Product Development Economics

BY H A R I S I Q B A L

Abstract
This Chapter addresses the importance of evaluating economic considerations in the
project design phase of the product development. It also discusses the different
economic strategies that the company should consider relative to its time-of-entry into
the market for a specific product. Lastly, it discusses what would be best for the
company’s economic interest, i.e. product replacement or product improvement. All of
the above considerations go a long way in determining the success of the product.

Background
“Development is the set of activities that transform a concept for satisfying perceived needs
into a product or service that is ready for the market,” (Johnson & Kirchain, 2011). In
today’s technology driven market, the importance of product development is well
established. The development phase not only helps to determine the functional performance
of a product but also helps to determine the financials of the product itself. In fact it is
reported that between 70 and 90 percent of the project’s costs are decided in the early
phases of the product development (Bhimani & Mulder, 2001; Shehab & Abdalla, 2001).
The rapid escalation in technology has led to a shift in parameters that companies compete
in to achieve maximum profits. One of these is time-based competition, which is discussed
in subsequent sections.

Time-based Competition
Concept that time is a resource and a firm that make better use of time (in responding to the
changing market situations) acquires a competitive advantage. The term was coined by the
consultant George of the Boston Consulting Group and popularized by his 1998
book Competing Against Time, in which he talks about the term time-based competition
after he realized how important it is to time the release of your product, and how long your
product development cycle is. He recognized the correlation between the change in
profitability of a product and the duration of its product cycle. In economics terms, he
observed that sooner a finished product was released in the market, it implied lesser
development costs and after the introduction of the product, being the pioneers in that field,
i.e. being an innovator/the first one to release the product, would lead to greater profits. In
today’s world this is more relevant than ever before considering the multiple patent wars
going on i.e. the Apple vs. Samsung patent wars. It is very important to be able to provide
something to the market that is not there already. This is made possible only when product
development cycles are short and efficient. However, it is also important to weight the
decrease in development cycles, versus the “finished-ness” of the product, which is
discussed in later sections of this article. For example, Clark (1989) estimates that if a
certain car cost 10,000 dollars, every day’s delay in the release of the product represents a
million dollar loss for the company. Another McKinsey study reports that a company loses
about ten times of its after-tax profits for shipping a product six-month’s late as compared
to what it would lose by overspending 50% more on product development. In their 1991
book Developing Products in Half the Time, Smith and Reinertsen argue that it is necessary
to adopt an incremental approach to product innovation in order to reduce time to market.
This is because incremental product innovation reduces the amount of effort and learning
that must be done and, consequently, the amount of time needed to invest in the new
product prior to its launch. Financially its implications involve reduction of development
costs since the same processes as before are being carried out by essentially the same
amount of labor as the reduction in the time-to-market is stemming from concurrent-phase
development and cross-functional development teams; the labor costs are significantly
reduced. Such a perspective has led some companies (e.g., General Electric, Hewlett
Packard) to adopt time-to-market as their principal product development metric. (Cohen et
al., 1996).
Minimizing the Time-to-Market and the Balance with
Product Performance
However, on the flipside of the argument for shorter product development cycles, it can
clearly be seen that there is a trade-off between minimizing the time-to-market, and optimal
performance of the new product. Even a minor increase in the performance of the product
could help the company grab a significant portion of the market share. While on the other
hand, this improvement in the product’s performance might take too long to be achieved
and thus the company could lose out on the window of opportunity that it may have had in
releasing the product without the additional improvement. A very good example of such a
case would be Apple Computer’s Lisa Macintosh development in the early 1980s. The
project was very ambitious and aimed to greatly increase the product performance as well as
to improve the general manufacture process, but its introduction that was late by several
quarters drove apple earnings down to about half their initial value as it started out with in
1983.

