Project Economics in New Product Development
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Make project tradeoffs based on the economic impact of your choices vs. gut feel or intuition. Learn how to create a project model based on economic impact.
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Project Economics in New Product Development
- 1. This work is licensed under a Creative Commons Attribution-NoDerivs 3.0 Unported License. Project Economics PLAYBOOK LEAN PRODUCT DEVELOPMENT SERIES PLAYBOOKHQ.co @PLAYBOOKHQ
- 2. PLAYBOOK LEAN PRODUCT DEVELOPMENT SERIES This series is for anyone interested in Flow, Lean, Agile and team principles and how they can be applied in new product development scenarios to increase innovation, improve delivery times and create engaged, happy, high-performing teams. PLAYBOOKHQ.co @PLAYBOOKHQ
- 3. Notes: 1. Maximizing Business Value (typically profit) is our goal. 2. In most cases Business Value primarily driven by value delivered to the end customer. PLAYBOOKHQ.co @PLAYBOOKHQ
- 4. Notes: 1. The Goal is to _______________ profit. 2. Profit = Revenue – Product Cost – _______________ 3. Cost is a Decrease in Profit either by: a. Increasing Project Expenses or Product Cost (Actual Costs) OR b. Decreasing Revenue (Lost Opportunity Costs) c. Generally, Lost Opportunity Costs are much _______________ than Actual Costs PLAYBOOKHQ.co @PLAYBOOKHQ
- 5. Notes: 1. Analysis combined with intuition is better than intuition alone. a. _______________ is average variability in intuition across individuals (100 to 1 is common). b. Even with simplified analysis, the accuracy is improved. 2. The recommended unit of measure is company profit. a. When comparing decision options, they must be compared in the same units. Otherwise, how would you compare a development delay (schedule slip) to a request to add a new feature (scope creep) to a unit cost reduction exercise? b. The unit you measure determines your behavior. i. A focus on departmental labor costs results in _______________ efficiencies... ii. …which increases development _______________ resulting in reduced profits. iii. Typical examples: • Engineering waits for a complete set of requirements before starting. • Manufacturing wants a complete design to review once. • What others can you think of? ________________________________________________________ 3. Therefore, the unit that drives us to our goal is profit. a. Always ask – which decision will make the most money? b. Use Economic Modeling to convert decision options into projected profits. PLAYBOOKHQ.co @PLAYBOOKHQ
- 6. Notes: 1. There are three types of Economic Models: Project, Application, and Process. We will focus on Project models, which… a. enable tradeoff _______________ within a project... b. …that are based on economics rather than _______________. 2. The Project Economic Model (PEM) is a simple, straightforward financial analysis (Profit & Loss statement) a. Everyone can understand it. b. Not perfect, but good enough and easy to understand. c. Can be customized to fit current financial projection tools, product families, etc. PLAYBOOKHQ.co @PLAYBOOKHQ
- 7. Notes: 1. The Standard Inputs to the Economic Model are: a. Expenses (Engineering, Marketing, Test, Tooling, Prototype parts, etc.) Any expense related to executing the project, outside of Unit Cost. b. Unit Cost The total cost of materials and labor required to produce each unit. c. Product Performance The expected sales volumes and sales price. d. Schedule Impact to sales forecasts and pricing as a function of time. e. Risk The probability that potential impacts will be realized. 2. The output is in Profit after ‘X’ years… a. … where ‘X’ is the product life or a shorter number of years, b. ‘X’ is typically chosen by Management and should be consistent across products. 3. There are always tradeoffs between these parameters. a. This is a way of quantifying the tradeoffs. b. It is the Triple Constraint (Schedule, Resources, Scope) in terms you can use to determine how a proposed change will impact profitability. 4. _______________ costs are typically much larger than the _______________ costs. PLAYBOOKHQ.co @PLAYBOOKHQ
- 8. Notes: 1. Typically, when a product is late to market, it never reaches the maximum sales volumes expected had it been launched on time. 2. Typically, when a product is early to market, it reaches a higher maximum sales volume than expected if it had been launched on time. PLAYBOOKHQ.co @PLAYBOOKHQ
