Do you pride yourself on your company’s engineering & design capabilities? Is your company the vendor of choice and the primary source for unique, custom-made products? More importantly, is your company known as a market innovator whose designs are above reproach? If you’ve answered yes to all these questions then you understand full well how important it is to charge for your company’s engineering capabilities. Unfortunately, a number of companies either don’t charge enough or don’t charge at all. If your company is known for its designs, then charging for engineering time is not only a must, it’s vital to your company’s future.
Accounting for your engineering & manufacturing capacity
When companies look to charge customers for engineering, they often refer to the fees as NRE charges, or “non-recurring engineering” charges. When thinking of these charges, think of your company’s production of standard parts. Think of the equipment and manpower used to manufacture these parts. Think of how your engineering department functions as a support and design role for new product developments for your entire market. Think of the time engineering spends on these new product designs, the role they play in launching those products and their efforts in troubleshooting issues for internal and external clients. Now think of your manufacturing resources in terms of equipment & machinery. Your company’s equipment, machinery, engineering capabilities and employees are allocated to manufacturing your company’s standard product lines. Diverting these resources away to manufacture a custom-made part is extremely costly!
Your company likely focuses on increasing production throughput by lowering manufacturing cycle times. Everyone plays their part in the pursuit of lower cycle times and increased manufacturing productivity. When your company’s engineering and manufacturing capacity is diverted to a custom design, doesn’t it just make sense that your NRE charges makes up for this lost capacity? Shouldn’t your company charge an amount that reduces the impact of diverting your engineering and production resources? It most certainly does! So, how should your company go about charging for custom-made products? To answer this question, we’ll provide the steps needed to determine your company’s NRE charges and then provide an example of how those charges can be applied.
- Determine expenditures on research & development – The first and most important step in determining your engineering charges is to account for your company’s expenditures on research & development during the previous year. These expenditures include all your company’s costs in new designs and new product introductions.
- Define revenue from standard products – Remember, pursuing new custom-made designs diverts engineering and manufacturing resources from current production. Therefore, your company must define what that production of standard products means in terms of your company’s revenue. For some companies, 100% of their revenue may come from the production of standard parts. For others, that amount may be 80% or less. For this second step, apply a percentage to the revenue derived from your standard product lines.
- Determine your engineering charge multiplier – Your engineering charge multiplier must be used to compensate for the reduction in your company’s engineering and production capacity. The multiplier must take your expenditures on R&D and multiply it by an amount equal to the revenue derived from your standard products. Another way to calculate this would be to divide your revenues (expressed in percentage) from standard parts by your company’s expenditures (again expressed in percentage) on research & development. This allows your company to cover the costs of diverting your company’s engineering and manufacturing resources.
An example of charging NRE
Let’s assume a company has a customer who wants a custom-made part. The company has determined its direct labor, direct material expenses and has accounted for both the design time and the company’s overhead. The cost up to this point is $5,000.00 for the design. The company reinvests 20% of its revenue back into research & development. Of the company’s revenue, 80% is derived from the production and sales of standard product lines. In order to determine the company’s engineering multiplier, it would take 80% and divide it by 20%, which gives a multiple of 4. Therefore, the company could charge $20,000.00 for the custom-made design ($5,000.00 x 4).
The importance of charging engineering time
Far too many companies ignore the importance of charging for custom products. Some companies feel it inhibits their ability to generate future sales. Others rationalize that no amount will help them cover the costs of diverting internal resources. Still, others believe that it sends customers the wrong message. Regardless of the excuses, not charging for engineering time is simply bad business. In fact, it does nothing more than reduce your product’s value proposition. Customers must appreciate the effort needed to produce a proprietary and unique custom part. If not, they’ll forever assume that everything your company does for them is simple.
There are many approaches to charging for engineering time on custom-made designs. However, the impetus must be on charging for that time. Don’t rationalize the decision not to use an NRE charge. Understand that your customer is relying upon your company for its expertise. As such, they should be more than willing to pay for your company’s engineering prowess.
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