## Monday, June 18, 2012

### The Cost of Manufacturing

So the reader goes to their local gun dealer's shop and decides to purchase a firearm. Say, this dealer's shop has a brand new firearm with a manufacturer suggested retail price (MSRP) of \$1000. So what is the cost of manufacturing such a firearm and what justifies such a high price, the reader asks?

Here's how the cost breakdown is in the firearms industry. The MSRP is typically around 40% above what the local dealer got it for, therefore it means that the price that the dealer must have purchased it for works out to about \$715.

Instead of selling it to the customer for the MSRP price of \$1000 though, the dealer may sell it at a "street price", which is around 15-20% of what he paid for it. So the customer may only pay something between \$820-860 or so, instead of paying \$1000. However, the dealer still makes a profit of 15-20% here. The profit that the dealer makes goes to pay the rent, employees, electricity, gas etc. + a little profit for the owner. Gun dealers also make money from selling used firearms (where the margins are around 30-35%), ammunition, extra magazines, accessories, cleaning supplies etc. (which may sell at 50% margins or so), so that's how they manage to stay in business.

Now, we've figured out the dealer purchased the firearm for around \$715 from a wholesale distributor. The wholesaler in turn, purchases the firearm from the manufacturer and sells it to your local dealer at 25-35% margin. Therefore, working backwards from \$715, we calculate that the wholesaler purchased them from the firearm manufacturer for about \$530-\$570 each. Some of the profit they make goes into paying for warehouses, shipping to local dealers, advertising in trade shows, paying employees etc.

So, the wholesaler gets the firearms for \$530-\$570 each, but the firearms manufacturer sells them to the dealer with around 2x the cost for them. Again, working the math backwards, this means that it costs the firearms manufacturer about \$265-\$285 to manufacture the firearm. This cost includes not only the cost of the raw materials, but also cost of tools, research and development costs, factory cost, employee pay etc. Some of the profits go into advertising, paying lawyers, rent, future research and development, paying stockholders etc. If we count just the cost of raw materials and components, it is typically around 50% of the manufacturing cost, which works out to about \$130-\$145 for just the raw materials alone.

So, we calculate that for a cost of around \$265-\$285 to manufacture, the MSRP is \$1000, which means the manufacturing cost is around 1/4th to 1/3rd of the MSRP. This ratio is also about the same as that of many other manufacturing industries as well.

Of course, these are just rough guesses, so what does the price look like for a real manufacturer. From a 2003 article in Forbes magazine, we find that a Glock pistol that retailed for about \$500 then cost Glock GmBH only about \$75 to manufacture. Which means that the sell price was over 6x the manufacturer cost! Remember though that Glock was actually wanting to retail for cheaper, except that a marketing guy persuaded the company to sell for higher margins, otherwise the gun would appear too cheap and not be taken seriously! Also, they sell very large volumes of products, so the unit cost is significantly reduced because of this.