Cost Modeling, Overhead and Markup: How CalcuQuoteHelps the EMS Industry Categorize Costs, Allocate Overhead Expenses, and Determine the Right Markups and Margins

By Kaitlyn Dotson, COO

Estimating the cost of a potential project can be the reason you win or lose a job. In the electronics manufacturing services (EMS) industry, there are common situations where a business owner, chief financial officer (CFO) and general manager have different approaches to a cost model. As a result, these different approaches create different outcomes for the estimated cost of a job. Usually, this is because there is no consistent model to estimate the cost and the markups that should be applied based on the specifications of the job and customer requirements.

It is important to implement an accurate cost model to both provide competitive quotes and to ensure accuracy and consistency of quotes delivered to customers.

What Is Cost Modeling?

By definition, a cost estimation model is a mathematical algorithm or parametric equation used to estimate the costs of a product. The result of a cost model is provided to a customer to understand a projected price for a job as well as financial planning for your business. In the EMS industry, a customer sends a request for quote (RFQ) for a printed circuit board assembly (PCBA) to one or more contract manufacturers (EMS companies) who use resources from each department to estimate materials, PCB, job floor labor, and overhead expenses. This RFQ would be put into a cost model to convert the resources from each of those areas into estimated costs to create a quote for the customer.

The inputs to a cost model are important to consider. A cost is an amount that is given up or paid. This can include giving up cost in the form of money or time. There are four main categories of cost modeling that CalcuQuote would recommend as a best practice for the EMS industry.

The four categories are Materials, Labor, Overhead and Risk:

1. Materials

Calculating material costs typically follows a specific path. An original equipment manufacturer (OEM) or original design manufacturer(ODM) provides a bill of material (BOM) to a contract manufacturer (CM). The CM will use software, such as CalcuQuote’s QuoteCQ application, and send it to their suppliers’ partners through application program interface (API) or another approach to identify cost and availability.

Material costs typically include:

● Cost of components

● Leader and attrition (scrap or manufacturing variance)

● Consumables directly related to job (special packaging, labels, etc.)

● Additional markup on the materials to consider risks of purchasing materials

● Consideration of supplier terms, delivery options, etc.

In the process of determining material costs based on the given inputs, it is important to consider the quantity of boards that a customer intends to purchase. As the quantity increases, the per unit cost typically decreases due to economies of scale. For a CM, it is crucial to factor in this quantity when calculating component costs. However, it is important to note that if excess components are acquired beyond the customer’s requirements, they should either be billed to the customer or seen as a potential risk to the business due to excess inventory.

Figure 1. If you are buying 100 capacitors, the unit cost is $2 per capacitor. However, at a quantity of 500, the cost decreases to $1 per capacitor. While the unit price of the individual capacitor decreases, the total cost of the materials increases. This cost advantage is established in the fact that as output increases, fixed costs are spread over a larger number of output items.

2. Labor

When capturing labor costs for EMS, different types of labor should be considered:

1. Assembly Cost: An activity that is performed for each assembly (example: pick and place, inspection, wash)

2. Batch Setup Cost: An activity that is performed for each batch or run of the job (example: kitting, machine setup)

3. Job Setup Cost: An activity that is performed only once for each order job unrelated to the number of assemblies or batches (example: purchasing, contract review, order entry)

4. Non-recurring Expense (NRE): An activity that is performed only once for each product unrelated to the number of jobs/orders, such as purchasing stencils.

The batch, job and NRE costs are all categorized as setup costs while an assembly cost is a variable cost. The job setup cost stays steady when assembly quantities increase. However, setup cost per unit would decrease as the quantities increase. Variable costs would stay the same per unit; however, the total variable cost would increase as quantities increase.

Figure 2. A $100 of setup cost stays constant whether building a single board or 100 boards. The unit setup cost would be $100 for one board and $1 for 100 boards.

3. Overhead

Overhead expenses for your business should also be considered when costing a job.

Overhead typically includes other expenses that are not included in labor and material costs attributed to the end customer. These are pulled from the Profit and Loss (P&L) statement below the gross margin line. Below are some examples of overhead cost pools:

● Rent

● Utilities

● Health insurance

● Depreciation

● Office supplies

Unlike labor and materials, overhead costs generally follow a stepping pattern. Higher quantities of production will create a large increase in total overhead costs. An example of this is rent. Entering into a more high–volume business can cause rent to increase from $10,000 to $20,000 when you expand the square footage of the facility. This is a single increase in cost and cannot be increased gradually or fractionally for each square foot as you grow. It will create a step up as opposed to a linear trend. Unit overhead costs slowly start to decrease until there is an increase in total overhead costs.

It is important to consider overhead in cost modeling in order tocharge the correct proportion of expenses to a job. There are four common methods of overhead allocation that can be applied to the EMS industry:

● Include in markup

○ Including overhead costs in markup calculations is typically used by companies in a basic phase of maturity. The sum of the total value of materials and total value of labor is marked up based on the known and unknown factors such as risk, profit, etc.

○ Pros: Simplistic and fast

○ Cons: Highly variable and unknown if covering actual costs

● Include in “shop rate”

○ Including overhead costs in a base wage allows separation of each cost pool and allocation for overhead cost in addition to base per hour.

○ If using this model, companies should update shop rates when something with overhead changes. The simplistic approach allows for ease of use; however, when a change occurs, it is difficult to adjust what the shop rate should be. For example, if your shop rate is $70 today, but you know your rentwill increase in the coming months, it is more difficult to come up with an accurate shop rate with this change without having to redo all the calculations.

○ Pros: Simplified cost allocation

○ Cons: Difficult to maintain and adjust

● Allocate by department/activity

○ This approach includes assigning each overhead cost pool to a specific labor activity or multiple departments that use the overhead cost.

○ Pros: More accuracy and clarity into cost

○ Cons: Difficult to maintain and costs are related to activities even if not activity driven

● Allocate by driver

○ Assigning overhead cost by driver is the most complex approach. Each overhead cost is assigned to a driver that can be an activity, department, dollar value, number of shipments, or other.

○ Pros: More accurate

○ Cons: Assumptions on drivers can cause over/under allocation of expenses, can be difficult to maintain, and take longer than the previous approaches

There are a few questions to consider when determining how to calculate an overhead cost model:

● Do you have the finance resources to keep up with granular tracking?

● How accurately do you need to track margins?

● Do you have a way to incorporate your cost accounting into action?

A software solution can enable you to access advanced capabilities to calculate overhead without the burden of maintenance challenges typically associated with manual calculations.

4. Risk

CalcuQuote sees most CMs using markup to account for unknown factors, risks, and desired profit. As quantities increase, total markup dollars also usually increase. However, per unit markup typically decreases as quantities increase.

All companies encompass the same principles and refer to the risk of doing business. There are at least five things to consider when deciding cost for risk:

1. Revenue opportunity

2. Customer need

3. Competition

4. Knowns

5. Unknowns

Conclusion

For an electronics contract manufacturer, creating a consistent and accurate cost model can help your business grow by pricing your services profitably. As a best practice, CalcuQuote recommends reviewing how you are calculating costs of a job today and how those costs are applied to a customer’s RFQ. Take a first step to review if you are including the cost of materials, cost of each labor activity that occurs in order to produce a product, overhead expenses you incur for the business, and additional markup to cover risk and profit.

For more information about CalcuQuote contact the company at 44 Englewood Dr., Murphy, TX 75094; 909-278-8233; E-mail: info@calcuquote.com; Web site: www.calcuquote.com.