Chapter 1

INTRODUCTION

Why analyze costs? Cost is an integral part of planning and managing systems. Unlike other system properties, such as performance, functionality, size, and environmental footprint, cost is always important, always must be understood, and never becomes dated in the eyes of management. As pressure increases to bring products to market faster and to lower overall costs, the earlier an organization can understand the cost of manufacturing and support, the better. All too often, managers lack critical cost information with which to make informed decisions about whether to proceed with a product, how to support a product, or even how much to charge for a product. Cost can represent a golden metric or benchmark for analyzing and comparing products and systems. Cost, if computed comprehensively enough, can combine multiple manufacturability, quality, availability, and timing attributes together into a single measure that everyone comprehends. 1.1. Cost Modeling Cost modeling is one of the most common business activities performed in an organization. But what is cost modeling, or maybe more importantly, what is it not? The goal of cost modeling is to enable the estimation of product or system life-cycle costs. Cost analyses generally take one of two forms: Ex post facto (after the event) Cost is often computed after expenditures have been made. Accounting represents the use of cost as an
1

Cost Analysis of Electronic Systems

objective measure for recording and assessing the nancial performance of an organization and deals with what either has been done or what is currently being done within an organization, not what will be done in the future. The accountants cost is a nancial snapshot of the organization at one particular moment in time. A priori (prior to) These cost estimations are made before manufacturing, operation and support activities take place. Cost modeling is an a priori analysis. It is the imposition of structure, incorporation of knowledge, and inclusion of technology in order to map the description of a product (geometry, materials, design rules, and architecture), conditions for its manufacture (processes, resources, etc.), and conditions for its use (usage environment, lifetime expectation, training and support requirements) into a forecast of the required monetary expenditures. Note, this denition does not specify from whom the monetary resources will be required that is, they may be required from the manufacturer, the customer, or a combination of both. Engineering economics treats the analysis of the economic eects of engineering decisions and is often identied with capital allocation problems. Engineering economics provides a rigorous methodology for comparing investment or disinvestment alternatives that include the time value of money, equivalence, present and future value, rate of return, depreciation, break-even analysis, cash ow, ination, taxes, and so forth. While it would be wrong to say that this book is not an engineering economics book (it is), its focus is on the detailed cost modeling necessary to support engineering economic analyses with the inputs required for making investment decisions. However, while traditional engineering economics is focused on the nancial aspects of cost, cost modeling deals with modeling the processes and activities associated with the manufacturing and support of products and systems. Unfortunately, it is news to many engineers that the cost of products is not simply the sum of the costs of the bill of materials. An undergraduate mechanical engineering student at the University of Maryland, in his nal report from a design class, stated: The sum total cost to produce each accessory is 0.34+0.29+0.56+0.65+0.10+0.17 = $2.11 [the bill of materials cost]. Since some estimations had to be made, $2.00 will arbitrarily be added to the cost of [the] product to help cover costs not accounted for. This number is arbitrary only in the sense that it was chosen at random.

Introduction

100

80
60

% Product Cost

80 60

40

40

20

Decided within first 20% of Design Cycle

Prototype

20 0

Verification

Simulation Specification Partitioning & Tradeoff

Start Logic Design

Physical Design

End

Fig. 1.1. 80% of the manufacturing cost and performance of a product is committed in the rst 20% of the design cycle, [Ref. 1.1].

Unfortunately, analyses like this are only too prevalent in the engineering community and traditional engineering economics texts dont necessarily provide the tools to remedy this problem. Cost modeling is needed because the decisions made early in the design process for a product or system often eectively commit a signicant portion of the future cost of a product. Figure 1.1 shows a representation of the product manufacturing cost commitment associated with various product development processes. Even though it is not represented in Fig. 1.1, the majority of the products life-cycle cost is also committed via decisions made early in the design process. Cost modeling, like any other modeling activity, is fraught with weaknesses. A well-known quote from George Box, Essentially, all models are wrong, but some are useful, [Ref. 1.2] is appropriate for describing cost modeling. First, cost modeling is a garbage in, garbage out activity if the input data is inaccurate, the values predicted by the model will be inaccurate. That said, cost modeling is generally combined with various uncertainty analysis techniques that allow inputs to be expressed as ranges and distributions rather than point values (see Chapter 9). Obtaining absolute accuracy from cost models depends on having some sort of real-world

