March 20031 Development Cost MANGT 497A Small Product Realization

March 2003 1

Development CostDevelopment CostDevelopment CostDevelopment CostMANGT 497AMANGT 497A

Small Product RealizationSmall Product Realization

March 2003Development Cost

MANGT 497AR. Weissbach

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Overview• Engineering Cost Estimation

– Labor and Material Analysis– Preliminary and Detail Design

Estimation– Classification of Estimates

• The Effect of Time on Development– Effect of Time to Market – How to Reduce Time to Market



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Labor Cost• Hourly Costs

– Regular Hours (x wage rate)– Overtime Hours (x 1.5 x wage rate?)

– Holidays, Vacation, Paid Sick Leave

• Non-Hourly Costs– FICA (Social Security Tax)– Workmen’s Compensation– Unemployment Insurance– Other Supplemental Insurance– Uniforms, Tools, etc.– Profit Sharing, Bonuses, Gifts



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Material Costs• Cost of Material can be estimated from

historical or measured data• Bill of Material (BOM)/Parts List

– Itemized list of materials for a design• Part Number or Symbol• Descriptive Title• Quantity• Material• Stock Size, Weight, Volume, etc.



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Material Costs (Cont)• Cost of Direct Material Equals…

– [(Cost/Unit Shape) x Shape] – Salvage• Shape

– Actual shape of the material in units of area, volume, mass, etc.

• Sa = St(1+L1+L2+L3)– Sa = Shape– St =Theoretical Shape Required– L1 = Loss Due to Scrap (human error)– L2 = Loss Due to Waste (chips)– L3 = Loss Due to Shrinkage (deterioration, theft,

shelf life)



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Preliminary and Detail Design Estimation Methods

• Opinion• Conference• Comparison• Unit• Cost Estimating Relationship• Probability Approach• Range



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Preliminary and Detail Design Estimation

Methods

• Opinion – shortage of data or time• Conference – each dept contributes

– Hidden Card Technique– Estimate-Talk-Estimate (Persuasion)– Lack of Analysis/Facts– Needs a Moderator to Direct Discussion



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Exercise• How much will it cost to hire

someone to successfully design, build and test a system which will enable an uncooked egg to be tossed from the roof of the Hammermill Building and land without breaking?



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Methods

• Comparison– Attaches a formal logic to the conference

method– Take difficult design problem (a) and

construct a simpler design problem (b)• Clever manipulation of the original design• Relaxation of technical constraints• Branch to (b) to obtain facts pertinent about (a)• Be conservative: Ca(Da) ≤ Cb(Db)



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Methods• Unit Cost

– Cost per… (pound/mile/year/ft2, etc.)– Based on a mean cost (y=mx + b)– Errors Introduced

• Cost may be non-linear (based on various parameters such as volume, etc.)

• Slope (m) may not be correct



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ExampleCast Iron Weight (lb) Cost ($)

2 23 34 6

The average cost per pound is $1.22, based on the total weight of 9 pounds and the total cost of $11.



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Concerns• Can we estimate the future cost

with a linear estimate?• Would it be better to estimate

linearly using a “best fit”?• Can either method be used if the

cost is non-linear?



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Different Analyses YieldDifferent Estimates

Comparison of Regression Analyses

-202468

10121416

1 2 3 4 5 6 7 8

Weight of Cast Iron (lb)

Co

st

($)

Regression A Regression B



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(cont)

• Cost and Time Estimating Relationships– Statistical regression models, based on

past designs– Formulated to present estimates for end

items– Design or performance parameters

(weight, speed, etc.) are used to predict cost (“cost drivers”), since these parameters are available early



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Cost Estimating Relationship (CER)

• Suggested Approach– Obtain actual costs from past designs– Interview experts who have knowledge of

cost and design– Find cost drivers– Plot data roughly and understand anomalies– Re-plot and perform regression analysis– Review for accuracy, publish, distribute



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(cont)• Probability Approach

– Looks at average and “expected value”– Requires knowledge of statistics

• Analysis of historical data• Convenient approximations (e.g., normal,

etc)• Introspection (opinion probability)

– Cumulative probability of each event



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Example• Market research indicates a product

will sell wholesale for $650 in year 1• Questions:

– What will be the sales volume in year 1?– What will be the cost per unit in year 1?– What will be the profit in year 1?



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Example Marketing Forecast

Annual Sales Volume Probability of Event Occurring15,000 0.220,000 0.225,000 0.6

Engineering ForecastCost Per Unit ($) Probability of Event Occurring

450 0.7500 0.2550 0.1



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Profit Analysis Options• Look at most likely scenario

– Most likely to sell 25,000 units at $450/unit ($200 profit)– Total Profit = $5M

• Look at the expected value – Expected Value of Sales

• (15,000)(0.2)+(20,000)(0.2)+(25,000)(0.6) = 22,000– Expected Value of Unit Cost

• ($450)(0.7)+($500)(0.2)+($550)(0.1) = $470/unit– Expected Profit per unit = $180– Total Profit = ($180)(22,000) = $3.96M

• A difficulty is being able to guess the opinion probabilities



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(cont)• Range Estimation

– Use the Beta probability density function

– Estimated Cost = (L + 4M + H)/6 where• L = lowest estimated cost• M = most likely cost• H = highest estimated cost



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Marginal Cost• The added cost of adopting a

change in operations or making an engineering change order for a product.

