How to Reduce Product Development Costs

Developing a product can be a major investment especially for startups and small niche market companies. Startups only have so much money.  Going over budget can be a terminal event.  According to CB Insight research (The Top 20 Reasons Startups Fail, Feb 2, 2018) running out of money is second only to lack market validation as the root cause for startup failure.

Small niche market companies have a similar problem.  Because they lack scale (selling a lot of units), the cost of development is a significant part of the COGS.  Reducing development cost means more profit and a more competitive product.

Most of these companies correctly recognize that 90% of product development cost is people cost.  The cost of the engineers, technician, and managers will be many times any cost for prototypes.  Unfortunately, they then assume that lowering the cost of people is the path to lower development cost.  If I can get an engineer for $10/hr versus $20/hr, then my cost will be less.  What could be more logical?

This “cheap engineer” myth is one of the most common reasons for increasing product development cost (see Six Myths of Product Development, HBR, May 2012).  The assumption in the cheap engineer myth is that the $10/hr. an engineer has the same quality as the $20/hr. engineer.  In free markets, the price is a quality indicator and arbitrages are small and short-lived (see: https://en.wikipedia.org/wiki/Arbitrage_pricing_theory and https://en.wikipedia.org/wiki/Price).  Economic theory would predict that the $20/hr. an engineer has higher productivity.  Our own experience bears this out in spades.

Of course, just hiring the most expensive engineers will also not results in lower product development cost – even if these engineers are incredibly productive.  Product development is complex, requiring a myriad of talents to be successful: leadership, management, technology, marketing, etc.; and products have a myriad of requirements.  Matching the unique talents available with the unique requirements of the product has a much larger effect on product development cost than what any individual engineers cost will be.

So if hiring the cheapest people is not the answer, then what is?  Our experience with 100s of small niche companies and startups has revealed a few strategies:

• Reference Designs
• Outsourcing
• Follow a Processes
• Experts
• Design Build

Reference Designs:  It is amazing how many common elements products have.  A car and a smartphone may seem to be as different as products come.  However, both have batteries, charging systems, communications systems, sensor, DAQs, displays, UI/UX, power supplies, etc.  A human being seems very different than a cat, but we share 90% of the same DNA.

In our experience, 90% of most product development project’s cost is spent on this “shared” technology – or, to say it another way, 90% of product development cost is spent reinventing the wheel.

Using a reference design instead of developing the design from scratch can go a long way to reducing development cost.  It’s like starting a marathon with only the last mile to go.

So, where do you find reference designs?

• Other companies that make what you need might be persuaded to OEM a sub-assembly to you. Usually requires a non-compete, but in niche market companies this is generally not an issue.
• Product Development Companies, especially the ones that specialize in small companies, often provide them for free as part of their services.
• Many vendors provide demo systems, or even free design services in exchange for agreeing to use their products.
• Reverse engineer a product that contains the sub-assembly you need.
• We have even seen cases were buying a complete product and removing just the subassembly needed was more cost-effective than designing one from scratch.

Outsourcing: It is not uncommon for us to see companies hire engineers for non-core activities.  These engineers have low productivity simply because there is not enough work to do that is within their area of expertise. Sometimes they are given busy work, or are learning some new skill on the company’s nickel; nonetheless, they spend very few hours actually doing what they do best. They are paid for 40 hours a week regardless.

Clearly, core activities that define what the company can be better at than anyone else in the world should not be outsourced, but all non-core activities can almost certainly be outsourced for lower cost and higher quality.  If I am going to LA for a weeks’ vacation, I can rent a much nicer car than I could ever buy for the same cost.  If I design an electronic PCB every few years (and it’s not a core part of the product), I can rent a much better team than I could ever afford to buy (employees).

However, this is only a valid strategy if you’re good at outsourcing.  Too many companies reject outsourcing because they “tried it once and it was a disaster”.  Of course, these same people have also hired employees to the same effect.  Your employees are only as good as your ability to recruit and manage them.  Outsourcing is only as good as your ability to choose an appropriate partner and your ability to work constructively with them.

How do you choose a good partner?

• Look for ones that have customers that look like you. If you’re a startup and all their customer are big, well-established companies, they are not very likely to be a good fit.
• Look for a long-term relationship. Will this company be here and still be a good fit for us in ten years?
• Look for ones were you leverage their leadership, management, processes, and reference designs. A company that provides “bodies” that work under your system is not going be as effective as a complete team with their own processes, management, and leadership.
• Hire teams that know how to work together, not individual freelancers. Half the battle in product development is stitching together all the parts into one homogeneous product offering.  Getting each expert to contribute in the way that is constructive to the whole is part of what you are paying for when you outsource.

How do manage to outsource?

• Keep in mind, you are part of the manufacturing processes and therefore play some role in the outcome. If things do not go well, you need to own your part.  It’s a relationship, and one-way relationships are doomed.
• Be open to their process – what they want to do and how they want to do it. You hired them because they are experts at product development. Vetoing every suggestion they make is only going to nullify their experience, knowledge, and expertise.
• Do not throw it over the wall and walk away. Its import to stay involved.  What decisions are they trying to make, and how do they make them?  Do they have a clear idea of the product vision?  Is their team communicating with my team?  Once a week meeting with a good facilitator is a good idea – at a minimum.

