Every now and then, articles get released stating how much higher the prices of products are than the cost of the parts that go into them. Most of these are based on woefully incorrect estimates, but they also ignore the full cost of bringing a product into market. As a consumer, it’s illuminating to dig in further. If you’re the one building and selling products though, understanding the full cost of designing, manufacturing, selling, and supporting them is a matter of life and death for your company. The generic guidance is that a product should be sold for around 3x the cost of the materials, but in actual products that could range anywhere from 0.5x (the razor and blades model) to 10x (Veblen goods) depending on company strategy and cost structure and the market the product is in.
Regardless of the pricing strategy, the best way to understand costs is to build out a detailed model and start running through different cost, price, and volume scenarios early in the development process. There are some great guides on this from Ben Einstein and Andrew Huang. My general recommendation is to read as much material as you can and then distill it down into the specifics that are relevant to your product and business. In addition to providing one more reference point, I wanted to release a practical cost model in Google Sheets and Excel that you can start from.
Our cost calculator is broken down into manufacturing costs, financing costs, fulfillment costs, support costs, fixed costs, internal costs, and program inputs. This may sound like a lot of data, but each of these is only a high level placeholder to use for early modeling. By the time you’re ready to start selling a product, you should have a portfolio of highly customized and detailed spreadsheets with a range of scenarios modeled. For now, let’s step through the sections in the basic model one by one.
Manufacturing Costs
| Manufacturing Cost | |||
|---|---|---|---|
| Material BOM | Quoted cost of parts, modules, and packaging | Costed BOM | $20.00 |
| FATP MVA | Assembly, test, and packout labor plus manufacturer overhead | Costed BOM | $2.00 |
| Yield | % FATP yield without reworks | Quality team | 98.00% |
| Rework cost | Average MVA and BOM cost to rework | Quality team | $5.00 |
| Final yield | % Final yield after reworks | Quality team | 99.00% |
| COGS at FOB | Cost paid to manufacturer(s) on receipt of goods at port | Calculated | $22.32 |
We’ll start with manufacturing costs, which are the most intuitive part of the cost of a product. This is the cost of the materials and labor required to make the product. You’ll need a detailed costed Bill of Materials (BOM) to feed into the calculator. You can reference Bunnie’s guide or a model that Dragon Innovation has made available. The BOM is made up of components, modules, royalties, consumables, packaging, and other materials, while the MVA refers to the Manufacturing Value Add of labor and manufacturer profit on the product. We also extend the model by considering yield and reworks. It would be extremely rare for a consumer electronics production line to output 100% perfect units. Typically a few percent (ideally decreasing over time) would have functional or cosmetic issues caught in testing and inspection, and would need to be “reworked” or repaired before they can be packed and shipped out. The output of this section is the amount of money paid per unit to the manufacturing partner at the Freight on Board (FOB) location, where you take ownership of the product inventory.
Financing Costs
| Financing Costs | |||
|---|---|---|---|
| Supplier payment terms | Days from receipt of goods to payment due to the manufacturer | Sourcing team | 30 |
| Days until sale | Average days from receipt of goods to sale to the consumer | Logistics+Marketing teams | 60 |
| Time value of money | Cost of money of holding inventory | Finance team | - |
| Financing rate | Loan APY | Finance team | 10.00% |
| Per Unit Financing Cost | Unit cost of loans (assuming simple interest) | Calculated | $0.18 |
| COGS with Financing | Calculated | $22.51 |
Cost models often skip over financing, but this is an important part for a startup. It may be difficult to cover the cost of inventory entirely with cash on hand, so you may need an Inventory Line of Credit or similar type of loan to cover the time between payment being due to the supplier and receiving payment from a customer. This is a very basic financing model that uses simple interest and doesn’t account for differing payment terms to different suppliers, but it is a starting point you can extend on.
Fulfillment Costs
| Fulfillment Cost | |||
|---|---|---|---|
| Units per Master Carton | Number of units that can fit in a human-manageable box | Logistics team | 40 |
| Master Carton cost | Cost of the packaging of that box | Logistics team | $5.00 |
| Master Cartons per pallet | Number of cartons that fit on a pallet | Logistics team | 15 |
| Units per pallet | Calculated units per pallet | Calculated | 600 |
| Pallet air freight cost | Cost of shipping a pallet by air | Freightos | $2,000.00 |
| Pallet air freight carbon offset | Cost per pallet of buying carbon offsets for the air cargo | Carbonfund | $25.00 |
| Pallet sea freight cost | Cost of shipping a pallet by sea | Freightos | $300.00 |
| Pallet sea freight carbon offset | Cost per pallet of buying carbon offsets for the sea cargo | Carbonfund | $0.10 |
| Per unit air freight | Per unit cost of air freight | Calculated | $3.38 |
| Per unit sea freight | Per unit cost of sea freight | Freightos | $0.50 |
| % Air freight | Percent of total sales that will be shipped by air (typically at start of program) | Logistics team | 20.00% |
| Pallet freight to warehouse cost | Cost to transport pallet from port to 3PL warehouse | Logistics team | $400.00 |
| Calculated Freight in | Per unit cost of transport from manufacturer FOB to 3PL warehouse | Calculated | $1.87 |
| Warehousing | Cost of holding inventory at 3PL | 3PL | $1.00 |
| Shipping packaging | BOM cost of the shipping packaging | 3PL | $1.00 |
| Fulfillment | Service cost to pick, scan, and pack product at 3PL | 3PL | $1.00 |
| Freight out | Cost of shipping to consumer | Shipwire | $5.00 |
| Freight out carbon offset | Cost per unit of buying carbon offsets for shipping to the customer | Carbonfund | $0.01 |
| Payment processing fee | % Fees for credit card processing | Stripe | 2.90% |
| Duties | Duties to bring product into country of warehousing | Logistics team | 0.00% |
| Per Unit Logistics cost | Total freight and handling cost | Calculated | $9.88 |
| Per Unit Payment processing cost | Cost of payment processing | Calculated | $1.74 |
| Per Unit Duties | Cost of customs and duties | Calculated | $ - |
| COGS Fulfilled | Cost of getting a unit to the customer | Calculated | $34.12 |
Now we start to get into the more obscure details of product cost, which are the costs of getting a unit from the FOB location to your customer’s doorstep. Note that this model only covers direct sale to the consumer and not retail sales.
