As a manufacturer producing custom-made parts, do you take the time to charge your customers a non-recurring engineering charge (NRE)? Do you understand the importance of using a non-recurring engineering charge to cover your costs of one-time or one-off designs? Perhaps you’ve rationalized that not charging for engineering time is a great way to improve customer relationships. Maybe your concern lies with customers who would be less inclined to purchase from your company if you were to charge for engineering time on custom-made parts. Maybe you're unaware of what it takes to charge for engineering and assume it's too much of a hassle. Regardless of the reasons why, not charging engineering time does more harm in the long run and does nothing more than negatively impact your bottom line.
Understanding Non-Recurring Engineering Charges
Not using a non-recurring engineering time charge reduces your company’s profit because custom-made products divert engineering and production resources from standard, consistent product lines, over to one-off designs with little opportunity to recoup design costs through large scale production. Ultimately, your company is providing an extra service, the kind of service where your costs for engineering must be well defined.
Not charging for engineering time reduces your company’s value proposition in the eyes of customers and does nothing more than negatively impact customer relationships. After all, if a customer gets a custom design, with no charge for the design work, it’s natural for them to assume the design was in essence, “easy”! Unfortunately, it’s never easy and it costs your company money.
- Custom made parts divert engineering & production resources.
- Not charging engineering time means the company will never recoup design costs.
- Not charging engineering time implies the work was simple, or “easy”.
- Not charging engineering time negatively impacts customer relationships because it fails to properly manage customer expectations.
How to Charge for Non-Recurring Engineering Time
While there are a number of different approaches to charging customers for engineering time, I’ll stick with what I typically propose my customers do. First, include the company’s direct material costs. Second, determine direct labor costs. Third, include design time. Fourth, apply the company’s overhead to the product's direct labor and direct material expenses. Fifth, determine your non-recurring engineering charge multiplier. What is the multiplier? To answer this question, think again about how a custom made part diverts your company’s engineering & production resources from standard product lines. Those standard produce lines represent 100% of your company’s revenue.
Pursuing a custom-made design must cover those engineering and production resources that would otherwise be used to generate that revenue. This means you must determine how much of your company’s revenue is spent on research & development during a given year and express this value as a percentage by a multiple, or multiplier, that coverts back to 100% (your company's revenue). For example, if your company spends approximately 8% -10% of its revenue on R&D, then the engineering multiplier would be 12 (8%x12=96%) or 10 (10%x10 = 100%).
- Define direct material costs
- Define direct labor costs
- Define design & engineering time
- Apply company overhead to direct material & labor costs
- Use non-recurring engineering charge multiple factor
Example: In the table below, the company has accounted for its direct material costs, its direct labor costs, its design time, its overhead and has used the engineering multiplier as 10 – after determining it spends 10% of its revenue on R&D. As such, their multiplier is therefore 10 (10 x 10% = 100% revenue coverage). The "TOTAL" section near the bottom includes material, labor, design time, and overhead (on material and labor only). This total is them multiplied by the engineering multiplier to get the desired price for the custom design.
** Special Note: The above sheet doesn't include calculating gross profit on sales as the multiplier takes care of that. However, if you're interested in a complete sample manufacturing price sheet, then read: Manufacturer Price Sheet: Direct Material, Direct Labor, Overhead & Profit
If you want access to the same excel spreadsheet above, with the multiplier included, then please read: Sample NRE Excel Pricing Sheet for Non-Recurring Engineering Charges
The Importance of Engineering Charges When Managing Customer Expectations
If you are a new visitor to this blog, you’ve likely not read about how properly managing customer expectations is the single most important aspect of sales success. A customer’s expectations must be managed in such a way as to ensure that the company is not exceeding its service capabilities. Mistakes are made when companies try to go above and beyond those capabilities – when they lack the ability to do so.
A non-recurring engineering charge is an essential aspect of properly managing customer expectations. In the end, if your company doesn’t explain the benefits of the design, the time needed to make it work, and the costs involved, then your customer will never fully understand what it took to make the part. Ultimately, they’ll be left to assume it was simple.
Trying to go back and change that dynamic later on, is next to impossible. However, customers that are willing to cover the costs of engineering charges are ones who understand the effort and time involved. Ultimately, they are customers who will forever understand your company’s value proposition. However, the question now becomes, when should a non-recurring engineering charge be applied?
When Not to Charge for Engineering Time
A non-recurring engineering charge is not applicable in situations where designs will lead to full scale production of assemblies that can be sold to a larger market, or better put, to other customers. For instance, if a customer were to call requiring a new part, and that part was seen by your company as a new viable market product, a product that would be sold to multiple customers, then charging your customers for engineering is not reasonable and should not be pursued. In essence, these design costs would fall under your company’s R&D (research & development) expenditures.
- Don’t charge for engineering time for market products.
- Individual customers should not cover design costs that are applicable to standard components for larger product portfolios & market applications.
When to Charge for Engineering Time
In cases where customers are asking for upgrades to existing designs, or an entirely new design, then charging for engineering time is required. In some instances, companies may charge for engineering and provide exclusivity on the design and its application. Companies must be willing to offer that exclusivity if the customer requests it. However, should the design have a market application later on in its life cycle, then the company must be willing to reimburse the customer the original design time charge. Why? Well, imagine if your company paid for a custom made part, paid for engineering time, and then found out your competitors got the same part for less!
- Only use a non-recurring engineering charge for custom made parts.
- Be willing to offer exclusivity to the customer for the custom part.
- If that part has larger market potential, your company must be willing to reimburse the customer their engineering charge.
Granted, there is a lot to cover when it comes to moving forward with the engineering charge. It’s not an easy decision and does require the company manage its customer’s expectations. However, a non-recurring engineering charge must cover the company’s costs to divert its engineering and production resources from its standard product lines. Charging for engineering time means to not only account for that time, but to ensure that the customer respects that time and appreciates the amount of work involved.
Not charging for engineering designs reduces the company’s value proposition and makes it far more difficult to charge for larger designs later in the relationship. It may take a while before being able to accurately predict engineering time. However, it will become easier on each subsequent project. If needed, start with a smaller engineering multiplier and progress forward.
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