• Requires a detailed cost estimate to perform marginal analysis.



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Marginal Cost (cont)• Cm = d(CT)/d(n), where

Cm = marginal cost ($/unit)

CT = total cost function

= nCv + Cf

n = number of production units per periodCv = variable cost per unit

Cf = fixed cost per period

• Requires polynomial regression analysis• Measures the rate of increase of total cost and

approximates the cost of a small additional unit of output from the given level.



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Marginal Return• Parallel to Marginal Cost• Rm = d(RT)/d(n), where

Rm = marginal return ($/unit)

RT = total revenue function

= nRv + Rf

n = number of production units per periodRv = variable return per unit

Rf = fixed return per period (often = 0)



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Breakeven Analysis• The point of production or

operation where there is neither loss, nor profit.

• n = (Cf-Rf)/(Rv-Cv)



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Classification of Estimates

Design Fundamental Characteristic

Symbolic Measure of

Economic Want

Example

Operation Worker and Tool Cost Crew Worker Assembler and Hand Tools

Product Quantity Price Toys, Vehicles Project Single End Item Bid Bridge

Plant Addition Refinery

System Configuration Effectiveness Weapon System Hospital

Rapid Transit System



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Systems• Made up of operations, products and

projects• Contains intangibles such as:

– Function– Beauty– Safety– Quality of Life– Ease of Use

• No specific profit entry, instead looking at the value of “effectiveness”



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System Effectiveness?• The ability to do the correct thing

efficiently (e.g., hospital)Cost Item Investment Opportunity Recurring Nonrecurring

Cost Cost Cost Cost

ContingenciesMarginal Cost Analysis xOperation Estimates xProduct Estimates x xProject Estimates x x

Engineering Estimates x



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The Effect of Time on Development

• Time to market is a crucial element in being successful in the global marketplace

• A six month delay can be worth 33% of life cycle profits (Reinertsen)

• There is a perceived trade-off between development speed and product quality



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ExampleWriting a book takes 12-18 months.

Putting out a Sunday newspaper takes approximately one day.

Both have approximate the same number of words.



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Why Develop Products Faster?

• Increased Sales– Customer loyalty– Higher peak sales– Higher profit margins

• Beat the Competition to Market• Be Responsive to Changing

Markets, Styles, Technologies



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Why Develop Products Faster? (cont)

• Maintain a Market Leadership Position

• “More New Products” is the wrong focus



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What Developing Products Doesn’t Imply• Developing products in half the

time doesn’t mean that productivity will double.

• It means providing more up-front resources to complete the project, with heavier staffing and people dedicated full time to the project.



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The Basic Economic Modeling Process

Develop Baseline Model

Develop Variatons

Calculate Total Profit

Impact

Convert to Decision

Rules

Development Expense Overruns

Initial Product Cost Overruns

Unit Sales Reduced due to Product Problems

Product Introduction is Delayed



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Potential Effects of Delayed Product

Introduction

• Case 1 - Inelastic products with limited competition– Total unit sales do not decrease– Customers are locked into a product– Cost of delay is due to price erosion

• Units are shipped during a relatively low-margin period in the product’s life



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Introduction (cont)

• Case 2 - Timing of the peak in market demand is determined by the marketplace, rather than the date of the product.– Lower market share throughout the

life of the product



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Introduction (cont)

• Case 3 – Delay results in loss of “design-in” victories (OEM markets)– Severe and continuous reduction in sales– Inability to dislodge the competitor



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Example: Product with a Long Product Life



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Half of the time spent on many development

projects occurs before the design team is assembled

and starts work

Need

Team

Starts Ship

Inefficient Development Time



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Advantages of Reducing the “Fuzzy

Front End”• It lasts a long time• It is a cheap place to reduce cycle

time– Much cheaper than the cost of cycle

time at the end of the development process

• It allows for competitive advantage



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How to Improve Front-End Processes

• Make Front-End Cycle Time a Measured Parameter– Parameters not measured do not

improve– Start the clock when the need is

addressed to management



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How to Improve Front-End Processes (cont)

• Calculate the Cost of Delay (Sensitivity Analysis due to reduced market share)

• Assign Responsibilities• Assign Resources and Deadlines• Capture Opportunities Early & Often

– Ensure it’s easy to submit an idea to management



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How to Improve Front-End Processes (cont)

• Overlap Planning and Design– Try to remove planning from the

critical path as much as possible

• Create a Quick-Reaction Plan



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Other Tips on Speeding the Development

Process• Develop Your Own Process• Move Beyond the “Phases” Mentality

– Focus more on the critical path– Overlap activity timeframes

• Requires more communication between teams.

• Find Examples where Processes were Sped Up Successfully



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Deliverables• Ensure the Final Business Plan

includes at least one method of estimating development cost

• Quiz on Monday (4/7/03) on Development Cost

Documents

March 20031 Development Cost MANGT 497A Small Product Realization