EEVblog #887 - The Economics Of Selling Hardware

[EEVblog]

In this Fundamental Friday Dave discusses the economics of selling your own hardware. Both directly and through a distributor/reseller.
Everything you need to know about pricing your product for your hardware startup. Cost Multiplier, Gross Margin Percentage, Markup, and Cost Of Goods Sold are all explained.

[AndyC_772]

I'd add a couple of important extra costs which need to be factored in if you're looking to sell any significant number of units.

First, unless the thing you're selling is just a component rather than a complete product in its own right, you'll need to CE mark it (or, alternatively, apply whatever other mandatory approvals mark is required by the country into which you're selling). For CE you can self-certify, but it is still a can of worms for the uninitiated, and it is very much a barrier to entry for the small business.

Without approvals in place, at best you risk having your shipments rejected by customs. At worst... don't go there.

The other thing you should have in place before you ship anything, is professional indemnity insurance including product liability. You'll get away without this right up until the point where someone alleges that your product has caused them some kind of damage or injury... whether it actually has or not.

Remember, you're probably going to be selling via the internet.

Read the internet for a while. Work out for yourself the proportion of people who are jerks, who are just plain thick, and who bitch and whine a lot. Multiply those proportions together however you see fit; that tells you the number of units you'll likely need to sell before you've unwittingly sold one to someone who meets all these criteria.

Add 'litigious' into the list, and you'll see why having insurance is a big deal if you expect to sell more than a handful of units. (Hint: many such insurance policies specifically exclude sales into the USA for some reason!)

[EEVblog]

I'd add a couple of important extra costs which need to be factored in if you're looking to sell any significant number of units.

The list could be 5 whiteboards long if you sat down and thought about every possible cost for every possible scenario.

[VK3DRB]

Regarding any electronics, it is not so easy for some types of products. For example, very few people can make medical device products due to the strict regulations such as IEC-60601 and IEC-62304 and IEC-13485 to name a few, and their collateral standards. You will not be selling any medical device in most countries unless your product and/or company have full approvals/compliance to these and other standards. You could be shut down, and incur severe penalties from the FDA and other authorities if you don't follow the regulations. These approvals are very expensive. The development process can take five times the development time of developing, for example, a consumer toy.

The costs are very high. Hence why the medical devices cost so much money. In fact, medical device companies are basically documentation companies. Their mandate is not to produce a product, but are required to produce fully traceable and controlled documentation for the product. One of the outputs of the documentation happens to be the device itself. And they can be audited at any time by the TGA, FDA or some other authority - at the medical device company's cost whether they like it or not.

For most other prodcuts we have EMC approvals such as conducted emissions, radiated emissions, drop-outs, surges, radiated susceptibility, ESD etc. You cannot sell any electronics product in most countries unless some or all of these tests have been carried out by a NATA approved test lab and you have the documentation to back it up.

[vk2amv]

Does the 2.5x multiplier continue up to more expensive prices?

The example given was with a project that cost's $100 to manufacture so you charge $250 to cover your overheads and make a living.

Does that continue up with items that cost $1,000 to manufacture? $5,000 to manufacture, $10,000 etc?

It would seem to me that you would get to a point that the 2.5x multiplier seems to break down.
Or I could be thinking completely wrong and looking at it the wrong way as I guess on the flip side you would not likely move as many units of the more expensive devices (Depending on what they are).

[ballanux]

Great video!

I'm finishing a small project that I would like to try to sell, I'm good on the technical aspect (I work on power electronics) but I had little idea on the resellers and how much they expect to charge. Other part that I'm a little afraid is on the customer support that the product would require... ranging from documentation, technical questions to refunds etc...

[ECEdesign]

What's the best way to gauge interest for a product?  I am working on a project (mostly for learning) but I'm not really sure anyone would want to buy it.

[kosine]

The 2.5x markup is pretty typical, though in my experience it's closer to 2x on average.