% Elapsed Design Time

80% of Product Cost/Performance Committed

100

Cost Analysis of Electronic Systems

data to use for calibration. To this end, the essence of cost modeling is summed up by the following observation from Norm Augustine [Ref. 1.3]: Much cost estimation seems to use an approach descended from the technique widely used to weigh hogs in Texas. It is alleged that in this process, after catching the hog and tying it to one end of a teeter-totter arrangement, everyone searches for a stone which, when placed on the other end of the apparatus, exactly balances the weight of the hog. When such a stone is eventually found, everyone gathers around and tries to guess the weight of the stone. Such is the science of cost estimating. Nonetheless, when absolute accuracy is impossible, relatively accurate costs models can often be very useful.1 1.2. The Product Life Cycle Figure 1.2 provides a high-level summary of a products life cycle. Note that not all the steps that appear in Fig. 1.2 will be relevant for every type of electronic product and that more detail can certainly be added. Product life cycles for electronic systems vary widely and the treatment in this section is intended to be only an example. In the process shown, a specic customer provides the requirements or a marketing organization determines the requirements through interactions in the marketplace with customers and competitors. Conceptual design encompasses selection of system architecture, possibly technologies, and potentially key parts. Specications are engineerings response to requirements and results in a bid that goes to the customer or to the marketing organization. The bid is a cost estimation against the specications. Design represents all the activities necessary to perform the detailed design and prototyping of the product. Verication and qualication are activities to determine if the design fullls the specications and requirements. Qualication occurs at
accurate cost models produce cost predictions that have limited (or unknown) absolute accuracy, but the dierences between model predictions can be extremely accurate if the cost of the eects omitted from the model are a wash between the cases considered that is, when errors are systematic and identical in magnitude between the cases considered. While an absolute prediction of cost is necessary to support the quoting or bidding process, an accurate relative cost can be quite successfully used to support making a business case for selecting one alternative over another.
1 Relatively

Introduction

Customer(s)

Requirements Capture Conceptual Design (Trade-Off analysis)

Bid

Specification

Design
Verification and Qualification
Production Sales and Marketing
Operation and Support End of Life
Fig. 1.2. Example product/system life cycle.

the functional and environmental (reliability) levels, and may also include certication activities that are necessary to sell or deliver the product to the customer. Production is the manufacturing process and includes sourcing the parts, assembly, and recurring functional testing. Operation and support (O&S) represents the use and sustainment of the product or system. O&S represents recurring use for example, power, water, or fuel as well as maintenance, servicing the warranty, training and support for users, and liability. Sales and marketing occur concurrent with production and operation and support. Finally, end of life represents activities needed to terminate the use of the product or system, including possible disassembly and/or disposal. A common thread through the activities in the life cycle of a product or system is that they all cost money. The product requirements are of particular interest since they ultimately determine the majority of the cost of a product or system and also represent the primary and initial inputs for cost modeling. The requirements will, of course, be rened throughout

6
External Influences
Competition Industry Roadmaps Standards Qualification Requirements Technology Opportunities and Constraints Supply Chain

Cost Analysis of Electronic Systems

Market Requirements
Functional Requirements Life Cycle Profile Size/Performance Requirements

Design, Technology and Manufacturing Realities

Resource Allocations Scheduling Design Tools Testing Manufacturing Skill Set Cost

Business Opportunities and Constraints Schedule (Time to Market) Risk Tolerance

Corporate Objectives and Culture

Product Definition

Customer Inputs Selling Price

Technology Base

Fig. 1.3.

Product/system requirements, [Ref. 1.4].

the design process, but they are the inputs for the initial cost estimation. Figure 1.3 shows the elements that go into the product requirements.

