| Introduction | | | | customer. In either case it adds to the price of |
| In this article I give information on creating price | | | | the product. If the product margin is low these |
| lists for a new product. This information is | | | | additional costs may price the product out of the |
| primarily for an inventor or entrepreneur that has | | | | market. However, if the vendor package holds 10 |
| started selling a new product and has received an | | | | units and the product is shipped in units of 10 the |
| inquiry from a wholesaler, distributor or retail chain. | | | | costs associated with processing an order is |
| This inquiry may hold the promise of a large | | | | distributed across 10 units rather than one. In |
| volume order. This new opportunity for potential | | | | addition, only one label, one package, one pickup |
| large volume order holds great promise. However, | | | | fee or one delivery is made for 10 units. If each |
| this is a two edge sword in that the opportunity | | | | unit were shipped individually it would at least take |
| also holds great potential risks. This article outlines | | | | 10 labels and 10 packages. The same type of |
| the risks and the basic concepts behind generating | | | | savings occurs when large orders are placed with |
| a price quote for a potential large volume order. | | | | the products manufacturer. When deciding the |
| First the Bad News | | | | MOQ one also needs to consider the customer |
| The biggest hazard is managing the cash flow for | | | | requirements. The customer may specify the |
| a large volume order. The next biggest hazard is | | | | MOQ based on their own economics. |
| the production issues associated with a large | | | | The Experience Curve |
| order. The two biggest hazards often work | | | | The theory behind the experience curve is that |
| together to completely destroy a business. It is | | | | the product of the costs and order volume raised |
| ironic that the very success of the product seeds | | | | to some power remains constant. As a |
| the failure of the enterprise. | | | | mathematical formula it is expressed as: |
| The problems with cash flow are that payments | | | | CVn = Constant, where C is the unit price, V is |
| for inventory occur many months before the | | | | the number of units ordered; n is a real number in |
| revenue from sales for that inventory is received. | | | | the range of 0.001 to 0.5. |
| It is usually the case that 50% of the costs of | | | | What the theory implies is that the costs per unit |
| inventory be paid before production begins. The | | | | declines as the total number of units ordered |
| other 50% is due when the product is loaded for | | | | increases. The total units ordered are taken to |
| shipment. It can take 45 days to produce the | | | | mean all the units ever ordered. What the theory |
| product and another week or so to load it for | | | | lacks is the price does not decrease forever and |
| shipment. If the product is made overseas, it may | | | | has a bottom where price reduction stops. The |
| take a week to clear customs and another 2 | | | | reasons for the price decline are numerous. One |
| weeks for transit. Once it lands in a US port it | | | | reason is that as the product is manufactured the |
| usually takes a week to clear customs. Then the | | | | process becomes more efficient. In short, people |
| product usually needs to be transported to a | | | | have learned to do the job better. Another |
| warehouse. This takes another week or two to | | | | reason is that expenses are spread out over |
| schedule and transport. Once the product gets to | | | | larger volumes so the per unit price increase to |
| the warehouse it takes more time to unload and | | | | cover those expenses decreases. For example, if |
| process. This processing could include staging the | | | | it take the same amount of work to process an |
| product according to the customer's specifications. | | | | order for 10 pounds of material as it does for a |
| Finally it will take time to either ship the product | | | | 1000 pounds, the marginal increase in a pound of |
| to the customer or arrange for it to be picked up | | | | material due to labor costs would be much less |
| at the warehouse. | | | | for the 1000 pound order than the 10 pound |
| After the product is received by the customer | | | | order. Other expenses such as facility, utility, etc... |
| and depending on the payment terms it may be | | | | would similarly be spread over a larger number of |
| another 30 days or more before payment. And | | | | units. |
| the payment check may be cut on the 30th day | | | | The simplest way to use the Experience formula |
| and mailed which adds another 5-9 days to the | | | | above is to set the value of the constant to the |
