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Go/no-go milestones:
‡Should we try to develop a product to meet this market need?
‡Should we proceed with the implementation of a selected concept?
‡Should we launch the product we have developed?
Such decisions commonly arise at the end of each development phase.

Operational design and development decisions:

‡Should we spend $100,000 to hire an outside firm to develop this
component In order to save two months of development time?
‡Should we launch the product in four months at a unit cost of $450 or
Wait until six months when the cost can be reduced to $400?
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|etractors of quantitative analysis argue that it suffers as following:

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discourage investment in intangible assets.

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. |etractors of financial analysis assert that such
activities provide a high level of planning and control at the expense of product
development productivity. In their view, extensive planning and review assure that a
brilliantly conceived, well-engineered product will reach the market after its market
window has already closed. |etractors also argue that overzealously applied
³professional´ management techniques stifle the product development process.
Potentially productive development time is devoted to preparation of analyses and
meetings. The cumulative effect of this planning and review can be a ballooning
development process.
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3. Use sensitivity analysis to understand  
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4. Consider the influence of the 
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This consists of estimating the timing and magnitude of future cash flows and then computing the
›
 
 îNPV) of those cash flows.
Estimating the timing and magnitude of future cash flows is done by merging the project schedule with the
project budget, sales volume forecasts, and estimated production costs. The level of detail should be coarse
enough to be convenient to work with, yet contain enough resolution to facilitate effective decision making.

The most basic categories of cash flow for a typical new product development project are:
 
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‡ Breakdown of production costs into direct costs & indirect costs îoverheads)
‡ Breakdown of marketing and support costs into launch costs, promotion costs,
direct sales costs, and service costs
‡ Inclusion of tax effects, including the depreciation tax shield and investment tax credits
‡ Inclusion of such miscellaneous inflows and outflows as working capital requirement,
cannibalization îimpact of the new product on existing product sales), salvage costs, and opportunity costs.
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Sensitivity analysis uses the financial model to answer ³what if´ questions by calculating
the change in NPV corresponding to a change in the factors included in the model.
Both internal and external factors influence project value.
Ô  h
are those over which the development team has a large degree of
influence, including development program expense, development speed, production cost,
and product performance.
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are those that the team cannot arbitrarily change, including the
competitive environment îe.g., market response, actions of competitors), sales volume,
and product price.
h There may be disagreement over whether price is an internal or external factor.
Regardless, there is little disagreement that price is strongly influenced by the prices of
competitive products and that it is linked to sales volume.
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are often influenced by the   h
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|evelopment teams attempt to manage six potential interactions between internally driven factors.

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, for example, decreasing development time
may lead to lower product performance. Increased product performance may require
additional product cost. Some interactions are, however, more complex in nature. For example,
decreasing product development time may require an increase in development spending, yet
extending development time may also lead to an increase in cost if the extension is caused by a
delay in a critical task, rather than by a planned extension of the schedule.
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Interactions are important because of the linkage between internal & external factors.
For example, increasing development cost or time may enhance product performance
and therefore increase sales volume or allow higher prices.
decreasing development time may allow the product to reach the market sooner and
thus increase sales volume.
Trade-off Rules:
These rules take the form of the cost per unit change in the internal & external factors.
Examples might be ³what is the cost of a one-month delay in development time?´ or
³What is the cost of a 10% development budget overrun?´ or
³What is the cost of a $1 per unit increase in manufacturing cost?´
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SIPOC from a Six Sigma Perspective:

From the Six Sigma Perspective, the model is a ³COPIS´ one in the sense that
Six Sigma projects are customer-driven, begin with the customer, and are
pushed back through the value chain as far, ultimately, as the supplier.
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‡ Cost data provide a basis for important decisions on
pricing, product mix, product design, process
improvement, and technology acquisition.

‡ Poor decisions in these areas can severely impair the

ability of a company to compete.
 

