What role does your NRE multiplier play with respect to better managing customer change requests on custom designs? Well, while there are varying opinions as to how a company should manage these changes, the best advice I can give is to first determine what your non-recurring engineering multiplier is, and then focus on the fact that any customer changes are exactly that, changes driven by customers who should cover those costs. By this I mean that once you’ve moved past the design phase, and have gone to full-scale production, any and all changes requested by the customer must be charged back to the customer in order to cover your holding costs of inventory.
Understand the Impact of Change Requests
I’ve written several tips on handling customer change requests for small manufacturers . However, it all boils down to answering the following question. What happens when a customer of yours makes a change request after you’ve started production? In order to answer this question, think of how those changes typically involve a review of the design. Think of how they fracture your production schedule. Think of the changes to your production package, how they divert engineering & drafting resources and how your entire team has to adjust work orders, bill of material outlines and assembly drawings. Think of the impact on your inventory when you have to urgently rush in parts and materials to accommodate these changes. Finally, think of how much this costs your company and how each and every time one of these changes occurs, your company simply chooses not to charge the customer.
Now ask yourself whether any profit is made on these orders? I guarantee you that if you don’t charge your customer for their changes, you’ll never make a profit and will at best, only break even. Customer changes must always be charged back to the customer. Don’t rationalize these holding costs and chalk them up to the cost of doing business. Your company is in business to make a profit, and these changes erode profit by increasing your carrying costs and forcing a diversion of manufacturing and engineering resources. So, how does your non-recurring engineering multiplier protect potential losses from these constant changes?
Understanding Your NRE Multiplier
The excel costing sheet below is taken from the post Sample NRE Excel Pricing Sheet for Non-Recurring Engineering Charges. Of particular importance is the NRE Multiplier. The multiplier itself is meant to cover the costs of your company diverting engineering and manufacturing resources away from standard product lines, over to the customer’s custom design. This is an approach used in software development, Telecom, and any other application where companies often require specially designed products.
** Special Note: The above doesn't include gross profit on sales as the NRE multiplier more than takes care of that. To see another excel sheet like the one above, one solely dedicated to defining a price for standard product lines, then please refer to: Manufacturer Price Sheet: Direct Material, Direct Labor, Overhead & Profit
The multiplier is based on a simple principle. First, define how much of your production is predicated on manufacturing standard products. Second, determine how much of your revenue is reinvested back into the business in the form of R&D (research & development). Your non-recurring engineering multiplier is simply the percentage of revenue derived by standard products, divided by your R&D reinvestment percentage. For instance, let’s assume your standard product lines represent 90% of your business’s revenue and that your company reinvests approximately 9% of your revenue back into R&D (Research & Development). Your NRE multiplier would therefore be 90% divided by 9% which would give you 10 as a multiplier. This is outlined in the above table under 5. NRE Multiplier.
Will this Help Cover the Impact of Change Requests?
The NRE multiplier isn’t meant to cover the costs of any and all customer change requests. This non-recurring engineering charge is meant to charge your customers for the time needed to come up with a design. However, it helps to offset the costs of these changes by allowing you to decide at what point you need to charge your customer to cover your holding costs. How costly are these costs?
In order to answer this last question, please refer to the example below. It’s taken from the post Define Your Inventory Carrying Costs on Custom-Made Products, The three points of reference (1,2,3) outline the company’s carrying costs as the product’s COGS (Cost of Goods Sold) moves through various customer change requests. A&B show the total carrying and finance costs. Think of this as “work in process” inventory, except in the case of customer change requests, that work in process inventory remains idle, waiting for revised designs, revised production packages, new assembly outlines and updated bill of material outlines. These are real holding costs and they increase each time a project is put on hold.
It all boils down to determining your multiplier for the new design, documenting the costs of customer changes and making sure your customer covers these costs. Remember, your company is making a special design, one that is beyond your normal manufacturing operations. It diverts your manufacturing and engineering resources from standard production. If managed properly, your customer should be ecstatic that your enterprise is willing to divert your resources to accomodate their needs. However, with that comes the responsibility of understanding that changes must be covered. Not by you, but by your customer.
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