Contract manufacturing pricing, cost, and respective pricing models employed by electronics contract manufacturers can hardly prove successful without a thorough understanding of the inputs and drivers for such models or business metrics.
Many cost drivers vary per location while some cost drivers such as material cost might apply to a number of locations.
For location dependent variables across the globe, an understanding of how a specific input may be used by contract manufacturers helps OEM executives to assess the factors going into the input.
For example, take direct labor: What is direct labor and what secondary costs should be included in the direct labor rate per hour? What follows will help executives understanding some of the ways contract manufacturers run their business and provide a launching point for companies to better understand some of the internal pricing decisions electronics contract manufacturers are likely to consider when determining pricing models and pricing business opportunities for various facility locations, worldwide.
The four primary categories driving pricing decisions are pricing components; location dependent variables, pricing drivers, and product pricing inputs.
In looking at pricing components, it is important to look at what is included in each line item on a particular quote submitted by a contract manufacturer. The primary pricing components include:
1. Freight: Cash flow for all inbound materials and components
2. Inventory Reserve: Material reserves for any volume upsides or change in order quantities
3. Scrap: Mandatory reserves for yield; freight damage and attrition
4. Warranty Reserve: Technical support and warranty liability
5. Material OH: All material movement and acquisition costs including direct and indirect, excluding freight
6. Labor and OH for PCBA/SMT: (this is broken-down further to include)
- Facility: leases, utilities, local taxes,
- Equipment: production equipment, NRE & amortization
- Manufacturing Overhead: Overhead associated with manufacturing
- Materials Overhead: glue, solder, flux, pallets, tape…
- Direct labor: line operators including manual insertion
- Functional, ICT: direct labor and Indirect overhead
7. Labor and OH, Box Build: Direct labor
8. Functional Test: Direct labor and indirect overhead
9. SG&A: Sales and administrative costs including IT, finance
10. Profit: Profit required for invested ‘working capital’
Location Dependent Variables
Location dependent variables can typically change for different locations across the globe. Each region, or location’s unique values, directly can influence the pricing variance. The following identify those drivers and the affect they have on price.
1. Freight Types: Determine the general nature of the components of the product are (rates for each are typically a percentage of material cost)
- Distribution or factory stores
- High cost per component
- Box Build
- Asia or foreign-based components
2. Inventory Reserve: typically broken-down into low, medium, high, very high
3. Labor Rates: All labor rates include hourly rate, all taxes and benefits (which include meals; transportation, education/training and any other obligatory social costs per region/country) but should not include burden of indirect labor overhead)
- Final Assembly: unskilled labor for box builds and other manual labor
- Functional Test: semi-skilled labor for post-production testing
- ICT: skilled labor for production testing
- Off shift premium: premium for second and third shifts (as a percentage of the primary shift)
- Warranty: Determined in number of years and usually dependent on a percentage of material cost
- Cost per square foot: lease or depreciation, all utilities, security, facility costs which include janitorial and repair, local or regional taxes, communications, direct and indirect facility staff
- Square foot cost floor: if efficiency rate is less than 100%, the least price per $ foot (use appropriate currency) the model will support
- Square feet/line: total facility square footage divided by maximum number of lines
- Utilization target: should answer the following, “What is the expected facility utilization of all programs?” (cost per square foot often divided by this percentage to inflate the price charged per square foot to cover the expected utilization)
6. SG&A: SG&A includes all sales and administrative costs not covered in facilities (typically includes sales commissions; corporate allocations, local accounting and finance costs, any charities and other office expenses not directly applicable to manufacturing or materials)
- First line: percentage of selling price charged to SG&A.
- Low Limit: lowest percentage of selling price charged to SG&A
- Tax rate of competitors for the region. This does not reflect any tax advantages that the Company may benefit from. These advantages are typically not considered in pricing because doing so would give away profit.
