New product development is an investment requiring a significant amount of capital to be successful
By Mike Collins, Author, Saving American Manufacturing
 "Anybody who advises SMMs on strategies such as developing new products, should also help them answer the money questions involved. New product development is an investment and may require a significant amount of capital to be successful."
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Anybody who advises SMMs on strategies such as developing new products, should also help them answer the money questions involved. New product development is an investment and may require a significant amount of capital to be successful.
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These are decisions with considerable risk and every effort should be made to help the manufacturer do a good diagnosis before offering a prescription.
New product development begs a lot of money questions such as:
- How much will the total project cost?
- What price will users pay for this product?
- Is the sell price comparable to competitor prices?
- What is the estimated cost and margin?
- How many products can I sell per year?
- How many years will it take to get my investment back?
These can be daunting questions to answer depending on the type of new product and risks involved.
Perhaps it is easiest to address money questions by starting with the spreadsheet on the following pages that shows the owners, investors, and shareholders when they will get their money back; and before they make the final decision on whether to fund the project.
The example is a simple one-page Return on Investment spreadsheet. The product is a small material handling machine I will call and SF100. This form is usually the last slide presented late in the new product process after most of the critical information has been gathered.
To give this exercise even more importance, I will also add that the owner of the manufacturing company will have to mortgage his house, and borrow money from the bank and from family and friends. Let me explain the form in a step by step manner showing how it was developed.
1. Average Sell Price – To be able to set a sell price, the manufacturer must know something about competition in the marketplace. Customers usually have competitive products that they are already purchasing, so they will want to know two things:
- What is the advantage of your machine over the ones they can already purchase?
- How does your price compare to the competition’s prices?
It is important to find the answers to these two questions before you have developed a prototype and are trying to sell it in the marketplace.
At a minimum, someone needs to find out how many direct and indirect competitors are already in the market, what their sell prices are, and the proof that you have a competitive advantage over existing competitive products
2. Margins/Costs – Management usually has a minimum margin that they would like to attain in any new product. In this case the margin is 30 percent. So when you have decided on the sell price and margin, it means the total cost of the product must be at 70 percent of the sell price.
If you don’t think it is possible to build a machine for this cost, then you need to make an early decision about the viability of the project.
3. Total Cost Of Project – It is also important to accurately estimate the total costs of developing the new product. This includes all engineering, building the prototype, tooling, necessary options and all marketing costs.
4. Sales Forecast – This is probably the most important number of the whole exercise because it is the multiplier of all costs and margins. If I were the owner and sticking my neck out to finance this project, I would want to know how the team arrived at this number in terms of units and sales.
Even if the numbers are just estimates the owner and investors will want some kind of evidence that customers will eventually buy the new product.
You might begin by trying to find out how many competitor machines have been sold per year which shows the size of the market, or you might get testimonials from prospects and customers on why they might buy the machine.
5. Total Projected Profits – If your numbers in 1 through 4 are fairly accurate it is pretty easy to project the total yearly profits by subtracting the total projected margins each year from the total cost of the project.
In the early years when sales are just beginning and the total cost of the project is being absorbed, this will be a negative number, but as sales and margins begin to increase they begin to pay for the project costs.
6. Payback In Terms Of Years – The final number is the year when all project costs have been paid off and the new product sales begin producing profit for the company. It is up to the owner at what year he wants to pay off the project and begin making money.
Most owners of midsize manufacturing companies with a board of directors don’t like to fund projects that have more then a four-year payback
The primary reason for the failure of new product projects is that sales do not materialize. If the sales forecast was inaccurate and sales do not materialize as projected the payback on the project may not happen. This can be a serious problem for the owner who has borrowed from the bank and friends with an agreement to pay the money back on a term loan with fixed dates.
Now I know what you are probably thinking, “Gosh do I really have to all of this stuff?” The answer is that it depends on the cost of the product and where the money comes from.
1. Trying to raise money from a capitalist or angel venture, do your homework.
Wayne Embree of Cascadia Pacific Management looks at many new product and technology ideas and reviews a lot of business plans. There are hundreds of new business plans submitted every year and hundreds of new product ideas that are ingenious and innovative.
But, only about one or two percent of the business plans and product ideas, however, get serious consideration for investment.
When asked what these inventors and entrepreneurs can do to increase their chances of commercializing their product idea, Wayne says, “They should spend a lot of time developing a case as to how their product idea is going to have compelling competitive advantage.”
This translates into gathering lots of information on competitors, channels of distribution, and customers if you’re going to convince anybody to invest money in your product idea. Wayne’s summary expression is, “An ounce of marketing beats a pound of technology”.
2. Borrowing money from the bank, refinancing your house, or getting personal loans from family and friends, do your homework.
It isn’t just your money. You owe these investors your best effort at trying your best to find the answers to these six questions. This is equivalent to “betting the farm” and there is a lot of risk for a lot of people.
3. Take shortcuts only if it’s your money, or the product is low cost.
If it is a simple, low cost product, you can build a prototype and do some kind of test marketing to find out if it can be sold as it, or must be modified for the market. If it is all your money — and as an entrepreneur you trust your gut instinct — go for it. On the other hand if it was everything you had and you get a sick feeling in your stomach, maybe it would be wise to find a quiet place and re-read the basic questions that show you the money.
Michael Collins is the author of Saving American Manufacturing. His website is www.mpcmgt.com