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Integrated Product Development

Integrated Product 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

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Integrated Product Development

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  1. Integrated Product Development Economics

  2. 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

  3. Costs • Product’s total cost to produce and market Cp 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

  4. The costs of the customer • The customer has several costs: • Purchase cost • Ownership costs • Use • Maintenance • Insurance • Amortization...

  5. 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

  6. 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…)

  7. 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

  8. 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)

  9. 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?...)

  10. Economic Analysis Process • Building a Base-Case Financial Model • Perform a sensitivity analysis • Use the sensitivity analysis to understand project trade-offs • Consider qualitative factors

  11. 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

  12. Example • If you invest 100 € today for one time period at an interest rate of 8%, how much money will you get?

  13. 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%

  14. 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%

  15. Example • Present value (x0) of received value (x) after (t) time periodsif the interest rate per period is (k)

  16. 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%?

  17. 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%

  18. 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

  19. 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

  20. Example • Cost estimates x 1000€ • Development1000 € • Production ramp-up750 € • Marketing and support 300 € /year • Unit production 0.2 € /unit • Sales and production volume20000 unit/year • Unit price0.3€ /unit

  21. Example – project schedule

  22. 2. Perform Sensitivity Analysis 3. Use analysis to understand projet trade-offs

  23. 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)

  24. 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

  25. 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) • ...

  26. Interaction with the market • Competitors • Customers • Suppliers • ...

  27. Interaction with the macro environment • Major economic shifts (exchange rates, materials prices, labor costs…) • Government regulations • Social trends • ...

  28. 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, PAand PB, probabilities,PVAand PVB present values, then NPV=PA*PVA+PB*PVB, ahol PA+PB=1

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