2.009 Product Engineering Processes!2.009 Product engineering processes!Today!business case the (very) basics!Acknowledgments: Victor Tang!A proposition"I will give you $1000 today!"or!I will give you $1200 next year!!factors in making your decision?!current financial/life circumstances!trust in the monetary source!Concept 1!Time value of money A dollar now is worth more to you than a dollar in the future. !interest rate r = % per period n!future value = present value x (1+r)n!t 0 2 1 n . . . . $1. $1.1 $1.21 $(1+r)n r = 10%!your personal, discount rate r per period n is …!(1+r)n = future value/present value "wait for $1200, your r per year is ≤ 0.2!take $1000 from me now, your r per year is > 0.2!so, if you decided to:"Concept 1!Discount rate personal discount rates tend to be high!!t 0 2 1 n . . . . $1. $1.1 $1.21 $(1+r)n when you perceive present and future value to be equivalent !Concept 2 !Net present value (NPV) Future cash flows can be converted into a present day value using an appropriate discount rate!t 2 1 5 NPV = Σ!n=1 m cn (1+r)n cn is cash flow in period n r is discount rate per period n m is total number of periods (3-5 years typical) 0 1/(1+r) 1/(1+r)2 . . . . 1/(1+r)5Another proposition"please give me $1000 today!and I promise…!I will give you $1300 next year!!…at least I am quite sure that I will pay you but there is some chance that I might lose it and won’t pay you back at all.!Concept 3 Internal rate of return (IRR) a.k.a. return on investment (ROI) At what discount rate will future cash flows have the same NPV as your initial investment?!t 2 1 5 . . . . i = investment!cn is cash flow in period n m is total number of periods r is the IRR i = Σ!n=1 m (1+r)n cn c1/(1+r) c2/(1+r)2 c5/(1+r)5Concept 3!IRR or ROI"If you gave me $1000 now expecting $1300 next year, !an expected IRR of 30% was enough for you to invest.!If you did not give me $1000 now, "an expected IRR of 30% was not enough.!1000 =!(1+r)1 1300Expectations!IRRs and risk"30+% for risky new ventures!20 % for new products!15 % for extensions/improvements to existing product!10 % for cost improvement to existing product!risk-free rate-of-return !historically ~ 6% for short term government bonds!question:"How to convince people to give you money?!Proof points !product is not “me-too”!clear target market!know why customers will buy!know why customers will not buy – product issues, competition!anticipate a desirable return on investment (benefit)!you are confident, enthusiastic, and trustworthy !answer:"Have a credible business proposal!Business Proposal!Important take away messages"We have an attractive market !market size $, and 3-year growth rate !profitability and/or other killer benefits!We have a competitive product !what makes the product different!what are its unique benefits !We have a viable business !IRR xx% with initial investment of $ xx!break-even at units in xx months!reach steady state in yy months !Business Proposal!Important take away messages"We have an attractive market !market size $, and 3-year growth rate !profitability and/or other killer benefits!We have a competitive product !what makes the product different!what are its unique benefits !We have a viable business !IRR xx% with initial investment of $ xx!break-even at units in xx months!reach steady state in yy months !Take Away Message!Market opportunity"target market"!what is your product and who will buy it? (in 25 words or less)!market characteristics "abc def $xx rpq $xx $xx $xx top 3 competitors $xx $yy $zz m% n% Year 1 the market Year 2 Year 3 where and how they are going to buy: store, sales rep, etc? !how will they find out about your product, its features, and benefits? !why is your price attractive? !Business Proposal!Important take away messages"We have an attractive market !market size $, and 3-year growth rate !profitability and/or other killer benefits!We have a competitive product !what makes the product different!what are its unique benefits !We have a viable business !IRR xx% with initial investment of $ xx!break-even at units in xx months!reach steady state in yy months !killer attributes attribute 2 attribute k Competition can be another product ... "or simply old way of doing things.!Take Away Message!A competitive product"abc def lmn 009 attribute k-1 attribute k … attribute 4 attribute 3 attribute 2 attribute 1Business Proposal!Important take away messages"We have an attractive market !market size $, and 3-year growth rate !profitability and/or other killer benefits!We have a competitive product !what makes the product different!what are its unique benefits !We have a viable business !IRR xx% with initial investment of $ xx!break-even at units in xx months!reach steady state in yy months !Getting a handle on your return!but first"Determine your revenue, costs, expenses, and initial investment!Take Away Message!A viable business"Revenue i) simplified sales estimation Assume volume, Qmax009=180K!4 years to reach asymptote .... and!Y1 180K 140K 100K 60K 20K Y3 Y2 Y4 guestimate intermediate pointsideally:!cost and price both decline,!margin increases!5X 3X $ time cost price Revenue ii) develop pricing strategy price ≠ cost"Cost A mini quiz! What is the relationship between the cost of an alpha prototype and the product’s cost?!answer:"there is no relationshipideally:!cost and price both decline,!margin increases!5X 3X $ time cost price Revenue ii) develop pricing strategy price ≠ cost"Revenue Other possible sources the value of goodwill?"strategic positioning?"Getting a handle on your return!but first"Determine your revenue, costs, expenses, and initial investment!Take Away Message!A viable business"manufacturing cost materials cost gross profit sales expense gen. admin. expense NEBT interest exp. taxes NEAT sales revenues T1 $ T2 $ … Tk $ R&D expense should be monotonic increasing Price x quantity $ paid for parts $ paid for labor, capital sales rev.-material cost- manufacturing cost $ paid for engineers and equipment & stuff $ paid for sales people, customer lunches, travel ... $ paid for office, insurance gross profit - Σexpenses use 4-year time horizon"Revenue, Cost and Expenses Simplified profit and loss statement (net earnings before tax) better be monotonic increasing (net earnings after tax)income structure!(normalized to 100% of revenue)!fabricated metal "SIC 3499"009"cost exp. SG&A profit Cost"materials, labor, overhead 69.7% Expense