Volume Pricebreaks: A Double-Edged Sword for Smaller Organizations?

For most electronics projects, the goal is to get as many well made units out into the world at the lowest cost. Price might not be the top priority, but it is a factor in the success of a device. Particularly in electronics, the economy of scale is taken as a law of nature: the more you produce, the less you pay for production per unit*. This cost structure makes life difficult for small producers, whether they are producing devices for non-commercial ends or are a small company just getting started: the design of a device might be great and the demand real, but the price prohibitive for early adopters at small volumes. The pressure to scale up production runs as quickly as possible can lead to risk taking, sacrifices in quality, and debt, especially when the producer doesn't have enough cash on hand to fund larger production runs.

Is it all worth it? In this post we'll take a look at the pricebreak structure for electronic components at initial production run sizes (100-10k units) and compare with the financial costs to raise enough capital to enable scaling. The BOM (bill of materials) is only one slice of the total price of electronic devices, so a similar analysis would need to be done for costs like PCB fabrication, assembly, quality control, and distribution. Larger organizations often spend as many person-hours on "design for manufacture", sourcing components, and optimizing production as they do on the original device design, and have built up industrial relationships to get special deals over time. This analysis is geared towards projects and organizations without these resources, with the goal of lowering barriers to entry for creative designers and engineers to innovate.

Using Octopart's database of part pricing and availability, we are able to compare the "steepness" of pricebreaks by category. One way to interpret pricing data is to consider the price markup at a given volume compared to the lowest unit price (at the largest volume). For instance, if a distributor sells an IC at $0.14/unit in quantities of 10,000 but at $0.42/unit at quantity 10 and $0.18 at quantity 1,000, then there is a 200% markup at quantity 10 and 29% markup at quantity 1,000. This is a huge difference in price!

The above figure shows price markup curves for hundreds of parts. note that the x-axis (quantity) has logarithmic scale. The coloring indicates the broad category of the part; here we are comparing Microcontrollers, D-Sub connectors, and individual resistors. The first thing that jumps out is that these curves are all over the place; different distributors pursue significantly different "steepnesses" of pricebreaks. In general, the resistors have the highest markups and the microcontrollers have lower markups, but it really depends on the individual part and distributor. Note that most microcontrollers reach almost zero markup at quantity 100, while most connectors and resistors reach low markups around quantities of 1,000. One thing to keep in mind is that many BOMs will have more than one of a given component; if a BOM has 10 identical resistors, then the "per unit" price curves get slid to the left a logarithmic step.

That's interesting, but how do all these pieces contribute to the total price of a device's BOM when parts are sourced aggressively?

This figure shows the per-unit cost markup for an example device which includes a microcontroller, a few connectors, ethernet transceiver, passives, etc. What's happened is that the microcontroller and fancy connectors, which dominate the BOM cost, reach low markups quickly, and the passive components contributing markups all the way up into quantities of thousands make only a small difference to the total unit markup. I'll show the actual figures later, but by a quantity of about 200 the total BOM markup is only 9% over the cost at quantities of 10k. A BOM dominated by through-hole component costs, connectors, or other steep-breaking components might look different and not have this nice niche in the low hundreds, but the total margin at these scales is almost certainly still better than with the single component example mentioned earlier.

Funding Schemes

Ok, so given that shifting to higher volume production lowers the BOM cost per unit, how can we raise the capital to fund that scaling? Here are a few options:

