Deeptech startup guide to contract manufacturing scale economics and true landed costs

The Illusion of Tiered Pricing in Contract Manufacturing

Receiving your first quote from a contract manufacturer (CM) feels like a major milestone. The tiered pricing table seems straightforward: buy more, and the price per unit drops. For deeptech and hardware startups, this appears to be the direct path to healthy gross margins. Yet this initial quote is often the source of significant financial miscalculations. Misjudging fixed-versus-variable cost breakpoints skews gross-margin forecasts, leading to underfunded production ramps and eroding investor trust. The key is to move beyond the quote and develop a realistic understanding of your true scaling economics. Learning how to forecast contract manufacturing costs accurately is not just an accounting exercise; it is a core strategic function for any company making physical products.

When you ask, "My CM's quote shows clear price breaks. Isn't that my cost?" the answer is almost always no. That tiered pricing represents only one part of your total cost: the base variable cost per unit. It is an illusion of simplicity because it omits numerous other costs that directly impact your bottom line. The pattern across deeptech startups is consistent: founders anchor on this quoted number, build financial models around it, and are later surprised by the cash required for their first production run.

The critical distinction to make is between the quoted per-unit price and the True Landed Cost per Unit. The former is what your manufacturer charges for components and assembly. The latter includes every single expense required to get that finished unit into your possession, ready for sale. Relying solely on standard contract manufacturer pricing models without digging deeper is one of the most common ways early-stage companies mismanage their cash flow. Understanding the difference is the first step toward building a predictable and scalable manufacturing operation and achieving meaningful volume discounts manufacturing.

How to Forecast Contract Manufacturing Costs: Deconstructing Your True Cost Per Unit

So, what costs are you missing beyond the per-unit price? These expenses fall into two primary categories: one-time fixed costs that must be amortized, and hidden per-unit variable costs that accumulate with every unit you produce. Identifying these manufacturing cost drivers is essential for accurate financial planning.

One-Time Fixed Costs (Non-Recurring Engineering)

First are the one-time fixed costs, often categorized as Non-Recurring Engineering (NRE). This includes the initial, non-repeating work required to prepare for your production run.

• Tooling and Fixtures: This is a major capital expense. Creating the custom molds, jigs, and fixtures needed to manufacture your product requires significant upfront investment. As research shows, custom tooling can range from $5,000 to over $100,000 depending on complexity and material. This cost is unavoidable for custom parts and is paid before the first unit is ever produced.
• Cost Amortization: You cannot simply expense this tooling cost at once and ignore it in your unit economics. To find your true cost, you must amortize it, or spread its cost, across a specific production volume. For example, a $20,000 tooling investment spread across a first run of 10,000 units adds $2.00 to each unit's cost. If you only produce 5,000 units, that contribution doubles to $4.00 per unit. This calculation is fundamental to understanding your production volume breakpoints.

Hidden Per-Unit Variable Costs

Second are the "hidden" variable costs that are incurred on a per-unit or per-shipment basis. These are often overlooked in initial forecasts but can severely impact margins.

• Scrap and Yield Loss: No manufacturing process is perfect. Some units will fail quality control. You pay for the raw materials and labor for these failed units, but you cannot sell them. A realistic scrap rate is typically between 2-5%. You must factor this loss into your total cost. If you need 1,000 sellable units and have a 3% scrap rate, you need to order and pay for approximately 1,031 units to hit your target.
• Shipping, Freight, Tariffs, and Duties: For US and UK companies sourcing internationally, this is a substantial and often overlooked cost. It includes freight from the factory, insurance, customs brokerage fees, and import taxes. UK guidance explains when to account for import VAT on your return. For US companies sourcing from Asia, this is especially important, as Section 301 tariffs on Chinese goods have been as high as 25%. Recent policy changes affect de minimis thresholds for US imports, making this an evolving landscape.

To calculate your True Landed Cost, you combine these elements into a single formula. For instance: ($10 Base Unit Cost + $2 Amortized Tooling + $0.30 Scrap) * 1.25 Tariff + $1.50 Freight = $17.25 True Landed Cost per Unit.

The Volume Dilemma: Balancing MOQs, Demand, and Cash Flow

This brings us to a central challenge for startups: how to balance a CM's minimum order quantity (MOQ) with an uncertain sales forecast. An MOQ is the smallest order a factory will accept, as it is not efficient for them to set up a production line for just a few units. The CM's MOQ is designed for their efficiency, not your cash flow.

Here lies a critical trade-off. Ordering at the MOQ often unlocks a better base unit price, but it forces you to tie up a large amount of cash in inventory that may not sell quickly. This directly addresses the pain point of uncertain demand versus contract minimums. For an early-stage startup, cash is oxygen. Wasting it on dormant inventory can be fatal, delaying key hires or marketing initiatives.

Compounding this problem are inventory holding costs. This is the money you spend to store, insure, and manage your inventory, including the cost of potential obsolescence if your product is updated. Average inventory holding costs are 20-30% of inventory value annually. So, $100,000 of inventory sitting in a warehouse for a year could cost you an additional $20,000 to $30,000. The reality for most pre-seed to Series B startups is more pragmatic: you cannot afford to have capital sitting on a shelf.

This is where the tension between gross margin and cash flow becomes most acute. A larger order may look better on a per-unit margin analysis, but the immediate cash outlay can put the entire company at risk. As we often see, the trade-off between cash and margin becomes critical when a company has less than 12 months of runway. In these situations, preserving cash by placing a smaller order, even at a higher per-unit cost, is frequently the wiser strategic decision.

A Simple Model for Scaling Production Costs

How can you build a simple model to forecast your costs and margins accurately? You do not need a sophisticated ERP system. For a startup using accounting software like QuickBooks or Xero, a well-structured spreadsheet is your most powerful tool for mastering the economics of scaling production costs.

Your model should have three parts: inputs, calculations, and outputs. This provides a clear framework for how to forecast contract manufacturing costs and make informed decisions.

1. Inputs: This is where you list all your known and estimated cost drivers. Create separate lines for NRE, tooling costs, the CM's tiered pricing (e.g., price at 1k, 5k, 10k units), your assumed scrap rate, an estimated freight cost per unit, and any applicable tariffs or duties. Be conservative with your estimates.
2. Calculations: This section of your model uses the inputs to determine costs at different volumes. Here, you will calculate the amortized fixed cost per unit across several potential production runs. For a $25,000 tooling cost, the amortized cost at 1,000 units is $25.00, but at 25,000 units, it drops to just $1.00. This is also where you model the impact of scrap rate and other variable costs.
3. Outputs: The final section should clearly show your True Landed Cost per Unit and total cash outlay at different production volume breakpoints. This is where you see the real economics of scale, allowing you to compare scenarios and understand the cash required for each.

For example, let’s trace the cost of a single unit from a 1,000-unit run to a 25,000-unit run.

• At 1,000 units:
  • Base Unit Cost: $15.00
  • Amortized Tooling ($25k / 1k): $25.00
  • Scrap (3% of base cost): $0.45
  • Landed Costs (Freight/Duties): $2.00
  • True Landed Cost: $42.45
• At 25,000 units:
  • Base Unit Cost: $10.00 (volume discount)
  • Amortized Tooling ($25k / 25k): $1.00
  • Scrap (3% of base cost): $0.30
  • Landed Costs (Freight/Duties): $2.00
  • True Landed Cost: $13.30

This simple model visually demonstrates how dramatically your unit economics change with volume, driven far more by fixed-cost amortization than by the CM's tiered pricing alone. It transforms your ability to plan, fundraise, and set pricing with confidence.

From Theory to Practice: A Founder's Checklist for Manufacturing Cost Optimization

Translating this understanding into action does not require a large finance team. It requires discipline and a focus on the right metrics. What founders find actually works is a pragmatic approach grounded in their financial reality.

1. Scrutinize Every Quote: Do not accept a tiered pricing table at face value. Ask potential CMs to break out NRE and tooling costs from their per-unit pricing. Inquire about their typical yield rates so you can more accurately estimate your scrap cost. This level of detail is a key part of negotiating with contract manufacturers effectively and signals that you are a serious partner.
2. Build Your True Landed Cost Model: Create your own cost model in a spreadsheet. Start with the template described above and update it as you get new information from suppliers and freight forwarders. This model becomes your single source of truth for all production-related financial planning and is invaluable during investor diligence.
3. Run Scenarios to Mitigate Risk: Use your model to game out different situations. What happens to your unit cost if your first run is 5,000 units instead of 10,000? How does a 25% tariff impact your margin and target retail price? Answering these questions in a spreadsheet is free; learning these lessons with real cash is expensive.
4. Integrate Your Model with Your Financials: Connect your operational plan back to your accounting system. The cash-out timing for tooling and inventory must be reflected in your cash flow forecast in QuickBooks (common for US companies) or Xero (widely used in the UK). Your calculated True Landed Cost per Unit should be used to value your inventory on the balance sheet and calculate your cost of goods sold on the income statement. See the topic hub: Manufacturing Scale-Up Cost Forecasting. This discipline ensures your operational reality is perfectly aligned with your financial reporting, building confidence with investors and empowering you to scale successfully.

Frequently Asked Questions

Q: How can I negotiate a lower MOQ with my contract manufacturer?
A: To negotiate a lower MOQ, try offering a higher price per unit for the smaller run, placing a deposit for future orders, or asking to use more common components the factory already stocks. Building a strong relationship and demonstrating your long-term potential can also make manufacturers more flexible.

Q: What is the difference between tooling NRE and design NRE?
A: Tooling NRE is the one-time cost for physical manufacturing equipment like molds and fixtures. Design NRE refers to the upfront engineering work to finalize your product for manufacturing, also known as Design for Manufacturability (DFM). Both are fixed costs but tooling is typically paid to the CM while design NRE may be an internal cost or paid to a design firm.

Q: Should I amortize tooling costs over my first production run or the product's entire lifetime?
A: For early-stage startups, it is generally best to amortize tooling over the first one or two production runs. This provides a more conservative and realistic view of your initial unit economics and payback period. Spreading the cost over a hypothetical lifetime volume can artificially lower your unit cost and hide the immediate cash impact.

Q: How do I choose the right production volume for my initial cost calculations?
A: Base your initial volume on a conservative sales forecast, not an optimistic one. It is often wiser to calculate your True Landed Cost based on the manufacturer's MOQ, as this represents your most likely starting point. This ensures your pricing and financial model are based on a realistic, worst-case cost scenario.