I was reading this fascinating account of getting a simple electronic device manufactured, from design and engineering to supply chain and distribution. I started to get worried. Everyone talks about their trials and tribulations when outsourcing their components to China - customs holdups, language barriers, holidays, counterfeits. Why do people go to all the trouble to go to China? Should I be doing this?
Let’s do a calculation that I’ve needed to do for a while. It's a kind of Reynolds number for business - e.g. to understand which forces are biggest at which scale. I would love to get feedback and hear any experiences on this - it's an important decision that many businesses need to make, and I'd like to better understand what is going on!
I'll start with some gross assumptions - obviously for different cases these will vary. But I think the basic behavior is captured in this example:
What are the cost savings of going overseas as volume increases?
I'll start with some gross assumptions - obviously for different cases these will vary. But I think the basic behavior is captured in this example:
- US BOM is $50 for a $100 retail part (50% gross margin) - not hard to do, if you have three or four $4 chips, a $8 display, a $5 enclosure, etc.
- Save a factor of two by going to volume (over 1000) - this is what I’m seeing when I calculate my BOMs on Octapart (which is an incredibly useful tool for these kinds of analyses)
- Save $10/board by assembling in China - guesstimate - and once you get even bigger volume, you save another $5/board. An aggressive estimate is that you save an additional 50% over the US BOM - in which case the savings is just half of the cost; if costs go down even further (like, 3% of US cost) then just use that savings.
What are the cost savings of going overseas as volume increases?
Volume | US BOM | China BOM | Total cost US | Total cost China | Savings (US - China) | Revenues |
---|---|---|---|---|---|---|
10 | $50 | $40 | $500 | $400 | $100 | $1,000 |
100 | $50 | $40 | $5000 | $4000 | $1000 | $10,000 |
1000 | $25 | $15 | $25,000 | $15,000 | $10,000 | $100,000 |
10000 | $25 | $15 | $250,000 | $150,000 | $100,000 | $1M |
100000 | $25 | $10 | $2.5M | $1M | $1.5M | $10M |
1000000 | $25 | $10 | $25M | $10 | $15M | $100M |
In this scenario it only make sense to spend significant time in China when I am projecting 10K units ($1M revenue) or more - at that point, the savings may (barely) justify hiring someone to do it. And even if I have that many sales, I still think I would rather be spending my time trying to generate more growth - finding small but fast growing, premium markets - than cutting costs and trying to compete directly with corporates.
The factors that can shift the inflection point are:
In addition there are non-economic risks and costs to consider. My core strength (I like to think) is in design and understanding domestic markets - not global supply chain management. As a small customer I have almost no leverage with suppliers or manufacturers aside from the possibility of getting big, and even less with manufacturers specializing in large volumes. And working with China is stressful - the time difference means that everything must be done immediately, lest you incur a 12 hour delay.
So, until I start getting some serious traction on my product, I'll stay away from overseas production - and not worry about margins yet.
Hope that this is helpful to those out there sorting through these issues!
Happy supply-chaining!
The factors that can shift the inflection point are:
- High assembly costs (e.g. a mostly hardware product), the China BOM could get even lower, so that shifts the inflection point earlier.
- For higher BOMS and high volumes (e.g. Apple) it certainly makes sense for them to send a few engineers over to babysit the operations.
- Low-cost, high volume, thin margin producers. If you are differentiating based upon cost, good supplier/assembly relationships in China are a core strength.
In addition there are non-economic risks and costs to consider. My core strength (I like to think) is in design and understanding domestic markets - not global supply chain management. As a small customer I have almost no leverage with suppliers or manufacturers aside from the possibility of getting big, and even less with manufacturers specializing in large volumes. And working with China is stressful - the time difference means that everything must be done immediately, lest you incur a 12 hour delay.
So, until I start getting some serious traction on my product, I'll stay away from overseas production - and not worry about margins yet.
Hope that this is helpful to those out there sorting through these issues!
Happy supply-chaining!