Determining Manufacturing Costs

Estimating manufacturing costs of a new product or process soon after research and development (R&D) has commenced can provide a good indication of the project’s economic viability. “Early” estimates can be used to direct research efforts to promising opportunities for cost reduction, and allow businesses to better assign resources to new products. Although potentially compromised because some information may be missing, early estimates are often sufficiently accurate to shed light on a product’s long-term viability. Quick determination of the relative contribution of variable costs, fixed operating costs, and capital depreciation to the total product costs allows cost-reduction efforts to be focused on those cost components that are likely to be most significant. Because the tasks required to develop cost estimates are virtually the same for all products, time invested in developing a generalized and consistent methodology for making cost assessments and comparisons can pay large dividends. In this article, the term “economics” is not used because cost assessments, which play a significant role in project economics, must be combined with information about the revenue the product is expected to generate. For example, the value of a new toothpaste formulation must be determined by those with knowledge of its market. Many technical personnel do not have the expertise required to address all relevant economics questions. The income side of the ledger can have a greater impact on a product’s success than the items on the cost side. A great deal of information has been published on methods of estimating manufacturing costs. However, much of this work has addressed the costs of a specific product or process or has concentrated on capital equipment and its depreciation, which is only one component of total product cost. Cost components. Product manufacturing costs can be categorized as fixed or variable (Table 1). Those that are insensitive to the volume of product made are considered to be fixed. Labor, although not completely fixed, is somewhat independent of product volume, since the number of people operating a plant and their salaries are not easily adjusted as demand fluctuates. Raw material costs are variable — if more product is to be made, more raw material is required. No cost is completely fixed or completely variable. Although labor is considered to be a fixed cost, personnel supply can be adjusted in response to anticipated seasonal product demand. Prices for raw materials fluctuate slightly with changes in demand. However, for estimates made in the early stages of a product’s development or for the purpose of high-level decisionmaking, determining which costs are largely fixed and which are largely variable, and then assigning them complete dependence or independence from production volume, will facilitate the development and use of a cost-estimating method.