Follow a Process:  If you google “product development processes”, you will discover thousands of research papers advocating different methodologies to be successful at product development.  Each of these studies looks at the product development processes and tries to glean some new insight into how to tweak the processes to be more effective.

What you will not find is any study advocating NOT using ANY processes. There are no atheists product development scholars. Those who study product development for a living might disagree on what process to use, but they would all insist on using a process. No one would get on an airplane if the pilot announced that he did not need to follow processes, or even complete the pre-takeoff checklist.  Why would anyone ever agree to spend a lot of money on risky product development activities without following a process that at least worked once in a similar project?

Maybe this seems all too obvious, but in our own study of startups, not following processes is the number one reason for the failure of the project to meet its goals – and second place was a long ways back.  All too often we see hundreds of thousands of dollars spent, and no one can clearly articulate the product requirements or the slightest thought of market validation efforts made.  This is despite the fact that studies after the study showed lack of market fit as a leading cause of startup failure.  The evidence about following a product development processes is very clear and overwhelming.  The real question is why are most entrepreneurs staunchly non-believers.

At a bare minimum, every product development project should contain a process for:

• Market Validation
• Requirements Generation
• Conceptual Design
• Detail Design
• Design Verification
• Pilot Production

Experts:  I enjoy working on cars.  I have been doing it since I was a kid, and have done everything from a full frame off restoration to tweaking the suspension of a race car.  Recently my car broke, I was in my business attire and miles from my home shop.  I got towed to a shop and watched the mechanic, a true expert unlike me, work on my car.  I was amazed.  What would have taken me four hours he did in 30 minutes.  Every move he made was effortless.  He reached into his giant toolbox without even looking and pulled out the right tool.  His hands seemed like a machine design specifically for the task, every movement as if it was part of a carefully choreographed dance.  He never once looked at the drawing, or book, but seemed to know by some a priori knowledge exactly what nut and bolt to move and which order.

My point is simple – true experts can be incredibly efficient.  My mechanic charged $125/hr. – my equivalent rate (4 hrs. vs. 30min) would be $15/hr.  Which is barely above minim wage, and I am an advanced amateur.  True experts save money, even though they often cost many times the hourly rate of an amateur.

In product development, the difference is even more pronounced than auto repair because of the scaling effect of knowledge workers.  Knowledge workers often decide or help decide, what to do.  If this decision is wrong, a lot of money can be spent before anyone is aware that it was the wrong decision.

In his book Good to Great, Collins argues that the very first step to business success is “getting the right people on the bus”.  The right people are true experts.  True experts get paid much more than apprentices who are learning from the masters, however, they bring much more value than their cost.  Meanwhile, the apprentice, especially without the master to guide them, often destroys value.

However, all of this does not mean experts are some magic pill that cures all ills.  Experts need processes, management, leadership, and other experts to be effective.  Here are a few things to keep in mind:

• If you’re a hammer, everything looks like a nail. Don’t hire an expert until you’re sure you need this expertise – they will not tell you to use some other expertise.  In order to determine if you need a specific expertise, you need a product development expert that follows processes.
• Make sure they are a true expert. True experts have done what you need many times before for many years – if not decades. Past behavior is the best indicator of future behavior.  A professor of Electrical Engineering may be an expert at electrical theory and how to teach it, but that does make him an expert at designing a product.  You do not just need an expert; you need an expert specific to your needs.
• Make sure the expert is willing to work under your processes and not the other way around (excluding the product development expert). Their expertise will be greatly diminished if it does not integrate to the rest of the team.
• Experts need management. Don’t just throw the problem over the wall to them.  They should work under a technical manager that is keeping them focused on the task and on the budget – otherwise, they can justify all kinds of activities that may or may not have value to the organization and drive up the cost.

Design-Build:  There is a new breed of vendors emerging into the marketplace -often called design-build.  These are product development companies that also have contract manufacturing abilities.  Some even have marketing services.

Instead of buying marketing services, then engineering services, then manufacturing services, you simply buy 1,000 units at $100 each.  These companies provide the services needed to fill the warehouse with the product you can sell – with a lot of help from you.

Design-build can be a win-win, especially for small niche market companies that do not do very many new product development projects per year.  The company gets a product they can sell without having to worry about a lot product development activities that they have little experience in managing.  The vendor is free to develop the product without a micro-managing customer and gets attached to recurring revenue as the product is sold.  By leverage what each does well, both stand to make more money with a superior product in the marketplace.

If you are considering this option, there are a few things to think about:

• Both the design and manufacturing parts of the vendor need to closely match your needs. It will be harder to find the right vendor, so expect more time and resources in the selection processes.
• Don’t expect this service to help with cash flow. There will be some kind of financial comment up front.
• This only works if the design-build company can convince the client can sell the product. This method rarely works for a startup for this reason.
• Make sure there is some kind of buyout clause in the contract. Some way to own the IP if things go wrong.