Avoiding New Product Surprises

by Dave Garwood

Several months ago, the DownHill Bike Company excitedly began developing the next generation of bike -- the Super-Lite Super-Fast Bike. Everyone was optimistic about getting it to market quickly and torpedoing the competition -- capturing a huge chunk of marketshare. Unfortunately, the new bike project went downhill fast, so to speak.

After overspending the product development budget by 40% and missing the launch date by a year, the DownHill Bike Company found out the new Super-Lite Super-Fast bike will cost almost as much to manufacture as customers are willing to pay for it. Now what?

The choices are few and none of them good. They could try to reduce costs by redesigning the bike. This could delay introduction of the Super-Lite Super-Fast bike at least 6 months. They could sell it at the competitive price and get zero gross margin. The shareholders would love that. They could try to sell the bike at a premium price and make a nice margin. The volume would likely be low and the sales group will get frustrated. This would also give them a built-in excuse for not meeting sales targets.There are no good alternatives. But DownHill could learn a valuable lesson and put a process in place to avoid this problem in the future. The preventive medicine is based on a price-drives-cost approach.

Establishing Targets
Several years ago, we introduced an effective new product development process called MAP (Market Aimed Products). MAP is a series of phases and go/no go gates.

A critical component of the Definition Phase is to establish a target selling price based on a collective opinion of what price the market will bear. For example, the DownHill Bike Company probably could have done a little market analysis and determined $500 per bike was a good target price. They also knew that 40% gross margin was the company objective to maintain proper profitability. Therefore, the bike had to cost $300 or less to meet the financial goal and still be sold at a competitive price.

Cost Estimate Evolution
Can this bike be manufactured for $300 or less? DownHill must get an answer to that question before they proceed and spend a lot of time and money on the development project. How can they make this estimate before designing the product? Although the design hasn't even started, they know that the new bike will likely have these types of major parts -- wheels, gears, frame, front fork and a few others. They have enough experience to "guesstimate" what each major component might cost. In this case, the initial cost estimate totals $350.

Oops! We have a problem. The estimate is higher than the target cost. What next? One alternative action is to stop development and forget about this bike. Another alternative is to spend a few days with engineering and marketing to brainstorm and look for potential cost reduction opportunities for the key components. If they can't find any with a reasonable confidence of succeeding, DownHill should fold 'em! In this case, the team had some ideas that reduced the initial cost estimates for the frame, wheels and gears.

The success of this development project from a profitability viewpoint hinges on the ability to design the frame, wheels and gears within the revised cost targets. So this becomes a logical place to begin the design, i.e. design the critical cost components first. Since the largest potential savings to meet the total cost target is the frame, it would make sense to design it first.

The traditional approach has often been based on "put off the toughest until last" approach. The problem is the engineers discover the target costs can't be met after spending a lot of time and money designing the other components. Sometimes we discover the target cost on the cost-sensitive parts can be met, but only if the parts that are already designed are redesigned! Since that would take more time and money (for a project that is likely already behind schedule and over budget), the temptation is to try to live with the higher cost and hope we can sell the bikes at higher price or find a lower cost method later. Unfortunately, neither happens. The development project becomes a financial failure. The non-negotiable rule should be: design the critical components first.

After some detail design work, we are ready for a more educated cost estimate. We have a bill of material, some supplier quotes and labor estimates. With a straightforward cost roll up, the cost is calculated and is close to the target cost.

The margin based on the new estimates would be 38%. We need to decide if that is close enough and begin looking for ways to squeeze more costs out during initial production or convince the customers to pay more because of differentiating product features.

We are now ready to launch the product into production and the marketplace. The initial production runs provide additional insight into the cost based on experience. Once again, the cost can be determined ...

The key to this approach is to recognize early in the development cycle the gap, if any, between a cost needed to be reasonably profitable and what is likely to be the cost. This eliminates surprises, gives the company more alternatives and gives them time to consider alternative action before they sink a huge investment in the development project.

Steps to Eliminating Gross Margin Surprises

Here are the 8 proven steps for avoiding gross margin surprises:

Step 1: Determine the target selling price during the Definition Phase. Do a little market research. See what customers are currently paying for comparable products. Carefully and honestly justify if any price premiums are planned.

Step 2: Determine the target cost. Once the target price is established, it is a simple calculation to determine the target cost to meet the desired gross margins.

Step 3: Identify key components that are likely to be needed in this new product. While the components have not been designed and assigned a part number yet, every product usually has a few components that are likely to represent most of the cost. For example, the chip and PWB in an electronic toy. The motherboard, hard drive and connectors in a computer. The top and legs for a table. In the software development, it may be key parts of the system architecture.

Step 4: Estimate the cost of the key components based on history and knowledge. The idea is to spend a day or two to get an educated estimate to see if we are in the ball park and how much we will have to reduce these costs to meet the cost target.

Step 5: Determine the feasibility of meeting the critical cost component targets. This may require some discussion with potential suppliers and experienced factory people. It certainly will require some out-of-the-box thinking. Consider new technologies, new material, etc. If the target seems unachievable, it may be time to drop this project before wasting valuable resources. If it appears we have a chance, proceed.

Step 6: Update the initial estimates after doing some more detail definition. Challenge some of the product features or performance standards that may be driving these costs higher. Closely examine the stated customer requirements, carefully separating wants from needs. Does the bike targeted for selling to 6-8 year olds really need to weigh less than 3 pounds and have 9 speeds, requiring high alloy titanium and complex gears? Look for new technologies not previously considered that might bring the cost down. If the target seems unachievable, it may be time to fold 'em. If not, proceed and learn more.

Step 7: As the product is being designed, load a skeleton bill of material with the key components listed in the system. The components do not have to be fully defined before assigning a part number. As they are designed and we learn more about the cost, load the new cost data into the file. Use conventional cost roll up programs to periodically calculate a revised cost estimate. Again, compare the revised cost estimates with the target. Keep applying creativity and working on the design until the cost target is met. If not, fold 'em or get prepared to make less money. At least it won't be a surprise!

Step 8: As the product is launched, we develop some actual cost data. We should have planned to reduce the initial cost as sales volume increased and we got better at making the product. These estimates of improvements should have been part of the data captured in the definition phase.

The principle here is an old one -- don't throw good money after bad money. Develop the data to know when to stop and when to go. Find the cost hurdles early in the new product development cycle when there is still time to cost effectively take corrective action. Follow these 8 steps and never experience the dreaded gross margin surprise again .... guaranteed!