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# Manufacturing Cost Calculations

07/24/2009 2:32 PM

We are planning on rolling out a new product line. We have loads of data such as Raw material costs, time studies, wages, packaging and shipping costs, etc etc. Does anyone know of a standard formula or procedure to use when calculating the cost that a product should / could be sold for? Not being sure if I am wording this well or not, so questions from anyone are welcome.

Thanks RW

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#1

### Re: Manufacturing cost calculations

07/24/2009 2:36 PM

The Schaum's Outline Series has something like "Quantitative Methods in Management" which deals with many problems of this sort.

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#2

### Re: Manufacturing Cost Calculations

07/24/2009 4:08 PM

At the risk of attracting a whole Boat load of anti-business school flak, I will answer first as a business person and then as an engineer.

This phrase is a fiction:"the cost that a product should / could be sold for?"

The MARKET doesn't give a hoot about what the product should or could be sold for according to any rational calculations. The market will pay what the market will pay.

Now, You need to identify two things, 1) what the market will pay for your new product line; and 2) What will it cost you to produce at the level of the market demand at that price.

In economics this is referred to as PriceElasticityOfDemand

This is difficult to understand on new products, so many companies take the easy way out and try to substitute IncomeElasticityOfDemand and 'guess' based on income and demographics. That's because that is cheaper to guess than to do actual math, sampling and work.

In addition to the factors that you listed, learning curves and scale economies will be issues to consider, as well as the fact that no one knows what materials prices are going to be let alone cost of energy... or what the availability/cost of capital will be in your horizon.

Markup will be what you are actually after. And that typically also depends on the market and product application. For example, Stainless steel costs \$2.00 a pound, Yet I know companies making gram weight catheter parts by machining for \$3-4 per gram weight part; I also know stamping companies that are selling stainless stampings for just little bit over \$2.25 per 1 pound part in high volumes...

The market sets the price. You have to manage your process costs to assure that you can produce saleable product at a price that is sufficiently lower than the market so that the surplus recovers both your cost of capital and the profit needed to balance the OpportunityCost of risk. (That is, What is the next best thing that could be done with the investment that has lower risk than your planned production investment.)

I am certain that there are a number of MBA's who will be glad to charge you princely sums to do these arcane calculations. You might find them in the yellow pages under 'Professional Scoundrels' or perhaps under 'Business Consultants." Avoid bringing in any 'Management Consultants' as they have nothing to offer except opinions and nothing to do until you have a system set up and problems running it, at which point they will happily muck around and charge you exorbitant fees for the privelege.

milo

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#3

### Re: Manufacturing Cost Calculations

07/24/2009 5:30 PM

Thanks for the bookmarks.

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#4

### Re: Manufacturing Cost Calculations

07/24/2009 5:33 PM

My pleasure.

milo

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#5

### Re: Manufacturing Cost Calculations

07/24/2009 7:05 PM

I was just going to tell him to talk to the marketing department, if he had one.

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#8

### Re: Manufacturing Cost Calculations

07/25/2009 12:37 AM

Milo -- GA from me too.

I do agree with Artsmith about the 2x rule of thumb for mfg. cost to selling price. In other words 50% gross margin. But that's usually a tough target in a competitive manufacturing business unless you've got some big edge like patents and a legal warchest.

There is also the issue of ROI (return on investment). Each enterprise needs to determine their own targets for this.

Ed Weldon

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#6

### Re: Manufacturing Cost Calculations

07/24/2009 7:21 PM

As a humble craftsperson, I learned to set my price as follows: all production cost including labour = wholesale price. Retail price= wholesale X 2.

After many years of experience including direct sales, I learned that this is a reasonable way to reckon marketing cost. You can sometimes do better than the wholesale deals in direct marketing, but there's no guarantee of that.

GA to Milo: the market ultimately sets the price. So, depending on the product I choose to produce, the market value of that product ultimately sets the value on my labour. Some media pay better than others, it's a fact: it's why I now work in metal.

In your case, with industrial production, the gap between market value and production cost X 2 should be significant, to provide that thing we call "profit".

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#7

### Re: Manufacturing Cost Calculations

07/25/2009 12:34 AM

Hi there,

First, another GA to Milo for his thoughts.

As a manufacturer who does not market their own products, but only sells 'private label' to others, the general 'rule of thumb' is 5-times the ex-factory cost to get to the suggested (or MAP or MSRP) retail price. As a manufacturer, I try to get 5% to 8% gross profit over my factory costs (material, labor, overhead), and that is my selling price to my customer. They, in turn have their own costs, as does the distributor (if there is one), and the dealer (retailer), to get to the suggested retail so everyone makes their 'cut' ... when all is said and done, that often equates to about 5 times my quote to my customer.

For our products, if we have a material cost of about US\$ 1.00, that plus our labor and overhead and profit margin usually nets an ex-factory cost of about US\$ 1.30. In that case, the suggested retail would be in the neighborhood of US\$ 6.50.

Of course, as Milo says, the issue is not what something DOES cost, but what the market will pay. If, in this example, there is already a similar product in the market selling for US\$ 5.00, the project should be called 'not feasible' early on before there is too much investment of time and materials ... that, of course, is the challenge of program management to track feasibility and, if necessary, 'pull the plug' (or re-design, etc.) before things go too far.

As a general breakdown, at least for many consumer products, if something has a suggested retail of US\$ 100.00, the manufacturer sold it for about US\$ 20.00 (ex factory), and had a net profit of about US\$ 1.60.

Recently, there have been many success stories of commodities who only sell via the internet, and their own clever marketing is the key to their success ... they must create a 'pull market', because obviously folks can't just come into the store and browse. In their case, their marketing goal is to create an awareness and desire, enough for people to 'look for' their goods. Because, in those cases,there is no distributor or retailer to pay costs and make an extra margin, often their products are being retailed at only 2 times the ex-factory cost, and they still make more margin than they would through 'normal' channels.

Did I confuse you? I hope not. Bottom line ... if you have a product and you know the total factory cost out your door (material, labor, overhead), and you will sell to a brand name to handle all the sales and marketing, if you are making 10% that is huge. If you are making 5% that is normal (except for OEM products which are usually much lower), so anywhere between is a good thing.

Finally, please don't take all this as the only method. There are many scenarios ... will you market the product yourself? Will you distribute the product yourself? Will you service the product after the sale? In any of these cases, you need to know your total costs, and decide if your situation calls for a different scheme.

Kind regards ...

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#10

### Re: Manufacturing Cost Calculations

07/25/2009 7:13 AM

Great insights into the retail chain and Markups DCAD!

The first time I saw numbers like that , I thought there was a mistake.

But there are costs at every step, and of course every one needs their"cut."

Your specifics provide the OP with excellent insight.

milo

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#9

### Re: Manufacturing Cost Calculations

07/25/2009 2:05 AM

In our manufacturing the matter is simple (leaving aside the calculations, at the end during audits etc the following things have come put.

50-60% = Raw material and other input costs.

15-20% = labour costs including the indirect ones (salary, perks, medical and other social benefits)

10-15% - profit margin etc.

(The percentages are different for different product lines and are aproximate value)

But these again differ for industry segment wise and the level of market competition.

Of course there is extensive calculation methodology for the EFC of the products but the end result is as above.

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#11

### Re: Manufacturing Cost Calculations

07/27/2009 8:29 AM

Thank you all for the input, there is a lot of meat to chew on here, I will definitely be full when I get done with going through it all this week.

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#12

### Re: Manufacturing Cost Calculations

03/01/2011 4:00 PM

Good comments from all and appreciated very much

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