13 Product Development Economics

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MSD606

PRODUCT DESIGN


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Chapter Table of Contents1. Introduction

2. Development Processes and Organizations

3. Product Planning

4. Identifying Customer Needs

5. Product Specifications6. Concept Generation

7. Concept Selection

8. Concept Testing

9. Product Architecture

10. Industrial Design11. Design for Manufacturing

12. Prototyping

13.Product Development Economics


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Concept Development Process

Build and Test Models and Prototypes

Benchmark Competitive Products

IdentifyCustomer

Needs

EstablishTarget

Specifications

GenerateProduct

Concepts

SelectProduct

Concept(s)

SetFinal

Specifications

PlanDownstreamDevelopment

MissionStatement Test

ProductConcept(s)

DevelopmentPlan

Perform Economic Analysis


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Case Study


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Quantitative analysis can capture only those factors that are measurable, yet projects

often have both positive and negative implications that are difficult to quantify. Alsoquantitative analysis rarely captures the characteristics of a dynamic and competitiveenvironment.

Qualitative Analysis

Qualitative analysis considers the interaction between the firm, the market and themacro economic environment


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Exhibit 15-5


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Exhibit 15-6


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Internal factorsDevelopment expense

Investigation cost

Development costDevelopment speed

Investigation timeDevelopment time

Production CostProduct Performance

Product

DevelopmentProject

Net Present Value

External factorsProduct Price

Sales VolumeCompetitive Environment

Exhibit 15-7 Key factors influencing development profitability


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A 20 percent decrease in development cost will increase NPV to $9,167,000. This

represents a dollar increase of $964,000 and a percentage increase of 11.8 in NPV.This is an extremely simple case: we assume we can achieve the same projectgoals by spending $1million less on development, and we therefore have increasedthe project value by the present value of the $1million in savings accrued over atime period of 1 year. The CI-700 development cost sensitivity analysis for a rangeof changes is shown in Exhibit 15-9. The values in the table are computed byentering the changes corresponding to each scenario into the base-case model andnoting the results. It is often useful to know the absolute dollar changes in NPV aswell as relative percentage changes, so we show both in the sensitivity table.


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Change inDevelopment

Cost,%

DevelopmentCost,

$ Thousands

Change inDevelopment

Cost, $Thousands

Change in

NVP, %

NVP,

$Thousands

Change inNVP,

$Thousands

502010

Base-10-10

-30

7,5006,0005,5005,0004,5004,000

2,500

2,5001,000

500base-500

1,000

2,500

-29.4-11.8-5.90.05.9

11.8

29.4

-2,412-964-482

0482964

2,412

5,7917,2387,7218,2038,6859,167

10,615


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Development Time Example

Consider the impact on project NPV of a 25% increase in development time. A 25%

increase in development would increase the development time from 4 quarters to 5quarters. This increase in development time would also delay the start of productionramp up, marketing efforts and product sales.

To perform the sensitivity analysis, we must make several assumptions about thechanges.

We assume the same total amount of development cost, even though we will increasethe time period over which the spending occurs thus lowering the rate of spending from$1.25 million to $1.0 million per quarter. We also assume that there is a fixed windowfor sales which starts as soon as the product enters the market and ends in the fourthQuarter of year 4. In effect, we assume we can sell product from the time we are ableto introduce it until a fixed date in the future. Note that these assumptions are unique to

this project. Different NPD projects would require different assumptions. For example,we might have instead assumed that the sales window simply shifts in time by onequarter. The change to the CI-700sfinancial model is shown in exhibit 15-10


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of the specific product context. In many cases the interactions are trade-off. For example,

decreasing development time may lead to lower product performance. Increased productperformance may require additional product cost. However, some of these interactions aremore complex than a simple trade-off. For example, decreasing product development timemay require an increase in development spending, yet extending development time mayalso lead to an increase in cost if the extension is caused by a delay in a critical task ratherthan a planned extension of the schedule.In general, these interactions are important because of the linkage between the internal

factors and the external factors. For example, increasing development cost or time enhanceproduct performance and therefore increase sales volumes allow higher prices. Decreasingdevelopment time may allow the product to reach the market sooner and thus increase insales volume.While accurate modelling of externally driven factors (e.g., price, sales volume) is often verydifficult, the quantitative model can nevertheless support decision making.

Exhibit 15-12 potentialinteractions betweeninternally driven factors


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Step 4 : Consider the influence of the qualitative factors on project success

Many factors influencing development projects are difficult to quantify as they are complex oruncertain. We refer to such factors as qualitative factors.

In t e r ac t i o n s b e t w e en t h e P r o j e c t a n d t h e F i r m a s a W h o l e

External i t ies: An externality is an unpricedcost or benefit imposed on one part of the firmby the actions of the second; costs are known as negative externalities and benefits as positiveexternalities. As an example of a positive externality, development learning on one project maybenefit other current or future projects but is paid far by the first project. How should the otherprojects account for such benefits gained at no additional cost? How should the first projectaccount for resources spent which benefit not only itself, but also other current or future

projects? S t r at e g i c f i t : Decisions of the development must not only benefit the project, but also beconsistent with the firms overall product plan and technology strategy. For example, how welldoes a proposed new product, technology or feature fit with the firms resources and objectives?Is it compatible with the firms emphasis on technical excellence? Is it compatible with the firmsemphasis on uniqueness?


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(Holding other things constant)


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13 Product Development Economics