The core concept of product economics is very straight forward and simple to understand:
Develop and market products and services that solve real customer problems profitably.
When we choose to pursue a business opportunity, the ultimate goal is to create positive returns on our investments.
After all, we are not in business to breakeven, we are in business to be profitable. And while it’s great to launch truly innovative products, if we don’t achieve sustainable profits – no one benefits – especially customers who are stuck with supporting the product on their own.
Most effective NPD system have screening mechanism that narrows down opportunities that provide the best chances for economic success. We are presented with several promising opportunities, and based on the credibility and risk associated with each business case, we choose what we believe are the best opportunities to invest development and marketing resources in.
There is a lot of work done upfront to create a credible business case.
And we know that the more “new” a new product opportunity is, the more uncertainty and risk is associated with forecasting profits. Never-the-less, the forecast provides us a baseline to shoot for and helps us compare the merit of one project over the next. And if all goes as planned, we achieve or exceed the forecast and are wildly profitable beyond our expectations.
Of course, nothing goes as planned in the game of innovation and new products.
What we assume in the beginning often doesn’t hold true as the market evolves and more evidence presents itself confirming or refuting core assumptions. Tradeoffs and critical decisions will be made all along the way as we transform our early concept into a viable new product.
In the course of developing and launching the new products, decisions we will face include:
- Do we have enough market information to know what the customers really want?
- What’s the cost and time required to get more voice-of-customer data? Is it worth it? How do we know?
- What is the tradeoff of adding a new feature if it delays the product launch by 2 months?
- What is the impact of spending additional schedule time on reducing the unit cost by 5%? And so forth.
Each of these decisions and tradeoffs will have an economic impact to the bottom line. For example, if we march forward without testing our designs and getting feedback from customers, we run the risk of launching a product the market simple doesn’t want. It’s pretty clear what that economic impact will be. A huge waste.
But what’s the best way to test our business model assumptions and designs?
Does it make more sense to conduct a whole series of voice-of-customer primary research up front? Or does it make more sense to create prototypes and present them to potential customers and listen to what they say and do more prototyping? Or maybe launch a minimal viable product (a barebones featured product) to see how many paying customers we can acquire while improving the design on the fly?
These can be tough decisions to make, but we can make them clearer by applying product economics to the decision tree. Donald Reinertsen has written extensively on using product economics to make more informed decisions. In his book “The Principles of Product Development Flow,” he devotes an entire chapter to understanding the economic view of product development.
Without this economic view, Reinertsen argues, a company cannot fully understand the impact of tradeoffs and schedule delays.
Maybe it makes sense to add a few months to the schedule to add an additional feature, or reduce the unit cost by 5%, or conduct more market research to gain more confidence we understand what customers want.
But these activities and delays will have a material impact on the overall total project lifecycle profitability. Some will be positive, and some will be negative. But until we learn how to frame impacts of our decisions in economic terms, we can’t make good informed decisions.
By using project sensitivity analysis, we can model the total lifecycle profitably impact of key controllable factors such as development expense, unit cost, product performance and schedule. The output of the model provides a set of tactical decision rules that enables the project team to make tradeoffs between one parameter and the next.
Of course the economic model we use needs to be put in context with the specific constraints and circumstances of the project type and overall scope of the opportunity.
For example, if we are launching a new product into an existing established market – for example smart phones – the impact of having an underperforming product will be far greater than if we launched a minimum viable product into an early stage market where likely customers will be early adopters and will accept partial solutions.
With an economic view of product development, we can put real meaning to value and waste. Meaning that everyone on the project team will understand. We can make an informed judgment if a feature that attracts only a handful of additional new customers is economically worth the effort if it means losing 2 months’ worth of sales we would have otherwise captured.
Product economics provides a clearer way to judge if we are creating value or adding waste. It takes some work to fully understand and manage the economics of making product development decisions – but it’s well worth the effort.
Stay profitable and make good economic decisions!