What is a COG (Cost of Goods) and when is it important to look at?

Hi, my name is Ian Peterman, and I'm CEO and founder of Peterman Design Firm. And today I want to answer the question, what is a COG, C-O-G, and when do you need to start looking at it in the product development process? So your COG is cost of goods. And there's many levels you can do that to. Some people will break it down into, you know, different areas. So they'll say cost of goods for packaging or cost of goods for product. And so you can use that to help figure out which areas of your product are more costly. You know, you can break down shipping. What is it? What is the COGS of your shipping? And that's, you know, distribution. Actual shipping costs, labor costs in order to box it all up and get it out the door. So that breakdown, and you have your overall total COGS, and that is what a lot of people think they know what that is, but don't actually know what goes into that because there's a lot of components that go into that, your actual COGS. And depending on your business model, it can be extremely detailed. So for example, you know, if you're, you're really trying to figure out exactly how much it costs to make a single product, then, you know, let's assume everything is in-house, you make it, ship it, and all that stuff. You need to calculate the amount of cost of the machinery that's being used over the lifetime of that machine. How many of that part is it going to be able to produce before it breaks down and requires a replacement part or fixing? You can look at the cost of square— cost per month per square foot. You can divide that down and say, well, the product is going to be on our floor for exactly 3 days. And it's going to require this much square footage in order to be stored and calculate down to your storage cost. You can calculate not only the equipment, but you also need to factor in things like what does it cost in hours? How, who, how many people? What are their hourly rates? How much time do they spend in each part? How much time do they spend assembling?

Assembling?

How much time do they spend packaging? What is the cost of the box you ship it in? What is the cost of the packaging you put it in? What is the cost of, you know, the electricity? What is— what is the— you have electricity coming to your building. How much electricity and water do you use? Now, sometimes, and a lot of times, those things get skipped because, you know, you— your cost of electricity is small enough that if you actually divide it by all the other components, you're talking about thousandths or ten-thousandths of a penny, and it becomes not really worth going down. But if you're at a large scale, and this is where people will ask the question, well, why does an automotive company care about decreasing a part by a tenth of a penny? Well, it's because they're making millions of that part. Every single year. So a 10th of a penny, 0.1 cents, is a lot of money when you multiply it times a million or 10 million. There's parts that people produce for cars, for example, that have been in use for 20 years with relatively little change. You know, there's— and it obviously parts do change, but you can have specific components that haven't changed. In years. And if you're producing— if you're an OEM and your part gets used in millions of cars per year or millions of other products, you can be looking— if you can save 1/10 of a penny, you're going to save millions of dollars over only a few years potentially of operation. A few million dollars in savings is huge. So it's really important to be aware of the scale that you are working at, because that will decide how detailed your COG needs to be and how, how deep into the minutiae you need to be tracking things. A million— you're producing a million vehicles, a million parts a year, your electricity bill is probably going to factor into it. Depending on your process, your water may factor into it. Things like disposal, your trash bill, many, many things go into it, and it partly depends on your accounting practices, how, how you're going to allocate different costs and things like that. And it— you can get as detailed as you want. You can go as fine a detail or as high level. You can just say, well, these parts cost this, I'm going to ignore labor, and I'm going to ignore, you know, any utilities, and the customer pays shipping, we're direct-to-consumer. Great, do that. But know that your pricing— so COGS is really important in pricing. And to go to the question of, you know, when, when should I look at your COGS? When should I start thinking about this? That answer comes actually very early. So in one of the first 2— in the first 2 phases of Peterman Method that we use, you're going to start defining the price because your COGS will determine your price, or your price determines what your COGS can be. So if you're setting MSRP, manufacturer's suggested retail price, You're saying that this should be able to be sold to a customer for X. So say the $20 MSRP, you then on average you need to have— be able to sell it at 40% and make a profit. Direct-to-consumer, that's 60% gap right there. So they will make this math easy. $100 product that you sell MSRP, you're doing direct-to-consumer. Then you could have it cost 50 to 70%, so you have a small margin, but you're still making 30%. Not bad, not super great, but not bad. Depends on how you build your COGS. Your COGS includes everything, including your admin hours spent working on it, your customer support. You know, your products might use an average of 3 hours of customer support over the next 10 years, and it's only supposed to last 10 years. Well, if you've calculated all that into your COGS and your COGS falls within that, then you're great. You're doing really well. You don't need as much margin in how you're doing your formula as you would if you— all your admin, if everything— you're only counting hard, you know, part costs, you're not counting labor or anything, you're going to need a larger margin because you're going to have to pay somebody hours to manage the company. You're going to have to pay somebody customer support. So there's a lot of, you know, the overhead, the quote-unquote overhead can be different based on how you do the math. And so when you do this, you need to be looking at your cost of goods beginning here in the early stages because you are going to determine that based on market research. You're— when you're doing this, you want to be doing market research. And if your competitor is selling a product for, uh, $90 instead of $100, then, you know, you have to justify that extra $10, which means you're probably going to spend more and have a higher quality product or have additional features. But you still have to be able to make a margin. And when you're doing not direct-to-consumer, when you're— you end up losing frequently 60% of it goes to Whoever's distributing it for you. So you get your product into Walmart, congratulations, they're probably going to take somewhere around 60%, meaning you have to be able to manufacture all of your costs. You have to be able to manufacture it, get it to Walmart, you have to be able to get it to your distributor, you have to be able to produce it. and make profit, you know, pay all your taxes, pay all your employees. And ideally, you're trying to have a successful company, so you have to profit in there, and you only get 40% of that. So that's why direct-to-consumer brands are able to offer so much cheaper product. They can cut 50% off of it, they can work off of 40, they can make it 10%, and they, they get an extra 10%. profit margin, and you, the customer, get 50% off of what they would normally have to charge if they sold it through a standard distribution model. So that's, that's the importance of COGS and figuring it out as early as possible. And you're not going to know it right at the beginning. It's impossible to estimate your, your final costs. You can set them and you say, well, we can only exceed this, and that will help determine how the product is designed because there's a certain cost that we're trying to aim for. And so that's something that I do with my clients is if there's a really important price point where it's the market won't— you can't sell it for $110, you have to sell it for $100, otherwise no one's going to buy it. Then that we work, we work backwards from that and say, okay, well, how are you going to distribute it? What do you— what is your process? And that way we figure out the cost and we figure out, okay, well, we need to be able to make the product for $15. That has— it has to be hard material, $15. That's what it got to cost. And we design around that. And so your COG, whether you know it or not, is going to determine your product development path. And so that's something that we have that— We have that conversation. I have it with my clients. Early on, what, what is the sale price you want? Because that's going to determine the process and it's going to help formulate what the COG is and will tell you if you have room. Do you have room to have really fancy packaging? Do you have room in there? And there can be this back and forth as well of, okay, well, we don't have room based on all of your costs. We don't have room for the fancy packaging that You really want. But does fancy packaging relative to your competitors give you the ability to raise your MSRP? And if so, well, now we can raise our MSRP, and now all the formula goes into— and we have room for that. And so there's a little bit of back and forth you can go on. And so your COG may change as you go through the process, but you want to have it as early as possible, at least an idea and a goal. to aim for. So, will that answer your question about COG and when you need to start looking at it?

Hey, thanks for watching. We really appreciate our viewers, and if you haven't subscribed yet, please do subscribe to our channel so you can get more great videos like this in your feed, and like the video. If you want to learn more about the Peterman Design Firm, please check us out on our website, petermanfirm.com. You'll find link and information in The description. And of course, we're on all social media as well, so check us out there. All right, thank you. Thank you.