The Reynolds Number of Business: when should I outsource to China?

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:

1. 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.
   
2. 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)
3.  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:  

1. High assembly costs (e.g. a mostly hardware product), the China BOM could get even lower, so that shifts the inflection point earlier.  
   
2. 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.  
   
3. Low-cost, high volume, thin margin producers.  If you are differentiating based upon cost, good supplier/assembly relationships in China are a core strength. 
   

What does this mean for niche markets and prototyping?  Anything that is less than 1000 units (at $100) is an experiment to test if there is a market - and so don’t worry too much about BOM cost yet.  A 50% gross margin, though not great in the long run, is reasonable if you can count on a factor of 2 or more decrease as you go to volume.

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!