First we’ll determine the logistics costs. This depends on the size and quantity of what you’re selling, but for consumer electronics, you would typically pack units together into a bigger box called a master carton and then stack together master cartons to fill a pallet. If you’re selling more or larger products, you may be handling container loads or if you’re selling fewer or smaller, you may do logistics at the master carton level, but we’ll stick with pallets for this model. Onpallet has a convenient calculator to estimate how many units can make up a pallet load. We then use Frieghtos to estimate the cost of getting a pallet from the FOB port to a port in the sales region by both air and sea, along with the truck or rail cost to go from the port to your fulfillment warehouse. Air is of course significantly more expensive and carbon intensive, but can cut 20-30 days off of the time to cross the Pacific Ocean. Carbon offsets from a non-profit like Carbonfund can help you mitigate the harm, but you should consider the air/sea split over time carefully. Companies often use air freight to accelerate a launch and then switch to sea as they are able to build up an inventory buffer.
The fulfillment partner, typically referred to as a Third Party Logistics (3PL) partner, will have additional costs you need to model around sorting and storing incoming goods as well as picking, scanning, and packing up the product to ship to the consumer. If you warehouse internally instead of using a 3PL, you’ll instead capture your staffing costs here. You will also need to capture the cost of shipping to consumers and the payment processing fees to be able to take payment from them. All of these will change from region to region, so your eventual model should include multiple fulfillment cost structures and a region split model.
Support Costs
| Support Cost | |||
|---|---|---|---|
| Non-warranty returns | % Remorse return rate (refunded) | Marketing team | 5.00% |
| Reverse logistics cost | Cost to receive product back from the consumer to the 3PL | Shipwire | $5.00 |
| Recovery cost | Average cost to recover a returned unit for resale | Sourcing team | $5.00 |
| Recovery price | % of original price for refurbished product | Marketing team | 80.00% |
| Warranty returns | % Warranty rate | Sourcing team | 5.00% |
| Warranty repair cost | Average cost to fix a unit under warranty | Sourcing team | $5.00 |
| Manufacturer warranty guarantee | % of field failures covered by manufacturer guarantee | Sourcing team | 3.00% |
| Support cost | Cost of customer support staffing to handle returns, replacement, and general support | Support team | $2.00 |
| Total Support Cost | Cost of covering bad things happening | Calculated | $19,000.00 |
| Per Unit Support Cost | Per unit | Calculated | $0.95 |
| COGS with Support | Calculated | $35.07 |
Next, we need to consider the overall cost of supporting a product in the field. This includes remorse returns from consumers, warranty failures, and the staffing costs of your support team. Something to keep in mind is that returns and warranty failures shouldn’t be written off, but should be refurbished and brought back into the market. We include the average costs of refurbishing and the percent of original price for the refurbished unit in the model.
Fixed Costs
| Fixed Costs | |||
|---|---|---|---|
| Product NRE | Development cost paid to FATP manufacturer | Sourcing team | $30,000.00 |
| Module NRE | Development cost paid to module manufacturers | Sourcing team | $5,000.00 |
| Product Tooling | Cost of plastics, metals, and line tooling for final product | Sourcing team | $50,000.00 |
| Module Tooling | Cost of plastics, metals, and line tooling for modules | Sourcing team | $5,000.00 |
| Certifications | Cost of certifying product and modules to ship into countries | Sourcing team | $10,000.00 |
| Excess and Obsolescence | % of total BOM projected to be wasted due to part changes or excess material at end of life | Sourcing team | 3.00% |
| Total Fixed Cost | Total program development fixed costs | Calculated | $112,000.00 |
| Per Unit Amortized Cost | Unit cost after baking in program-wide manufacturing costs | Calculated | $5.60 |
| COGS with Manufacturing Amortized | Calculated | $40.67 |
In addition to the range of per-unit costs, we have to consider the fixed manufacturing costs for the product. That includes development payments to the manufacturing and component partners, the costs of tooling and line equipment, and certifications. It also includes excess and obsolescence (E&O), which is the amount of material that goes unused when parts change or the product goes end of life. Note that many of these costs are not truly fixed, since tooling will wear out and your line costs may increase if you decide to increase manufacturing capacity.
