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Overhead Absorption

Inventors need to understand a little about manufacturing accounting to see the potential of striking a deal with the right manufacture.  Manufactures use a term overhead absorption to cover their costs that include, equipment and plant depreciation, rent, equipment costs maintenance and all other items considered overhead. They take those costs and divide it typically by manufacturing hours to get an overhead absorption rate. This can account for 40 to 50% of a product’s cost.  Manufactures who are operating at below 60% capacity have an enormous need to get more products, because those new products cut the absorption down not only for their new products, but also all of their existing products.  Often this means a manufacture at 60% capacity might just be breaking even, but if that same manufacture is at 80% capacity, they will be at a20% profit margin.  The profit swing is dramatic as plant utilization rates increase.

Finding manufactures that are closer to that 60% capacity utilization provides inventors with tremendous leverage, often manufacturers will pick up much of your start-up costs if you can show your product will really sell, typically by having sales agreements in place.  Manufactures too far below a 60% utilization rate often don’t have any money, and manufactures too far above the 60% utilization rate don’t benefit nearly as much from your business.

The key for inventors is not just go with the first manufacturer they find but to probe just how important their business will be to a manufacture. The manufacture’s efforts to sell you on their services are a first indication. But you can also inquire about the company’s product line, what products they make under their own brand and when they products were introduced and also what products they make for others.  Manufacturer’s with an older product line often have falling sales and if there sales are still fairly strong, they will be your best candidate for a manufacturer that will pick up much of your manufacturing costs.

Show the Product Will Sell

The key to getting a manufacturer to pick up your costs is to have proof that the product will sell.  The best way to do this is to have a sales or distribution agreement with an establish company in the market.  You can do this in a number of ways.

• Marketing Agreement. A marketing agreement is where a company agrees to buy the product from the inventor and sell it under the inventors brand name, usually marking up the inventor’s price 35 to 50%. The inventor is responsible for producing the product.
• Private Label Agreement. A private label agreement with another manufacturer or distributor where a company agrees to sell the product under their name. Companies usually mark the inventors price up 50%. The inventor is still responsible for production.
• Exclusive or Non-Exclusive Sales Agreements.  You can have an agreement with large retailers and distributors, in many cases inventors will have agreements with many regional companies, who are easier to sell to than a national chain.  These agreements provide inventors with their best opportunity for larger profits, as marketing and private label agreements require you offer substantial discounts to the other party
• Agreements with large manufacturer’s sales reps.  Most manufacturing sales rep groups are regional, but many have 10-20 reps. These rep groups can generate great sales.  The manufacturer won’t invest if you have small, two or three person rep groups, so you need to aim for the larger rep groups.