In this case, we have a base logic for R&D allocations -- the X6 needs to be feature-rich in order to attract buyers. The X7 needs only to be current in its features. The X5 is more or less locked into a particular sales, revenue and profit trajectory. Adjustments made at this point in the product life cycle may impact total company profitability by a few million in either direction, but the real profit potential lies in the X6 and X7. Under Joe Schmoe the X6 had a contribution margin of $400 -- 250 = $150. I hypothesized that if the features were improved I could raise the price and therefore the contribution margin. I delivered a margin of $450 - $250 = $200 or $50 more contribution margin than the Schmoe strategy. This came at a cost of a $6.6 million increase to the R&D cost. In 2007 for example this equated to $8.50 per unit, meaning that I added $41.50 per unit to the net profit. This came at a slight reduction in sales. Schmoe sold 5.363 million units and I sold 5.298 million units. Thus, for the X6 Joe did $150 * 5.363 = $804.45 million in profit. I did $191.50 * 5.298 = $1,014.56 million in profit. This is because there is low price elasticity of demand on the X6, especially when its features are improved. The next strategy will build on that theory, testing the upper limits of profitability for the product. Using the price elasticity...
This can be found in Appendix A. The ideal price point for the X6 therefore is $432.
The CVP analysis also provides insight into the value of the X7. In this case, I made an initial decision to lower the price because I noticed that the contribution margin was the highest of the three products ($200 - $65 = $135 or 67.5%). This gave me flexibility to lower the price. The objective of this price reduction was volume. At $200, the X7 only sold 2 million units. At $150, it sold 4.932 million units. Thus, Joe Schmoe delivered 2 million * $135 = $270 million in profit and I delivered $85 & 4.932 = $419.22 million. There is still room to improve the total volume sold by the end of 2009 on the X7. We have a sense from Time Warp 1 what the price elasticity of demand might be for this product. If we use that information, we can estimate that the ideal price point to maximize profit of the X7 is around $137 (see Appendix B). It is the price elasticity of demand that gives the slope of the line determined by the price and the contribution margin. Any lower and the product will sell volume, but the lower profit per unit will result in decreased total profit. The $137 price point is simply an…
