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Can stage-gate systems deliver the goods?

Cost considerations aren't always the best yardstick for a new product. Take a look at stage-gate systems -- a brave new world for financial executives.

Do any of these scenarios sound like your product-development process?

* The managers closest to technology can't authorize project feasibility studies, because it's tough to get funding approvals from higher-ups.

* Promising projects that emerge outside the normal financial planning cycle are unlikely to be funded. And product champions can't get past unit budget constraints to secure seed money because alternative funds aren't available.

* A cost mindset creates an under-staffed project, limiting slack time for innovation or "tinkering." That means missing market windows and opportunities to profit.

* Financial measurements ignore the cost-time trade-offs in time-to-market factors.

* Financial and technical functions have become adversaries, so finance is excluded from product-development teams and restricted to a narrow budget oversight role.

An increasing number of companies have concluded that these problems, all of which spring from a cost mentality, are symptoms of a product-development process that isn't serving them well. These companies are rethinking their processes, a change that has major implications for financial executives, since cost must now yield to other measurements like time, quality and customer service. In fact, a paradigm shift in product development is on the horizon, and it calls for a new finance role in bringing products to market.

To product developers, the traditional cost attitude affects the entire product-development spectrum. It starts early in the process, when they must justify the cost for a new project even before they can accurately estimate its future value. In most U.S. companies, the development budget is still the main performance measurement, while schedules, which affect the time to market, are routinely expected to slip in the face of cost restraints.

For the most part, companies are going back to basics by installing or revamping the stage-gate system for developing products. A stage-gate system is a disciplined process that brings products through the corporate maze from concept to customer. The payoff is more new product successes and more efficient development. This approach offers a strong role for finance, while giving product developers more cost latitude than usual.

WHAT'S IT ALL ABOUT?

The stage-gate system breaks a company's new-product process into a series of development stages. These stages are partitioned by a series of gates -- quality control and cost escalation checkpoints. The project must meet a set of criteria before it can pass through a gate and continue down the development path. The CFO and other senior managers review the project's progress, controlling financial, technical and market risk as projects are approved for market launch.

Companies usually tailor their stage-gate systems to satisfy different product-development needs. Usually, the number of stages ranges from three to 10. Xerox has three major stages, while General Motors' new copyrighted development process is called the "Four Phase" system. GE incorporates a 10-stage "Toll Gate" process in many business units. Motorola and Northern Telecom each use four development stages to bring new products to market.

By establishing the review gates and guiding criteria, senior management empowers product developers to do their jobs and restricts detailed financial and technical oversight to the review gates. This avoids tight control and decision delays, which impede development and frustrate developers, who traditionally spend as much time working on paperwork and oversight preparation as they do on solving engineering problems.

At Xerox, the development team, finance and other functions determine cost, performance and time measurements at the beginning of a project's development phase. The project leader agrees to the set of measurements, and a senior management progress-review schedule is established that extends to the product's final design stage. The financial resources needed to complete the design are allocated in advance and funds are disbursed regularly, provided the project stays within the financial parameters. If the project team can't do this, it holds an immediate exception review with the senior management review group. This funding approach lets product developers move quickly between review gates and avoids constant meetings with management to justify costs.

LOOSENING THE PURSESTRINGS

Implementing a gate-review process at a company centers on the inevitable cost escalation as projects move downstream. The gate system recognizes that the early development phase is highly innovative but low-cost. Since the financial risk is low and accurate information often lacking, CFOs at many companies minimize financial involvement at this stage. Instead, they support a policy of discretionary spending through financial guidelines that call for distributing discretionary funds to lower management levels, allowing supervisors to approve initial spending to pursue interesting ideas.

Several innovative companies back up their discretionary spending authority by including slack time in their human resources plans. 3M, noted for its entrepreneurial culture, provides $50,000 grants to innovators and allots them extra time for individual projects. In addition, CFOs sometimes support discretionary "innovation funds" as an avenue to secure funding outside the formal financial planning process. Eastman Kodak pioneered an Office of Innovation to provide seed money and guidance to innovators. NCR recently installed a discretionary innovation fund and a fund manager at the corporate level, and it allocates additional discretionary money in its divisions to encourage new ideas that otherwise might not be funded.

Companies are also beginning to realize that design engineers need more customer knowledge. General Motors' Cadillac division sends designers to showroom floors so customers can tell them what they want. And they periodically put designers on the assembly line to show them how their designs are manufactured, inevitably saving money by curtailing potential manufacturing glitches.

Most of these efforts occur at the low-cost, ambiguous early stages of development. However, as projects gain clarity and secure sponsorship, they must pass through the main gate: establishing the business case. At this point, the project is at the go/no-go crossroads.

The project development team needs a detailed financial analysis to explain why the project should exit from this crucial gate to become a costly development project. The costs rise significantly at this point, and the CFO's key role is leading the business case preparation and review. Finance typically integrates the financial analysis and the results of market, technical and manufacturing plans. The analysis includes product sales forecasts, prices and margins, profitability by year, opportunity costs (the cost to the company if the project didn't move ahead) and usually a discounted cash-flow analysis.

The business case ensures that the company allocates resources only to rigorously screened projects and allows it to formally veto the ones that still can't be justified, accommodating fast product development. Although a detailed business case takes time, it's cheaper to stop projects in their early stages. Therefore, changes to the development process should accent delegation. Companies adept at moving products to market rapidly allow teams to manage the subphases of their processes and have also squared away the cost versus time issues that traditional cost-oriented companies still resist.

Gate reviews allow product-development flexibility and a comprehensive set of performance measurements. For instance, Hewlett-Packard uses break-even time to measure project performance. Break-even time measures the time necessary for the product's contribution margin to recover all expenses in the development cycle, including equipment acquisition. Analog Devices, which is in the fast-moving semiconductor business, emphasizes on-time delivery to external customers and internal manufacturing cycle time and time to market as much as cost.

BE FIRST, NOT FRUGAL

The ideal scenario is fast development that reduces the overall "burn rate" (cost per day to develop) by 40 to 50 percent and also produces profits six months to a year ahead of the normal product introduction. One economic model demonstrates that high-technology products that come to market six months late but on budget earn 33 percent less profit over five years, whereas arriving on time and as much as 50 percent over budget reduces profitability by only 4 percent. Usually, products that are first in the marketplace can command a higher price until competitors catch up and enter the fray. Japanese firms devote twice as many resources to meeting time-reduction goals as U.S. companies, and management accounting in these firms is more concerned with gaining market share than with cost. Short product-development cycles also allow technologists to incorporate the latest innovations in their designs.

Xerox, a troubled company in the 1980s, is a good example of the preferred time-cost scenario. It has cut time to market by 50 percent over the past decade and improved product cost and quality simultaneously, dramatically reviving its core copier business and shareholder value. Chrysler has also been fighting to maintain its position as a major player in its industry. The company's ability to be first to market with minivans positioned it to maintain a dominant market share for years.

The time-cost trade-offs are important, but not all of them can be made on the back of an envelope in a team meeting. When huge resources are at stake, it's a business decision. The stage-gate review process can be used to negotiate trade-offs using a strategic business orientation, not just development-cost figures. As the leader of the business-case review, the CFO should understand that even if accelerating product development increases project costs, it may be worth the investment to deliver value to customers and make up the difference in future profits.

To facilitate this approach, the CFO must play a new and broader role in the stage-gate reviews that recognizes development budgets as only one factor in bringing a new product to market. Finance should reflect this new awareness with a role in the product-development process that goes beyond aloof cost oversight. This participation should ensure that finance participates on product-development teams along with other nontraditional functions. Motorola, like many other companies, includes a finance representative on teams, which has proven invaluable for pricing different options and analyzing scenarios.

Finance can bring a business perspective to development teams. For example, Hewlett-Packard has encouraged a business outlook by forming a board of directors, which brings project participants together to resolve product-development problems. The board enables all participants to understand the bottom line, the project margins, cash-flow projections and profit estimates. And John Deere has opened up previously guarded financial information to product teams that include hourly union employees.

Avoiding cost-driven product development does not mean switching back to technically driven products. Instead, companies need a business view that allows the right combination of trade-offs between cost, time and performance requirements. Achieving this requires finance to expand its vision of the development process and to supply broader business information to product teams, so that technical team members can focus on meeting strategic business goals and the technical challenges of their designs.

FINANCE COMPLETES THE PICTURE AT MOTOROLA

"The financial executive is often the missing piece to the puzzle," says Gray Benoist, director of finance for Motorola's Wireless Data Group in Schaumburg, Ill. He's talking about the financial executive's role on the product-development team, which is no small task at Motorola. Like a growing number of companies, Motorola gets finance involved in the product-development process from the ground up.

This practice isn't just an end to itself. About 10 years ago, Benoist recalls, the company challenged itself to improve the quality of its products. It set a goal of improving cycle times by a factor of 10, and it recognized that establishing cross-functional product-development teams would help it reach that goal. Today, the finance area is represented on product development teams 95 percent of the time, and often a financial executive serves on several teams simultaneously. But this role extends far beyond characteristic financial and oversight functions.

Typically, projects start with the creation of a contract book, which is essentially a project proposal. In the contract book, the product-development team outlines its goals for the project and explains which markets it wants to target. The team also estimates the financial and human resources necessary to complete the project and how much time it needs. The financial executive, who sets up the financial parameters with which the team must work, is one of the main architects of the contract book. For example, Benoist typically helps craft financial statements, profit and loss statements, balance sheets and cash-flow projections -- all the typical long-term financial planning that goes into a project.

But he also has some fairly atypical duties, such as procuring materials and studying business and economic conditions in various markets. He tries to keep abreast of similar initiatives within the company to capitalize on any opportunities to re-use software and circuitry, and he's also responsible for obtaining benchmarking information. These broad-spectrum duties are pretty much the norm at Motorola, which tries to maintain an environment where the financial executive can serve as a generalist business expert in areas like global finance or internal audit, Benoist says.

Partly for this reason, the financial executive is the product-development team's link to broader business and competitive concerns and, in many respects, can paint the necessary big picture. "Often the engineering specialists are very focused," Benoist explains. "My questions are more business-oriented -- What are the competitive aspects? Do we have good distribution channels? What's the market feasibility?"

Benoist spends half of his product-development time on ad-hoc planning revisions and changes to the business template to reflect the project's evolution. Another 20 percent to 30 percent of his time goes to "blocking and tacking," as he calls it. This includes administering the project, developing efficient processes and work flows and obtaining answers and information for team members. He devotes another 20 percent to 30 percent to internal control issues associated with the project.

As you might expect, conflicts between product development and internal control goals sometimes arise, but Benoist points out that such friction has produced some of Motorola's best innovations. Nevertheless, this can be a tricky balancing act for a financial executive who must reconcile the overall needs of the company with that of the project. "One principle of reducing cycle times is stepping out of the way but maintaining the internal control demanded by the board of directors," he explains, adding that it's all a question of perspective. "Is it a problem? No. An art? Yes."

Mr. Anderson is a principal of Kendall Consulting Associates in Cambridge, Mass.
COPYRIGHT 1993 Financial Executives International
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1993, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:Management Strategy; includes related article
Author:Anderson, Richard E.
Publication:Financial Executive
Date:Nov 1, 1993
Words:2358
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