- 9. Notes: 1. The lost revenue s the difference between the Baseline and Delayed curves. PLAYBOOKHQ.co @PLAYBOOKHQ
- 12. Notes: Scenario A - Expedite Long-Lead Parts Pay $3000 to expedite some critical components to save 2 days of schedule. 1. Do you make this bet? 2. How much does it increase or decrease your profit? 3. Does this make the decision clear? If not, why? 4. Would you have arrived at the same decision if you hadn’t done this analysis? PLAYBOOKHQ.co @PLAYBOOKHQ
- 13. Notes: Scenario B – Improve Product Performance Unit cost increases $10, no additional capital equipment is required, the project extends 5 wks, and adds $75K for additional development and validation. Improved performance is expected to increase sales 2%. 1. Do you make this bet? 2. How much does it increase or decrease your profit? 3. Does this make the decision clear? If not, why? 4. Would you have arrived at the same decision if you hadn’t done this analysis? 5. How much would sales need to increase to breakeven? PLAYBOOKHQ.co @PLAYBOOKHQ
- 14. Notes: • These formulas can be used to quickly assess tradeoffs in lieu of using the spreadsheet. • Sensitivities for Sales, Schedule, and Unit Cost refer to A, B, and C above. • Increases in Sales, Schedule, Unit Cost, and Expenses and are expressed as POSITIVE values. • See D, E, F, and G above. Examples: 1. Do you add a feature which will increase sales 2% and add 2 weeks to the schedule? _______ * _______ - _______ * _______ - _______ * _______ - __________ = _____________ 2. What if it also adds $10 to the unit cost? _______ * _______ - _______ * _______ - _______ * _______ - __________ = _____________ 3. What if it requires $50K added expenses (labor, tooling, etc.)? _______ * _______ - _______ * _______ - _______ * _______ - __________ = _____________ PLAYBOOKHQ.co @PLAYBOOKHQ
- 15. Notes: 1. When making economic decisions involving expense money, you want to make more than 1 ____________________ dollar for every ____________ dollar you spend. 2. Opportunity dollars are ___________________ (you may not get that dollar back). 3. Usually you want to make ________________ than 1 Opportunity dollar per expense dollar. 4. The Minimum Decision ROI should be determined by ______________________. 5. Above this ROI you probably do it. Below this ROI, you probably don’t. PLAYBOOKHQ.co @PLAYBOOKHQ
- 16. Notes: 1. A baseline Minimum Decision ROI has been established (sort-of) – the ROI for the project. 2. The Project ROI is the Average ROI of all Project Work & Decisions 3. When evaluating tradeoffs, if your Decision ROI > Project ROI, you will increase the overall ROI for the project. If your Decision ROI is less, you decrease the overall ROI for the project. 4. When additional expense dollars are held tightly, or when ROIs of other competing projects are greater, your Minimum Decision ROI may need to be greater than the Project ROI. 5. You may still make money by accepting Decision ROIs lower than the Project ROI as long as they are still large. PLAYBOOKHQ.co @PLAYBOOKHQ
- 19. Notes: Risk simply means there’s a chance you’ll get an unexpected outcome (which might take the form of a failure). PLAYBOOKHQ.co @PLAYBOOKHQ
- 20. Notes: 1. Determine values of EMV and ROI for the options above: a. ____________________ b. ____________________ c. ____________________ 2. Applying lean thinking to Option A, would you invest $10K if it would increase the probability of success to 75%. a. EMV _______________ b. ROI _______________ 3. Do you see a large batch in the any of the options? Explain. PLAYBOOKHQ.co @PLAYBOOKHQ
- 22. Notes: 1. Since there’s always uncertainty in the sales forecasts, consider modeling the project economics on conservative estimates. 2. This can go a long way toward gaining organizational buy-in to use and leverage Project Economic Models (PEM). 3. Typically you’ll come to the same decisions, i.e. the tradeoff decisions based on the PEM will be the same, because the economic parameters have about the same relative importance. PLAYBOOKHQ.co @PLAYBOOKHQ
- 23. Notes: 1. Which project is more important? a. Use Cost of Delay (COD) b. Project A’s COD * the amount of Delay incurred by working on Project B vs. Project B’s COD * the amount of Delay incurred by working on Project A c. The higher the number, the greater the potential loss of profit, therefore the higher the project’s priority. PLAYBOOKHQ.co @PLAYBOOKHQ