As Dave mentions, fast-moving consumer goods (FMCGs) can be much less, slower moving "luxuries" much more. Here's another way of explaining it:

If an item costs $1 to make, and you sell on for $1.50, you're making 50c profit. Sounds good, until you realize that if your costs increase by 10%, you're now down to just 40c profit. That's a 20% hit!!

But if you buy at $1 and sell at $2, then a 10% increase only costs you a 10% hit.

Of course, if you could sell for $3 it's only a 5% hit, but then you leave loads of room for competitors to undercut you.

So natural selection tends to weed out those charging too little or too much, and a 2x markup (or 50% profit margin in business speak) becomes the norm. Cost increases are then manageable: Could be inflation, minimum wage increase, oil prices, exchange rate fluctuations, stock loss/returns, bad debt, etc etc. It happens a lot, and you can't always pass on the increase to the customer. That 2x markup helps you weather the storm.

To use Dave's example: cost of $50, sell at $78, profit $28. A 10% cost increase would wipe out 18% of your profits. Not great, but I've seen worse!

However, I think the 60% distributor markup is a bit on the low side. Everyone in the channel plays the same game, so they tend to double-up as well. (Retailers are even worse - they'll try to squeeze the pips out of it!)

If you're looking to get a product onto the shop shelves, it works out to about 10x the ex-factory cost:

Say it costs you $1 to make, so you'd sell it to a distributor for $2. They'd sell to a retailer for $4, and it'd be on sale for $10 (inc sales tax). It's really that bad, and it also helps explain why there is so much badly made stuff out there. The folks at the bottom of the food chain really have to save every last cent to stop it multiplying up.

A better strategy is to find a niche market. and make what the customer wants. If you're trying to sell something, it'll be hard work. If you've got something people want to buy, you can name your price.

[nctnico]

Good video about doing business in a sensible way!

[VK3DRB]

The maths for the cost price versus selling price is fine. But you can have the best product in the world but it you are an idiot, no amount of good design or profit is going to save you.

Many small electronics businesses are not run very well in Australia. Their owners often have few management skills. When money gets tight they start cheating on the employees. Usually its the superannuation payments or supposed bonuses that go first. Valued employees up and leave, so the electronic product or service becomes untenable.

I know a bloke who works for one small business where the owner is the master of false economy. The owner is happy to spend thousands of dollars outsourcing simple modifications to circuit boards rather than buying a decent soldering iron and doing it in house (he has technicians and engineers working for him). I was told he runs an old 7 year old inkjet printer that is gummed up with dried ink - it cannot print properly and has scanning problems. Apparently hundreds of man hours are spent by his employees trying to fix it, but for $250 he can buy a new higher performance which he refuses to do. The same guy turns UP the air conditioner temperature in summer to a hot stuffy environment and turns it DOWN to very cool in winter to save a few dollars on the electricity whilst making the employees uncomfortable. Finally, he turns disconnects the microwave oven every night to save about one cent per year on the digital clock electricity costs. He is a micro-manager too. When it comes to buying test equipment which is rare, he famous phrase is "whatever is cheapest", disregarding technical specs. His main multimeter is an eBay cheapo from China which cannot even turn on an LED. My friend loaned him his monitor four years ago because the owner would not buy one for the employee. Ironically, the owner wonders why he cannot attract and retain employees.

Eventually such businesses languish for years or go out of business altogether and wonder why. It is particularly the case with electronics businesses and with small businesses in Australia. Some people are just not suited to run a business. Despite training, most of the owner's real eccentricities and personality issues come into play. So there is a lot more than just selling a product and making money. Successful businesses are well managed by level-headed intelligent people who can enthuse and retain their employees.

Ever wondered why many big successful businesses got that way? Its not just the product or the profit. It is due to good management and leadership.