• Put it on a credit card. If your organization has an existing credit card with and the total BOM cost is within in the credit limit, you could go out on a limb and charge the cost of the entire BOM. This is risky because you might not actually sell all the units, or something might go wrong with production and you would be left with a pile of debt. The longer it takes to get the devices paid for the more you have to pay in interest, and if you are accepting credit card payments you will still need to pay overhead on received payments.
• Presales: you can accept payments up front for a production run (possibly getting commitments from users to make sure you'll be able to cover costs before taking the payments), or you can use an "escrow" community service like Kickstarter to help manage all the details. Kickstarter charges 5% plus the roughly 3.2% overhead from using Amazon Payments. There are many benefits to Kickstarter, like a more trusting community and a well designed central project page, but we're just crunching the numbers here. With such a service you are still on the hook if something goes wrong during production and there is a cost over-run.
• Bank Loan: for comparison, we'll pretend you are able to get a 8% annual rate business loan, and that you will be able to pay it back in 6 months. This kind of thing does happen despite the economy, and if your business/organization has a good track record you can end up paying much less than the credit card rate. It's also possible to negotiate a larger loan or a "two-part" loan to cover costs in case there is a production problem. You're still on the hook if you can't get people to pay for your device, but at least you're paying much less in interest if it takes longer to push the product out.
• Don't scale production large and just spend whatever money you have now. This is assuming you have some capital on hand. You are on the hook for any production or sales problems, but you won't be paying interest on delays, so there can be much less time pressure, and the amount of money lost would be much smaller. The downside is that the per-unit costs would be higher.

How does the overhead due to interest from these funding schemes impact the final unit price that end users would have to pay for our example device?

Quantity	Total Cost	Base Cost	Base Markup	Kickstarter	Credit Card	Bank Loan
10	$277.10	$27.71	81.11%	$30.19	$30.79	$28.96
100	$1,718.00	$17.18	12.29%	$18.71	$19.09	$17.95
175	$2,929.50	$16.74	9.41%	$18.24	$18.60	$17.49
500	$7,975.00	$15.95	4.25%	$17.37	$17.72	$16.67
1000	$15,830.00	$15.83	3.46%	$17.24	$17.59	$16.54
5000	$76,750.00	$15.35	0.33%	$16.72	$17.06	$16.04
10000	$153,000.00	$15.30	0.00%	$16.67	$17.00	$15.99

The above table summarizes the unit costs at different scales using the above funding schemes. With this particular device, if you use Kickstarter to get the price margin near zero percent over the 5k price, the adjusted unit cost will be $16.72 once you factor in the 8.2% overhead. That is almost the same as $16.74/unit base price for a volume of 175 with a total cost of only $2,930. If you can figure out a way to avoid credit card overhead and have $3,000 capital available, you can make a run of 175 devices available for same cost as the larger run.

The above numbers and specific pricebreaks only cover the BOM portion of a device's total cost: PCB fabrication, testing, and assembly costs can often apply further pressure to scale up production up into the hundreds or thousands, so you'll need to check the numbers for each project individually.

Conclusions and Advice

• Don't forget to order 10% extra components to cover manufacturing loss, QA yield, and development spares.
• Frankly, buying electronic components is a total pain. Assume the worst when re-ordering electronics components. Even if you chose mainstream parts, with more than a dozen components on a BOM there is a good chance that something will now be out of stock or discontinued, prices will have gone up, you will need to purchase from a different distributor, etc. It will take hours to sort all this out, even if it's the 5th reorder in a year.
• Do pricechecks and "design for manufacturability" right after the prototyping stage. Try to get a feel for the market price of components that will carry over from design to design. When searching, choose components for their price at hundreds or thousands, not at unit costs. The variance in pricebreaks can be surprising!
• You can score some great one-time deals sourcing generic parts (connectors, passives) through brokers, auction sites, and surplus suppliers, but you won't necessarily be able to get the same deal when you re-order. If you are doing a one-off project that might be fine.
• Be very careful when trying to cut costs on "unimportant" components. It might seem hard to screw up a button or rectangular header or basic LED, but these are the components which will wear down the fastest or cause tricky intermittent errors if they don't function well. Make sure any connectors or "interactive" components will robustly behave as the user expects.

I hope if you read this far you found this article informative. If you have any questions please leave them in the comments below; if you find this kind of analysis interesting and want to help making electronics part sourcing faster and more transparent for everybody, you should come work at Octopart! Shoot us an email at jobs@octopart.com.

*: Interestingly, this "law" only goes so far: if you scale up production too far you run into higher costs because of the scarcity of resources and inefficiencies in running very large organizations. This means means the cost/scale curve is actually U-shaped; see Wikipedia for more background.