Article: Product Costing - How To
Note: - This Article is part of a series of Articles on the subject of 'Taking a Prototype to Production'
Product Costing is an important exercise used for determining the cost of production as well as selling price of a product. At the end of this exercise, a good idea of how much the product will cost as well as how much it can be sold at, can be achieved. A decision can then be taken as to whether to proceed with product development, or not. A product idea may make sense, but only at a certain price. This exercise will help determine viability. Rather than spend 6 months developing a product, only to find it is too expensive, Product costing will save time, money and help develop a cost effective product.
When to do it
It is a good practice to carry out this exercise as soon as product features and market have been decided. The output of this exercise will set the price targets for the design of this product. It will also bring clarity in terms of the business plan and set goals for different areas required for successful launch of the product.
Cost of Product and Selling Price of Product
It is useful to arrive at two major numbers at the end of a product costing exercise. These are the cost of the Product, and the selling price of the product. The former is basically how much money it requires to make one product, and the latter is how much it can be sold at. Explained below are some of the factors which influence both these numbers.
Some Factors to consider for cost of Production
|Production Order Quantity||Assembly Cost||Raw Material Cost|
|Development Cost||Packaging Cost||Inventory Costs|
|Warranty||Operating Costs||Marketing Costs|
Production Order Quantity
All production cycles are based on how much to produce at one time. This number is the Production Order Quantity. This should be calculated based on sales projections, and inventory to be maintained. All component costs depend on this number.
Raw Material Cost
This includes the cost of electronic components, PCB, Plastics, connectors etc. Bear in mind Forex fluctuations, since most of the electronic components are imported. All component costs must be determined based on Minimum Order Quantity or (MOQ) which is basically the number of components of one type which shall be ordered at one time. Component costs vary greatly based on volumes procured and so it is very important to determine MOQ for each component.
This is the additional cost of assembling each product. It may include soldering, testing, painting, stickering, etc. It could vary from between 10% to 30% of raw material cost depending on product complexity. Decisions may need to be taken on how much of the assembly is to be done in-house, and how much of it can be outsourced to EMS units.
Cost of product development, including Hardware, Software, App development, Plastics, Metal Works, Jigs and Fixtures, Production test benches etc.
This is the cost of the cardboard or plastic packing material in which the product shall be shipped. Material to prevent damage during transit and shipping.
Vendors and suppliers may need to be paid once the product is made. Sales may happen a bit later, and so money from sales may take some time to come in. Now this means maintaining inventory, costs money and this needs to be calculated.
Cost of shipping the product to various places identified as market for the product.
The cost for insuring the product while it is in transit.
Development cost needs to be divided by the projected total sales the product may achieve. This is done so that initial customers are not overloaded with development costs and it is evenly distributed across the life of the product.
Cost of replacing or repairing faulty product
Employee costs, rent and power, travel and other expenses incurred during operation of an organization
Marketing material, media, ad spend, promotions, participation in trade shows etc
Factors to consider for Selling Price
|Margins||Product Life Cycle|
|Value Due to SW/HW||Taxes|
The easiest way to calculate selling price is to calculate all the costs, divide it by number of product planned, and add a margin which you find reasonable for that product. But this may not be the best way to calculate Selling Price. Value of the product may be different than above. It could depend on the following factors:-
Product Life Cycle
Is it a long lasting product which can evolve over time? Or is it a one dimensional single purpose product. Can it be upgraded to increase or even change its functionality, with little or no additional cost to user for upgrade? Such a product can be perceived as having greater value and so may sell for more.
Value Due to SW/HW
If product value is purely hardware based, i.e. product is not 'intelligent' than cost + margin method may still hold. But if the Software provides excellent functionality and features, then value is not reflected by cost of Raw Material. Here calculations have to be made based on the effort required to develop the Software and also the value the solution is providing.
All applicable Taxes, depending on operations and Region where Product is sold. Always better to consult an expert to get the right picture at the right time. Data from these calculations could help determine which location is most suitable for manufacture.
Overall, a Product Costing exercise helps in clearing many doubts about the product in the minds of the developers themselves. It also weeds out ideas which may sound great but are not feasible. The exercise charts out a plan and goals for the future. So it's a very good idea to do Product Costing at the very beginning.