Integrated

Integrated Product
Product
Development
Development
Economics
 Introduction
• Value is defined as the ratio of perceived quality of a product to
its cost
• One of the primary goals of the IPD team is to create a product
for the least cost, while still satisfying the customer’s
requirements
• The amount of savings should not only be in relation to cost of
the product, but also in relation to an increase in the total profit
to the company
• First, the selling price of the product at which the product can
succeed in the marketplace should be determined, and than the
costs are targeted and allocated (Design for Costs)
• Selling price – Costs = Profit
• Costs evaluation is performed throughout the product
development, but the detailed cost estimates can take place
during the embodiment stage
 Costs
• Product’s total cost to produce and market Cp

C p  N p ( M  L  R)  To  S  D
Np - Total number of units
M- Material cost/unit
L- Direct labor for manufacturing and assembly/unit
R- Production resource usage/unit
To - Tooling and capitalization costs (Usually one-time costs)
S- System costs (overhead or indirect costs) (rent, maintenance…)
D- Development costs
Selling price – Total cost of
product and desired total
profit

Total cost of product

Total product
Total manufacturing General and
development Marketing and sales (S)
costs Administrative (S)
costs

Direct and variable

Product design
material
(D)
(Np*M)

Tooling and Direct and variable

capitalization (To) Labour (Np*L)

Direct and variable

Testing and
Manufacturing systems
Evaluating (D)
(Np*R)

Overhead on
Engineering activities
(S)

Total pretax profit

 T o ta l s a le s

T o ta l o p e ra tin g
p ro fit

T o ta l in v e s tm e n t

B re a k -e v e n
a fte r re le a s e

T im e to m a rk e t

P ro d u c t P ro d u c t
d e fin itio n d e v e lo p m e n t M a n u fa c tu rin g a n d s a le s

T im e
 The costs of the
customer
• The customer has several costs:
– Purchase cost
– Ownership costs
• Use
• Maintenance
• Insurance
• Amortization...
 Elements of Economic
Analysis
• The product development team needs
tools to make decisions in the
development phase
• There is a need for quick, approximate
methods for supporting decision making
within the project team
• There are two types of analysis:
• Quantitative
• Qualitative
 Quantitative analysis
• There are several basic cash inflows (revenues)
and cash outflows (costs) in the life cycle of a
successful new product
• Cash inflows come from product sales
• Cash outflows are several:
– Product and process development
– Production ramp-up (equipment and tooling)
– Marketing and product support
– Production costs (raw material, components, labor…)
 Quantitative analysis
• Economically successful products are
profitable; they generate more cumulative
inflows than cumulative outflows
• A measure of the degree to which inflows
are greater then outflows is the net
present value of the project NPV, or the
value of today’s money of all of the
expected future cash flows
 Qualitative analysis
• Quantitative analysis is restricted only to factors
that are measurable
• There is a need for qualitative analysis
considering the interactions between the project
and the
– Firm
– Market
– Macroeconomic environment
(today, something is a loss, but if it is done, in future it
would be a profit. If it isn’t done, in future it would be a
huge loss)
 When to perform a cost
analysis?
• Go/no-go milestones
– (should we try to address this opportunity?
Should we launch the product now? Should we
proceed with the selected concept?...)
• Operational design and development
decisions
– (should we outsource the development? Should
we sell now at high prices or later at low?...)
 Economic Analysis
Process
1. Building a Base-Case Financial Model
2. Perform a sensitivity analysis
3. Use the sensitivity analysis to
understand project trade-offs
4. Consider qualitative factors
 Building a Base-Case
Financial Model
NPV of a project
• A net present value is a recognition
of the fact that a money today is
worth more than a money tomorrow
• NPV calculations evaluate the
present value of some future income
or expense
 Example
• If you invest 100 € today for one time
period at an interest rate of 8%, how much
money will you get?

