Lecture 1: Introduction to Engineering Economy Engineering Economy Selecting the most suitable robot for a welding operation on an automotive assembly line. Making a recommendation about whether jet airplanes for an overnight delivery service should be purchased or leased. Determining the optimal staffing plan for a computer help desk. Engineering is the profession in which a knowledge of the mathematical and natural sciences gained by study, experience, and practice is applied with judgment to develop ways to utilize, economically, the materials and forces of nature for the benefit of mankind. (Accreditation Board for Engineering and Technology) Principles of Engineering Economy Seven Fundamental Principles of Engineering Economy 1. Develop the alternatives Economy It is an area of the production, distribution and trade, as well as consumption of goods and services by different agents. Engineering Economy involves the systematic evaluation of the economic merits of proposed solutions to engineering problems (Sullivan). Solutions to engineering problems must: promote the well-being and survival of an organization, embody creative and innovative technology and ideas, permit identification and scrutiny of their estimated outcomes, and translate profitability to the “bottom line” through a valid and acceptable measure of merit. Roles engineering economic analysis can play in many types of situations. Choosing the best design for a highefficiency gas furnace. Carefully define the problem. Then the choice (decision) is among alternatives. The alternatives need to be identified and then defined for subsequent analysis A decision situation involves making a choice among two or more alternatives “The correct solution to any problem depends primarily on a true understanding of what the problem really is. “Arthur M. Wellington (1887) 2. Focus on the differences Only the differences in the future outcomes of the alternatives are important. Outcomes that are common to all alternatives can be disregarded in the comparison and decision. For example, if your feasible housing alternatives were two residences with the same purchase (or rental price), price would be inconsequential to your final choice. Instead, the decision would depend on other factors, such as location and annual operating and maintenance expenses. This example illustrates the basic purpose of an engineering economic analysis: o To recommend a future course of action based on the differences among feasible alternatives 6. Make uncertainty explicit 3. Use a consistent viewpoint 4. 5. The prospective outcomes of the alternatives should be consistently developed from a defined viewpoint or perspective. The perspective of the decision maker, which is often that of the owners of the firm, would normally be used. The viewpoint for the particular decision be first defined and then used consistently in the description analysis and comparison of alternatives. Use a common unit of measure For measuring the economic consequences, a monetary unit such as dollars (or Philippine pesos) is the common measure. Other outcomes which do not initially appear to be economic should be translated into the monetary unit. Consider all relevant criteria The decision maker will normally select the alternative that will best serve the long-term interests of the organization. In engineering economic analysis, the primary criterion relates to the longterm financial interests of the owners. This is based on the assumption that available capital will be allocated to provide maximum monetary return to the owners. 7. Risks and uncertainty are inherent in estimating the future outcomes of the alternatives and should be recognized. The analysis of the alternatives involves projecting or estimating the future consequences associated with each of them. The magnitude and the impact of future outcomes of any course of action are uncertain. The probability is high that today’s estimates of, for example, future cash receipts and expenses will not be what eventually occurs. Revisit your decisions A good decision-making process can result in a decision that has an undesirable outcome. Other decisions, even though relatively successful, will have results that are significantly different from the initial estimates of the consequences. Learning from and adapting based on our experience are essential and are indicators of a good organization. Engineering Economy Study Engineering Economy and the Design Process An engineering economy study is accomplished using a structured procedure and mathematical modeling techniques. The economic results are then used in a decision situation that normally includes other engineering knowledge and input. Engineering Economic Analysis Procedure 1. Problem Definition Problem definition is particularly important, since it provides the basis for the rest of the analysis. A problem must be well understood and stated in an explicit form before the project team proceeds with the rest of the analysis. The term problem includes all decision situations for which an engineering economy analysis is required. Recognition of the problem is normally stimulated by internal or external organizational needs or requirements. An operating problem within a company (internal need) or a customer expectation about a product or service (external requirement) are examples. Once the problem is recognized, its formulation should be viewed from a systems perspective. That is, the boundary or extent of the situation needs to be carefully defined, thus establishing the elements of the problem and what constitutes its environment. Evaluation of the problem includes refinement of needs and requirements, and information from the evaluation phase may change the original formulation of the problem. In fact, redefining the problem until a consensus is reached may be the most important part of the problem-solving process! 