Product Development Economic Analysis

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Product Development Economic Analysis
A product is economically viable if its value in
the market is greater than its cost by a
sufficient margin to justify the investment
required to make it.

• Cash inflows
• Revenues from the product sales
• Cash outflows
• One-time development cost (engineering)
• Production costs (equipment, labor)
• On-going production cost (raw materials,
  maintenance, labor, .)
• Marketing and support cost

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Example Fingernail Clipper
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Net Present Value (NPV)
A measure of the degree to which inflows are
greater than outflows is the NPV of the project.
A dollar today is worth more than a dollar
tomorrow
1000 invested today at a rate of 4 per year
interest rate will be worth (1.04)x1000 1040
at the end of the year. 1000 received a year
from now is worth 1000/(1.04) 961.5 now. In
other word, 961.5 today is worth 1000 received
in a year.
PV (present value) C / (1 r)t , C amount
received, r interest rate, t time period
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Merging Project Schedule with Financials
Financial estimate must be merged with timing
information.
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The period Cash flow
The period cash flow is the sum of cash inflows
and cash outflows (year 3).
Marketing cost - 250,000 Production cost
-2,000,000 Product revenues 4,000,000 Period
cash flow 1,750,000
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Present Value and Net Present Value Calculations
Calculation for year 3, first quarter.
Q1
Assume interest rate of 10 a year or 2.5 a
quarter, back to the first quarter of year 1 (8
quarters total).
PV (present value) C / (1 r)t , C amount
received, r interest rate, t time period
1,750,000 / (1 .025)8 1,436,306 (present
value)
The Net Present Value (NPV) is the sum of all
present values for each period.
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Cash flow table
NPV 8,203,000, proceed with development
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Sensitivity Analysis
Sensitivity analysis studies different what if
scenarios, looking at factors (internal and
external) influencing the NPV.

• Development Expenses

• Product Price

• Development Speed

• Sales Volume

• Production Cost

• Comparative Environment

• Product Performance

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Sensitivity Analysis
Decrease development cost by 20 (250,000 for
each period).
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Sensitivity Analysis
Increase development time by 25 (5 quarters
instead of 4).
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Assumptions for Sensitivity Analysis Increase in
Development Time

• Total development cost remains the same, the time
  period for spending is increased, lowering the
  rate of spending.

• The shift in sales window by a quarter has no
  effect on sales.

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Project Trade-Offs
Six potential interaction
Interactions could be used to link internal
factors to external ones.
Increase in development cost or time
Decrease in development time
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Sensitivity Analysis
Sensitivity analysis could be used for decision
making.
If a 10 increase in development cost is
forecasted, by what percentage the volume sales
has to increase to offset the drop in NPV?
(10x5.9)/21 2.8 percent increase in volume
sales (linear relationship is assumed).
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Influence of the Qualitative Factors on the
Project Success
There are other factors that influence the
success of a product which are difficult to
quantify.

• Interaction between the Project and the Market

• Competitors provide products in direct
  competition

• Customers income, expectation and taste may
  change

• Interaction between the Project and the Macro
  Environment.

• Major economic shifts materials prices, labor
  cost, or changes in foreign exchange rate.

• Social trends increase in environmental
  awareness

• Government regulations new regulation can
  destroy or spawn new industries.

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Summary of Product Development Economics

• Build a base-case financial model
• Perform a sensitivity analysis to understand the
  relationship between the internal and external
  factors.
• Use the sensitivity analysis to understand the
  trade-offs.
• Consider the influence of qualitative factors on
  the the project.