Return on Development
Enhanced product portfolio management techniques
Decisions for product lifecycle events
Despite efforts to make the drive to bring products to market controlled and predictable, companies are often ill-equipped to make decisions at key points in the product development lifecycle. Challenges include justifying investment in new innovations; winnowing down large product portfolios; balancing the price, volume and time-to-market of a new product and restoring competitive returns for an existing product.
These are just a few of any number of events that trigger the need to analyze Return on Development (RoD). Here, we describe such events, clarify RoD’s place among traditional measurements and discuss the role RoD plays in stage gate processes. Finally, we describe the processes and metrics required as a foundation to determine RoD-based management techniques are feasible.
Return on development defined
Managing product development output is often regarded as more art than science despite continuous efforts to quantify, measure and standardize the effort. Companies that struggle with this process typically apply inadequate analyses to product development and often at the wrong times in the process.
Based on Deloitte's work and benchmarks, we previously identified specific drivers and improvement actions that are the primary levers of overall Return on Development. RoD is simply the net present value (npv) of product revenue times the new product gross margin percentage, divided by the npv of development cost. This simple formula however has multiple variables feeding into each component, describing the future potential of the product, competitive pressures and production learning curve maturity. RoD analysis and decision making efforts are often stifled by qualitative debate on the underlying assumptions about the product’s potential
Return on development refined
Once companies start to apply RoD measurement, they will encounter some important nuances along the way. For example, RoD concepts and modeling can help companies handle platform vs. extension products. RoD measurement can also be done for specific metrics, enabling product portfolio management under varied conditions.
Further defining quantitative measurement techniques for a portfolio’s Return on Development is key. Companies fund new “platform” development projects which offer the potential for breakthrough or disruptive growth – and also fund “extension” products which offer financial stability and defend market share but have a finite lifecycle. Companies should decide what balance of these two strategies is required, to not only extract prompt return of R&D investments for today’s business but also generate sustained growth from their R&D investments for the longer term. RoD concepts and modeling can help companies differentiate between their platform and extension products and then balance their product portfolio along those lines. This idea is explored more in Deloitte’s 2010 Benchmarking Study: Measuring product development performance in high-tech companies.
Companies can also use quantitative techniques to measure and monitor RoD, monitoring important metrics such as product gross margin returns based on Time to Market, Competitor Time to Market, Product Gross Margin, Product Unit Volume, Ramp and Half-life and Cost/Price Learning Curve. With visibility into the cash curve (outflows and inflows), companies can conduct portfolio level analysis/views and sensitivity analysis for the overall portfolio and individual product models. And with a portfolio view of products, companies are equipped to plan and manage products as market and economic conditions change. They can also use quantitative analysis for stage gate decisions during the development process.
When traditional measurement methods aren’t enough
RoD serves as an enhancement to traditional methods of evaluating product development effectiveness, not a replacement. Traditionally, established corporate cost models or Return on Investment (RoI) and Internal Rate of Return (IRR) calculations are used to determine project funding and make go/no-go decsions at stage gates.
However there are contrasts between these traditional methods and enhanced RoD techniques:
- RoI is a suitable measure of return on a single cash outflow and inflow. RoD considers a series of cash flows
- RoI can only be applied after a return has been realized, thus, it is a backward looking measure. RoD can be used to forecast product margins
- RoI analysis does not allow control over the operational, market and competitive parameters that impact the return. RoD can be used for a sensitivity analysis on such parameters
- IRR gives a relatively easy-to-compare percentage return but does not consider the cost of capital and is not an appropriate measure to compare products/projects. RoD takes these factors into account
Where to apply RoD in the product lifecycle
Throughout the product lifecycle, modeling RoD helps to enable product risk management by shaping development to meet or exceed an expected RoD benchmark value. There are three discrete areas where RoD can be applied throughout the lifecycle.
- Planning and managing a portfolio of products: Analysis can be used to calculate the RoD of a group of projects; effectively allocate resources and funding and help project future financial performance scenarios.
- Individual product analysis: Analysis can be used to revisit RoD at product stage gate reviews and refine products. It can also be used to uncover counterintuitive investment options based on cash flow timing.
- Post-release optimization and sensitivity: Analysis can help align sales targets and marketing goals to expected returns, as well as modify sales activities to address areas of most sensitivity to returns such as pricing or volume.
Ways to use RoD analysis for tough product development decisions
RoD analysis can help answer these questions and support thoughtful data-driven decisions when executives are faced with challenging product lifecycle events.
- Justifying an investment: You want to invest more in innovation but have no means to justify the investment. What financial metric should you use to show a competitive return on investment?
- Culling a product portfolio: Your company has a large portfolio of products at different stages of development. How do you decide which products to focus on and which to cut?
- Bringing products to market: You are developing a new product. How do you determine the price, volume and time-to-market?
- Boosting product returns: You realize that you are not getting the returns you achieved historically or your competitors are getting. What product development levers can you pull to get the desired returns?
- Basing decisions on data: In order to achieve many benefits, a sufficient S&OP process and clean product, sales and marketing data must be present.
- Making change stick: The human element is critical. Engineering, finance, operations, marketing and sales need to understand the models and buy into the approach. This requires change management and data stewardship.
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