4.7Tools: Financial Viability
Now that you have learned about the first two elements of the cycle of satisfaction—deep customer insight and endtoend development—let's take a moment to reflect. What are you really trying to accomplish with all of this work? Answer: Your goal is to consistently bring great new products to market that solve customers' problems profitably! Without profit, you won't have the money needed to invest in the next generation of customerpleasing products.
With this goal in mind, you need to ask, "Can we justify bringing this new product to market?" This question is part of the discussion at each stage gate. Two tools are commonly used to evaluate financial viability:
Breakeven Analysis
Net Present Value
BreakEven Analysis
Let's return to the stagegate process. The first "go/nogo" decision takes place right up front as you screen each new product idea. As part of your evaluation, you ask, "Does the product provide a positive returntorisk ratio?" At this early design stage, you don't have enough information to perform a detailed profitability analysis. However, you can probably run a breakeven analysis.
As the name implies, a breakeven analysis asks, "Can you make money (i.e., break even) with this product?" That is, are likely sales (in units) sufficient to cover the costs of making the product? The equation to calculate the breakeven point is as follows:
where,

Q _{BE} = Number of Units to Break Even

FC = Fixed Costs

VC = Variable Cost per Unit

P = Sales Price per Unit
Now, let's talk through the logic of the equation. The total cost of producing a product is the sum of the fixed and variable costs (see Figure 4.13).
Fixed costs exist regardless of how many units you make. They are the costs of being in business (e.g., overhead and insurance).
Variable costs are the costs associated with making each unit and include direct labor and materials.
Assuming your sales price (P) is greater than your variable costs (VC), every time you sell a unit, you pay off some of your fixed costs. This amount (PVC) is called the contribution to fixed costs. So, you break even when you sell enough units (QBE) to cover your fixed costs. You may be wondering, "Where do you get the numbers needed to calculate the breakeven point?" Because you are early in the design process, you really don't have accurate numbers. Rather, you work off of forecasts made by your marketing (price) as well as accounting (fixed costs) and production (variable costs) teams.
Now, let's walk through an example. Imagine you want to start up a company to manufacture and sell sporty polarized sunglasses designed in university colors and featuring university logos. You've done your homework and estimate the variable costs (including trademark privileges) will be $57 a pair and the fixed costs to be $78,000. Answer the following two questions.
If you sell the sunglasses for $99 a pair, how many pairs do you need to sell to break even?
If you can sell 5,000 pairs to current students and alumni of your alma mater, how much money will you make?
BreakEven Quantity
$$ \begin{align*} Q_{BE} &= \frac{FC}{P  VC} \\ &= \frac{$78,000}{$99  $57} \\ &= 1,857 \textrm{ pairs} \end{align*}$$
Your breakeven quantity is 1,857 pairs of Wildcat (insert your alma mater's mascot) sunglasses.
Contribution to Profit
You calculate your contribution to profit by subtracting your total costs (i.e., fixed plus variable) from your total revenue, which is equal to your price times the number of units you sell. That is,
$$ \begin{align*} \textrm{Profit} &= P \times Q  [FC + VC \times Q] \\ &= $99 \times 5,000  [$78,000 + $57 \times 5,000] \\ &= $132,000 \end{align*}$$
Net Present Value
If a product makes it past the first stage gate, your next step is to develop a rigorous business case analysis (BCA). Your goal: To determine whether expected sales, growth, and profit justify the investment. Simply put, you want to know if the product will be profitable. At this point, you need to perform a serious profitability analysis. The financial analyst on your NPD team will calculate the expected net present value (NPV) of the product.
The NPV is simply the current value of all cash flows (current and future) related to the product. To calculate the NPV, you first need to identify all relevant cash flows and their timing. Typically, you will incur three types of cash flows: Initial outlays, annual costs/revenues, and endoflife cost/revenues.
Initial Outlay:

What will it cost to develop and launch the product?
Annual Costs/Revenues:

How many units of the product will you sell (on a yearbyyear basis)?

What will it cost to promote and sell each product (on a yearbyyear basis)?

What will it cost to produce and deliver each product (on a yearbyyear basis)?

How much revenue will you generate on each sale (on a yearbyyear basis)?
Endoflife Cost/Revenues:

What will the product's endoflife costs (disposal) look like?
Once you've identified all of the relevant cash flows, you may want to build a table to help you organize your analysis (see Table 4.5).
Initial Outlay; i.e., Design and Launch Costs:  $90,000 
Annual Costs/Revenues:  
Year 1: 2,500*(9988)  $27,500 
Year 2: 5,000*(9988)  $55,000 
Year 3: 5,000*(9988)  $55,000 
Year 4: 5,000*(9988)  $55,000 
Year 5: 5,000*(9988)  $55,000 
EndofLife Cash Flows  $100,000 
Net Present Value:  $120,173 
Now, let's work through the sunglasses example above, using the cash flows shown in Table 4.5. Imagine your upfront design and launch costs are $90,000. You expect to sell, 2,500 pairs of sunglasses the first year and 5,000 pairs each year for the following four years. Your sales price will be $99 and your costs per unit (including overhead) will be $88. At the end of the five years, you hope to be able to sell Wildcat Sunglasses for $100,000. If your required return (aka, your discount or hurdle rate) is 15%, what is your net present value (NPV)?
$$NPV = \textrm{Sum of the Present Value of All Cash Flows  Initial Outlay}$$
You can use either your calculator or Excel to run the numbers. Since each calculator model uses a different sequence of buttons to compute the NPV, refer to your calculator's user manual or Google the instructions to learn how your calculator works. In Excel, you will use the =NPV function as follows: =NPV(.15,27500,55000,55000,55000,155000)90000.
The decision rule is to proceed with the product development if the NPV is greater than zero and favorable when compared to other products vying for capital investment. Since your NPV is $120,173, you need to ask, "Do you have any other products under consideration that provide a higher expected return?"
You care about the world you live in—don't you? According to Nielson research, 55% of global consumers feel the same way. They claim they are willing to pay more to buy from socially responsible companies.1 More and more companies count on your desire to buy and use sustainable products and are investing in the following design for environment practices:

Design for Energy Efficiency. Designing products to minimize energy use throughout their life cycle.

Design for Environmental Processing. Designing products to be made out of materials that can be sourced and manufactured in a safe and efficient way.

Design for Environmental Packaging. Designing products to use as little packaging as possible. When packaging is needed, materials should be environmentally friendly.

Design for Disposal or Reuse. Designing the product for reuse when possible and easy recycling when necessary. The goal: Eliminate waste and pollution.
Putting these concepts into practice, PUMA, the German athletic apparel company, has developed a CradletoCradle certified line of footwear, apparel, and accessories.2 How is Puma pursuing design for environment principles? Consider the following:

PUMA designs its C2C line for easy recycling, which requires that "products" be decomposable into pure, homogeneous materials (i.e., Puma doesn't blend materials). Recycling uses far less energy than raw material creation.

PUMA uses biodegradable polymers and organic cotton, eliminating the need for pesticides, fertilizers, and other hazardous chemicals.

Puma uses recycled materials. The PUMA Track Jacket is 98% made from recycled polyester (you know, the PET bottles used to package sodas and bottled water). When the jacket is warn out, it can be turned into polyester granulate, which can then be used in a "thirdgeneration" product.
PUMA is on the fast track to making the world more habitable for everyone.
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