x0  100euro
k  8%  0.08
x?
x  x0  kx0  (1  k ) x0  (1  0.08) *100  108euro
 Example
• How much was invested originally (how much is it
worth now) if after the one time period the amount
of money received back is 100€ if the interest rate
is 8%
x0  ?
k  8%  0.08
x  100euro
x  x0  kx0  (1  k ) x0 
x 100
x0    92.59euro
(1  k ) (1  0.08)
 Example
• How much was invested originally (how much is it
worth now) if after two time periods the amount of
money received back is 100€ if the interest rate
per period is 8%
x0  ?
k  8%  0.08
x  100euro
x  x0  kx0  (1  k ) x0 
x
x 100
x0  (1  k )    85.7euro
(1  k ) (1  k ) 2 (1  0.08) 2
 Example
• Present value (x0) of received value (x)
after (t) time periods if the interest rate
per period is (k)

x
x0 
(1  k ) t
 Example
• How much was invested originally (how much is it worth now)
if after one time period the amount of money received back is
100€, after two time periods the amount of money received
back is 100€ and after three time periods the amount of
money received back is 100€ if the interest rate per period is
8%?
x0  ?
k  8%  0.08
t1  1
t2  2
t3  3
x1  x2  x3  x  100euro   x  300euro
3
xt x x x 100 100 100
x0    0        257.7euro
t 0 (1  k )t (1  k ) t1 (1  k ) t2 (1  k ) t3 (1  0.08) (1  0.08) 2 (1  0.08)3
 Interest rate – discount
rate
• The discount rate is the reward that investors
demand for accepting delayed payment
• It is a key variable for NPV calculation
• Sometimes the firm’s weighted average cost of
capital is used, but for riskier project a higher
rate is used
• Another approach to choosing the discount rate
factor is to decide the rate which the capital
needed for the project could return if invested in
an alternative venture
• Usually it is between 10% and 20%
 1. Building a Base-Case
Financial Model
• Constructing the base-case model consists of estimating
the timing and magnitude of future cash flows and then
computing the NPV of those cash flows
• The level of detail of cash flows should be determined to
be convenient to work with but it should be detailed
enough to facilitate effective decision making
• Development costs
• Ramp-up costs
• Marketing and support costs
• Production costs
• Sales revenues
 Building a Base-Case
Financial Model
• The numerical values of the cash flows
come from budgets and other estimates
obtained from the development team,
the manufacturing organization, and the
marketing organization
• The financial estimates must be merged
with timing information
 Example
• Cost estimates x 1000€
1. Development 1000 €
2. Production ramp-up 750 €
3. Marketing and support 300 € /year
4. Unit production 0.2 € /unit
5. Sales and production volume 20000
unit/year
6. Unit price 0.3 € /unit
 Example – project
schedule

1. year 2. year 3. year 4. year

1. q 2. q 3. q 4. q 1. q 2. q 3. q 4. q 1. q 2. q 3. q 4. q 1. q 2. q 3. q 4. q
Development
Production ramp-up
Marketing and support
Production an sales
2.Perform Sensitivity Analysis
3.Use analysis to understand projet
trade-offs
 Limitations of
quantitative analysis
• It focuses only on measurable quantities
• It depends on validity of assumptions and
data
• Bureaucracy reduces productivity
(potentially productive development time is
devoted to preparation of analyses and
meetings)
 4. Considering the
qualitative factors on
project success
• Many factors influencing
development projects are difficult to
quantify because they are complex or
uncertain
• The development project interacts
with the firm, the market and the
macro environment
Interaction between the
project and the firm
• How does the project influences the
other projects
– The results from one project can be
used by another project (OK)
– A project uses to much resources to be
finished on time, therefore other
projects are late (NOT OK)
– ...
 Interaction with the
market
• Competitors
• Customers
• Suppliers
• ...
 Interaction with the
macro environment
• Major economic shifts (exchange
rates, materials prices, labor costs…)
• Government regulations
• Social trends
• ...
 Modeling uncertain cash
flows using net present
value analysis
• Example
– Analyzing scenarios
– There are different scenarios for an outcome
– The probability to each scenario can be
defined
– The present value to each scenario can be
defined
– If there are two scenarios A and B, PA and PB,
probabilities, PVA and PVB present values, then
NPV=PA*PVA+PB*PVB, ahol PA+PB=1