changes in some types of tariffs. As of today, tariffs are applied only if you import electronic components, not the finished product.
Fortunately, at the time of this writing, the tariffs (25%) are only for the very low-cost passives components (resistors and capacitors) so the financial impact is almost negligible.
Total Landed Manufacturing Cost
The final step is to now add up all these individual costs to determine your total landed cost. Landed means after it has arrived in your warehouse. This has to include all of the costs to get the product manufactured, shipped from China, and transported to your warehouse.
Your total landed production cost is what you’ll use to figure out your profit margins and the retail price for your product. That’s what we’ll be discussing next.
Suggested Retail Price
Now that we have calculated the landed manufacturing cost, we can make realistic estimates on what the suggested retail price should be.
Figure 4 – Sample report showing estimates for the suggested retail price.
You first need to know there are two general ways to sell a new product. One way is to sell it through your website directly to the consumer. You would buy the product from the manufacturer and sell it directly to the consumer.
The other way is to sell your product through retail stores. The main difference between the two is that your profit margin will be a lot higher if you sell directly to the consumer because a third party (the retailer) isn’t taking a cut.
For instance, if you sell your product through Walmart, they will take a significant percentage of the sales price.
The standard markup when selling through retail channels is to set your suggested retail price at four times your landed manufacturing cost. This means you sell the product to the retailer at double your manufacturing cost, and then the retailer sells it to consumers at double what they pay (wholesale cost).
If you’re going to sell directly to the consumer, then your total markup can be lower. I would shoot for three to four times your manufacturing costs.
Keep in mind that although you can technically sell your product at a lower price when selling via your website, this strategy can have some negative consequences once you begin also selling in retail.
Retailer won’t want to sell a product in their stores that can be purchased directly from your website at a much lower cost. You are essentially undercutting your retailers, and that is generally not acceptable.
Even though you can afford to use only a 2x markup when selling direct to consumers, that probably isn’t a good idea.
The manufacturing cost varies drastically depending on the volume of parts. You’re going to be competing with other companies that are obviously already running high volume on their product.
To be able to compete, you’ll need to base the price of your product on your high volume landed production cost.
In my example, I’m using the price at 100K units to set the retail price. The total landed cost for the hypothetical BLE GPS tracking device was $24.09 at 100k units.
If we use a 3-4x markup then that gives a suggested retail price range of $72.27 to $96.36.
For more details about setting your product’s suggested retail price be sure to read my definitive guide to pricing your new electronic hardware product.
Once you know the suggested retail price and manufacturing costs, you can now estimate your profit margins for selling direct to consumers and through retail channels.
A retail price that is four times the manufacturing cost will typically give you a 50% profit margin when selling retail. That’s because each person in the distribution chain commonly doubles the price that they pay for a product (called keystone pricing). For a hardware product, aim for a 40% to 60% margin, with 50% being the standard.
You should expect to sell your initial hundred units or more at a loss. But profit isn’t your priority at these low levels. Getting orders and feedback are the top priorities at the beginning. Profit comes later.
Once you reach around a thousand units, your margins will increase but still be very minimal. At these small volumes, you’re going to have to take a margin hit at least until you are able to get your volume ramped up.
You have a lot more flexibility on your pricing if you start off selling directly to the consumer. That is one of the main advantages to selling direct to a consumer.
Selling direct to consumers also allows you to get more direct feedback from the consumer. If you sell your product through Walmart, you’re not going to ever hear what the end user thinks of your product.
Instead, you’ll hear what Walmart thinks of your product and how it sells, but you won’t get the direct feedback that allows you to improve the product or improve your marketing message.
Another nice thing about selling direct to the consumer through your website is you don’t have to have to spend as much time on your packaging. It also reduces your cost because packaging can be rather expensive.
In most cases I recommend that you start by selling directly to the consumer. Get some initial sales under your belt, and use that success to start selling your product through retailers.
In part one of this two-part series we designed the system block diagram, selected all of the critical components, and listed the key technical specifications for our hypothetical BLE tracking device.
In part two we priced out everything that goes into manufacturing the product to estimate the manufacturing cost for the product. We also looked at how to determine the suggested retail price based on the estimated manufacturing cost.
If you have any comments or questions please post them below. I personally answer all questions.