[ECEdesign]

I know a bloke who works for one small business where the owner is the master of false economy. The owner is happy to spend thousands of dollars outsourcing simple modifications to circuit boards rather than buying a decent soldering iron and doing it in house (he has technicians and engineers working for him). I was told he runs an old 7 year old inkjet printer that is gummed up with dried ink - it cannot print properly and has scanning problems. Apparently hundreds of man hours are spent by his employees trying to fix it, but for $250 he can buy a new higher performance which he refuses to do. The same guy turns UP the air conditioner temperature in summer to a hot stuffy environment and turns it DOWN to very cool in winter to save a few dollars on the electricity whilst making the employees uncomfortable. Finally, he turns disconnects the microwave oven every night to save about one cent per year on the digital clock electricity costs. He is a micro-manager too. When it comes to buying test equipment which is rare, he famous phrase is "whatever is cheapest", disregarding technical specs. His main multimeter is an eBay cheapo from China which cannot even turn on an LED. My friend loaned him his monitor four years ago because the owner would not buy one for the employee. Ironically, the owner wonders why he cannot attract and retain employees.

LOL sounds like quite a guy.  I love the part about the mircowave 

[Tinkerer]

The maths for the cost price versus selling price is fine. But you can have the best product in the world but it you are an idiot, no amount of good design or profit is going to save you.

Many small electronics businesses are not run very well in Australia. Their owners often have few management skills. When money gets tight they start cheating on the employees. Usually its the superannuation payments or supposed bonuses that go first. Valued employees up and leave, so the electronic product or service becomes untenable.

I know a bloke who works for one small business where the owner is the master of false economy. The owner is happy to spend thousands of dollars outsourcing simple modifications to circuit boards rather than buying a decent soldering iron and doing it in house (he has technicians and engineers working for him). I was told he runs an old 7 year old inkjet printer that is gummed up with dried ink - it cannot print properly and has scanning problems. Apparently hundreds of man hours are spent by his employees trying to fix it, but for $250 he can buy a new higher performance which he refuses to do. The same guy turns UP the air conditioner temperature in summer to a hot stuffy environment and turns it DOWN to very cool in winter to save a few dollars on the electricity whilst making the employees uncomfortable. Finally, he turns disconnects the microwave oven every night to save about one cent per year on the digital clock electricity costs. He is a micro-manager too. When it comes to buying test equipment which is rare, he famous phrase is "whatever is cheapest", disregarding technical specs. His main multimeter is an eBay cheapo from China which cannot even turn on an LED. My friend loaned him his monitor four years ago because the owner would not buy one for the employee. Ironically, the owner wonders why he cannot attract and retain employees.

Eventually such businesses languish for years or go out of business altogether and wonder why. It is particularly the case with electronics businesses and with small businesses in Australia. Some people are just not suited to run a business. Despite training, most of the owner's real eccentricities and personality issues come into play. So there is a lot more than just selling a product and making money. Successful businesses are well managed by level-headed intelligent people who can enthuse and retain their employees.

Ever wondered why many big successful businesses got that way? Its not just the product or the profit. It is due to good management and leadership.

So what exactly is the response when its pointed out that to make a mod in house would cost far less including the price of an iron than to outsource it? If he complains about labor costs, then you could ask why he has his employees spend so much time fixing the printer.

[joeqsmith]

Actually watched this one with the wife.   Good job.

[Brumby]

So what exactly is the response when its pointed out that to make a mod in house would cost far less including the price of an iron than to outsource it? If he complains about labor costs, then you could ask why he has his employees spend so much time fixing the printer.

I would be concerned about responses from this guy about any questions that, in effect, challenge his competence.  Such people tend to have their own views and priorities and heaven help anyone who challenges them.  Even though the business case for alternate paths - eg, buying a new printer - are clearly unambiguous, it's 'his' company and he'll do things 'his' way thank you very much.

[EEVblog]

If an item costs $1 to make, and you sell on for $1.50, you're making 50c profit. Sounds good, until you realize that if your costs increase by 10%, you're now down to just 40c profit. That's a 20% hit!!

