IBDP Design Technology - 10.5 Economic Viability

Commercial Production / 10.5 /
Economic Viability

Designers must consider the economic viability of their designs for them to gain a place in the market. Designers need to consider how the costs of materials, manufacturing processes, scale of production and labour contribute to the retail cost of a product. Strategies for minimizing these costs at the design stage are most effective to ensure that a product is affordable and can gain a financial return.

10.5.1 | Cost-effectiveness

Businesses have to spend money to make money. They need to invest in design, production, distribution and marketing to bring a product to market. The price of the product must take into consideration these costs while possibly also ensuring a profit margin. By analyzing costs associated with the materials, the scale of production, distribution and marketing of a product, businesses can determine whether a product is financially viable to bring to market.

Cost-effectiveness focuses on strategies that minimize the cost of producing a product. The total cost of a product is calculated by adding together the fixed and variable costs.

Fixed costs (often referred to as overhead) are costs that do not change regardless of the scale of production. Fixed costs are time-based and include rent, salaries, insurance etc. Fixed costs need to be paid regardless if a product is being produced.
Variable costs change with the level of production. They are related to volume. These could include, raw materials, energy, distribution etc.

The break-even point is the point of balance between profit and loss. It represents the number of sales of a product required to cover the total costs - fixed and variable.

Designers can make their products more cost-effective by:

Reducing the number of components
Standardizing components for use in a product family
Reducing the number of processes
Using automated or low-skilled processes

Companies can make their manufacturing more cost-effective by:

Negotiating down raw material prices
Reducing wastage
Reducing the number of faulty products
Implementing greater automation
Moving factories to cheaper countries (cheaper labour, cheaper rent)

The fast fashion industry is an example of an industry with a high-profit margin that provides a product at a low price for consumers. One might argue the cost is not fairly calculated though as workers conditions and environmental impact are not considered 'costs'. - https://www.fashionrevolution.org/

Cost Analysis involves the examination and evaluation of the separate elements of costs, including profits. Cost.

Financial Cost Analysis: How a financial decision will impact an individual or single company.
Economic Cost Analysis: The impact of a financial decision on the economy as a whole, including the environment and society.

An environmental impact assessment matrix is a tool that might be used in Economic Cost Analysis.

Return on investment (ROI) determines the profit made from selling a specific predicted number of products over a specific timeframe (the sales volume over time). ROI is usually expressed as a percentage and can be used to compare investments to evaluate their cost-effectiveness.

A financial cost analysis might find out the ROI on a coffee shop was 25% when 80,000 USD was invested and 100,000 USD profit was made for the investor.

(100,000 - 80,000) / 80,000 = 0.25

Note that when predicting ROI, the investor predicts an ROI given a particular time period and sales volume.

Over a longer time frame, the ROI usually grows as the fixed costs are overcome for a longer period of time.
Over a longer time frame, the risk of the ROI not materializing due to unexpected circumstances increases.
With a low-risk prediction of a low sales volume, the predicted ROI will be lower.
With a high-risk prediction of a high sales volume, the predicted ROI will he higher.

An investor will consider several possible scenarios of time frame and sales volume to determine their investment.

10.5.2 | Value

The relationship between a product's worth (value) and its cost is complex and influenced by several factors. While they are not always directly correlated, both play a significant role in determining a product's price and ultimately, its success in the market.

Value is subjective and determined by the customer's perception of what the product is worth to them. It's based on factors like:

Benefits: How well the product solves their problem or fulfils their need.
Features: The specific characteristics and functionalities offered.
Brand perception: The brand's reputation and image.
Emotional connection: How the product makes them feel or what it represents.

Ideally, the price should reflect the perceived value to the customer while also covering the cost of production and providing an acceptable profit. While a product's cost sets a baseline for its price, it is ultimately the customer's perception of value that determines its success in the market. Beyond customer perception, there are other factors involved in

Market competition: In a competitive market, companies need to consider the prices of similar products to remain competitive.
Supply and demand: If demand is high and supply is limited, the price can be set higher than the cost, reflecting the product's scarcity and value to customers.
Brand reputation: A strong brand reputation can allow companies to charge a premium price due to the perceived higher value associated with the brand.
Marketing and advertising: Effective marketing can convince customers of a product's value, justifying a higher price.

When the Segway launched it was heralded as a giant leap forward in personal transportation and Segway said that it "will be to the car what the car was to the horse and buggy". People were excited about the possibilities as an alternative to bicycles, roller skates or skateboards or motorised transport such as scooters or motorcycles. However, at launch excitement didn’t translate to sales. Research and development costs drove the selling price of a Segway to between $3,000-7,000US (about the price of a second-hand car). Clearly, people did not feel the advantage of not having to use their legs to move around was worth the high price tag.

10.5.3 | Costing versus Pricing

When calculating the cost of goods sold, the business must add the cost of everything necessary to produce that item. In the case of a manufacturer, this calculation would include the cost of the parts, labour to assemble them, and then transportation from the factory to the retail location. Cost can be determined per batch of products or per individual unit. The unit cost is the costs a company incurs to produce, store, and sell one item. Unit costs include fixed and variable costs.

If a business runs a retail store, the cost of that same item would include a proportion of the building's operational expenses, as well as the salesperson's salary. If the item is to be only sold online, then the cost of designing, setting up and operating the website will also need to be considered.

The Typical Manufacturing Price is the price the manufacturer sells the product at. This price includes the total cost per unit (including fixed and variable costs) and a profit margin.

The Wholesale Price is the price of the product sold in large quantities to distributors or retailers. The wholesale price is higher than the manufacturer's price but lower than the retail price.

The Retail Price or Manufacturer Suggested Retail Price (MSRP) is the price the manufacturer suggests the product to be sold at. This is to standardize pricing across regions. Some retailers may sell below this price to attract customers.

10.5.4 | Pricing Strategies

There are many strategies available for calculating the price of a product and often more than one strategy is used to determine the best price.

Cost-Plus Pricing: Add a markup percentage to your production cost to get the selling price. Often used in new businesses or the sale of simple products where cost control is crucial. (e.g., bakery setting prices based on ingredient and labour costs).
Value-Based or Demand Pricing: Price based on what the customer perceives the product's worth to be. Often used with unique, premium, or experience-driven products. (e.g., diamond jeweller pricing based on perceived value and exclusivity).
Competitive Pricing: Set your price based on what similar products cost in the market. Often used in established markets with similar products and price sensitivity. (e.g., gas stations adjusting prices based on local competitors).
Penetration Pricing: Start with a low price to gain market share, then raise it later. (e.g., introductory offers at low prices).
Skimming Pricing: Charge a high price initially for a new product, then lower it over time. Often used with innovative products with high initial demand and brand image focus. (e.g., high launch price for the latest smartphone, lowering it later).
Psychological Pricing: Use price endings (e.g., $.99) to influence buying decisions.
Product Line Pricing: Setting a range of prices by offering ‘add-ons’ to improve or vary the product.
Plus-Minus Pricing: Settubg a reference price, often higher than the actual selling price, alongside a discount to create a sense of savings for the customer. Often used to move slow-selling inventory or create a sense of urgency for the purchase. Plus-Minus pricing must be done ethically and is prohibited by law in particular contexts as it can be misleading to customers.

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