‡ Cost Behavior: this analysis tells us how the activities of an
organization affect its costs.
‡ Cost |rivers: the activities that affect costs. Cost drivers can
be volume related or non-volume related. Examples for the
case of a warehouse that receives and stores material and
supplies are:
± Total monetary value of inventory;
± The number of different orders received;
± The number of different items handled;
± The fragility of the items handled.
 

‡ Variable Cost: is a cost that varies in direct proportion to
changes in the cost driver. Typically the number of units of the
product is the cost driver.
‡ A 20% increase in the number of units produced will cause a
20% increase in the cost of raw material used.
‡ This relationship holds for some relevant range. There may be
quantity discounts available.
 

‡ Fixed Cost: is a cost that is not affected by changes in the cost
driver within some relevant range. For example, the rent paid
for storage space îa warehouse) is not affected by the number
of units of product stored, within the capacity of the warehouse.
Beyond this range, it may be necessary to rent a larger
warehouse, the cost for which would be fixed over some new
and, probably, higher range.
‡ Cost-Volume-Profit Analysis: is the study of the effects of
output volume on sales, costs, and net profit.
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‡ This is the sales volume at which revenue equals expenses
and net income is zero, that is:
‡ îUSP)*îN) = îUVC)*îN) + Fixed Expenses
‡ Break Even Point îunits) = îFixed Expenses)/ [USP ± UVC]
‡ Where:
o USP = unit sale price
o UVC = unit variable cost
o N = Number of units.
 

  

‡ In a manufacturing environment, where labor and factory facilities are used to convert
materials into other goods, products are frequently the cost objective. THUS:
‡ |irect-material costs: include the acquisition costs of all materials that form part of the
manufactured goods and can be traced at some reasonable cost. These would include
the cost of raw materials, components, and subassemblies, BUT NOT supplies and
indirect materials such as lubricants and cleaning supplies. These would appear in
³factory overhead´.
‡ |irect-labor costs: include the wages of all labor that can be traced to the manufactured
goods at reasonable cost, e.g. wages of machine operators and assemblers. Indirect
labor costs îfor storeroom personnel, janitorial staff, security personnel) are included with
factory overhead.
‡ Factory-overhead costs: include all costs associated with the manufacturing process not
classified as direct material or direct labor ± see above and supplies, indirect labor,
supervision, rent, insurance, depreciation. THESE are also known as SUPPORT
RESOURCES.


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‡ COST ACCUMULATION: this collects costs by some
classification such as materials or labor.

‡ COST ALLOCATION: traces and reassigns costs to one or

more activities of interest, such as departments or products.
‡ Costs are first allocated to departments îto evaluate
performance) and then to products îto value inventory and
judge product profitability). The process of cost allocation is
thus a two-stage process.
 



 
‡ The costs of two resources are typically
charged directly ± material and labor îdirect
material and direct labor) Resources such as
these, which are consumed in direct proportion
t the number of units produced, can be
measured fairly and accurately.
 



 
‡ In a traditional cost accounting system, the costs of all other resources are indirectly
assigned to products using direct labor or some other unit-based measure. This can
cause serious distortions in product costs for several reasons
‡ Timing: the R&| costs of future products are assigned to products currently being
produced. Certain costs for current products ± such as warranty costs ± may be omitted.
‡ Life Cycle Costs: In the early stages of a product¶s life cycle, engineering and support
costs are high while production costs are low. These costs get assigned to higher volume
products that do not require similar levels of support.

‡ Many support resources are not consumed in proportion to their

production volumes.
 



 
The distortion from unit-based product cost systems is most severe in
organizations producing a diverse product mix for the following reasons.

‡ 1. Increasing product diversity ‡ 2. Products that differ in volume,

increases levels of support complexity, and stage of life cycle
consume support resources in
activities and related indirect significantly different amounts.
costs.
‡ The high proportion of overhead
‡ In other words, the overhead costs are thus allocated incorrectly
costs of support resources tend by measures such as direct labor
to be a larger proportion of total or direct material.
costs.
 



