Economics for Products

(cont’d)
Cash Flow Including the Time
Value of Money
 Suppose we want to buy a car costing $10,000.
 If we buy it now, we need $10,000.
 If we buy it in a year, we need less:
 We can put the money in a bank, earn say 8% interest for
the year, and buy the car at the end of the year.
 More specifically:
 [money needed for the car](1.08)=$10,000
 [money needed for the car]=$9,260.
 Delayed gratification saves money.
 This effect is called “time value of money” is also
present in engineering economics.
Cash Flow Including the Time
Value of Money
 Time value of money affects all the costs and
revenues of product development.
 It changes most of the numbers shown in the
table in previous presentation.
 The key effect is to alter the cash flows
shown by means of the equation:
present value
[adjusted cah flow] 
[1  (int erest rate / 4 quarters)]n 1

where n is the number of quarters involved.

Cash Flow Including the Time
Value of Money
 As illustration, the adjusted cash flow for the
$10,000 car mentioned earlier is:
$10,000
[adjusted cah flow]  4 1
 $94,200
[1  (0.08 / 4)]

 The cash needed is more than in our first

calculation because, in this case, the interest will
be paid back every quarter.
 The cash flows in the earlier table can be corrected
for the time value of money.
 Assume that money costs 15%, or 3.75% per quarter
Cash Flow Including the Time
Value of Money
Cash Flow Including the Time
Value of Money
 The corrections for the time value of money
significantly alter the net present value.
 Without corrections, the value is $6.84 million
 With corrections, the value is $3.42 million, a reduction of
50%.
 Other considerations – variable product demand and
inflation – will reduce the value even further.
 Such examples, increases our respect for those in
business who tame these numbers to make profits.
 Such number taming is essential to product
development – even though it does not center on
engineering skills.
Time to Market
 So far we have neglected time to market.
 This is the other unusual factor in product economics.
 The business cliché is: the first company to bring the
product to market gets 60-70% of the total sales.
 Competitors who arrive late fight over the remaining
fraction.
 For e.g., Nafion is an ion exchange membrane
produced by Du Pont and used in the chloralkali
process.
 Nafion was the first of its kind, and even though Dow
and Asahi Glass now produce superior menbranes,
Nafion continues to dominate sales.
Time to Market
 Being first to market is very important.
 But the reasons need not always concern product quality and
product cost.
 A drug such as insulin is a good example.
 The company that gets approval first and markets first will certainly
get most of the initial sales.
 A second company can make it at higher quality and lower cost has
good chance of gaining market share at the expense of the first.
 As the drug comes off patent, some other company stands to gain.
 Nevertheless, the business cliché normally holds: the first to
bring a new product to market will get a clear majority of the
product sales.
Example: Scottish Mussel
Farming
 Mussels (a shelled creature) are eaten in Western countries.
 They are farmed on vertically suspended ropes (harvest ropes) in
Scottish lochs.
 Often tube worms settle on the mussel shells and leave a hard,
calcinaceous deposit – considered unappealing.
 The seriously fouled mussels are manually sorted and discarded to
maintain product quality – loss of 5 – 25% of the mussel crop.
 A vital fact – tube worms are less tolerant to fresh water than mussels.
 In the Scottish lochs, though the bulk of the water is salty, the top 1m
layer is fresh water.
 It should be possible to discourage tube worm settlement and growth
by periodically raising the harvest ropes into the top 1m of water.
 Need: to investigate the economic viability of this project.
Example: Scottish Mussel
Farming
Example: Scottish Mussel
Farming
 In current practice, the mussel harvest ropes are 7m
long and 30cm apart.
 They hang from long horizontal header ropes.
 Nylon ropes can be attached to the dangling ends of
the harvest ropes for easily raising them into a
horizontal position.
 Specifications:
 Harvest ropes are grouped in batches of ten.
 Nylon ropes of 3m length are tied to the ends of ten harvest
ropes.
 The header ropes are anchored such that they run parallel at
an approximate distance apart of 7m.
Example: Scottish Mussel
Farming
 We now work out the economics:
 A typical mussel farm has 15,000 harvest ropes.
 Produces 150 tons of mussels annually, sold at £810 per ton.
 For every ten harvest ropes we need 3m extra nylon rope,
i.e., 4500 m additional rope in total.
 Since 200m of nylon rope costs £550, the cost of extra rope
is £24,750.
 The labor cost is estimated to be £3200 per year (32 man
days).
 A pilot study shows that raising the ropes leads to 10%
increase in mussel yield per year.
 This gives an increase in income of 150 x 0.1 x £810, i.e.,
£12,150 per year.
Example: Scottish Mussel
Farming
 We expect the ropes will need replacing after 5
years.
 This is the project lifecycle.
 We can calculate the NPV of the project over its 5-year
lifecycle.
 Assume the cost of money is: 8% per year.
 Net present value = £10,985.
 The investment will pay off, with a healthy ROI of over 40%.
 The profit will be affected by factors such as the increased
yield of mussels and the labor required to raise the ropes.
Summary and Conclusions
 This chapter emphasized the differences between key costs of
commodity processes and specialty products.
 Commodity products:
 Needed in larger amounts
 Synthesized in dedicated equipment
 Operated continuously
 Specialty products:
 Made in small amounts
 Made in generic batch equipment.
 Different approaches for evaluating product value:
 For commodity products, we use the economic potential
 We assume a long term market exists for our chemical.
 For small-scale products, NPV is a more useful idea.
 We focus on the speed of product development – time to market is critical.
 The product’s lifetime is unpredictable, and often short.
Summary and Conclusions
 The economic calculations outlined in this
chapter are preliminary.
 For actual manufacture, we need much more
detailed estimates.
 This will include many more factors.
 Beyond the skills of most chemical engineers.
 Need to interact with experts.
 Engineers and scientists are more necessary
to the aspects of product design described in
earlier classes.
Final Management Review
(Fourth Gate)
 This is the last big management review.
 The first review, after we had defined needs and specifications, was
superficial.
 At this point the management is usually enthusiastic esp. since the project
is so new.
 The second review, after the screening of ideas, is also benign.
 The management is often charmed and intrigued by the science of our
potential invention.
 At this point, we engineers need to be critical and objective about our own
ideas.
 The third review comes after selection.
 The management will be more engaged, even hostile, because we are
asking for a lot of money.
 Management may not know chemistry or engineering, but they know
money well.
 Here our job is to be as accurate as possible.
 We and our organization are about to take a significant risk.
Final Management Review
(Fourth Gate)
 At the fourth gate, we will know how to manufacture
the product.
 At this point, the management should become our
allies, not just our critics.
 They, too, want the new product to be successful.
 This means we need to have our technology
completely worked out.
 No part marks for the wrong answer.
 No part marks in Chemical Product Design – need to
get everything right!