The development capability hurdle needed to profitably undertake a new project increases
with the total existing product performance of all products readily available in the market. It
decreases with the product category demand rate, the profit margin, the market share lost to
the competitors, and the window of opportunity of releasing the new product. One of the
most important things to remember is that an improvement in the product’s performance
does not necessarily guarantee a shorter time-to-market (Cohen et al., 1996).

The basic breakdown of Cohen’s findings are that if performance improvements are additive
in nature, most of the limited time should be spent on the stage that leads to the biggest net
improvement, and is the most productive. Another observation they made was that faster
was not better if the product being replace has a high margin or if the new product has a
large market potential. It is always the best strategy to take more time developing the
product better if the product is going to face an intermediate rivalry in the market. Care
needs to be taken in minimizing the break-even time as it may lead to a premature product
introduction (Cohen et al., 1996).

Case Study: Hewlett Packard

Hewlett Packard realized this balance between the two objectives of high product
performance target and a reduced time-to-market, with their BET metric i.e. Break-Even
Time, which was aimed at reducing the break-even time of their products by half. (Smith &
Reinertsen, 1991).

Figure 1 depicts the return map employed by HP for managing the development process of a
new pocket calculator. The breakeven point is when the total cumulative investment in the
development of the project is equal to the total cumulative net revenue. Reducing break-
even time can motivate the product development team to address the crucial balance
between a high product performance target and a short time-to-market. A significant
improvement in the product performance target is likely to increase the slope of the sales
curve, at the cost of delaying the new product launch. Incremental product improvements
on the other hand, are likely to generate sales curve that are less steep but which bring
revenues to the firm earlier. Again this trade-off varies from industry to industry and
product to product and needs to be studied closely, before the development strategy is
chosen. (Cohen et al., 1996).

Figure 1
The Return Map for the HP Pocket Calculator. Source: Adapted from Cohen et al., 1996.

Application to Senior Design Project

The Blue Team’s Senior Project focuses on the development of a solar insolation calibrator.
When thinking about how we can achieve an acceptable balance between our product’s
performance and its development cycle, one of the most important things that needs to be
considered is to recognize and understand that product performance improvement
processes have a multistage nature. We need to evaluate each and every decision we make
about out project in terms of design and think if the amount of time/resources spent on the
implementation of a certain feature contributes enough to the product’s performance, i.e.
adds at least as much as the value of resources spent, if not more to it. It is helpful to study
the competitors, the market, already existing comparable products, and the nature of the
product. Other things to be considered are the productivity of certain design phases and the
return on the product improvement developmental processes.

Conclusion
In conclusion, there exists a very delicate balance between minimizing the product
development cycle to be able to push products in the market at a faster speed, and the new
product’s performance. This balance can be achieved by carefully studying the competitors,
the market, already existing comparable products, and the nature of the product.

Cited References
 Bhimani, A., & Mulder, P. S. (2001). Managing processes, quality, and costs: A case
study.Cost Management, 15, 28-32. Available from ABI/INFORM Complete Database.
 Clark, K. B., & Fujimoto, T. (1989). Lead time in automobile product development
explaining the Japanese advantage. Journal of Engineering and Technology
Management, 6(1), 25–58. DOI: 10.1016/0923-4748(89)90013-1
 Cohen, M. A., Eliashberg, J., & Ho, T.-H. (1996). New product development: the
performance and time-to-market tradeoff. Management science, 42(2), 173–186.
DOI: 10.1287/mnsc.42.2.173
 Johnson, M. D., & Kirchain, R. E. (2011). The importance of product development cycle
time and cost in the development of product families. Journal of Engineering Design,
22(2), 87–112. DOI: 10.1080/09544820902960058
 Shehab, E., & Abdalla, H. (2001). Manufacturing cost modelling for concurrent product
development. Robotics and Computer-Integrated Manufacturing, 17(4), 341–353.
DOI: 10.1016/S0736-5845(01)00009-6
 Smith, P. G., & Reinertsen, D. G. (1998). Developing products in half the time: New
rules, new tools. New York: John Wiley & Sons. OCLC WorldCat
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 Stalk, G. (1988). Time — the next source of competitive advantage. Harvard Business
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Innovative new products are the fuel for the most powerful growth engine you
can connect to. You can grow without new products--AT&T sold essentially the
same telephones for decades while becoming the world's largest
telecommunications concern--but most small companies will find it difficult to
grow at all, much less rapidly, without a constant stream of new products that
meet customer needs.