- Local taxes are not included: Such taxes should be included in material or facility charges where applicable
8. ROIC required to be profitable: where Profit = ROIC x (inventory + P,P+E, – payables)
9. Surface Mount Technology (SMT)
- Base: minimum number of SMT direct labor needed for any line.
- Retouch/rework: average number of direct labor needed for retouch
- Components per person: an additional direct labor person will be added for each increment of components entered. For example, if the number is 200 and there are 500 components on the product, 2.5 people will be added to the SMT line.
- Rate with benefits: labor cost per hour for retouch and SMT.
- Premium for second and third shifts
- PTH Components/Direct Labor: pin through hole components per person (an additional direct labor person is typically added for each increment of components entered.
- PTH Direct Labor/line: if product has no SMT and PTH only, base this on how many direct labor are typically needed on a line
10. Working parameters: Each location can have different working parameters although the flexibility with this can lead to serious implications. Since profit and overhead allocation is dependent on volume, longer work days and a maximum number of shifts will yield far lower costs than a single shift, short work day facility regardless of labor costs. When setting these values, contract manufacturers must consider what they want the factory to run at and what the competition is running their factories at in order to win profitable new business programs. Setting these parameters so that they are greater than the competition, the contract manufacturer runs the risk of giving money away.
- Hours per day: total payable working hours not including productivity loss
- Days per week: working days per week
- Shifts per day: typical shifts for the plant
11. Box Build direct labor per line: Determined as direct labor per assembly line with number of direct labor where there is no SMT. Where SMT is in place, direct labor for box build will be ramped up to meet SMT speeds to prevent WIP buildup.
12. Equipment: This is determine based on the types of equipment available
13. Equipment speed: Based on type of machine/equipment
- Small: minutes required to place a pre-determined number of small components
- TBD: minutes required to place certain component types
- Large: minutes required to place a pre-determined number of large components including shields and ICs
- Panel: minutes delay for panel changes
- Cost: acquisition cost including procurement; delivery, equipment setup
These are typically determined by asking what drives the cost in each line item identified in pricing components?
1. Freight: Material cost and delivery complexity
2. Inventory Reserve: Material cost, project risk, demand predictability
3. Warranty: Length of warranty
4. Scrap: Cost of material, product type
5. Material Overhead: Number of components, complexity, volume
6. Direct Labor: Time, labor cost
7. Labor and Overhead, SMT
- Facility: Number of lines, square footage
- Equipment: Number of lines, optimal tact time
- Manufacturing Overhead: Number of lines, product complexity
- Material Overhead: Number of lines, Component count
- Direct labor: PTH, large components
- Functional, ICT: Cycle time, yield
8. Labor and OH, Box Build: Production time
9. SG&A: Volume, % Sales
10. Profit: Profit required for invested working capital
Product Pricing Inputs
These inputs are typically determined by asking, what inputs are required to price a product?
1. Material Cost: Total material cost excluding freight
2. Monthly Volume: In single units, expected average monthly volume for the year
3. Functional Test (minutes): Average cycle time for functional test
4. Final Assembly (minutes): Average cycle time for final assembly after SMT
5. ICT (min.): Average cycle time for ICT
6. Warranty Years Expected
7. Freight: Type of freight expected
- Distribution or plant stores
- High cost per component
- Box Build
- Asia Components
8. Inventory Reserve: Expected reserve requirement as a percentage of sales
9. Scrap Rate: Expected scrap percentage
10. Payment Terms: Agreed receivable days
11. Inventory Turns: Expected inventory turns (important to be realistic)
12. Product specification for each board (up maximum number TBD)
- Boards per Panel: Number of boards on a panel
- TBD: Number of TBD components
- Small components, Chips: number of small components and chips
- Larger components, ICs, Shields: number of larger components, ICs and shields
- Pin through hole (PTH): number of pin through hole components
13. Yields for each board
- First Pass Yield (FPY), Functional: expected first pass yield for functional test
- FPY, ICT: expected first pass yield for ICT
14. NRE: charges and additional capital investment amortized over given years.