| delivery time. Then when the check is cashed the | | | | price of one unit and then experiment with |
| bank might add another 5 days to clear the check | | | | different values of n. Therefore set Constant |
| and post the payment to the account. | | | | equal to C and try various values of V and n is |
| The lag between when the inventory expense is | | | | shown below: |
| occurred and revenue is received from that | | | | C = Constant = $10 |
| inventory can prevent the ordering of more | | | | C for a 1000 units n = 0.001; |
| inventory. What usually happens is that sales take | | | | C(1000) = $10/1000^0.001 = $9.93 |
| off but the inventor or entrepreneur cannot | | | | C for a 1000 units n = 0.01 |
| purchase more inventories to fuel the growth. | | | | C(1000) = $10/1000^0.01 = $9.33 |
| Since the orders are not filled in a timely manner, | | | | A better method is to determine the value of the |
| customers cancel their orders and sales dry up. | | | | Constant and n from manufacturing bids. Most |
| There are ways to finance inventory such as | | | | manufacturers provide bids with a price |
| early payment discounts, factoring, and purchase | | | | breakdown for the costs related to the volume |
| order financing but each has risks and draw backs. | | | | of the order. There is a slide on my Web site |
| These methods will not be covered here. | | | | under the "Helpful Inventor Information" showing |
| Another way the business can sink is related to | | | | how to calculate the values of the Constant and n |
| manufacturing issues. One may be that the | | | | from manufacturing bids. This is better the value |
| manufacturer is not set up to handle large orders. | | | | of the Constant and n are not arbitrarily assigned. |
| As with the inventory financing above the orders | | | | Putting It Altogether to Generate a Price Quote |
| cannot be filled in a timely manner and are | | | | After the MOQ has been established and the |
| eventually canceled. Another problem may be | | | | savings due to the experience curve have |
| quality. For a new product there will be a learning | | | | calculated this information can be used to produce |
| curve and if the product involves new processes | | | | a price quote for a distributor, wholesaler or retail |
| and machines this learning curve can take some | | | | chain. Any other information that affects the |
| time. New manufacturing equipment and | | | | profit margin of the product should also be |
| processes can take some time to debug. What | | | | included. If the inventory is financed through a |
| usually happens is that a large volume of bad | | | | loan, factoring, or purchase orders the costs of |
| product is made because of quality issues have | | | | obtaining the financing should also be included. |
| not been discovered and resolved before it is too | | | | Furthermore, any special requirements of the |
| late. In this case sales dry up because many | | | | distributor, wholesaler, or retail chains that |
| customers receive low quality products. | | | | significantly increase costs or lower margins should |
| Minimum Quantity Order and Vendor Packages | | | | also are considered. Retail chains often demand a |
| Packaging for large orders is not the same as the | | | | defective product allowance, defective packaging |
| retail packaging. This vendor packaging usually | | | | allowance, promotional allowances and early |
| holds multiple retail packages. The number of retail | | | | payment allowances. All these allowances are take |
| packages that are in the vendor packages is | | | | off-the-top and reduce the price paid for the |
| determined by economics of the product. When | | | | product. It is best to consider these deductions |
| establishing the specifications on the vendor | | | | when generating the price lists. The idea is to sell |
| package the minimum order quantity (MOQ) | | | | the product at a profit. |
| needs to be evaluated. For example, it may take | | | | Finally ask the distributor about the minimum and |
| 15 minutes to package and label a product for | | | | maximum size of the order and generate a price |
| shipment. In addition, the shipping company may | | | | quote for at least those 2 volumes. If the |
| charge a pick up fee or someone may need to | | | | differences between the minimum and maximum |
| deliver the packaged product to the shipper. The | | | | volumes are significant consider producing price |
| time, fees, and materials (packing boxes and | | | | quotes in step sizes that makes sense (i.e. 2000 |
| labels) all add to the costs of the product. These | | | | to 5000 volume increments). |
| costs must either be absorbed by business or the | | | | |