Internal Costs
| Internal R&D and SG&A Costs | |||
|---|---|---|---|
| Development OpEx | Internal prototyping costs | Engineering team | $50,000.00 |
| Internal Labor Cost | Total cost of internal full time and contractor staffing on the program | Engineering team | $100,000.00 |
| Promotion Costs | % of revenue spent discounting units for promotional pricing | Marketing team | 1.00% |
| Direct Customer Acquisition Cost | Average cost to source and complete a sale, including targeted advertising or affiliate marketing | Marketing team | $3.00 |
| Indirect Marketing Cost | Total cost of marketing promotions not associated with a specific unit sale | Marketing team | $100,000.00 |
| Total Fixed Cost | Internal fixed cost of staffing the program and selling the product | Calculated | $250,000.00 |
| Total Variable Cost | Average Per-unit variable selling costs | Calculated | $71,400.00 |
| Per Unit Internal Amortized Cost | Amortized over unit volume | Calculated | $16.07 |
| COGS with R&D and SG&A Amortized | Calculated | $56.74 |
Finally, we have to consider the internal costs of developing and selling a product. Each of these rows can again come from a much more detailed model, but you can start with rough estimates.
| Manufacturing Cost | |||
|---|---|---|---|
| Material BOM | Quoted cost of parts, modules, and packaging | Costed BOM | $20.00 |
| FATP MVA | Assembly, test, and packout labor plus manufacturer overhead | Costed BOM | $2.00 |
| Yield | % FATP yield without reworks | Quality team | 98.00% |
| Rework cost | Average MVA and BOM cost to rework | Quality team | $5.00 |
| Final yield | % Final yield after reworks | Quality team | 99.00% |
| COGS at FOB | Cost paid to manufacturer(s) on receipt of goods at port | Calculated | $22.32 |
Program Inputs
| Program Inputs | |||
|---|---|---|---|
| Product Price | Price of product sold to consumer | Marketing team | $50.00 |
| Shipping Price | Price charged to consumer for shipping | Marketing team | $10.00 |
| Total Price | Calculated | $60.00 | |
| Sales Volume | Marketing team | 20,000 |
Against all of these, we have to state our inputs of sales price and volume. This is usually the most interesting place to start playing with different scenarios to determine what is needed to make a program break even and eventually profitable. Note that if you have multiple versions or SKUs of a product, you’ll want to build a more detailed calculator with SKU splits, BOM costs per SKU, and the added fixed costs per SKU.
Program Outputs
| Program Outputs | ||
|---|---|---|
| Full Per Unit Cost | Payment to manufacturer, fulfillment cost, and financing cost | $34.12 |
| Full Per Unit Cost including Amortization | Including amortization | $56.74 |
| Sales Revenue | Sales minus returns | $1,140,000.00 |
| Refurb Volume | Units resold as refurbished | 1,000 |
| Refurb Revenue | Revenue from refurbished units | $48,000.00 |
| Total Revenue | Revenue from new and refurbished units | $1,188,000.00 |
| Total Cost | Per unit and program level costs | $1,134,849.85 |
| Gross Profit | $53,150.15 | |
| Profit Margin | 4.47% | |
| Unit Summary | ||
| — | — | — |
| BOM | $20.00 | |
| MVA | $2.00 | |
| Yield | $0.32 | |
| Financing | $0.18 | |
| Payment | $1.74 | |
| Logistics | $9.88 | |
| Duties | $0.00 | |
| Support | $0.95 | |
| Fixed Cost | $5.60 | |
| Internal Cost | $16.07 | |
| Profit | $3.26 |
As you can see from our overall outputs, quite a lot more than the bare materials goes into the cost of a product. With a high level calculator in place, you can better understand what levers are most important to focus on for cost reduction.
What Now?
With a model in hand, you can start to do scenario analysis and sensitivity analysis. For scenario analysis, you can start by duplicating your data into new columns and adjusting some inputs to simulate different program scenarios. For example, you can create a range of columns that each have differing total sales volumes, which allows amortizing the fixed costs over more units and would generally also enable cost negotiation leverage in areas like the BOM and MVA. You can also sanity check trades between different buckets like BOM cost and internal development costs. As an example, you can check the volume at which it’s worth spending a few person-months of engineering time to save a dollar on a cheaper microcontroller.
It’s generally worthwhile to make some best-case and worst-case scenarios on volume and other inputs to see where you most need to focus for derisking a program. Sensitivity analysis is basically a method to formalize this and determine which inputs are most important for improving a target output, but it is outside the scope of this already very long blog post.
We hope this was a helpful starting point to understand product costs, and we’re happy to respond to any questions you have on it. We’ll plan to update the basic model as we get feedback over time to make it as useful as possible.
