What's Your Return on Development?
Identifying the Key Levers and Moving the Needle
For the semiconductor industry, the ability to achieve business
goals corresponds to constant focus on new products. This is, after
all, an industry that has made an art of monetizing the "learning
curve." But the relentless pace of product innovation creates enormous
pressure to manage the development pipeline with speed and rigor. In
the end, the new product portfolio must generate compelling value and
continue to fund an increasingly costly development process. Is your
company adeptly managing all the moving parts of the development
machine, and is it accurately measuring the performance factors
needed to achieve financial growth?
As the costs of bringing new products to market continue to
grow exponentially, semiconductor companies are finding they need
to shift to a new performance curve to innovate, grow, and increase
revenue and earnings.
Figure 1. Increasing Costs of Semiconductor Product Development
Source: Synopsys, 2008
Based on Deloitte's work and recent benchmarks, we have
identified key drivers and improvement actions that are the primary
levers of overall "return on development" (RoD). RoD is a metric
that allows companies to track their performance over time and
measure it against other companies. Pull these levers correctly for
your specific business situation and you stand a greater chance of
reaping the rewards of new product development.
Armed with a solid understanding of how to address the
components of RoD, these key factors of product development—engineering effectiveness, portfolio optimization and time-to-market—all converge in a stage-gate framework that sustains the
focus on project performance, enables informed decision making and
drives accountability for delivering "big picture" results.
Product Development and the Importance of Margin Pools
Product development aims to exploit candidate market areas that
represent attractive margin pools—areas of customer demand that
seem to command a desirable premium over the cost of accessing them.
Margin pools are a function of market size and the gap between
the prevailing price and the cost to service the demand. In the
semiconductor industry, technology's constant learning curve steadily
opens up new margin pools, both by increasing the gap between price
and cost, and by introducing new features and capabilities which
widen and deepen the market's appetite. Advances in low-power
computing and 3-D graphics are a prime example. The smartphone
boom accelerated when the power of handheld devices passed a
tipping point, expanding into a wider, mainstream audience and
exploiting consumer features along with the business capabilities—notably e-mail—of prior generations.
At the same time, the cost of defining, designing and delivering
products to tap into those margin pools is increasing. The exponential
increase in development cost previously described continues through 40
nanometers and beyond, yet at the same time the unavoidable
uncertainty about "if, when and how big" pervades the entire go-to-market process. Ultimately, though, the bets placed in product
development must fund the whole enterprise. The overall gross
margin pool (money left over after the cost of the goods is accounted
for) must pay for the rest of operations, selling and administration,
and sustain ongoing development efforts that will produce future
For companies on a steep growth trajectory, this forward
investment must reflect future, not current, business magnitude.
So the bar is set very high for how big a margin pool is needed to
achieve business objectives. Implementing an RoD framework helps
a company identify where it is performing well and where it most
stands to benefit from "moving the needle."
The Metrics of RoD
RoD is defined as the net present value (NPV) ratio of gross margin
produced to the corresponding investment in product development.
It is an intuitive, effective and concise yardstick for judging the
financial merits (or results) of a development effort.
For example, if your RoD is 3 (3:1), the gross margin "harvest"
of your development investment is triple that investment, in present
So the components of RoD are:
- The price-volume curve that the product or service commands
in the marketplace (and where your company decides to land
- How much money you are investing to develop the saleable
product or service in question.
- The cost of producing and delivering each unit of the product
- The points in time where these monies are moving in and out
of the enterprise.
- The company's cost of capital.
Now, how can you improve this metric, despite trends in
increasing development costs, product life cycle compression, and
more aggressive competition and margin erosion? What are the levers
you can pull?
Portfolio and Pricing
Choosing a portfolio of products to develop with the right price,
volume and technology is, of course, paramount. The margin pools
you select to tap and how well they are chosen is critical. Their
interactions with your company's existing product set, their influence
on end-to-end development cost, and the degree to which they are
accessible or coveted by others can all affect RoD. But the reality is
that these also change over time, so your company's ability to track,
adapt and reshape its portfolio—especially with respect to products
still in the pipeline—is key.
The design locks in 90 percent of product cost, although sourcing and
operational wizardry can be tweaked in various places. Establishing
design cost targets is the key way of influencing this.
Development cost is always an area of major contention. One key
point is that development monies are spent on both the winners
and the losers. There is tremendous leverage in selecting the highest
probability efforts to work on in the first place—and smartly cutting
losses when future prospects start to fade.
The other key area of development cost lies in individual and
collective engineering effectiveness. In many companies, hard-to-find
engineering talent spends too much time locked in tasks and
activities that don't contribute to product development progress,
but instead are artifacts of inefficient development processes and
Time-to-market is not just a competitive question; if your
development process takes too long, the revenue dollars that
ultimately roll in are nearly worthless compared to the development
Figure 2. Revenue Loss for Being Late to Market
Source: IBS, 2007
Cost of Capital
Take cost of capital as a given. Weighted average cost of capital
(WACC) is useful as a tool to take time out of the equation and put
today's spend and tomorrow's margin on a level playing field in terms
of impact to the company.
Raising the Bar on Product Development Performance
Once a company puts RoD into play and has specific metrics for
measuring current performance, it becomes a matter of utilizing
effective management techniques, processes and other metrics to
jumpstart product development performance. The following includes
some of the most effective ways in which leading companies raise the
bar to achieve their goals:
Portfolio and Development ROI Metrics
There's inconsistency in how companies approach development
financials. The tiered nature of semiconductor development, where
individual projects often share "core" intellectual property (IP)
and platforms whose development costs are meant to be amortized
across multiple end products or families, can be frustratingly
ambiguous. This sometimes results in the participants backing off
from the controversies that can arise from trying to model and
apply tests of financial return. Consequently, many companies are
effectively flying blind, with only high-level "rear view mirror"
metrics of development results. This can be too little, too late if
they happen to get off track.
Leading companies address this challenge by adopting
consistent, workable models for financial analysis of multi-tiered
development, even if they're not perfect for every use case. The key
elements of these models include:
- Thorough capture of development spend at both the individual
project and at the platform/core IP levels.
- An allocation mechanism for distributing cross-project spend,
such as core IP.
- Consistent models for product cost, including target cost analysis.
- Steadily maintained market and average selling price (ASP)
- A development proposal/project ranking based on gross margin
or contribution margin metrics.
- A NPV-based "hurdle rate" total return benchmark for
company financial performance.
Requirements management offers two avenues to enhancing RoD.
The first is associated with value engineering and design-for-cost
disciplines, which force emphasis on feature-cost tradeoffs. It also
counters an unfortunate tendency to "load up" product requirements
unless they meet stringent criteria.
The second avenue is associated with time. A well-managed
requirements process is time-sensitive, and requirements
definition is notorious for being one of the most frequently
extended stages of product development. Some companies
even have "redefinition" as a named stage in their development
process. Sure, you can argue that it's a fact of life, but extended
development timelines create their own "redefinition" issues as
the market passes them by.
The impact of time reduction on development financial
performance is twofold. First, it reduces the uncertainty and the
likelihood of changes to initial estimates. Second, time compression
improves the NPV comparison of margin inflows and development
Lean Engineering and Engineering Efficiency Management
A key driver for many companies is simply how much time each
engineer or designer is actually able to devote to core, value-added
tasks instead of administration, cross checking, error correction
or sorting through disorganized information. Study this data and
you will come away surprised by how high a percentage of your
development staff time is unavailable for work that actually moves
the process forward. By using value stream analysis and other lean
techniques, a lot of engineers' non-productive time can be harvested
And let's be clear. Higher effective utilization of key technical
resources is not only a cost reduction benefit. Again, it is a key lever
for elapsed time. Now, the same staff can execute a given development
effort in substantially less time than previously required and slash
Stage-gate Controls and Go/No-go Deployment of Development Resources
Many companies have established functioning stage-gate processes
that fairly clearly delineate the progress from requirements to design,
first silicon and revenue launch. Yet far fewer incorporate the basic
question, "Is it still worth it?"
The criteria that may have launched a development effort are
often not revisited for a hard-headed look at whether they still hold
water. In the quarters and years that elapse from initial development
decisions to later gates, forecast prices may have eroded, estimated
product unit costs may have risen, the cost to develop may have
overrun and the realistic time-to-market may have elongated.
Whether for good reasons or due to imperfect execution, all of these
factors can change the original equation of the development effort's
fundamental merits. In short, the potential for those hoped-for large
returns may have evaporated.
Figure 3. RoD Leverage is Front-loaded in the Development Cycle
Source: Deloitte Consulting LLP
Any high-performing company will charter development projects
that, for a variety of reasons, run out of runway before they make
it to revenue ship. Here's a simple diagnostic question for your
development process: "Do you ever kill projects?" If you can't answer
yes, it's possible you are failing to identify and terminate unrewarding
development efforts as early as possible in the process. And that
means you may also be failing to recoup the available development
resources and spend of a lackluster project that could be redeployed
to more promising efforts.
Targeting Increased RoD
These are the basics, but implementing improvements that move the
RoD needle have to come from all sides:
- Work on the right things. Apply useful financial tests to your
portfolio before committing the spend.
- Work effectively. Implement lean-based engineering methods
that increase the value-added component of your workforce's
time. Stress test requirements to ensure that incremental value
mitigates RoD impact.
- Continue to test ongoing projects against criteria for success.
Be willing to terminate projects whose value proposition has
faded, and re-invest teams' time into higher return efforts.
- Recognize the capital value of time reduction and the true cost
of time spent redoing or reworking. Be willing to penalize the
business case of laggard projects appropriately.
Figure 4. Accelerating Gross Margin Inflows and Controlling Development Outflow is Key to RoD
Source: Deloitte Consulting LLP
RoD is simple to visualize, but no single improvement lever
will consistently send sales soaring. Focus is required on every
aspect of the management and operational processes of product
development, from critical attention to portfolio-level economics
and the minute details of each engineer's work patterns. RoD can
provide a valuable collecting point for tying together multiple
improvement efforts, all sharing a common objective of making
the NPV of gross margin from development substantially exceed
the NPV of development cost to meet your profitability and
About the Author
Mark Davis is a principal in Deloitte Consulting LLP's Silicon Valley office and
leads the firm's product development practice. He has over 22 years of experience
helping companies improve strategic and operational processes around product
development and supply chain. You can reach Mark Davis at firstname.lastname@example.org or 408-464-6060.
John La Bouff is a 30-year veteran of the semiconductor industry, and was among
the first to develop supply chain practices and systems designed around the fabless
model. John is now a senior manager in Deloitte Consulting LLP's Silicon Valley
practice, where he focuses on operational performance and product development
improvement for semiconductor companies. You can reach John La Bouff at
email@example.com or 650-450-6056.
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