1.3. Life-Cycle Cost Scope The factors that inuence cost analysis are shown in Fig. 1.4. For low-cost, high-volume products, the manufacturer of the product seeks to maximize the prot by minimizing its cost. For a high-volume consumer electronics product (e.g., a cell phone), the cost may be dominated by the bill of materials cost. However, for some products, a more important customer requirement for the product may be minimizing the total cost of ownership of the product. The total cost of ownership includes not only the cost of purchasing the product, but the cost of maintaining and using it, which for some products can be signicant. Consider an inkjet printer that sells for as little as $20. A replacement ink cartridge may cost $40 or more. Although the cost of the printer is a factor in deciding what printer to purchase, the cost and number of pages printed by each ink cartridge contributes much more to the total cost of ownership of the printer. For products such as aircraft, the operation and support costs can represent as much as 80% of the total cost of ownership.

Introduction

Life-Cycle Cost
(Total Cost of Ownership) Sustainment Cost

Price Cost of Sale

Marketing Sales Shipping/transportation Shelf space Rebates

Operation and Support Cost

Operating Expenses Financing (cost of money) Insurance Cost of Failure Qualification/certification Maintenance (spare parts) Training Retirement and Disposal

Profit
Manufacturer Retailer/distributor

Design and R&D

Engineering Prototypes (hardware) Software Intellectual property Licenses

Manufacturing
Recurring Labor Materials Quality Non-Recurring Capital Tooling

Post-Manufacturing Support
Training Warranty Legal/liability Disposal Financing (costof money) Qualification/certification Refresh/Redesign

Fig. 1.4.

The scope of cost analysis (after [Ref. 1.5]).

Since manufacturing cost and the cost of ownership are both important, Part I of this book focuses on manufacturing cost modeling and Part II expands the treatment to include life-cycle costs and takes a broader view of the cost of ownership. 1.4. Cost Modeling Denitions It is important to understand several basic cost modeling concepts to follow the technical development in this book. Many of these ideas will be expanded upon in the chapters that follow. Price is the amount of money that a customer pays to purchase or procure a product or service. Cost is the amount of money that the manufacturer/supporter of a product or system or the supplier of a service requires to produce and/or provide the product or service. Cost includes money, time and labor. Prot is the dierence between price and cost. Thus, Price = Cost + Prot (1.1)

Technically, prot is the excess revenue beyond cost. Prot is an accounting approximation of the earnings of a company after taxes, cash, and expenses.

Cost Analysis of Electronic Systems

Note that prot may be collected by dierent entities throughout the supply chain of the product or system. Recurring costs, also referred to as variable costs, are costs that are incurred for each unit or instance of the product or system produced. The concept of recurring cost is generally applicable to manufacturing processes. For example, the cost of purchasing a part that is assembled into each individual product is a recurring cost. Non-Recurring costs, also referred to as xed costs, are charged once, independent of the quantity of products manufactured and/or supported. For example, design costs are non-recurring costs. Labor costs are the costs of employing the people required to perform specic activities. Tooling cost is a non-recurring cost that is dependent on the quantity of products manufactured and/or supported. Examples of tooling costs are programming and calibration costs for manufacturing equipment, training people, and the purchase or manufacture of product-specic tools, jigs, stencils, xtures, masks, and so on. Material costs are the cost of the materials associated with an activity. Material costs may include the purchase of more material than is used in the nal product due to the waste generated during the manufacturing process, and it may include the purchase of consumable materials that are completely used or wasted during manufacturing, such as water. Capital costs, also called equipment or facilities costs, are the costs of purchasing and maintaining the equipment and facilities necessary to perform manufacturing and/or support of a product or system. In some cases, the capital costs associated with standard activities or processes are incorporated in the overhead rate. Even if the capital costs are included in the overhead, specic capital costs may be included that are associated with buying unique equipment or facilities that must be created or purchased for a specic product. Depreciation is the decrease in the value of an asset (in the context of this book, the asset is capital equipment or facilities) over time. Depreciation is used to spread the cost of an asset over time. Direct costs can be traced directly to (or identied with) a specic cost center or object, such as a department, process, or product. Direct costs

