EEVblog #887 - The Economics Of Selling Hardware

hi welcome to fundamentals Friday I thought we'd do something a bit different today instead of electronics or circuit design I thought we'd take a look at the economics of selling your own hardware because these days it's super simple anyone from their home can get into manufacturing and selling electronics you can buy any part you can possibly imagine from digi-key a mouse or some other supplier PCBs are almost free and they're dirt cheap and electronics assembly the assembly of your PCB everything you're so cheap and there's even like web-based turnkey solutions to do the whole thing though manufacture your board they'll similarly your board they'll test it they'll do everything and you can go into the hardware business yourself but I thought we'd take a look at the economics of it now I've actually done a blog post on this several years back so essentially I'm going to redo the stuff I've done in that blog post now there's a bit of a rule of thumb in regards to how much you should charge for your product and this is basically 2.5 times the cost of goods sold see OGS we'll call it nothing better than a four letter acronym is there so if your product costs $100 to manufacture included everything as we'll talk about shortly then you need to sell it for about two hundred and fifty dollars as a minimum to sort of stay in business where does this 2.5 figure come from well that's what we're going to take a look at now first take a look at how you price your product there's actually two different methods of pricing your product one is called the top-down pricing method the others called the bottom-up pricing method the top-down method can be based on what similar products are priced at so you look at the market out there what a similar competing products your one's a bit better in some way but you know you probably don't want to charge a lot more you want it like a similar price to existing products or you could use this method if yours is the only product in the game for example pretty much that includes the third point here is that you could pretty much charge anything you want in a exclusive or more traditionally high-priced product for example so that could be the luxury goods market or a market like say the audiophile market for example where people are just used to paying high prices for a valve audio amplifier or some other audio product or something like that but basically it comes down to the fact that you can pretty much charge what the market is willing to pay but there's obviously a downside say you wanted to make a new ad we know compatible board for example well people who used to paint pretty low prices for these boards so it's not like you can come out with a new Arduino compatible boarder and Arduino shield and then charge $200 for it the markets going to go what's that's totally out of the price range that I expect but of course there's an obvious trap with this a similar product here sells for $10 and you think that you can you know make some big huge business making a margin on a $10 retail cost board it's probably not going to pay your wages to stay in business so the market could be done and dusted of right there if you're trying to compete in a highly competitive low-cost market the next method the bottom-up pricing structure is probably the most popular one used by people just starting out sort of like a side business making hardware products you've got your idea for your great hardware product you make a few prototypes and you want to start a little business or side business selling the thing what are you price of that oh you've got no idea so it could be the only product in the market and you don't know what to price it at so what do you need to price of that to stay in business well you look at your manufacturing cost your cost of goods sold and then basically you put in a multiplier we've mentioned the rule of thumb before 2.5 and we'll see where this figure comes from that allows you to stay in business the good thing about the bottom up pricing structure and why a lot of people use it it's probably the most popular is that it's easy you don't have to worry about be concerned about all am i competing and all that sort of stuff what should I charge or I'm so worried I've got no idea having been in this business before the price is what it is it costs you a hundred dollars in parts to manufacture this thing you're going to sell it for 2.5 times that or 250 dollars and you can even be upfront with your customers and say hey look you know the May factoring cost is about this I need to sell it for this to stay in business and probably the majority of customers out there you know going to appreciate the fact that you need to make a decent margin to stay in business it's not like a cutthroat you know five dollar farty novelty toy toy from Alibaba in China right you know you need to pay your bills you need to eat you need to feed your family everything else but here's the thing regardless of whether you use a top-down pricing structure to determine your price on the bottom-up it doesn't matter which method you use or what retail price you choose you need this sort of multiply this 2.5 times to stay in business if it's any lower than that you risk going out of business pretty quickly must be noted that this is just a minimum baseline required to stay in business especially if you have distributors which we'll talk about but hey if you can if you've got a really cool product that only cost you $10 to actually manufacture but you add value in you might have some software or something like that a classic