Recently, Brad Feld published an insightful post on hardware gross margin. As a follow-up, I thought it would be useful to take a deeper dive into this critical topic because it's one of the core metrics that will determine whether you have a viable hardware business (i.e. you make money on every unit sold, and have enough left over to fuel your growth).
Let’s start by defining a few terms (some below, additional can be found here):
As an example, say you are selling to a retailer for $50 and your COGS are $25. The retailer sells to the customer for $79.99. In this case, your GM Percentage is 50% and the Retailer Margin Percentage is 37%.
Why is gross margin as important a metric as revenue? Gross margin represents the amount of money you retain after manufacturing that can be put towards marketing, R&D and profit. To have $100MM in revenue only tells half of the story - you could be losing money with every product sold.
Typically, a consumer electronics company will need a Gross Margin Percentage greater than 50% to be healthy and drive profitability for two reasons:
Therefore, to maximize your GM, you have effectively two levers:
The sale price is largely determined by the market and you may have limited influence over it. In turn, it makes sense to focus on what you can influence: COGS (which is also directly related to manufacturing and one third the Manufacturing Triangle along with quality and schedule).
COGS is primarily driven by:
Setting a COGS target based on expected Net Sales Price and desired GM Percentage and then engineering to meet this goal should start at the earliest stages of your hardware journey. The decisions you make early will cast a long shadow and can be difficult and expensive to change later. The foundation for calculating your COGS is the Bill of Materials (BOM). To help get started on the right track, we recommend utilizing our Standard BOM (more information about why your BOM is so critical here). Another great resource is our Design for Manufacturing Series which specifically includes a deeper dive into costing.
Stay tuned - over the next few months, we’ll be releasing new software tools with a strong manufacturing point of view to further help companies manage their product journey.
Comments or questions? Please let us know!