Introduction

(such as labor and material) vary with the rate of output but are uniform for each unit item manufactured. Overhead costs, also called indirect costs, are the portion of the costs that cannot be clearly associated with particular operations, products, or projects and must be prorated among all the product units [Ref. 1.6]. Overhead costs include labor costs for persons who are not directly involved with a specic manufacturing process, such as managers and secretaries; various facilities costs such as utilities and mortgage payments on the buildings; non-cash benets provided to employees such as health insurance, retirement contributions, and unemployment insurance; and other costs of running the business such as accounting, taxes, furnishings, insurance, sick leave, and paid vacations. In traditional cost accounting, overhead costs are allocated to a designated base. The base is often determined by direct labor hours or the sum of all the direct costs, but it can also be determined by machine time, oor space, employee count, material consumption, or some combination of these. When overhead is allocated based on direct labor hours, it is often called a burden rate and is used to determine either the overhead cost, COH , or a burdened labor rate, LRB , as follows: COH = Npm bCL or LRB = LR (1 + b) where Npm = the total number of units produced during the lifetime of the product b = the labor burden rate (typical range: 0.3 b 2) CL = the labor cost of manufacturing and assembly (per unit) LR = the labor rate (often expressed in dollars per hour), which, when converted to an annual basis, is an employees gross annual wage Cost of money constitutes the nancial costs that are part of the economics of both producing the product and buying it. Whether a manufacturer or supporter has to borrow money to fund the development and manufacture of a product or has to use resources already on hand in lieu of using those resources elsewhere, there is a cost associated with the use of the money involved. For a customer, there are similar costs. If a (1.3) (1.2)

10

Cost Analysis of Electronic Systems

buyer has to obtain nancing to purchase the product or has to use cash on hand that could otherwise be earning money in another investment, these are costs that are associated with acquiring the product. One way to determine the cost of money is to obtain its present value, and to compare this value to its future value. The premise for computing the present value is that money available today can be invested and grow, whereas money spent today cannot. If we ignore the eects of ination or deation and we denote the value of an investment when it is made as Vn , then the present value of Vn that is made nt time units (in discrete time) from the present is given by Present value = Vn (1 + r)nt (1.4)

where r is the discount rate per time unit. For example, if nt is in years, then r is the annual discount rate.2 There are other forms of the present value calculation that have been used for various assumptions about the growth of money over time (see, for example; [Ref. 1.7] and footnote 11 in Chapter 13). The eective after-tax3 discount rates (r) vary, depending on the business sector: public, private, non-prot, or government. In the 2011 budget, the discount rate for the U.S. government varied between 0.9 and 2.7%,4 and for moderate-growth public companies the rate can range from 10 to 12% or higher. The eective discount rate assumed by an organization is not just the interest rate that could be earned if the money was placed in a bank or invested in the stock market; it is the return on the money that could be obtained if the money was used for another purpose. For a high-growth-rate company with limited resources, if $1,000,000 can be invested in opportunity A and the investment returned $1,500,000 at the end of one year, then the discount rate that must be used for the cost of using the $1,000,000 for a dierent opportunity is 50% (Vn = 1,500,000, which is the value 1 year in the future; r = 0.5, and nt = 1 in Equation (1.4) gives a present value of $1,000,000). An alternative example is the present value of spending the $1,500,000 one
2 The discount rate is the interest rate paid to borrow money or the interest rate that could be earned by investing the money. 3 After all applicable taxes have been deducted. 4 The eective discount rate for the United States government is often taken as the forecasted interest rate on treasury notes and bonds reported by the Oce of Management and Budget (OMB).

