True Cost of Manufacturing. The value of Contract Manufacturing
Do you know the costs of manufacturing? I mean really know. You know what your parts cost and you know how many hours that it takes but do you know the true cost?
There are 2 principles to follow to be successful in manufacturing. Always remember these 2 things:
- Earn more than you spend.
- Spend less than you earn.
4 areas of manufacturing: Parts, Labor, Margin, and Incidentals.
Let’s break it down and examine the impact on your bottom line.
Parts – buying parts right. If you buy too many, you have parts to store. Every box and pallet costs money to buy and store. You have them in the way every time you turn around. You could build a big warehouse and throw it up on a high shelf. There is a better way. Let’s only buy the parts that you need. Leverage your sourcing relationships. Look for common parts between manufacturers and common suppliers between projects. This will help your buying power and start to bring the costs down. It is better than buying many years’ worth of parts just for a good piece price. What if your design changes? Buying all those parts will cripple your ability to make changes to improve your product. If you buy too few, you pay a higher price and you could have lead time issues. It is a delicate balance. You will be buying common parts all the time. Those aren’t the ones you run out of. It is the unique parts or the custom parts or the long lead time items that can cause you trouble. Your buyers should know your product well and have a good relationship with the salesman or owner of your supplier. Many good suggestions can come from your suppliers. It might be delivery options, forecasting, discounts, design suggestions or difficulties making the parts. Talk and listen to your suppliers. Ask questions.
Your parts will be 30-50% of your total price.
Labor – finding the most efficient way to make it at the lowest cost. The 2 variables here are hourly rate and labor time. Hourly rate is likely determined by the going rate to pay good employees in your area. Labor time can be affected by tooling, manufacturing steps and skill level of your employee. You should be constantly reviewing design and the steps it takes to manufacture. Once the design is complete and the product is released, you are ready to get production involved. You should listen to your employees. They have good insight. It would be a good idea to let them work with you during the prototype stage to make sure it is manufacturable. Treat your employees well. Training a new employee always takes longer to get it right and your efficiency suffers. Having a stable workforce is critical. Can you handle an increase in orders with your current setup? You should think about scalability. How soon do you run out of capacity? Can you handle 2x the orders? 10x? 100x?
Your labor cost will be 5-35% of your total price.
Margin – after direct costs, you have some money left. This is used to pay your utilities, real estate, storage space, capital equipment, interest, tools and vehicles. Indirect employees like: Buyers, Sales, Engineering, Quality, Receiving, Shipping, HR, and Accounting are included here. Employee benefits such as healthcare, vacation, training and sick pay come out of margin. You need to pay incoming freight costs for the parts you ordered. You need to pay taxes, insurance, and charity. Keeping margins high and your costs low is a constant battle. If there is anything left after all of this, we call it net profit or the “bottom line”.
To stay profitable, your margin will be round 20 – 35% of your total price.
Incidentals – these are the things, the hidden things, that can rob the bottom line. They can leave you working extra hours for nothing or worse yet, you spend more than you earn. They include things like: cash flow, payment terms, inventory storage, finding and retaining good employees, scrap or rework costs, quality certification, engineering support, vehicles, maintenance, lead time, laws and regulations, and travel.
A few of them are important enough to go into more details.
Cash flow and payment terms
Your cash is tied up from the minute you pay your supplier until the moment your customer pays you. Ideally, your customer would pay before you pay your suppliers. In that situation, you would enjoy positive cash flow. That is not the situation for most manufacturers. Depending on your business, the payment term range from your customer is pre-pay to 120 days. Every day your customer doesn’t pay you is one day that you don’t have money to pay your costs. This affects your cash flow. Getting good payment terms from your suppliers will help since your payment “clock” begins ticking on the day you are invoiced. This is likely the day it ships. Overseas suppliers typically require pre-pay at the time of shipment and have much higher inbound freight costs. This is a disadvantage for oversea or long distance suppliers due to travel time. This is often overlooked when selecting suppliers based on price. Cash flow will prevent a company from being able to accept a big order because it ties up all your cash with your upfront costs like parts, space and employees
Your employee will not work for free. Your supplier will not ship more parts if you do not pay them. Your builder or bank needs paid on time.
Every dollar you have sitting on the shelf is a dollar that has delayed its appearance to your bottom line. You turn sales into profit, you don’t turn inventory into profit. Worse than too much inventory is not having enough parts to deliver the products that are sold. It is important to know how your design changes affect the inventory that you already have. This is why you shouldn’t focus on piece price but on the total price of the purchased parts. You should work with your suppliers to see what they can store for you or keep in raw form without committing. You should decide how much finished good inventory is needed at your place or in distribution.
You can see again the delicate balance between having parts available to build but not tying up all your cash in inventory. Forecasting helps.
This is the time it takes to get the parts, build it, and ship to your customer. Delays are missed sales. How long will your customer wait to get product after you have “sold” him to buy? 1 day? 1 week? 1 month? Having product on the shelf ready to ship at all times, no matter what the quantity, is idealistic and impractical. That would require an enormous amount of inventory stored somewhere with the risk that you have too much because your idea wasn’t as good as you thought it was or it needs a design change to work as advertised. The speed to market is going to depend on your lead time and your scalability. How fast can you double sales? How much cash would be needed to 10x your forecast? How soon can your suppliers react? Having good suppliers is essential. You can buy the long lead time items and minimize your exposure. You can buy the common parts. You can buy raw stock. You can buy parts that you know are not going to change. All of this helps reduce lead time.
What if I told you that I can free up your cash? What if I told you that you can focus on what you do best?
Using a Contract Manufacturer to keep more cash and maintain focus.
CM’s bring a value beyond your costs. The cost savings is much higher than what is left after you pay parts and labor. That goes directly to your “bottom line”
Contract Manufacturers give you time to focus on your idea and your customer.
A contract manufacturer will have established relationships with suppliers. They bring engineering support. They have people handling specialized areas of the business. They level out cost and capacity “peaks and valleys”. They store inventory to react quickly to an increase in sales. They have an established work force that is already trained and reliable. They reduce steps to increase efficiency. You pay when product is delivered. Your cash is freed up! Your focus is spent on your market!
Find a good contract manufacturer today.