Integrated Product Integrated Product
Development Development
Integrated Product Integrated Product
Development Development
Economics
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 = ProfitSelling price – Costs = Profit
• Costs evaluation is performed throughout the product
development, but the detailed cost estimates can take place
Costs
• Product’s total cost to produce and market Cp
D S
T R
L M
N
Cp p( ) o
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…)
Selling price – Total cost of product and desired total
profit
Total cost of product
Total product development
costs
Total manufacturing
costs Marketing and sales (S) General and Administrative (S)
Product design (D)
Tooling and capitalization (To)
Testing and Evaluating (D)
Direct and variable material
(Np*M)
Direct and variable Labour (Np*L)
Direct and variable Manufacturing systems
(Np*R)
T o t a l i n v e s t m e n t
T i m e t o m a r k e t P r o d u c t
B r e a k - e v e n a f t e r r e l e a s e
T o t a l s a l e s
T o t a l o p e r a t i n g p r o f i t
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?
euro x
k kx
x x x k
euro x
108 100
* ) 08 . 0 1 ( )
1 (
?
08 . 0
% 8
100
0 0
0 0
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%
x k kx
x x
euro x
k x
) 1
( 100
08 . 0
% 8
?
0 0
0 0
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%
x k kx
x x
euro x
k x
) 1
( 100
08 . 0
% 8
?
0 0
0 0
Example
• Present value ( x
0) of received value ( x ) after ( t ) time periods if the interest rate per period is ( k )
k
tx x
) 1
0
(
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%?
euro x
euro x
x x x t t t k x
300 100
3 2 1
08 . 0
% 8
?
3 2 1 3 2 1 0
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
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=P *PV +P *PV , ahol P +P =1
