New product development is an investment and may require a significant amount of capital to be successful. These are decisions with considerable risk and every effort should be made to answer the primary money questions right from the beginning of a project. If you can answer the following money questions early on in the process, you will increase your chances that the new product will be a success. In addition you may find the answers to be negative and lead to a decision to kill the project before it costs a lot of money. The primary money questions are:
- What price will users pay for this product?
- What is the estimated cost and margin?
- How much will the total project cost?
- How many products can you sell per year?
- Can you project the total profits?
- How many years will it take to get your investment back?
These can be daunting questions to answer depending on the type of new product and risks involved. But if it is not your money then you should do your best to tell the owners, investors and shareholders when they will get their money back before they make the final decision on whether to fund the project. Here is what you need to answer:
1. Average Sell Price -- To be able to set a sell price for your product, the manufacturer must know something about competition in the marketplace. This is a 2 part question:
- What is the advantage of your machine over the competitor products customers can already purchase?
- How does your projected price compare to the competition's prices?
2. Margins/Costs -- Management usually has a minimum margin that they would like to attain in any new product. So when you have decided on the sell price and the average margin, the remaining percentage is the total cost of the product. 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 estimate the total costs of developing the new product. This includes all engineering, building the prototype, tooling, necessary options and all marketing costs. This is the total cost of the investment
4. Sales Forecast -- This is probably the most important (and most difficult to attain) number of the whole exercise because it is the multiplier of all costs and margins. The owners and investors are going to want some kind of evidence that customers will buy the units per year that you forecast. You might do a focus group, or survey targeted customers, or get testimonials. But however you do this step you need enough evidence to convince the people who are putting up the money that there will be sales. Putting the product out into the market to see if it sells is not an option unless the price of the new product is very low.
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.
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 really begin producing profit for the company. It is totally up to the owner at what year he wants the project paid off and begin making money.
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.
- If it is only your money you are spending or if the product is low cost you can take shortcuts -- Go for it!
- If you are trying to raise money from a venture capitalist or venture angel you had better answer all of these questions
- If you are borrowing money from the bank, refinancing your house, or getting personal loans from family and friends, you had better answer these questions very accurately or not do the project.
If it is all the money you can raise and you are "betting the farm" and have 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.
If you would like a simple spread sheet that shows you how to do this exercise, email me at [email protected] and I will email it to you.
Michael Collins is president of MCP Management . He has 35 years of experience in manufacturing. He is the author of Saving American Manufacturing