example of this might be the sale early logic analyzer for example the harbor itself isn't much at my cost like ten twenty dollars to manufacture might sell for a couple of hundred dollars because you've got all the software and the IP and the support and everything else that goes in to the product and if your product happens to be in that sort of market well that's fantastic of course if you can get away with a higher margin by all means do but before we look at our cost multiplier here we have to know how much it costs us to manufacture our product the cost of goods sold it's not just the manufacturing cost there's a lot of stuff involved here let's take a quick look at it your bill of materials parts your bomb cost is the obvious one that's the list of all your parts from your schematic from your project on piece of B including your case and all sorts of stuff plus one thing a lot of people forget is the real overruns when you're getting something manufactured you're most likely going to be buying things in reels like this you're going to be buying a thousand of if you only want to manufacture one hundred you might have to buy them in a thousand and you might have to amortize that cost ie spread that cost into the cost of your first batch because usually when you're costing a product for the first time you usually want to do what for your first production run or maybe you might you know spread it over a second production run or something like that but just be careful of reel overruns that can be an issue but they get some difficult because different parts come in different real quantities and things like that and so batch from bad she gets all a bit complicated but you might have to add in something there of course you've got your blanket PCB that's obvious they're pretty cheap but that's you could include that in your bond cost then you've got your assembly cost that's just your base level assembly cost from your assembler how much it would cost will per board usually to assemble the thing but of course there will usually be a set-up charge for that so you have to amortize that cost into say your first production run for example might be $500 to set up the pick-and-place machine as a one-off cost to do that then you've got your testing and your programming if you've got a modern modern product with a microcontroller you need to program it that could all be part of the assembly cost or it could be separate depending on how your assembler charges that then you got packing do you want your assembler the packet or are you gonna do it yourself if you're gonna do it yourself if you're gonna hire someone down here to do that then all that cost comes into it and then you've got all the shipping for all the above this is not shipping to the customer this is shipping parts to you and then to assembler to and from and all that sort of stuff that can add up don't forget to include that a lot of people forget that and you know they wonder why they're not making as much as they should then you've got consumables you've got all sorts of stuff that you've got a you know pens and pencils and labels and envelopes and all sorts of things you've got to remember the consumables then you might have taxes involved we won't go into that but you might need to in your country and here comes that word amortize again which means sort of like spread the cost across the entire thing you have to amortize in the cost of defective units you might get 100 shipped to you but they might test 105 and find that five or defective they're not gonna pay for that that's part of your cost you've got to absorb that so you might typically add in say 5% your first run could be higher than that but you know it's a not a bad rule of thumb 5% extra board so if you've got a production run over hundred boards cost him a hundred and five for example then don't forget you're gonna lose some in shipping as well it's just going to happen people will go I didn't get it and you have to ship me a new one don't haggle with them just ship him a new one build it into your cost here typically a couple of percents right it wouldn't be as high as five percent if it is something's horribly wrong but be sure to add in a couple of cent and then you got wages as well are you gonna do it yourself are you going to hire someone to do the packing this shipping for you or you might hire a logistics company to do that for you well you can include that down here as well now normally I don't like to include the cost of shipping to the customer in my product I typically just charge my shipping at cost sometimes they make a loss on it sometimes I make a gain depending on different countries but all sorts of averaged out and then I don't have to include that here but there's a lot of things involved in the cost of goods sold so you've got to add all these things up put it in a big massive spreadsheet add it all up sometimes you'll have to guess at these sort of things if you're working out for this viable or not you don't exactly have all sorts of quotes and things like that for everything you might have to guess a few things that's okay welcome in a big spreadsheet and you'll get a number out and that is your cost of goods sold and you want to sell it for at least 2.5 times is the usual rule of thumb you can get away with less under circumstances we'll talk about and you can get away with more as we first looked at right at the start now we have to talk about distributors and how you're going to sell your product because this could be a huge reason why you need at least this 2.5 multiply here or one of the reasons why you might be able to get away with a lower margin on your product so let's take a look at the distributors this can be you know the likes of art of fruit Sparkfun or insert a million other places to sell your product these days but basically what they are is a retail storefront that sell your products so the advantages the pros of these are that they have a ready market there's people going there all the time shopping they can advertise your product they can promote it they can you know include it in things and people whack it in shopping carts along with other stuff so if you're starting out and you don't have an existing audience or you know you can easily reach an audience for your product because you don't want to pay for marketing don't do that trust me so that could be a real major reason that could make or break your product if you can't somehow get to the customers but a distributor can then by all means and good reason to use them and they also handle the ship in the orders the returns and the complaints and everything else so no worries they take away a lot of the hassle and they buy in bulk which makes things much easier not dick around with onesies and twosies but of course there's downsides with going with distributors this will vary with distributors but typically they're going to want to make a 60% markup and I'll explain in a minute what markup is what that actually means and they can actually make more per unit than you do if you're they could make $50 in unit and you only make $30 a unit and that may not sit right with you it may not seem right you have to outweigh the advantages and everything else and it actually may not make your business or product viable at all if you are selling into a cost sensitive market for example you may not be able to have enough margin in there to account for the 60% markup of them and the whole thing just made completely fall flat you won't be able to feed yourself and you'll just go out of business and the other thing is it may not feel as satisfying it may not feel like you're building a business yourself because you know you're just sitting in your garage and ears box and up stuff and shipping off actually not dealing with the customers so that act can actually be quite satisfying so pros and cons both ways you'll have to weigh it up yourself now of course you can actually do both you can have a distributor for example I'm based here in Australia I might have some overseas distributors which makes selling into different overseas markets much easier especially in the Europe might be difficult to get in to for outsiders for example so it could be worth running a combination of these things but typically just be careful you're going to want to have to have the similar or same retail price for both because the customers may go huh you're selling it under the price of your distributor and your distributors may not like that your customers don't feel good about it so just be careful that can cause a bit of a conflict and I forgot a more technically correct term perhaps is a reseller for that because they're reselling detail but I just used the terms interchangeably here and also I'm not talking about getting the distributor / reseller to actually manufacture the hardware for you because a lot of companies will actually do this they will take your design and they'll actually do everything the Bill of Materials they'll source the components they'll assemble it they'll test it they'll pack it though ship it they'll do everything and they might give you ten or fifteen percent of the retail price or something like that so really that's a different ballgame entirely and you can actually make a business from that just taking the ten fifteen percent off the top and getting somebody else a reseller to handle assembling and doing everything else the materials and all you do is get a check every month but that's not really building the business that we're talking about here all right let's see how much profit we make or as it's called the gross margin percentage let's assume that we're making a turbo in cab you later beauty okay let's assume that our cost of goods sold is $50 okay that includes everything on that huge list that we saw before everything to do with the business of making this turbo in cab you later and let's use our rule of thumb 2.5 times multiply it which I'll still get to trust me and that gives us a retail price that we need to sell it at over one hundred and twenty-five dollars so the gross margin percentage is the revenue ie the retail price minus the cost of goods sold divided by the revenue times one hundred percent easy you should really already know this that's sixty percent gross margin percentage or profit essentially so let's assume that we can sell a thousand turbo in capital a ders per year which is not much it sounds like a lot to a lot of people but and there's a big market out there so you know a thousand is not a huge volume for a typical niche hardware product so we make $75 profit on each one times a thousand it's easy you make 75 K a year beauty that you can conceivably quit your job for that right and just sell your turbo and cab you later and that's fantastic but aha what happens if we want to use a distributor a reseller to sell your product the things change because 75 K here might be fantastic for you if you're doing all the work and everything else that's effect your wages that's what you're getting paid after all the cost of goods sold and everything to do with the business and you got to pay tax on that but you know that's your income effectively your wages if you're just doing it yourself but if you want somebody else to do it if you want distributors resellers it's a different story let's take a look now right back at the start I mentioned markup and this is important this is where it matters when you sell you through a distributor / reseller I mentioned that they will typically want the large ones anyway will typically want a sixty percent markup so markup is the retail price that either you've chosen or you've chosen in consultation with the reseller the retail price / the reseller cost ie the cost to them - one that's all it is now this is often given in a percentage but we didn't multiply by hundred there so the figures actually no point six but they'll typically tell you we want a sixty percent markup thank you so they will do this calculation and you need to do it - what is their buy price ie the price that you're going to sell it to them for it you simply rearrange that it is the retail price divided by the markup plus one and remember that's not sixty percent it's that not 0.6 so if we do the calculation for our one hundred and twenty five dollar turbo in calculator here two hundred and twenty five dollars divided by 0.6 plus one or seventy eight dollars that is what they are going to ask to buy it if I sell it to them for $78 remember the cost of goods sold was fifty dollars we're only making a twenty five dollar profit when we had per unit when we have a reseller but when you are selling it on your own you're making seventy five dollars profit per unit huge difference and that might sound unreasonable why do the large resellers want a sixty percent margin it's massive right well they have distributors as well like the likes of artists fruit and Sparkfun for example they have distributors in all these different countries they have to sell it at a wholesale price to them and they have to still make a profit this is not uncommon at all in the retail trade take for example a bookstore you know old fashioned dead tree most of the profit on that is made by the bookstore then the distributor will get there and the publishing house and right down the bottom and the author might get 10 15 percent of that retail price if they're lucky so if the reseller is selling at 425 and they're buying it from you for $78 they're making forty seven dollars per unit that's assuming that they sell it sell it direct themselves and not through one of their further distributors down the chain so they're making forty seven dollars profit per unit you're only making 28 dollars profit per unit not so good is it so this is why pricing your product is vital and also getting the correct cost multiplier in there it matters so that you can make a viable business out of this if you have to use or you decide to use a distributor slash resell it you're not making as much as they are typically per unit but that depends on your cost of goods sold and your cost multiplier so now we're actually going to take a look at some graphs of this cost multiplier actually put this into a spreadsheet and work out where this 2.5 comes from because that's what I promised right at the start of the video I can show you that 2.5 why it's a decent rule of thumb all right let's have a look at the spreadsheet we got our markup here of 60% or not 0.6 we've got our cost in here $50 we can change these to our hearts content then we can calculate various things to retail price and the gross margin if we gross margin percentage if we still direct our profit when we sell direct our the sale price to the distributor the gross margin percentage if we go to the distributor so that's between the difference between selling directly and going through a distributor and a bunch of other stuff the reseller profit profit difference anyway we can go down here and we can plot this I love graphs of course and let's let's take a look at this one this is the difference between the blue line here is the one the our gross margin percentage if we sell directly to the customer ourselves we don't have a reseller at all and of course obviously we make a profit we make a percentage gross margin on anything over our cost of goods so we go on up to cost multiplier between 1 and 5 here so if we if it costs us $50 result for $50 of course we could not going to make any profit but anything over that is cream okay so that's looking pretty good but you'll notice that if we have a look at the gross margin percentage if we use a distributor ie a reseller because of that sixty percent markup we have to get we have to sell at a cost multiplier of at least one point six times to break-even at least so we've had a figure of roughly two point five here and you can see that you start getting on the ballpark and you see that the difference between these two here once you go up to cost multipliers of three four or five there's not much difference you don't sort of it's diminishing returns in in terms of the difference that you'll get in profit between the two and of course we can go in there and change this figure and let's say we had a better reseller oops not 0.4% then you would notice that we only need a one point four multiplied to break-even and so forth so you can actually just go in there and change things to your heart's content and if we have a look at this graph here we'll try and get an idea of why that 2.5 multiplier matters but it's not a hard-and-fast thing it's more like a maybe a psychological thing if anything it totally depends on your cost of goods sold and you know other market factors and things like that but if we have a look here at our blue one okay this is our profit this is our dollar profit if we sell directly the blue one there obviously anything over our cost of goods sold now costs multiplied over one we make profit on that and likewise we've got the orange curve here which once again we need that one point six multiplier just to start making a profit but was so why two point five well if you have a look at around it it's actually around about two point three some people in the industry use a figure of 2.3 2.4 I use 2.5 just sort of round it up ah that means that you're making look on the right-hand y-axis here here is the percentage difference in profit between what the reseller makes and what you make at around about that two point three to two point five mark you're looking at about 50% it actually occurs at 2.3 there so you're owning half of what the reseller does and you know do you want to earn less than half so you can clearly see it's not a linear function here because once again it gets down to zero on the right hand y-axis here at once again surprise surprise that one point six multiplier because we our reseller is asking for a 60% margin so that'll slightly change so what multiplier do you need to earn exactly the same profit as your reseller does well look it's precisely for here BAM at a hundred percent they're at a cost of four times of four times multiplier so if your turbo and cab you later costs fifty dollars you need to sell it for two hundred dollars retail before you can earn the same profit the same gross margin percentage as the reseller does and often that'll price you out of the business some industries here you can easily get four times cost multiplier but others you know so this is why generally a the rough rule of thumb is around about two point three two point five as my figure that I use because you're earning half of what the reseller does so there's some justification for a multiplier of the two point five and as you can see it you know it starts to drop off fairly quickly under that so if you're using a reseller oh you're starting to become a borderline business under there so anyway it's not a bad value to work from when you're starting up your hardware business and you don't really know the economics of it oops I realize I didn't show you the bottom of the y axes there anyway this will of course depend entirely on the markup that your particular reseller is charging I've changed it to not 0.5 or 50% markup now and as you can see instead of being a four times multiplier now you only need a three times multiplier and we can go all the way up here and we can change that again to not point four and that will change again completely and as you can see oh look at this we only need a 2.3 multiplier to actually earn the same as the reseller does so yeah you got to be aggressive these markups so you can see the dramatic difference going through a reseller makes it could actually make or break your business as we said before you could be earning 75 K a year profit if you sold your thousand turbo in Cape you laters using the figures that we got and you can basically quit your job and turn that into a full-time business pretty much but if you went through the reseller at the same retail price in the same cost and everything else the same volume the only owner 28 K a year that's not enough to quit your job for but hey this is just one example using some numbers just you know typical figures just plucked out of the air your product could be completely different and you can make a really huge viable business going through a reseller but if you can do it yourself I highly recommend it because today there's many places to sort of advertise your product and get you know forums and through other video bloggers like myself you sent and then you get reviews and word gets around and things like that you don't necessarily have to go through a reseller and it's by far the better option if you can actually sell it yourself in fact taking this example here if you made $75 profit per unit you only need to sell 373 of them to make that same 28k a year as you would selling a thousand of them through the reseller so the reseller has to add value at least three times in this particular case they have to sell three times as many as you would be able to sell yourself before you start seeing any extra profit out of it so I hope you enjoyed this video was longer than I was hoping it wouldn't be I thought it'd be about half this link but I covered quite a lot of stuff and I hope you got something out of it and I hope it's possibly encourage you to start your own hardware business start selling your own hardware it's easy go for it catch you next time hi now I know a lot of you out there and like designing your own products and that's fantastic now let's say you've come up with this great new design okay you've got this one off you built it works great you've debugged it fantastic and you want to make 50 on a hundred five hundred a thousand think big ten thousand hundred thousand what do you do how do you take your project from a one-off to volume production well I'm glad you asked

Channel: EEVblog

Views: 125,573

Rating: 4.9488583 out of 5

Keywords: eevblog, video, economics, hardware, oshw, distributor, reseller, how to, tutorial, gross magrin, percentage, markup, adafruit, sparkfun, pcb, profit, margin, cost multiplier, advice, tip, open source, assembly, bom, cost, selling, sales, profit margin, startup

Id: UwrkfHadeQQ

Length: 26min 47sec (1607 seconds)

Published: Thu Jun 02 2016

Reddit Comments

[u/RangerHiker]

Great video! I'm not in the electronics business but this is still great info!

[u/DrewOJensen]

Gotta love EEVBlog. His videos are always worth the watch.