Engineering Economics

Lecture 1.3
Engineering Economy and the Design Process

Sullivan, et al. (2015). Engineering Economy, 16th ed., pp. 7-15

• A sound engineering economic analysis procedure incorporates the 7 basic principles
(Lesson 1.2) and involves several steps.
• The procedure is represented in terms of the seven steps (left-hand column of Table 1-1).
• There are several feedback loops (not shown) within the procedure.
• Ex. 1: Within Step 1, information developed in evaluating the problem will be used as feedback to
refine the problem definition.
• Ex. 2: Information from the analysis of alternatives (Step 5) may indicate the need to change one or
more of them or to develop additional alternatives.
• The seven-step procedure is also used to assist decision making within the engineering
design process (right-hand column in Table 1-1).
• In this case, activities in the design process contribute information to related steps in the
economic analysis procedure.
• The general relationship between the activities in the design process and the steps of the
economic analysis procedure is indicated in Table 1-1.
• The engineering design process may be repeated in phases to accomplish a total design
effort.
• Ex. In the first phase, a full cycle of the process may be undertaken to select a conceptual or preliminary
design alternative. Then, in the second phase, the activities are repeated to develop the preferred detailed
design based on the selected preliminary design.
• The seven-step economic analysis procedure would be repeated as required to assist
decision making in each phase of the total design effort.
Engineering Economic Analysis Procedure

1 • Problem Definition
2 • Development of Alternatives
3 • Development of Prospective Outcomes
4 • Selection of a Decision Criterion
5 • Analysis and Comparison of Alternatives
6 • Selection of the Preferred Alternative
7 • Performance Monitoring and Post-evaluation of Results
Engineering Economic Analysis Procedure

Step 1. Problem Definition

• The first step of the engineering economic analysis procedure
(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.
Engineering Economic Analysis Procedure

Step 1. Problem Definition

• The term problem is used here generically.
• It 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.
Engineering Economic Analysis Procedure

Step 1. Problem Definition

• 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!
Engineering Economic Analysis Procedure

Step 2. Development of Alternatives (a.k.a.

Option Development)
• 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.

Searching for Developing

superior investment
alternatives alternatives
Engineering Economic Analysis Procedure Step 2. Development of Alternatives

1. Searching for Superior Alternatives

• “In the discussion of Principle 1 (Lesson 1.2), creativity and
resourcefulness were emphasized as being absolutely essential to the
development of potential alternatives.
• The difference between good alternatives and great alternatives
depends largely on an individual’s or group’s problem-solving
efficiency.
• Such efficiency can be increased in the following ways:
Engineering Economic Analysis Procedure Step 2. Development of Alternatives
1. Searching for Superior Alternatives

Ways to Improve Problem-solving Efficiency:

1. Concentrate on redefining one problem at a time in Step 1.
2. Develop many redefinitions for the problem.
3. Avoid making judgments as new problem definitions are created.
4. Attempt to redefine a problem in terms that are dramatically
different from the original Step 1 problem definition.
5. Make sure that the true problem is well researched and
understood.
Engineering Economic Analysis Procedure Step 2. Development of Alternatives

1. Searching for Superior Alternatives

• 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-
than-perfect problem solutions in the practice of engineering.
Example 1-1 Solution:
Engineering Economic Analysis Procedure Step 2. Development of Alternatives

2. Developing Investment Alternatives

• “It takes money to make money,” as the old saying goes.
• 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.
Engineering Economic Analysis Procedure Step 2. Development of Alternatives

2. Developing Investment Alternatives

• 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.
• Truly new ideas are often excluded from consideration!
• 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).
Engineering Economic Analysis Procedure Step 2. Development of Alternatives
2. Developing Investment Alternatives

(1) Classical Brainstorming

• Classical brainstorming is the most well-known 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:
1. Criticism is ruled out.
2. Freewheeling is welcomed.
3. Quantity is wanted.
4. Combination and improvement are sought.
Engineering Economic Analysis Procedure Step 2. Development of Alternatives
2. Developing Investment Alternatives

(1) Classical Brainstorming

• A. F. Osborn lays out a detailed procedure for successful
brainstorming.
• A classical brainstorming session has the following basic steps:
1. Preparation. The participants are selected, and a preliminary statement of
the problem is circulated.
2. Brainstorming. A warm-up session with simple unrelated problems is
conducted, the relevant problem and the four rules of brainstorming are
presented, and ideas are generated and recorded using checklists and other
techniques if necessary.
3. 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.
Engineering Economic Analysis Procedure Step 2. Development of Alternatives

Step 2. Development of Alternatives

• 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.
• Truly new ideas are often excluded from consideration!
• There are 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).
Engineering Economic Analysis Procedure Step 2. Development of Alternatives
2. Developing Investment Alternatives

(2) Nominal Group Technique (NGT)

• 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.
• Ex. A question that might be given to the group is, “What are the
most important problems or opportunities for improvement of . . .?”
Engineering Economic Analysis Procedure Step 2. Development of Alternatives
2. Developing Investment Alternatives

(2) Nominal Group Technique (NGT)

• The technique, whenproperly 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:
1. Individual silent generation of ideas
2. Individual round-robin feedback and recording of ideas
3. Group clarification of each idea
4. Individual voting and ranking to prioritize ideas
5. Discussion of group consensus results
Engineering Economic Analysis Procedure Step 2. Development of Alternatives
2. Developing Investment Alternatives

(2) Nominal Group Technique (NGT)

• 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).
Engineering Economic Analysis Procedure Step 2. Development of Alternatives
2. Developing Investment Alternatives

(2) Nominal Group Technique (NGT)

• 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.
Engineering Economic Analysis Procedure

Step 3. Development of Prospective Outcomes

• Step 3 of the engineering economic analysis procedure incorporates
Principles 2, 3,and 4 (Lesson 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.
Engineering Economic Analysis Procedure

Step 3. Development of Prospective Outcomes

• 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.
Engineering Economic Analysis Procedure

Step 3. Development of Prospective Outcomes

• 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:
1. Meeting or exceeding customer expectations
2. Safety to employees and to the public
3. Improving employee satisfaction
4. Maintaining production flexibility to meet changing demands
5. Meeting or exceeding all environmental requirements
6. Achieving good public relations or being an exemplary member of the community
Engineering Economic Analysis Procedure

Step 4. Selection of a Decision Criterion

• The selection of a decision criterion (Step 4) 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.
Engineering Economic Analysis Procedure

Step 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 cash flow and other required estimates are eventually determined,
alternatives can be compared based on their differences called for by
Principle 2.
• Usually, these differences will be quantified in terms of a monetary unit.
Engineering Economic Analysis Procedure

Step 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.
Engineering Economic Analysis Procedure

Step 7. Performance Monitoring and Post-

evaluation 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 follow-up 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
postimplementation 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.
Example 1-2 Solution:
Example 1-2 Solution:
(c)
Example 1-2 Solution:
A tip to the wise:
• Regularly review your own credit report for unauthorized activity.
• Consider getting a credit report every four months from:
Example 1-3 Solution: