There are three financing models for new product design and development:
Flat Fee, Hourly Fee For Service, and Reduced Fee + Equity.
Searching for a product design firm to help with your new product idea is tough. A quick Google search will give you dozens of potential firms with a range of services, pricing models, and experience.
The challenge is choosing the right firm that will deliver a successful project right, the first time. Understand what finance models firms offer will help you make the right choice.
To help we have put together the three most common financing models you will face when searching for hardgoods (physical) product design firms and how you can budget the development cost of your project.
There are three financing model's product design firms use to charge clients. It is always best to review who you hire and ask specific targeted questions up front.
1) Flat Fee (Fixed Price):
The first popular finance model is a Flat Project Fee, when you have very clear inputs, specifications and requirements and well-defined outputs and expectations to design to.
This model is often favored by startups that report to investors because costs and burn rates can be predicted and locked in. But as with all physical product development where the product has innovative with new features, changes to the product definition will occur, decision on features must be tied to user value and not program cost and the effort and budget will grow.
Fix price models are best reserved for product variants where the variables that are being investigated are few and the known elements of the product make up more than 80% of the design. (Example would be a re-design of an existing product or a copycat of another product in the market where the goal is to make changes to how the product looks and the electronics and user interface are remaining substantially the same).
Use the 80% known and fixed and 20% innovative and new rule and you can find companies will to fix quote and also to not surprise you with up-charges on scope changes.
Type of Firms you can approach depending on the nature of the work: Industrial Design Consultancies, Mechanical Engineering Firms, Electronics Design Firms, Full-Service design to manufacturing firms, Manufacturers with an ODM manufacturing department.
2) Fee For Service:
The second service for hire model works best for both parties when the product ideas are not defined enough where hard requirement specifications are not yet possible as and cannot be precisely specified, quantified and tested. This is the most common partnership arrangement for outsourced physical product design where innovation and new product value requires exploration and testing of potential concepts to meet the needs of users in the new potential market segment.
Generally, there are parts of the design and engineering work that can be fixed cost and other parts that require exploration, testing and iteration to fine tune the new value. A working model between the two parties is arrived at by separating the higher-risk exploratory elements from the more predictable parts of the work that can be fixed cost.
Rates for full-service design plus engineering companies are similar to model 1 and will range from ($100 USD up to $450 USD per hour) depending on who you hire, where they are located, what markets they serve and their track record and network they can leverage on your behalf.
You will always be able to find cheaper hourly-rates down to $25/hour by souring independent freelancers and managing them yourself, overseas companies and manufacturers that compete on initial price to gain the work then use scope creep and decision changes to drive up the fees.
Payment for this model is usually done in stages, based on milestones or monthly effort with a deposit up front to start the work.
3) Fee + Equity/Royalties:
This model is favored when your goal is to find a partner willing to commit to your idea, reduce their rates and take risk on your opportunity to drive down the initial cost of development and defer the development cost until revenue on product from sales or with equity until the company gets acquired. There are pitfalls and opportunities with this model. Inventors, entrepreneurs and startups have limited cash to deploy across many activities to fund. Sharing the risk and reward with the outsourced design partner has a tremendous early stage appeal.
The first challenge will be to find a reputable company to work with. Established companies with a strong track record steer away from this model because the R&D is a short-term activity finished in under a year. If you can convince an established company you have a hit, the royalty on a successful product which can quickly turn into 3 times the development fees they would have charged.
Be wary as design firms will discount an inflated hourly rate and ask royalties. Careful shopping to find the competitive hourly rate baseline then reducing from this level for royalties is recommended.
The downsides, many hardware startup companies go through refinancing and hard times during the startup stage and these contractual relationships become additional costly legal situations to resolve. If the product fails then this is a great model but is it wise to go into a venture with the mindset of planning for the product to fail. Intellectual property often gets tied up in these deals as both parties want to protect their downside failure and the IP is difficult to untangle and costly.
There are great success stories with this financing model however these stories are the exception. Design companies know how to develop great products when the targets are specified well by the business team. Good design helps a lot but does not make a business successful on its own, the business team will ultimately determine the success and failure of the venture.
With this equity or royalty financing model the design company is put in a situation of trying to recover their losses when things don’t go to plan (happens when designing new hardware 80% of the time). Just when you want creative risk takers at the table to continue to invest without pay the design company has hard costs of staff to deal with and are placed in a situation set up for failure.
Which pricing model is best for you?
It comes back to looking carefully at how innovative and exploratory you need to be with your new design. Are you doing incremental design with known technologies, components and interfaces OR will it require significant R&D and IP developed? Generally, the more defined or incremental the design innovation is the better the Fee model 1 and 3 can be for a successful outcome.
It may be wise to start in fee model 2 until you have very good definition then switch to model 1 or 3 if you see advantage to do so and you find a suitable design, engineering and manufacturing company that fits your business model.
The lower the design innovation risk and the more lucrative the market the more money the R&D will cost you with fee model 3. With products that have a good run in the market for 10 years as an example, the total cost of the R&D in fees and royalties can be more than 10 times the fee for service model.
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