As part of a continuing series, we have been investigating the economic tools deployed within an innovation process. You’ll recall that new product development (NPD) is usually managed through a stage-gate process to minimize risk and investment cost. NPD work is done in stages and plans for the next phase of work are reviewed for appropriateness at the management gate reviews. While the scope of work and its corresponding investment increase with each stage of the NPD process, risk is minimized by the added information and data gained from each prior stage of work.
Typical stages in an NPD process are:
- Stage 1 – Opportunity Identification,
- Stage 2 – Concept Generation,
- Stage 3 – Concept Evaluation,
- Stage 4 – Technical Development, and
- Stage 5 – Commercialization.
A concept statement in NPD reflects the usage of a new product expressed in a narrative describing the benefit, form, and technology of a new product. In testing with potential customers, the concept statement may also include an emotional linkage to further confirm market research studies. Customers are exposed to the concept statement for a short time, perhaps 30 seconds to one minute, and asked to indicate their interest in the product.
A concept statement is most commonly presented as a narrative description of the new product or service, but may also be displayed as a sketch or non-working prototype. Recent advances in 3D printing have allowed a more diverse set of concepts to be tested with potential customers.
What is Concept Evaluation?
In Stage 3 of the structured NPD process, the NPD team will need to evaluate the new product concepts and ideas that were generated in earlier stages. Recall that brainstorming in Stage 2 (Concept Generation) will have led to proposals of perhaps hundreds of ideas (divergent thinking). Convergent thinking techniques will categorize and combine these numerous ideas into a few coherent themes that are logically tested with potential customers. An expected outcome of concept evaluation is the advancement of just a couple of fully developed new product ideas as well as a business case to support the new product.
Several market research techniques are deployed during concept evaluation to both verify and validate new product and service ideas. Eliminating poor concepts at this stage is far more cost effective than designing and building a product for which there is only tepid market response. Market research at this stage will also lead to refining and improving the product concepts based on customer feedback. Some suggested market research techniques for concept evaluation include:
Economic Evaluation of Concepts
As indicated, one of the major deliverables of Stage 3 is a business case to support further development of the new product or service. Recall that one of the key components of a business model is the profit formula. Comprised of (1) revenue and (2) growth, the profit formula details the financial attractiveness of the new product. Fundamental to the revenue model is the product’s pricing scheme.
Because profit is equal to revenue minus cost, revenue generation from a new product determines overall life cycle profitability. Revenues are based on the sales volume and sales price (unit price).
- Profit = Revenue – Cost
- Revenue = (volume) x (price)
Any new product business case must include a specific pricing scheme. Setting the price too high might turn away otherwise interested consumers, while setting the price too low may leave money on the table. In fact, if the price is set too low early in the commercialization of a new product, the revenues may not be projected high enough to support further development work. Recall that both NPV and ROI include discounted future revenues and are used to screen and filter NPD active projects included through portfolio management.
New product pricing schemes need to account for the expected volume of sales in conjunction with the business model and innovation strategy. Mass market products may have low prices with gains through high volume. Differentiated products may need higher pricing to demonstrate exclusivity and to offset lower sales volumes.
Firms will use many economic and financial analysis tools to construct the business case for a new product. Sensitivity analysis produces a model of the different variables for the new product (e.g. pricing, volume, development cost, manufacturing cost, etc.) to evaluate and study the effects of these variables on the overall potential profit of the product.
For example, the base case scenario may indicate 100 million unit sales at $10 per unit with a total development cost of $1M and manufacturing costs of $3/unit. Market research may inform the NPD team of sales varying from 80M units to as high as 130M with pricing from $7.50 per unit to $11 per unit. Development costs may range as high as $2M but likely no lower than $900,000. Meanwhile economics of scale may reduce the manufacturing costs to as low as $1.50 per unit or as high as $4.75 per unit.
Using a sensitivity model, each variable is plotted to show the best, worst, and most likely case. This analysis helps the firm focus on problems, issues, and risks involved in further developing and commercializing the new product.
Using Concept Evaluation in NPD
Stage 3 of the structured NPD process includes critical decision points for the new product project. First, product concept ideas are subjected to rigorous market research to determine if customers are interested in the concept. Poor concepts are eliminated while attractive ideas are refined for later development.
Next, several elements of the business case (profit formula) are captured for data analysis. An appropriate pricing scheme must be designed to support the business model and strategic plans for the innovation effort. Pricing too high may drive away customers while pricing too low may not deliver desired profits.
Finally, the business case should be probed for sensitivity of profit relative to key variables. Key variables in the profit formula are related to revenue and growth.
An in-depth evaluation of new product concepts is crucial to new product success. To learn more about the activities required for Stage 3 in an innovation effort, please consider an NPDP certification workshop, which addresses the structured stage-gate process, business models, and innovation strategy. Workshops are held monthly through guided webinars or at your own pace in an effective self-study format. Please contact Global NP Solutions at email@example.com or by phone at 281-280-8717 for additional details.
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