Factory Pricing for Contract Manufacturing: Materials + Labour + Overhead + Margin

Why Small Manufacturers Win Contracts and Lose Money#

A pattern repeats itself in small contract manufacturing: a factory wins a major new contract, runs flat out for six months, then discovers they've made a 3% net margin — or less. The win felt like a success. The outcome feels like betrayal. The root cause is almost always the same: incomplete pricing. The quote was built from materials and direct labour only. Machine time allocation, facility overhead, tooling depreciation, quality control, shipping management, and SG&A were never factored in. The contract was priced like a direct cost, but the factory ran it like a business with full fixed costs. The gap between those two models is the margin that disappeared.

The Manufacturing Pricing Model: Step by Step#

Step 1 — Direct materials: raw material cost per unit, including inbound freight and any material wastage rate (typically 3-8% in machining, 5-15% in fabrication). Step 2 — Direct labour: machine operator time per unit × fully loaded labour rate (wage + national insurance + pension + training allowance). Step 3 — Machine overhead: machine depreciation + maintenance + power consumption per hour, allocated to each unit by machine cycle time. Step 4 — Facility overhead: rent, utilities, insurance, and indirect labour (supervisors, quality control, stores) allocated per direct labour hour or machine hour. Step 5 — SG&A: sales, general, and administrative costs allocated as a percentage of revenue (typically 8-15%). Step 6 — Target profit margin: applied to total cost.

Calculating the Full Cost: A Worked Example#

A precision-machined component. Direct materials: £4.80 (including 6% wastage). Direct labour: 12 minutes at £24/hr fully loaded = £4.80. Machine overhead: 8 minutes at £35/hr machine rate = £4.67. Facility overhead: allocated at £18/direct labour hour → 12 min = £3.60. SG&A: 10% of cost = £1.79. Total cost: £19.66. Target margin 18%: price = £19.66 ÷ 0.82 = £23.97. Most small factories quote this component at £14-16 — covering materials and direct labour but ignoring the rest. They wonder why the contract doesn't pay them.

Machine Rate Calculation: The Most Commonly Skipped Step#

Your machine rate is the true hourly cost of running each machine — not just the operator's wage. Machine rate = (annual depreciation + maintenance budget + power cost + tooling budget) ÷ annual productive hours. A CNC machining centre costing £85,000 depreciated over 7 years = £12,143/year depreciation. Annual maintenance: £4,500. Power (22kW at £0.28/kWh × 1,800 hours): £11,088. Tooling: £3,200. Total: £30,931 ÷ 1,800 productive hours = £17.18/hour machine rate. Add operator cost (£18/hour) and your total machining rate is £35.18/hour. If you're quoting based on operator time only at £18/hour, you're underpricing by almost 100% on machine-intensive work.

Overhead Absorption: Getting the Rate Right#

Facility overhead must be absorbed across all production — not just charged to large contracts. If your facility overhead is £12,000/month and you run 1,600 direct labour hours per month, your overhead recovery rate is £7.50 per direct labour hour. Every job quote should include this rate × the direct labour hours for that job. If you under-absorb overhead (running at 60% capacity), your overhead rate per unit increases — meaning you should price higher at lower volumes, not lower. Many small manufacturers do the opposite: they discount to win volume without realising that lower volume means higher overhead per unit and thinner margin.

AskBiz: Tracking Job Profitability Against Quote#

The best pricing model is useless if you can't verify whether actual jobs met the quoted margin. AskBiz integrates with Xero to capture actual material costs, labour hours, and overhead for each production job and compare them to the original quote. Where jobs run over budget — more material wastage than estimated, more machine hours than planned — AskBiz flags the variance. This data improves your quoting over time: you discover which job types consistently run over budget and adjust your estimates or overhead allocation accordingly.

Pricing for New Customers vs Long-Term Contracts#

New customer pricing should carry a risk premium: add 8-12% to your standard cost-plus price to compensate for setup costs, learning curve inefficiency, and the risk of scope change. Long-term contract pricing can be slightly lower — but only if volume and consistency genuinely reduce your overhead per unit. Many small manufacturers offer long-term contract discounts without modelling whether the discount is offset by genuine efficiency gains. AskBiz's job profitability reporting shows you the actual cost per unit across the first, third, and sixth months of a contract — giving you the data to negotiate contract renewals from a position of knowledge.

• Contract manufacturing pricing should follow a clear build-up: materials + direct labour + machine overhead + SG&A allocation + profit margin.
• Most small manufacturers skip the overhead and SG&A steps, resulting in quotes that look profitable but aren't.