The Business of Ideas: Let the Numbers Speak

Developing your intellectual property into a viable business opportunity is a complex proposition! In this series of posts, Porticos co-founder and President, Greg Patterson shares his insights on navigating the process. First written ten years ago, these posts revisit (and update) Greg’s original content for a new decade of product development.

Read previous post: Risk vs. Reward

Successful ideas need to be backed up by the numbers. Everyone’s idea is the greatest idea to them but if the investment doesn’t offer an attractive return then it’s probably not worth going forward. What is an attractive Return on Investment (ROI)? There isn’t a firm number as it typically depends on the circumstances but a good goal is 10:1. Meaning that for every $1 you invest, you would want to get a return of $10.

I find the best way to determine the ROI is by creating a spreadsheet that organizes investments and revenue. Once you have these two categories defined, the ROI is a simple calculation (revenue / investment). Unfortunately, determining the investments (expenses) and revenue is not always straightforward. 

To find these numbers, assumptions must be made, and ultimately, you want your assumptions to be as accurate as possible. It is worth noting that regardless of whether you plan to license your invention or manufacture and sell the product yourself you will need to calculate the ROI with manufacturing costs included. Understanding those numbers is a necessary step to determine the potential royalties and for negotiating licensing. The more prepared and informed you are the better your chances of interesting a buyer and inking a good deal.

Now let’s start looking at that spreadsheet and consider your costs.

Material Costs

Material costs refer to all the parts that constitute the build of the product. Everything from major components to the smallest parts like screws, tapes, or labels. The accuracy of your Bill of Materials (BOM) is dependent on how well your concept is defined. Hence this will be your first assumption.

Photo by Ashley Diane Worsham on Unsplash

When in doubt, err on the conservative side. For example, if you aren’t sure how your product will be held together, plan on screws instead of snaps.

Once you have the list, you need to enter cost estimates for these parts. This is the point where you make assumptions #2 and #3. Part costs are a factor of the manufacturing material (plastic, metal, wood, etc.), manufacturing processes (injection molding, progressive die, machined, etc.), and manufacturing volume. Typically the more you make of something the less the part will cost. So Assumption #2 will require you to determine what your quantity will be. The good news is that if you’ve subscribed to the activities defined in the previous installments of this blog series, you should have a lot of supporting data to help you with your decision. If you are developing an idea with an existing market, research annual sales volumes of similar products. 

Next, consider how much of that market you expect to capture. Start small. The fact is, it will take time to wrestle much of the market from the current competition. You should not be surprised to only garner 5% in the first full year with growth to 20% by year 5.

Assumption #3 is the part cost (and fixed costs such as tooling, etc.). If you work closely with the material and manufacturing processes needed to build your product, then you might be comfortable making cost estimates based on your experience. If not, don’t be afraid to contact manufacturing sources and get preliminary quotes. Again, the accuracy of the quote will be subject to the completeness of the design, so keep that in mind.

A good rule of thumb is that most products take between 6 and 18 months to design and bring into production.

Consider any assembly and sub-assembly costs. This will be related to the amount of time it takes to do the assembly and the hourly rate. This estimate will be your fourth assumption, but use any data you have to inform this number. If you’ve built a prototype, make sure you time the various assembly activities. With regards to the rate, consider if it will be made domestically or overseas and enter a value accordingly based on researching rates in those fields.

Finally, add 0.15 to 0.20 cents per assembly for shipping and multiply the entire part cost by 20%. This buffer should help account for the unknowns. The number you land on is the cost per part.

Resource Costs

Resource costs include the costs to design, develop, and industrialize your concept. If you are in the business of product design, then you will be well-positioned to estimate this cost. If not, you will probably be faced with the choice to estimate these yourself with less informed data, versus outsourcing this to a consultant or design firm.

Assumption #5 is the estimate of how much effort is required to build your product. As you might imagine, it is directly related to the complexity of the design and the manufacturing processes involved.

For engineering costs, a good rule of thumb is that most products take between 6 and 18 months to design and bring into production. The number of engineers involved may range from 1 engineer for a simple product, to a team of ten, hundreds, or thousands in extreme cases like automotive or aircraft design. Assuming you aren’t competing directly with Ford or Pratt & Whitney, you will most likely find yourself needing between 1 and 5 engineers and should calculate costs based on the going rate of engineering expertise.

Business Costs

Photo by Doris Morgan on Unsplash

Business-related costs are things like insurance, office space, utilities, marketing, etc.  While you might be tempted to assume that these costs will be negligible, the fact is they can add up quickly. Product liability insurance can be very expensive, particularly if the failure mode of your product or its construction (regardless of the cause) can result in bodily injury. For example, one simple product we developed and manufactured for the pet industry required $10K annual liability insurance.

Marketing is another area that can add up quickly. Recall from our previous Marketing post that you may need to invest in advertisements in publications or other print media, trade shows exhibitions, radio, and/or TV. Various combinations of these options can easily incur $20K to $100K worth of expenses for even a short period.

Adding it Up

When calculating ROI, numbers are usually based on some period of time, typically 3-5 years. Whatever your range, get the total investment for materials, multiply the cost per part by the volumes expected over the period, and add the fixed and business costs.  This final number will be your total investment over the period.

This number may seem overwhelming but the next step is more fun: revenue. Our next post will look at the other side of the spreadsheet and let the numbers tell us whether this is really an idea fit for a business.

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About Porticos

A WORLD OF OPTIMIZED PRODUCTS

Porticos, Inc. is a Product Engineering and New Product Development firm located in Research Triangle Park, NC.

Established in 2003, Porticos produces innovative and effective solutions for their clients and the markets they serve. Porticos provides broad expertise in development, planning, and production. 

Contact us for more information or support bringing your idea to market.