Sunday, June 10, 2012

A Suckers' Game

Yesterday I ordered five of my hookah widgets - prototype run. I plan to distribute them to my friends and family who smoke hookah and get some feedback.  They may be entirely worthless, but like a overly-optimistic parent I'm going to choose to believe that my baby will somehow change the world for the better. 

Everything else aside - even if my widget absolutely ruins hookah smoking and I get run out of town I'm excited about having made something. Just seeing a physical objects manufactured to my specifications is worth every penny of the cost of the prototype run in my opinion.  I will be more excited if it's useful to me and tickled pink if it's useful to anyone else.  If it goes that well then a Kickstarter effort wouldn't be out of the question in my opinion.  And that gets me thinking - am I going to get rich off of this?


Pretty please?

We can all dream can't we?  And I'm told that America is the place to make your dreams come true.  With enough skill, tenacity, gumption and luck you too can live the American dream - the dream of living in a giant treehouse with a helicopter pad and an upside-down pool and complaining about people poorer than you.  And I aim big - I want to complain about Mitt Romney.  Come on Mitt!  Your pool is rightside-up and it's lowering my property values because it's not awesome enough! Do I have to sue you?

 So how rich could this make me? Well I know a few things about business and I think that the more units I sell the more money I make.  But I'm only one lazy person - the more widgets, the more I have to do.  I'd rather get it over with quickly and ship my product than to draw it out months because I got greedy and tried to ship 1000 units.  Plus, I've seen Kickstarter projects that were too successful - 10x the profit sounds good, but trying to handle that many orders without the trappings of a real business (returns department, quality control, lawyer, etc) while keeping customers happy turns out badly. With those things in mind, I decided to limit myself to 100 units only for a first run. I am considering a possible stretch goal of 250 though.

Now the second thing I know about business is that I only make money on each unit if I sell it for more than I paid for it.  Thus the next question I have to answer - how much does each unit cost?  To answer this question I created a spreadsheet that has all of the costs I could think of.  Let's go over the per-unit costs before anything.  The per-unit cost is the cost for each unit sold assuming a certain number are sold.  My assumption is going to be that I will sell and ship 100 units as my Kickstarter goal.  Kickstarter won't fund me if I don't make this goal, so I don't have to worry that it's about whether I'll make it.

The first and most obvious cost is the cost of getting a manufactured unit shipped to me. Since I plan to go through I don't have to worry about separate costs for material and machining - they handle it all and ship it to me.  That gives me one cost for each manufactured unit.  I got several quotes from them and created a lookup table which you can see at row 12.  This gives the ability to change the size of my production run and still get good numbers without guessing.  The next cost is the cost to hard anodize each unit.  I found a local place that gives me a significantly better deal on hard anodizing than did, so I'm going to receive delivery of the manufactured items from and then transport them to the local place to get anodized.  That saves money. Next cost is shipping - this is easy if you want to ignore international shipping.  Through I just did a postage calculation knowing the weight and size of the item.  It turns out to be fairly inexpensive.  International shipping however is a whole different game that I don't want to get into right now.  The next two costs get more complicated, so they get their own paragraphs.

You might think it's odd that I'm counting labor as a cost.  Do I plan on hiring someone?  No, not in the least - I'll do it all myself.  But since it's my business why pay myself?  It's a good question.  Not paying myself might seem like saving money but practically it's not.  As the owner I can re-capitalize  (read: give more money to) my business any time I want.  So even if I pay that money to myself I can just give it right back if I feel like it (with the only downside being any potential tax costs).  And in any case if this gets successful enough there will be a lot of orders and that means a lot of work.  I may want to hire someone sooner than I thought, so it's good practice to start accounting for labor costs early.  That being said it's not as if my labor is magically free.  It's only free if you ignore my health, time with my family, friends and sanity.  Plus if I don't pay myself now it will make it a greater financial shock later when I do have to account for the cost of labor. I prefer to keep costs out in the open.

