Cost Modeling & NPD

Copyright, NWI, NCSU - 2000-2011

Innovation: The critical path to success

New products are the key to successful growth,
competitiveness, and increased profits

Sources of innovations are different changes in

industry structure, in market structure, in local and global demographics, in human perception, mood and meaning, in the amount of already available scientific knowledge, etc.

Innovation allows businesses and industries to adapt to

change

Today, new products launched in the last 3 years account for

28% of company sales, on average
Copyright, NWI, NCSU - 2000-2011

New Product Failure Rates

1 successful product 2 full-fledged product launches

10 well-developed projects 100 exploratory projects

3000 raw ideas

Only 1 out 3,000 new innovative ideas becomes a commercial success

Copyright, NWI, NCSU - 2000-2011

Source: Stevens, G.A. and Burley, J., 3,000 Raw Ideas = 1 Commercial Success!, Research Technology Management, Vol. 40, #3, pp. 16-27.

New Product Failure Rates

1 of 3 launched products fail despite research and
planning

1 out of 4 projects that enter development make it to

the market

~ 46% of all resources allocated to new products by

U.S. firms is spent on failed products

Source : Winning at New Products, p.9

Copyright, NWI, NCSU - 2000-2011

Why New Products Fail

Inadequate market analysis ~ 32% Bad product ~ 23%

Higher costs than anticipated ~14%

Weak marketing program ~13% Poor timing ~10% Competition ~8%
5

PLC & Costs Dynamics

Scope for cost reduction after design stage

Copyright, NWI, NCSU - 2000-2011

Cost Reduction Potential vs. Cost of Effort

The management of product cost begins with the

conception of a new product
Copyright, NWI, NCSU - 2000-2011

Two Approaches to Cost Estimating

Top-down

Estimates product costs based on its global properties and characteristics using historical data from similar products Expert judgment, Rules of thumb, Parametric models, Analogies, or Cost estimating relationships (CERs)

Bottom-up

Decomposition of product/process into simple units, analysis and cost estimation of each unit, integration these costs into total product cost Used for cost model development Technical cost modeling, Activity-based costing

Copyright, NWI, NCSU - 2000-2011

Bottom-up vs. Top-down

Top-down
Minimum product details Less time and resource
consuming, easier to implement Useful at the early stages of PLC Gives less accurate cost estimates

Bottom-up
Complete information Time and resource
consuming, more difficult to implement Useful at the late stages of PLC Gives more accurate cost estimates and detailed cost structure

Copyright, NWI, NCSU - 2000-2011

Cost Estimation and NPD

Phase
Purpose Level of Detail

Concept
Screening Rough Estimate

Definition
Feasibility Good Estimate

Development Introduction Deployment

Budget authorization or cost control Accurate Projections Actual Cost control Actual

Methods

Top-down (e.g. Parametric estimating) Bottom-up (Cost Models) Cost accounting systems
10

Copyright, NWI, NCSU - 2000-2011

Production Cost Model: Bottom-up approach

Is a set of mathematical equations that
converts resource data into cost data
Input
Product Process Production conditions Economic environment

Output
COST OF: Materials Labor Utilities Maintenance Equipment Building

COST MODEL

Copyright, NWI, NCSU - 2000-2011

11

Components of total product costs

TOTAL PRODUCT COST MANUFACTURING COSTS
(costs of all resources consumed in the process of making a product)

NON-MANUFACTURING COSTS
(costs necessary to maintain business operations)

Variable
Materials Utilities Waste disposal

Fixed
Depreciation Labor & Employee benefits Maintenance Insurance & Taxes Finance charges Royalties General plant overhead

Distribution

G&A expenses
R&D Marketing Sales Administrative

Shipping

Copyright, NWI, NCSU - 2000-2011

12

Cost Behavior: Variable and Fixed Costs

Total variable cost

costs which are constant per unit of output but change in direct proportion to the volume of activity

Fixed Costs

Units of output

Unit variable cost Units of output Units of output Unit fixed cost Units of output

Variable Costs

Total fixed cost

costs which decrease proportionally on a per-unit basis with the level of activity but remain constant in total for a specific period of time

Copyright, NWI, NCSU - 2000-2011

13

Developing Cost Model

STEP 1: Define the product and process

Materials, Composition, Basis weight, etc. Machinery and Tooling, Operating variables, Production conditions

STEP 2: Identify cost elements

Materials, labor, energy, etc. Cost behavior pattern

Copyright, NWI, NCSU - 2000-2011

14

Developing Cost Model

STEP 3: Develop predictive equations for each
identified cost elements

Understand relevant underlying mechanism which effects cost Build causal chain of analytical and semi-empirical formulas Reach a set of variables that are controllable by model user

STEP 4: Validating the Model

The most important step Comparing the model output with known or expected values

Copyright, NWI, NCSU - 2000-2011

15

Uses of Cost Models

To determine the potential profitability of a product Cost structure Identification / examination of cost drivers Comparative cost estimation

Materials Processes Designs Exogenous conditions

Sensitivity analysis Risk analysis

Monte Carlo simulation

16

Etc.
Copyright, NWI, NCSU - 2000-2011