How do you know when you need new products? Early detection of a problem
with existing products is critical. The following eight symptoms of a declining
product line will provide clues far enough in advance to help you do something
about the problem before it's too late. Not all the symptoms will be evident in
every situation, but you can start suspecting your product line when more than
just one or two crop up.

1. You're experiencing slow growth or no growth. A short-term glitch in

product sales can happen any time. If, however, company revenue either flattens
or declines over an extended period, you have to look for explanations and
solutions. If it isn't the economy or some outside force beyond your control, if
your competitors didn't suddenly become more brilliant, if you still have
confidence in your sales force, and if there are no major problems with
suppliers, examine your product line.

2. Your top customers are giving you less and less business. It may not be
worth your trouble to determine your exact market share when a rough idea of
where you stand will suffice. But knowing how much business you get
compared to your competitors is critical. Every piece of business your
competitors are getting is business you aren't getting--and may never get. If your
customers' businesses are growing and the business you get from them isn't,
your product may be the culprit. Chances are, someone else is meeting your
customers' needs.

3. You find yourself competing with companies you've never heard of. If
you've never heard of a new competitor or don't know much about them, watch
out! They have found a way to jump into a market with new products and
technology that could leave you wondering what hit you. It might not be that
your product has a fundamental flaw. It's more often the case that someone has
brought innovation to the industry. You earn no points for status quo thinking.
4. You're under increasing pressure to lower your prices. No one likes to
compete strictly on price. When your product is clearly superior and offers more
value than lower-priced competitors, you don't have to. Everyone understands
that great new products eventually run their course and turn into commodities.
One day, a customer tells you she can't distinguish the benefits of your widget
from those of one or more of your competitors, and now you are in a price
squeeze. If you want the business, you have to lower your prices to stay
competitive. If that was where it ended, things might stabilize, although at a
lower price level. But lower prices usually mean lower profit margins, which
usually mean less investment in keeping the product current, which means more
price pressure, lower margins?and so it goes.

5. You're experiencing higher-than-normal turnover in your sales

force. Good salespeople want to win customers so they can make more money.
When they have trouble competing, they can't win customers or make money.
So they look for new opportunities and challenges that will bring them what
they want. You'll always have turnover, but heavy turnover is a symptom of
something very wrong. It could be an ill-advised change in the compensation
scheme or a new sales manager coming in with a negative attitude. But it could
also be that members of your sales team are frustrated because they're having
trouble selling your products. When business owners start to pressure their sales
forces to get order levels up, morale drops because the salespeople know there
isn't much they can do.

6. You're getting fewer and fewer inquiries from prospective customers. We

all dread the time when the phone stops ringing and prospects stop coming in.
When advertising or other forms of promotion aren't creating the results you
want, and you see fewer positive results from the money spent, something could
be wrong with the way customers see your company. An obsolete product line
positions you as an obsolete company.

7. Customers are asking for product changes you can't or don't want to
make.Here is a not-too-subtle sign that your product may no longer meet
market needs. There will be times when you have to decide whether filling a
customer's request is in your company's best interests. When customers say "I
want it this way," you may want to say no because you doubt you could ever
recover the costs of the change, even by raising the selling price. But when the
customer says "I want it this way, and it's standard at ABC Widgets," you
should suspect you aren't keeping up with changing customer needs. When your
competitors have leapt ahead of you in features and benefits, you must either
catch up or leap ahead of them with innovations of your own, or you'll fall so far
behind you become a marketplace postscript.