Overhead is perhaps the most interesting cost.  The goal is to list every cost that is not directly associated with each unit sold and the amortize that total cost over every unit to recoup it.  There are several costs associated with overhead:
  • Business costs - licensing, insurance, web page, etc.  Things that you have to pay if you want to stay in business even if you don't sell a single thing.  Those costs are not included because I view this spreadsheet as a worksheet for this production run alone.  However, these sorts of things probably run me around $500/year if my business doesn't do much except exist and have a website.
  • Prototypes - You never want to avoid having a prototype.  There were several warnings given off by the Design Rule Check on eMachineShop's CAD software.  The pieces could come out of the shop looking terrible - holes in the wrong places or with scratches, abrasions, etc. You need to know what you're getting before you order 100 of them and you have to know if your design even works.  Perhaps not intelligently I ate this cost for now - it won't be recouped by the production run.  If things turn out well I might sell any leftover prototypes as special gifts for  generous backers to recoup the cost.
  • Refunds - Some people are going to want their money back and I want to give it to them.  Too many Kickstarter runners seem surprised and terrified of requests for refunds - they prefer to think of their customers' money as a donation rather than a business transaction.  I think that's dishonest.  If I screwed up and I know its my fault I'm not going to try to hang on to a few more dollars.  I do hope that it doesn't happen very often, but I don't have any real numbers.  I included an assumption that 10% of the units sold will result in refunds and I'll have to give a full refund plus pay for return shipping.  This turns out to be a very expensive cost, but I'd rather plan for the worst.
  • Fees - Don't forget about this!  Kickstarter takes 5% of your total and Amazon takes up to 5% for credit card processing fees.  Best to assume the worst and assume that you'll lose 10% of whatever you make to fees.
  • Unsold Units - This is a bit harder to wrap your head around, but bear with me.  If I sell 100 units on Kickstarter, should I buy only 100 units from eMachineShop?  Seems like a dumb question no?  But what if they screw up machining just one of the units?  I'm not going to ship a defective unit if I can help it, butI can't order just one more from eMachineShop.  I should add some additional units on to the initial order to ensure that I receive at least 100 shippable units.  The number of units above 100 that I order is the number of unsold units, and I have to recoup those costs by making everything else more expensive.
If you sum all of those costs up you get the cost to sell and ship one unit.  Now all you have to do is arrange your Kickstarter such that you charge more for each of the units than they cost. The final Kickstarter goal is calculated in column H and is obtained by multiplying the cost I plan to charge for each unit times the number of units that I will sell.  All I have to do is play with the price I charge until I see the level of profit that I would enjoy them most.   Being a greedy capitalist I'm thinking my profit should be $LOTS.

Of course, if I charge $LOTS some people just won't buy it.  In that case I get nothing.  Now, typical profits per unit for manufactured goods like this are pretty low - much less than 10%.  And for this Kickstarter a profit of 10% still only gives me something absurd like $150 profit when all is said and done.  That's not $LOTS.  However, if I deliver 10,000 units instead of 100 then things get different.  With 10,000 units my manufacturing costs get very low and even if I keep my profits very low (even as low as 1%) I get a lot of profit because 10,000 * $Anything = $Some.  $3,000 in profit in one year is possible if my profit on each unit is $.30 and I charge around $30.  Of course, why make $.50 when surely the market can handle a dollar of profit or even two?  Now we're talking real money - if I can fulfill all of those orders on my own AND keep my actual job.

That's pretty much the problem with manufacturing - it doesn't scale down very well.  As it is I'll have to charge around $60/unit for a run of 100 units and I won't make a whole lot of profit.  It's only when you get into high volume that it really gets to be profitable.  But to handle high volume you need capital investment in automating processes, systems to track purchases, paying workers, etc. If I'm lucky I won't have to worry about this and I can just find an existing online shop to sell the widget - I deliver manufactured units ready to sell and worry about nothing else. 

So as you can see, there's a lot of thought that goes into deciding how much to charge for a product and plenty of pitfalls you have to watch out for.  Once you start adding everything up it becomes clear that manufacturing things is a suckers' game - you either have to be fairly large or you're never going to make real money.  Kickstarters beware....