And for those wondering how costs can magically increase by 10%, just look at currency conversion. That can easily happen in the span of a month.

[Brumby]

Over longer time scales, that exchange rate impact can be much, much greater.

I know someone who purchases their (non-electronics) goods from overseas (US mainly).  Last year they faced an Australian dollar being worth around 72 cents American and some of the products they previously ordered at an exchange rate closer to 94 cents.  This drop happened inside a year and represented a cost increase of over 30%.

... and that's just from that ONE factor.

[VK3DRB]

So what exactly is the response when its pointed out that to make a mod in house would cost far less including the price of an iron than to outsource it? If he complains about labor costs, then you could ask why he has his employees spend so much time fixing the printer.

I would be concerned about responses from this guy about any questions that, in effect, challenge his competence.  Such people tend to have their own views and priorities and heaven help anyone who challenges them.  Even though the business case for alternate paths - eg, buying a new printer - are clearly unambiguous, it's 'his' company and he'll do things 'his' way thank you very much.

And that will probably be his downfall. Fools never learn.

[kosine]

Corporate psychopaths and narcissists are sadly part of doing business. They're drawn to the power and status. (You get them in politics as well.) Often their only real skill is manipulating people to serve their own agenda, and some of them are very good at it.

They also have a nasty habit of being able to hide their true nature until you're already involved, by which time it's too late. Professional investors (well the successful ones, anyway) learn to spot them early on. A good investor will invest in people, not products. They know a good team can take a mediocre product and make it a success, whereas the best product in the world will fail if in the wrong hands.

The founding of Fairchild Semiconductors might be an appropriate example of what a great team can do once free of poor management. Mutiny is sometimes the only solution.

[coppice]

A video about the cost of selling your own products that doesn't devote some reasonable amount of time to the costs, time scales and other hurdles of approvals seems rather lacking. Its a huge part of entering markets, especially when you are doing it  for the first time.

[Brumby]

A video about the cost of selling your own products that doesn't devote some reasonable amount of time to the costs, time scales and other hurdles of approvals seems rather lacking. Its a huge part of entering markets, especially when you are doing it  for the first time.

I would not disagree - but you would have a very long video series if you were to cover even a fraction of the detail in the full cycle from concept to market.  Dave has just done bullet points that cover two basics - the cost multiplier and direct/reseller sales channel comparison.

[jancumps]

Coincidently, we were discussing the same topic on element14, just before this video was posted.
https://www.element14.com/community/thread/54798/l/psoc-5lp-hat-for-a-raspberry-pi

[Poe]

Nice video, but I like to look at that comparison another way:

    $1K to $28k     <to do relatively nothing>
+    $50k            <to earn anywhere between $0 to $50/hour, doing shitty work>
=    $75K

Although I think if you're trying to build a company, not just sell a product or sell the company itself, then there really is no choice. 

[edy]

Awesome video as usual. And I even learned about the turboencabulator, somehow I managed to completely miss the class on this device:

[EEVblog]

What's the best way to gauge interest for a product?  I am working on a project (mostly for learning) but I'm not really sure anyone would want to buy it.

Make 20 of them and take a chance. Post it on here.

[EEVblog]

Nice video, but I like to look at that comparison another way:
    $1K to $28k     <to do relatively nothing>
+    $50k            <to earn anywhere between $0 to $50/hour, doing shitty work>
=    $75K

Some people like to think that working for the man is shitty, and would happily take $75k a year working for themselves doing something they enjoy.
I've had my own side business selling kits and products for 25 years, and it's far from "shitty work".
And who said it takes a full working week to pack and ship and support 1000 units a year? Remember, that's only 2.7 units per day. If you can't pack and ship 50 units a day then you are doing it wrong.
You could be earning $1000 an hour and have oodles of free time to work on other projects or just enjoy life.