 
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‡ Consider the case of two Tumbling |ice Electronics, Inc. plants - |omino and
Geronimo ± both producing C| Players.
‡ The |omino Plant makes 100,000 C| Players per year of a single model with a
stable design.
‡ The Geronimo Plant makes 100,000 units of a dozen different designs in
volumes ranging from 1000 to 30,000 and the designs of some of the lower
volume models are subject to frequent changes.
‡ It is clear that Geronimo will have much higher levels of indirect costs due to
larger costs for scheduling, setups, inspections, materials management, design,
and engineering changes.
‡ The traditional system would provide accurate costs for |omino, but for
Geronimo, the high support activity costs would be allocated incorrectly by unit-
based measures to high volume models.
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‡ ABC takes a different approach in assuming that products incur costs
by the ACTIVITIES they require for design, engineering, manufacture,
sale, delivery and service.
‡ These activities, in turn, cause costs by consuming support resources
such as the production planning and control dept., setup dept.,
engineering dept., shipping dept., and so on.
‡ ABC attempts to trace as many of the indirect costs as possible directly
to products, as is done with direct material and direct labor.
‡ To implement an ABC system, a company must identify the major
activities undertaken by support departments and select a cost driver
for each. Some examples are: îa) Engineering and hours of engineering
services, îb) inspection and hours of testing, îc ) Shipping and number
of orders and îd) Production Setup and number of setups.
‡ A|VANTAGES:
‡ Improved decisions through more accurate cost data. This becomes
especially important when manufacturing overhead costs account for a
large percentage of production costs ± e.g. as in the electronics and
machinery industries where overhead accounts for 70%-75% of value
added.
‡ Improved insights into activities that lead to overheads. By linking activities
to financial costs, ABC provides cost information to complement non-
financial indicators of performance. It is therefore compatible with TQM
efforts.
‡ It recognizes the non-manufacturing costs of products through the
activities that are linked to products.
‡ It allows cost analysis at the design stage. |esigners can keep in mind
cost drivers îe.g. number of components) while designing the product.
‡ Any scheme for allocation of indirect costs can be considered arbitrary
because another consultant or expert could design an alternate scheme.

‡ The use of single cost drivers is naïve. For example, shipping and handling
costs are likely to depend on the number of orders shipped, the weight,
volume and special packaging needs of products. Using only one of these
drivers will not reflect costs accurately.

‡ Many fixed costs are treated as variable costs. This could lead a company
to mistakenly use the per unit cost obtained from an activity-based costing
system as a marginal cost.

‡ The cost of implementing an ABC System, with many cost pools and cost
drivers, can be high.
‡ |iversity in the product mix in terms of complexity of
products, stages of life cycle, volumes, number of batches
produced, requirement for engineering and quality related
activities, etc.

‡ Profitability of products and competitors prices are hard to

explain. Common symptoms of this problem are winning
bids that you considered high, and losing bids that you
considered low. The higher the cost of such measurement
errors, the more important it is to get more accurate
product costs.
‡ CIM provides a good example of an environment where support activities generate high
percentage of the costs:

± 1. |evelopment of the computer programs that run the machines, direct the material
handling system, coordinate the different elements of the system, and provide
feedback to supervisors.
± 2. Scheduling and sequencing of products
± 3. |esign of products and process routes so that production can be assigned to CNC
equipment with minimum human intervention; and
± 4. Increased levels of preventive maintenance.

The flexibility of CIM systems ± e.g. ± a Flexible Manufacturing System îFMS), allows
many different products to be produced simultaneously in small batches and in
random order. This makes the prior tasks even more complicated. At the same time,
the highly automated and computer controlled nature of the production process
means that direct labor costs tend to be a very small component of the total cost. Any
overhead cost allocation based on direct labor will provide distorted product costs.
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