Product Development Risks

Internal Auditor, Oct, 2000 by Barry S. Leithhead

Internal auditors can help to maintain the lifeblood of the organization by keeping a close eye on its latest creations.

AN ORGANIZATION'S Performance often hinges largely on its ability to develop successful products. By introducing new products and reshaping existing ones, companies create markets and growth opportunities. If these items fail to meet customer expectations, however, an organization can quickly lose its competitive edge and compromise its relevancy to the marketplace.

From an internal audit perspective, product development is one area of business operations that clearly demonstrates the two sides of risk management--the opportunities essential to progress and the threats that can damage or destroy the organization. Internal auditors must know the appropriate questions to ask and issues to examine to ensure that these two components of risk are managed properly. Equipped with the right knowledge, auditors can provide assurance that management recognizes, understands, and takes appropriate measures to address critical exposures.

OPPORTUNITY RISKS

Organizations constantly look for opportunities to reward stakeholders, increase customer satisfaction, and gain advantage over competitors. Making the most of opportunities is the positive side of risk management. By managing opportunity risk successfully, an organization can increase the likelihood that new products will achieve expected results.

Most product development is a result of applying market research and engineering to offer new or improved items that customers need or want. Physical products often require expensive tooling during development, and they may necessitate custom software and hardware applications and extensive training to supply or support the product. Many of the opportunity risks that affect product development, therefore, are associated with investment and project management. Both of these areas merit internal auditing's close scrutiny.

INVESTMENT RISK The primary issues related to investment risk are the assumptions used and the source of fundamental data. Assumptions may have no basis in fact or science and could represent different attitudes or expectations about the same situation. For example, a product might have features that designers expect will appeal to new customers, whereas marketing specialists for the same product may create advertising directed at existing customers.

Data may come from a secondary or outdated source--thus making it unreliable. Market research data, for example, could be misused in calculating the effect of assumptions on costs or revenues. Marketing and customer data are especially difficult to verify.

Internal auditors need to pay close attention to assumptions and data sources associated with investment projects. The following questions can serve as a starting point for assessing the potential risks:

* How consistent is the investment purpose with organization strategy and objectives?

* How complete, current, and reliable is the data used to assess the options?

* How objective are the decision criteria that will be used for prioritizing projects and selecting options?

* How realistic are volume, price, and cost data on which the return on investment is calculated?

* What other product development projects competed for these investment funds?

* Was the priority for this project objectively assessed and soundly based?

* How viable were the alternatives that were discarded in the investment analysis?

Because product development is similar to many other types of investment decisions, the general risk assessment and control processes associated with capital expenditures may be applied. Internal auditors' extensive involvement and familiarity with capital expenditures can provide valuable assistance with product development investment decisions.

PROJECT MANAGEMENT RISK Product development projects need to be successful to satisfy customers' changing needs, gain market position, and take advantage of opportunities. Like all projects, product development is subject to three main resource constraints: time, funds, and required quality and features. Project managers must achieve balance among these resource constraints. Product development projects should include a risk assessment module that allows managers to identify and measure the risks associated with resource constraints and then develop appropriate responses.

Internal auditors can help to assess potential risks and provide assurance that project controls are effective by asking the following questions:

* How are time pressure points or peak loads identified and managed?

* What compromises have been made for cost, quality, safety, and the environment?

* How are project activities planned and coordinated?

* In what way are variations identified and managed?

* How are product development prospects assessed for investment and priority?

* How are the risks inherent in product development projects identified and tracked? For example, such risks may be associated with the following activities: