I Was Told There Would Be No Math…

Product costing is one of those tricky things that doesn’t really have a very clear answer as to how it should be done. Now, you might be thinking how is that even possible? But I wager you if you lined up people from 20 different companies and asked them how they costed products, you’d get 40 different answers. Think about your own product, or products, and ask yourself if you really know how much they cost you to produce.

Let’s work though a small example here to see some of the myriad of ways the cost of a product can truly be calculated. 

For our example, we’re going to pretend for a second that we’re the manufacturer of the thermal tumbler pictured. We’re making some assumptions on component costs simply for illustration purposes. 

The tumbler itself has twelve total components to it. 

1 - Primary Plastic Lid: $1.10
1 - Plastic Trigger: $0.80
1 - Plastic Lid Valve: $0.90
1 - Lid Valve Spring: $0.20
1 - Lid Rubber O-Ring: $0.20
1 - Stainless Steel Inner Jacket: $1.90
1 - Painted Steel Outer Jacket: $1.50
1 - Stainless Steel BottomCap: $0.90
1 - Logo Label Plate: $0.80
1 - Plastic Shipping Bag: $0.10
1 - Instruction Booklet: $0.30
1 - Product Box: $0.50

Total Material Cost: $9.20

As part of our example, let’s say the company retailed this mug for $18.99. If you take the costs at face value, that would represent a 51.6% gross margin. 

Now, this is where things get a little more murky…

There are two categories of additional product cost that companies normally add to the material cost of their product: fixed and variable overhead.

Fixed overhead represents all of the cost associated with producing a product that do not change regardless of production level. In this example, the labor to assemble the tumbler, and the tooling required to make the parts are both fixed cost. 

For our tumbler, it takes an average of 3 minutes each of two workers to compete assembly. Based on a national average labor rate, that would add $2.50 worth of labor to the cost of the  tumbler. Additionally, the hard tooling for both the plastic and metal parts has a finite lifespan. Based on wear and tear rates and replacement costs, each tumbler has a $0.45 each of tooling cost associated with it. You could dive into utility costs, regulatory costs, and other equipment depreciation costs as they relate. However, for this, we’ll just keep it at $2.95 in fixed overhead.  

Now, we’ve upped our product cost to $12.15, and lowered our margin down to 36.0%.

With variable overhead, these are all of the costs that change based on rate of production. Items such as leases/mortgages, administration, warehousing and shipping would all be included in this category. These amounts can rise or fall depending on how many products are produced in a given year. The more products you make, the more these cost are spread out. The fewer products you make, the more these cost must be accounted for on a product-by-product basis. For the example we’re working with, we’ll assume they have $2.10 in variable overhead costs per tumbler. 

Now, we’ve upped our product cost to $14.25, and lowered our margin down to 25.0%.

As you can see, the cost/margin landscape changes pretty quickly. 

Many companies calculate their costs similar to the example above. This gives them a complete picture when it comes to product pricing, which is a whole other topic in-and-of itself. However, depending on the industry and scale, overhead costs can be line item on the balance sheet. 

Having a solid handle on what your product actually costs you to make is absolutely essential to the health of your business. Helping you pick the right strategy, and how it may contribute to other areas of your business is something Salyer and Associates is here for. From the simplest product, to the most complex, we can work with you to see the best way forward.