Lecture 23 Product Development Econonmics

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Lecture 23Product Development Econonmics

• Progress memos due by COB each Monday
• Gantt Chart due by COB today W 11/14
• Three minute elevator pitch in class F 11/6
• Send PPT slides to hjs1_at_psu.edu before 800 AM
• Proposals due by COB on F 11/30
• Preliminary testing in class F 12/7
• Final testing in class W 12/12
• LF Showcase at HUB on R 12/13
• Final report due by COB on F 12/14

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Product Development Economicsref Ch.15
Product Design and Development, By Ulrich
Eppinger, 3rd Edition
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• All decisions are based on economics

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Economic justification for your mini-vac

• Inputs required
• Development Cost
• Ramp-up Cost
• Marketing and Support
• Unit Product Cost
• Unit Price
• Sales Volume 100,000/year for 4 years

Make reasonable estimates
What is the NPV and ROI (return on investment)
for r 10?
A preliminary estimate should appear in your
proposal. A detailed analysis must be included
in your final report
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Decisions based on economic estimates are made at
many points during the product development process

• Go/No-Go Decision Gates
• Sensitivity and Trade-off Analysis

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Example - Polaroid Color Photo Printer
Estimated Economics Development Cost 5M Ramp-up
Cost 2M Marketing and Support 1M/year Unit
Product Cost 400/unit Sales Volume 20,000/year U
nit Price 800
Should Polaroid Proceed?
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A typical assignment for a rookie engineer A
purchase decision, in this case, for a 20 HP
motor to run an air conditioning compressor
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Economic Justification

• What is the total cost of your solution?
• Direct cost of components
• Labor
• Development costs (including your time)
• Tooling (molds, jigs, etc)
• Other (legal, marketing, advertising, service,
  etc)
• What are the savings?
• Direct labor
• Quality Improvement (reliability, less scrap)
• Other (repetitive stress, job satisfaction,
  customer satisfaction, hearing loss, etc)

Overhead
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Product Development Cash Flow
Cumulative Cash Inflow or Outflow ()
Time
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Economic Analyses are used to make go/no-go
decisions and to manage trade-offs

• Should we spend 100K more in development to get
  to market two months sooner?
• Should we launch the product in four months at a
  unit cost of 450, or wait 6 months when we can
  reduce the cost to 400 ?
• Do we purchase a motor for 20K or one for 30K
  that has lower operating and maintenance costs?

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Three metrics are commonly used to assess project
economics

• Net Present Value (NPV) the present worth of
  the total costs and profits over the period of
  the project at an assumed interest rate.
• Return on Investment (ROI) The equivalent rate
  of return that an investment in this project
  would earn
• Payback Period how long it takes before the
  investment pays for itself (break even)

Most common method is NPV (according to our text)
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• Positive NPV means that the project is a better
  investment than simply investing at the
  prevailing interest rate (also called the
  discount rate)

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Business 101 - Buy low, sell high

• The time value of money
• If you had a choice of receiving 100 today, or
  120 one year from now, what would you choose?

Future
Interest rate
Today
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Is the project economically attractive?
If you just put money in the bank
Discount (Interest) Rate
Amount invested (spent on project)
Today
Future Date
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Net Present Value
period cash flow
S
NPV
period
(1 discount rate)
periods
N
C
S
i
NPV
i
(1 r)
i 1
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Comparing NPV of two alternatives

• Expenditure
• do we purchase machine A or B?
• Best alternative has lower NPV (lower total cost)
• Investment or Product launch
• do we introduce product A or B
• Best alternative has higher NPV (higher total
  profit)

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Motor Selection Example total cost of Blaylock
motor is 55,724
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Ajax motor is better purchase because it has its
total cost is 42,620
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ROI
The interest rate that makes NPV0
S
period cash flow
0
NPV
period
(1 discount rate)
periods
N
C
S
i
NPV
i
(1 r)
i 1
Solve for r that makes NPV0
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Inputs required for NPV Analysis

• Development cost and timing
• Testing cost and timing
• Tooling investment and timing
• Ramp-up cost and timing
• Marketing and support cost and timing
• Sales volume and lifetime
• Unit production cost
• Unit revenue
• Discount rate

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Use Appendix B to estimate component
manufacturing costs
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Economic Trade-offs
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Basic Economic Trends

• ? NPV increases as ?
• Product Cost ? ?
• Sales Price ? ?
• Development Cost ? ?
• Time to Market ? ?
• Interest Rate ? ?
• Sales Volume ? ?
• Quality ? ?

• But which factors are most important?
• What are the trade-offs?
• We need a tool to help us do what-if studies

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A simple spreadsheet is all we need. Example -
Polaroid Printer analysis, Exhibit 15-6
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Reasons to Proceed, even if NPV is negative

• Benefit to related products HP
  Inkjet Printer, Razors
• Development of core competencies Pontiac Fiero,
  Toyota Prius
• Competitive response Formula 409
• Goodwill Voluntary product recalls
• Corporate Image Halo
• Ford GT40, Corvette, Viper

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An analysis is only as good as the assumptions it
is based on. It can be hard to predict

• Interest rate
• Economic trends
• Social trends
• Brand loyalty
• Political events
• Emergence of new technologies (ex. demise of
  Kodaks film business)