Introduction

11

year in the future if r = 0.5 is $1,000,000. Equation (1.4) assumes that the discount rate is constant over time, though in general it is not. Hidden costs are those costs that are dicult to quantify and may even be impossible to connect with any particular product. Examples of hidden costs include: the gain or loss of market share the stock price changes of a company the companys position in the market for future products impacts on competitors and their response the future value of engineering, manufacturing, and support experience associated with using new technologies or materials in the current product long-term health, safety, and environmental impacts that may have to be resolved in the future The impacts listed above are dicult to quantify in terms of cost because they require a view of the enterprise (i.e., the entire organization or company) that includes more than just one product and an analysis horizon that is longer than the manufacturing and support life of one product. However, these costs are real and may contribute signicantly to product cost. Often these costs are key to estimating the return on investment (see Chapter 17). 1.5. Cost Modeling for Electronic Systems Fundamentally, all of the topics treated in this book are applicable to nonelectronic products and systems, however, taken in total, the modeling techniques discussed are those required to assess the manufacturing and lifecycle sustainment of electronic products. The following paragraphs describe attributes of electronic systems that dierentiate their costs from nonelectronic systems. For electronics products such as integrated circuits, relatively few organizations have manufacturing capability, because of the extreme cost of the required facilities. The cost of recurring functional testing for electronics alone can represent a very large portion of the cost of products (even highvolume products), making the modeling and analysis of recurring functional testing an important contributor to cost modeling (see Chapters 7 and 8). For all but the highest volume products, manufacturers and supporters of electronic products have virtually no control over the supply chains for

12

Cost Analysis of Electronic Systems

their parts. As a result, products that are manufactured and/or supported for longer than a few years experience a high frequency of technology obsolescence, which can be very expensive to resolve (see Chapter 16). The majority of electronic products are not repaired if they fail during eld use; they are thrown away (exceptions are low-volume, long-life, expensive systems). Moreover, most electronic systems are not pro-actively maintained and are traditionally subject to unscheduled maintenance policies. 1.6. The Organization of this Book This book is divided into two parts. The rst part (Chapters 28) focuses on cost modeling for manufacturing electronic systems. Several dierent approaches are discussed, in addition to manufacturing yield, recurring functional testing (test economics) and rework. Demonstrations of the cost models in the rst part of the book focus on the fabrication and assembly of electronic products, ranging from fabricating integrated circuits and printed circuit boards to assembling parts on interconnects. The second part of the book (Chapters 1120) focuses on life-cycle cost analysis. Life-cycle costing addresses non-manufacturing product and system costs, including maintenance, warranty, reliability, obsolescence, and addresses the total cost of ownership of electronic products. Additional chapters (Chapters 9 and 10) address modications to cost modeling to account for uncertainties and learning curves. These topics are applicable to both manufacturing and life-cycle cost analyses. A rich set of references (and in some cases bibliographies) have been provided within the chapters to support the methods discussed and to provide sources of information beyond the scope of this book. In addition, problems are provided with the chapters to supplement the examples and demonstrations within the text. References
1.1. Sandborn, P. A. and Vertal, M. (1998). Packaging tradeo analysis: Predicting cost and performance during system design, IEEE Design & Test of Computers, 15(3), pp. 1019. 1.2. Box, G. E. P. and Draper, N. R. (1987). Empirical Model-Building and Response Surfaces (Wiley, Hoboken, NJ). 1.3. Augustine, N. R. (1997). Augustines Laws, 6th Edition (AIAA, Reston, VA).

Introduction

13

1.4. Sandborn, P. and Wilkinson, C. (2004). Chapter 3 Product requirements, constraints, and specications, Parts Selection and Management, Ed. M. G. Pecht, (John Wiley & Sons, Inc., Hoboken, NJ). 1.5. Magrab, E. B., Gupta, S. K., McCluskey, F. P. and Sandborn, P. A. (2010). Integrated Product and Process Design and Development The Product Realization Process, 2nd Edition (CRC Press, Boca Raton, FL). 1.6. Ostwald, P. F. and McLaren, T. S. (2004). Cost Analysis and Estimating for Engineering and Management (Pearson Prentice Hall, Upper Saddle River, NJ). 1.7. Newman, D. G., Eschenbach, T. G. and Lavelle, J. P. (2004). Engineering Economic Analysis, 9th Edition (Oxford University Press, Inc., Oxford, UK).