8. Some of your competitors are leaving the market. In the short term, this
sounds great. Your competitors drop out, and you pick up the business they
leave behind. The pie is shrinking, and as it does, business gets better than ever.
But beware: This is a classic signal of a declining market. Nobody walks away
from a growth business. Vibrant growth markets attract new competitors; they
don't discourage them.

If you decide to develop new products as part of your growth plan, you're in
good company. Small companies like yours contribute at least half of the major
industrial innovations occurring in the United States, according to the SBA. At
the same time, approximately one-third of all new products are unsuccessful,
and in some industries the percentage of failures is much higher. The way to
increase your chances of coming up with good ideas is to follow the tested track
to new product development success.

New product development can be described as a five-stage process, beginning

with generating ideas and progressing to marketing completed products. In
between are processes where you evaluate and screen product ideas, take steps
to protect your ideas, and finalize design in an R&D stage. Following are details
on each stage:

 Generating ideas. Generating ideas consists of two parts: creating an

idea and developing it for commercial sale. There are many good
techniques for idea creation, including brainstorming, random association
and even daydreaming. You may want to generate a long list of ideas and
then whittle them down to a very few that appear to have commercial
appeal.
 Evaluating and screening product ideas. Everybody likes their own
ideas, but that doesn't mean others will. When you are evaluating ideas for
their potential, it's important to get objective opinions. For help with
technical issues, many companies take their ideas to testing laboratories,
engineering consultants, product development firms, and university and
college technical testing services. When it comes to evaluating an idea's
commercial potential, many entrepreneurs use the Preliminary Innovation
 Evaluation System (PIES) technique. This is a formal methodology for
assessing the commercial potential of inventions and innovations.
 Protecting your ideas. If you think you've come up with a valuable idea
for a new product, you should take steps to protect it. Most people who
want to protect ideas think first of patents. There are good reasons for
this. For one thing, you will find it difficult to license your idea to other
companies, should you wish to do so, without patent protection. However,
getting a patent is a lengthy, complicated process, and one you shouldn't
embark on without professional help; this makes the process expensive. If
you wish to pursue a patent for your ideas, contact a registered patent
attorney or patent agent.
 Many firms choose to protect ideas using trade secrecy. This is simply a
matter of keeping knowledge of your ideas, designs, processes, techniques
or any other unique component of your creation limited to yourself or a
small group of people. Most trade secrets are in the areas of chemical
formulas, factory equipment, and machines and manufacturing processes.
The formula for Coca-Cola is one of the best-recognized and most
successful trade secrets.
 Finalizing design research and development. Research and
development is necessary for refining most designs for new products and
services. As the owner of a growing company, you are in a good position
when it comes to this stage. Most independent inventors don't have the
resources to pay for this costly and often protracted stage of product
introduction. Most lenders and investors are trapped by a Catch-22
mentality that makes them reluctant to invest in ideas until after they're
proven viable in the marketplace. If you believe in your idea, you can be
the first to market.
 R&D consists of producing prototypes, testing them for usability and
other features, and refining the design until you wind up with something
you think you can make and sell for a profit. This may involve test-
marketing, beta testing, analysis of marketing plans and sales projections,
cost studies, and more. As the last step before you commit to rolling your
product out, R&D is perhaps the most important step of all.
 Promoting and marketing your product. Now that you have a ready-
for-sale product, it's time to promote, market and distribute it. Many of
the rules that apply to existing products also apply to promoting,
marketing and distributing new products. However, new products have
some additional wrinkles. For instance, your promotion will probably
consist of a larger amount of customer education, since you will be
offering them something they have never seen before. Your marketing
may have to be broader than the niche efforts you've used in the past
because, odds are, you'll be a little unsure about the actual market out
there. Finally, you may need to test some completely new distribution
channels until you find the right place to sell your product.