2. Development of alternatives The two primary actions in Step 2 of the procedure are (1) searching for potential alternatives and (2) screening them to select a smaller group of feasible alternatives for detailed analysis. The term feasible here means that each alternative selected for further analysis is judged, based on preliminary evaluation, to meet or exceed the requirements established for the situation. 2.1 Searching for Superior Alternatives In the discussion of Principle 1, creativity and resourcefulness were emphasized as being essential to the development of potential alternatives. The difference between good alternatives and grea alternatives depends largely on an individual’s or group’s problem-solving efficiency. Such efficiency can be increased in the following ways: o Concentrate on redefining one problem at a time in Step 1. o Develop many redefinitions for the problem. o Avoid making judgments as new problem definitions are created. o Attempt to redefine a problem in terms that are dramatically different from the original Step 1 problem definition. o Make sure that the true problem is well researched and understood. In searching for superior alternatives or identifying the true problem, several limitations invariably exist, including (1) lack of time and money, (2) preconceptions of what will and what will not work, and (3) lack of knowledge. Consequently, the engineer or project team will be working with less-thanperfect problem solutions in the practice of engineering. 2.2 Developing Investment Alternatives Alternatives “It takes money to make money,” as the old saying goes. Did you know that in the United States the average firm spends over $250,000 in capital on each of its employees? So, to make money, each firm must invest capital to support its important human resources—but in what else should an individual firm invest? There are usually hundreds of opportunities for a company to make money. Engineers are at the very heart of creating value for a firm by turning innovative and creative ideas into new or reengineered commercial products and services. Most of these ideas require investment of money, and only a few of all feasible ideas can be developed, due to lack of time, knowledge, or resources. Consequently, most investment alternatives created by good engineering ideas are drawn from a larger population of equally good problem solutions. But how can this larger set of equally good solutions be tapped into? Interestingly, studies have concluded that designers and problem solvers tend to pursue a few ideas that involve “patching and repairing” an old idea. This section outlines two approaches that have found wide acceptance in industry for developing sound investment alternatives by removing some of the barriers to creative thinking: (1) classical brainstorming and (2) the Nominal Group Technique (NGT). Classical Brainstorming. Classical brainstorming is the most wellknown and often-used technique for idea generation. It is based on the fundamental principles of deferment of judgment and that quantity breeds quality. There are four rules for successful brainstorming: o Criticism is ruled out. o Freewheeling is welcomed. o Quantity is wanted. o Combination and improvement are sought. A. F. Osborn lays out a detailed procedure for successful brainstorming. Classical brainstorming session basic steps: o Preparation - The participants are selected, and a preliminary statement of the problem is circulated. o Brainstorming - A warm-up session with simple unrelated problems isconducted, the relevant problem and the four rules of brainstorming are presented, and ideas are generated and recorded using checklists and other techniques if necessary. o Evaluation - The ideas are evaluated relative to the problem. Generally, a brainstorming group should consist of four to seven people, although some suggest larger groups. Nominal Group Technique The NGT, developed by Andre P. Delbecq and Andrew H. Van de Ven,‡ involves a structured group meeting designed to incorporate individual ideas and judgments into a group consensus. By correctly applying the NGT, it is possible for groups of people (preferably, 5 to 10) to generate investment alternatives or other ideas for improving the competitiveness of the firm. Indeed, the technique can be used to obtain group thinking (consensus) on a wide range of topics. Indeed, the technique can be used to obtain group thinking (consensus) on a wide range of topics. For example, a question that might be given to the group is, “What are the most important problems or opportunities for improvement of . . .?” The technique, when properly applied, draws on the creativity of the individual participants, while reducing two undesirable effects of most group meetings: (1) the dominance of one or more participants and (2) the suppression of conflicting ideas. The basic format of an NGT session is as follows: o Individual silent generation of ideas o Individual round-robin feedback and recording of ideas o Group clarification