New Product Surprises
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.
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?
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.
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
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.
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
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.
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.
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.
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.
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
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 ...
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.
to Eliminating Gross Margin Surprises
Here are the 8 proven steps for avoiding gross margin surprises:
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.
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
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
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.
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.
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
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!
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.
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!