- 24. PEM Tips • Develop with a cross-functional team • Do the modeling early in program • Embed the model in your planning process • Have a clear Process Owner responsible for organizational acceptance, improvements, etc. • Focus on critical assumptions (unit sales, baseline schedule, delay scenario) • Update quarterly, or when key assumptions change • Communicate the results to the entire team & management • Use an economic basis for making decisions PLAYBOOKHQ.co @PLAYBOOKHQ
- 25. Key Takeaways • Projects of all types can be modeled on the basis of their economics. • All decisions can be more widely accepted and objective when based on the economic impact on profit. • … when you use a consistent, simple, company-accepted tool and process. • Faster decisions can be made with clear project level guidelines & buying limits (Minimum Decision ROIs). • This results in projects that are more profitable. PLAYBOOKHQ.co @PLAYBOOKHQ
- 26. Want to See More? Read more about making project decisions based on economic impact on Audible Ready, the #1 blog for teams engaged in Agile, Lean and Flow in new product development. – Profit Based New Product Development Decisions: Part 1 – Introduction to Cost of Delay Graphical Economic Models of Various Project Types – – – – – – New to the Company Product Product Enhancement Replacement/Next Generation Product Sustaining Cost Reduction Regulatory or Component End of Life (EOL) Feasibility Studies to Improve Products PLAYBOOKHQ.co @PLAYBOOKHQ
Editor's Notes
- Notes:Typically, when a product is late to market, it never reaches the maximum sales volumes expected had it been launched on time.Typically, when a product is early to market, it reaches a higher maximum sales volume than expected if it had been launched on time.
- Notes:The lost revenue s the difference between the Baseline and Delayed curves.
- Notes:
- Notes:These formulas can be used to quickly assess tradeoffs in lieu of using the spreadsheet.Sensitivities for Sales, Schedule, and Unit Cost refer to A, B, and C above.Increases in Sales, Schedule, Unit Cost, and Expenses and are expressed as POSITIVE values.See D, E, F, and G above.Examples:Do you add a feature which will increase sales 2% and add 2 weeks to the schedule?_______ * _______ - _______ * _______ - _______ * _______ - __________ = _____________What if it also adds $10 to the unit cost? _______ * _______ - _______ * _______ - _______ * _______ - __________ = _____________What if it requires $50K added expenses (labor, tooling, etc.)?_______ * _______ - _______ * _______ - _______ * _______ - __________ = _____________
- Notes:When making economic decisions involving expense money, you want to make more than 1 ____________________ dollar for every ____________ dollar you spend.Opportunity dollars are ___________________ (you may not get that dollar back).Usually you want to make ________________ than 1 Opportunity dollar per expense dollar.The Minimum Decision ROI should be determined by ______________________. Above this ROI you probably do it. Below this ROI, you probably don’t.
- Notes:A baseline Minimum Decision ROI has been established (sort-of) – the ROI for the project.The Project ROI is the Average ROI of all Project Work & DecisionsWhen evaluating tradeoffs, if your Decision ROI > Project ROI, you will increase the overall ROI for the project. If your Decision ROI is less, you decrease the overall ROI for the project.When additional expense dollars are held tightly, or when ROIs of other competing projects are greater, your Minimum Decision ROI may need to be greater than the Project ROI.You may still make money by accepting Decision ROIs lower than the Project ROI as long as they are still large.
- Notes:
- Notes:
- Notes:Since there’s always uncertainty in the sales forecasts, consider modeling the project economics on conservative estimates.This can go a long way toward gaining organizational buy-in to use and leverage Project Economic Models (PEM).Typically you’ll come to the same decisions, i.e. the tradeoff decisions based on the PEM will be the same, because the economic parameters have about the same relative importance.
- Notes:Which project is more important?Use Cost of Delay (COD)Project A’s COD * the amount of Delay incurred by working on Project B vs. Project B’s COD * the amount of Delay incurred by working on Project AThe higher the number, the greater the potential loss of profit, therefore the higher the project’s priority.