Whether you’re licensing your invention to another company or going it alone, you will need — at some point — an evaluation of how much your invention is worth as a commercial product or the basis of a business. When negotiating, this allows you to know the value of what you’re offering, and when arranging finances (such as writing a business plan or applying for a loan), you are able to look to the future with more confidence. The evaluation will necessarily have to be rough, but is essential.
Some large companies (and most notably governments) opt to neglect this aspect of their business, as costs increase out of control on projects where the momentum is too great to halt, or where intra-company rivalries among departments prevent a consistent assessment (for example, BMC only found that each Mini was making a loss after rival Ford did its own assessment of just how BMC could be making the car for the money), but you are in the position, as an independent inventor, of being able to have a much fuller view of your product. While there are plenty of unknowns at an early stage, you can make decisions based on research rather than established commitments.
The total turnover from a product will differ depending on how it’s sold — through intermediaries or direct to the customer — and whether there are any other partners involved. From the turnover you receive, you would deduct the costs of manufacturing, transportation and so on incurred on the product to that point, to get the profit (pre-tax). Whether you choose to write off ‘sunk costs’ such as the money spent on developing the product in the first place, or amortise that over each product, is up to you: if those costs were paid for by a loan, you’ll pretty much have to amortise them.
A good route to determine the value of your invention, as a product, is to find a similar, existing product (your invention probably won’t have any direct competitors — it’s new, after all — but there will most likely be items which are sold to the same kinds of customers in the same kind of way), and attempt to work out how much that product is worth. If this is sold through, say, a chain of DIY stores or supermarkets, note the normal retail price (i.e. not a special offer, not a clearance item) and knock off 40% as the store’s margin, and 30% of what’s left as the distributor/wholesaler’s margin, if applicable (own-brand products may not always have this to the same extent), to leave 42% of the retail price — say 40% to be conservative.
Then take the product apart and look at the materials. Are they in similar proportion to those in your product? Injection-moulded plastic parts are very cheap individually, but the set-up costs are large and these must be amortised over each unit. Assuming that the product is profitable for the manufacturer, that 40% of the retail price represents the manufacturer’s production costs (materials, labour), whatever it is choosing to amortise on each unit (e.g. tooling, rent, equipment costs, management salaries), and the profit, which then gets split to pension fund, dividends, cash at bank, and so on. Can you compete with this? With little bargaining power, and lower volumes to start with (be conservative when estimating these), you will have to pay more for materials, but if you or your family are the sole labour and management costs then these will be less.
Also, if your product is truly innovative and offers new benefits to buyers, you can probably charge more than the established products in the field, and without shareholder pressure, making a large profit at this stage is not vital. If your costs for material, salary (if any), rent and money set aside for loan repayments come to less than 40% of the retail price of a competitor, then you are doing very well. Even if they don’t (and it’s likely they won’t), then assuming the retail price would still be realistic (multiply your cost figure by 250%) then you may still be in the game, because of the innovation price premium mentioned earlier. But if you’re nowhere near, then you need to consider reducing the production costs of your product. Can you use cheaper materials? Can you use fewer parts to achieve the same function, e.g. by combining functions into a single part? Can you design your product to be quicker or simpler to assemble?
Its here that evaluating a product’s value can come into its own: changes suggested by doing the evaluation can improve the design of a product as well as reducing the costs, which will put your invention even further ahead of the competition.