Calculating total manufacturing cost is an important part of any successful manufacturing operation. For a product to be profitable, its total manufacturing costs must be less than the value added during production—and not all manufacturing costs add value.Calculating total manufacturing cost provides insight into what companies pay for, and whether those things add value to products. This article looks at the three components of total manufacturing cost—direct materials, direct labor, and manufacturing overhead—and what they can say about the quality of a product
Direct materials comprise any physical raw materials or subassemblies that go into a product. This includes material that makes it into the finished product as well as scrap. It does not include consumables like machine oil or cutting tools.
The type and quality of materials affect their costs, but high direct material costs don’t necessarily reflect quality. Other suppliers may offer the same or equivalent materials for a lower price. Companies with consistent demand can reduce costs while maintaining quality by buying material in bulk.
Waste can also drive up direct material costs in the form of scrap and overproduction. Excessive scrap can result from poorly maintained equipment, inadequately trained operators, bad processes, or other factors. Poor production planning may lead to overproduction. If a shop produces more than it can sell, it must absorb the cost of materials, increasing direct material costs.
Direct labor includes all labor that goes directly into production—for example, the machinist who makes the part itself. Direct labor costs include paying those employees for working on a particular job, including wages and payroll taxes. It does not include supporting functions like maintenance, administration, or management.
Just like direct materials, many factors affect direct labor costs, including waste. A shop with highly skilled and experienced workers may need to pay them above-average wages, increasing direct labor costs in exchange for reliable, consistent results. Alternatively, a shop with inefficient processes might have high direct labor costs resulting from overprocessing, unnecessary waiting times, or overproduction.
Unlike direct materials and direct labor, which are direct costs, manufacturing overhead includes all the indirect costs of production, including:
Most find overhead costs more complicated to account for than direct costs because they don’t reflect a specific production activity. For example, facility rent has nothing to do with the amount of production taking place. Rent for producing ten parts a month will equal that of 1,000. In other words, the smaller the scale of production, the more significant manufacturing overhead can become when calculating total manufacturing cost. It’s essential to track and allocate overhead to identify opportunities to improve efficiency and reduce costs.
Manufacturers calculate overhead rate as the percentage of monthly revenue they spend on overhead costs and cover them by incorporating them into pricing. Therefore, even operations with low direct labor and materials cost may still have a high total manufacturing cost if they have high overhead.
Manufacturers know profitability depends on efficient operations. Calculating total manufacturing cost shows you how manufacturing operations impact the bottom line. With this information, companies can identify sources of waste and target inefficient processes for improvement.
For example, a smaller shop may not justify the overhead costs of purchasing and maintaining equipment they only use occasionally. In this case, outsourcing that operation to a reliable machine shop might represent the most cost-efficient option.
Consider how vendors’ direct materials, direct labor, and manufacturing overhead contribute to their total manufacturing costs. For example, imagine two vendors who charge the same price for the same service. One has a high scrap rate because their machines are old and in disrepair, while the other uses top-shelf equipment that increases their overhead but produces much more consistent parts. Waste drives one vendor’s costs while quality drives the other’s. Even at the same price, it’s clear which vendor offers the better value.
When choosing a machining vendor, make sure you know what you’re paying for by calculating the total manufacturing cost. A machine shop with efficient processes and robust quality procedures offer the most value by minimizing waste and maximizing quality, ensuring that companies don’t throw money away on non-value-added activities.
At Plethora, we proudly offer the Manufacturing as a Service model of business. We feature the best machinists and engineers working on the best equipment in the industry. We are ISO 9001 certified and constantly look for ways to improve processes and elevate our capabilities to the highest quality. Our online DFM and quoting systems are ready to receive your data so we can begin working on your next project. To get started, upload your design files to Quote My Part or call us at 415-726-2256.
The Plethora Team
The Plethora team is your go-to CNC manufacturer for hardware done right the first time. We have the tools and experience needed to create high quality custom parts quickly and with precision, whether you need a prototype or production run.