of each idea o Individual voting and ranking to prioritize ideas o Discussion of group consensus results The NGT session begins with an explanation of the procedure and a statement of question(s), preferably written by the facilitator. The group members are then asked to prepare individual listings of alternatives, such as investment ideas or issues that they feel are crucial for the survival and health of the organization. This is known as the silent-generation phase. After this phase has been completed, the facilitator calls on each participant, in round-robin fashion, to present one idea from his or her list (or further thoughts as the round-robin session is proceeding). Each idea (or opportunity) is then identified in turn and recorded on a flip chart or board by the NGT facilitator, leaving ample space between ideas for comments or clarification. This process continues until all the opportunities have been recorded, clarified, and displayed for all to see. At this point, a voting procedure is used to prioritize the ideas or opportunities. Finally, voting results lead to the development of group consensus on the topic being addressed. 3. Development of prospective outcomes Step 3 of the engineering economic analysis procedure incorporates Principles 2, 3, and 4 from Section 1.2 and uses the basic cash-flow approach employed in engineering economy. A cash flow occurs when money is transferred from one organization or individual to another. Thus, a cash flow represents the economic effects of an alternative in terms of money spent and received. Consider the concept of an organization having only one “window” to its external environment through which all monetary transactions occur—receipts of revenues and payments to suppliers, creditors, and employees. The key to developing the related cash flows for an alternative is estimating what would happen to the revenues and costs, as seen at this window, if the particular alternative were implemented. The net cash flow for an alternative is the difference between all cash inflows (receipts or savings) and cash outflows (costs or expenses) during each time period. In addition to the economic aspects of decision making, nonmonetary factors (attributes) often play a significant role in the final recommendation. Examples of objectives other than profit maximization or cost minimization that can be important to an organization include the following: o Meeting or exceeding customer expectations o Safety to employees and to the public o Improving employee satisfaction o Maintaining production flexibility to meet changing demands o Meeting or exceeding all environmental requirements o Achieving good public relations or being an exemplary member of the community 4. Selection of a decision criterion The selection of a decision criterion (Step 4 of the analysis procedure) incorporates Principle 5 (consider all relevant criteria). The decision maker will normally select the alternative that will best serve the long- term interests of the owners of the organization. It is also true that the economic decision criterion should reflect a consistent and proper viewpoint (Principle 3) to be maintained throughout an engineering economy study. 5. Analysis and comparison of alternatives. Analysis of the economic aspects of an engineering problem (Step 5) is largely based on cash-flow estimates for the feasible alternatives selected for detailed study. A substantial effort is normally required to obtain reasonably accurate forecasts of cash flows and other factors in view of, for example, inflationary (or deflationary) pressures, exchange rate movements, and regulatory (legal) mandates that often occur. Clearly, the consideration of future uncertainties (Principle 6) is an essential part of an engineering economy study. When cashflow and other required estimates are eventually determined, alternatives can be compared based on their differences as called for by Principle 2. Usually, these differences will be quantified in terms of a monetary unit such as dollars. 6. Selection of the preferred alternative. When the first five steps of the engineering economic analysis procedure have been done properly, the preferred alternative (Step 6) is simply a result of the total effort. Thus, the soundness of the technical-economic modeling and analysis techniques dictates the quality of the results obtained and the recommended course of action. Step 6 is included in Activity 5 of the engineering design process (specification of the preferred alternative) when done as part of a design effort. 7. Performance monitoring and postevaluation of results. This final step implements Principle 7 and is accomplished during and after the time that the results achieved from the selected alternative are collected. Monitoring project performance during its operational phase improves the achievement of related goals and objectives and reduces the variability in desired results. Step 7 is also the followup step to a previous analysis, comparing actual results achieved with the previously estimated outcomes. The aim is to learn how to do better analyses, and the feedback from post implementation evaluation is important to the continuing improvement of operations in any organization. Unfortunately, like Step 1, this final step is often not done consistently or well in engineering practice; therefore, it needs particular attention to ensure feedback for use in ongoing and subsequent studies.
