business management tablet simulation

SLP

Introduction

The SLP 3 scenario saw relatively poor performance, using a strategy that did not waver much from the original scenario. There were a few interesting findings from the cost volume profit analysis that can be applied to the strategy utilized in SLP 4. Each product will be covered in detail.

X5

The X5 in 2012 has already been on the market and is probably at the top of the product life cycle. It sells good volume and is profitable, but past simulations have shown that the X5 becomes less profitable over time. The X5 has the highest fixed costs of any product, at $75M, and is expected to drop below the margin of safety by the final year, 2015. By this year, the contribution is expected to be below fixed costs. Therefore, the X5 should be discontinued for the 2015 year.

There is also the matter of pricing the X5. The original price is currently making the X5 profitable. The only real decision with respect to pricing the X5 is how to price it in such a way that extracts the absolute maximum number of sales prior to the 2015 year, at which point it will be discontinued. Basically, any potential sales still on the table after 2014 will be sales that could have happened, but did not. However, the trade off is that lowering the price of the X5 to win those sales will also reduce the per unit contribution. There is a risk that lowering the price to increase sales will lower the total contribution – lower the price too much and those additional new sales will simply not be worth it.

The other element is the R&D funding. The company has a set amount of R&D funding each year. This cannot be changed; it is an organization-wide fixed cost. However, the R&D funding can be divided among the products. More R&D invested into a product will impact on the desirability of the product. The written reports that come at the end of each year discuss this issue in terms of "customers feel that this product is priced too high for the features" and verbiage like that. There is also a lag of one year in between when the company invests in R&D and when the fruits of that investment are reflected in sales. In other words, R&D in 2012 doesn't show on the bottom line until 2013. Where the X5 is concerned, money invested in 2012 shows in 2013, at a point when the X5 is peaking. Furthermore, if price is going to be massaged in order to squeeze all the potential unit sales out of the X5 by 2014, there is no value in investing any R&D money into this product. Literally, R&D money invested into the X5 will not have any meaningful impact on the bottom line. Therefore, it is recommended that the R&D money from the X5 is shifted to the other two products.

The strategy employed in the SLP 4 will therefore see R&D for the X5 cut to zero immediately, and the price lowered slightly to $270 in order to ensure that there are as few remaining potential customers as possible at the end of 2014.

X6

The X6 is closer to the beginning of the product life cycle in 2012. This is the company's premium product, which means that consumers are generally willing to pay higher prices, as long as the features match up with the price. This has implications for aligning the price and the R&D funding. The fixed costs associated with this product are $37.5M, half the fixed cost of the X5. This means that the margin of safety is much higher. In fact, upon closer examination, the conclusion of the SLP 3 analysis that the X6 needs to be discontinued in 2015 was incorrect; this product will still be profitable at that point and should be continued through 2015.

In terms of pricing, for premium products consumers are not particularly price sensitive. They are more driven by features. In that sense, the R&D money that was invested in the X5 should be shifted to the X6, in order to ensure that this product remains competitive at the high price it commands. There is the question of whether this is going to be enough, but if the company can maintain the higher price then ultimately that will be good for profits.

Thus, it is recommended that the X6 is not discontinued, that it takes on 67% of the R&D money, and that it maintains its price throughout.

X7

The X7 is at the very beginning of the product lifecycle in 2012. The issue with the X7 is that it appears to be priced too high, as the market saturation level is very poor throughout. While this product appears to be unprofitable, the reality is that the potential demand is by far the highest of any of these products. This is a low-end product, and at the low-end, consumers are far more price sensitive than they are anything else. At the end of the day, the high price is creating problems for this product.

R&D investment is still important, even at the low end. The way to think of it is this – consumers are still looking for all the features they can get; if you are priced roughly the same as every other low-end product but have more features, then you will win market share. Thus, the 33% level of R&D spending will be maintained, as the X7 is expected to continue to sell throughout the four year time period.

The price needs to be reduced, however, to make this product more competitive. It is believed that, because of the massive amount of potential customers, that the price should be dropped significantly in order to capture some of these customers. A price drop to $150 is recommended. Because the price drop was not tested in SLP3, there is no data to estimate the price elasticity of demand, so the best course of action in SLP 4 is to set a price for the full four years, and see what that does to demand. Leaving the R&D allocation alone will mean that the new $150 is the only variable to change, which means that the price elasticity of demand can be calculated outright using the data gathered.

The Strategy

X5

Price

R&D

Discontinue?

X6

Price

R&D

Discontinue?

No

No

No

No

Yes

No

x

x

x

No

X7

Price

R&D

Discontinue?

No

No

No

No

The Results

Cumulative Profit

Units

Revenue

Profit

Market Sat

X5

X6

X7

Units

Revenue

Profit

Market Sat

X5

X6

X7

Units

Revenue

Profit

Market Sat

X5

X6

X7

Units

Revenue

Profit

Market Sat

X5

X6

X7

Analysis of Results

There are a few interesting things about these results. First, the performance was not bad. Cumulative profitability was higher with this strategy than it was with the prior strategy:

SLP4

SLP2

X5

X6

X7

The performance of the X5 was slightly weaker, which one has to imagine is the result of lowering the R&D allocation on that product, without a corresponding decline in price. There is probably a trade-off that is being made there, however. In theory, lowering the total profitability of the X5 is something that should allow the other products to be more profitable. The X5 was also profitable in 2014 in the SLP2 scenario – a closer look at the analysis that determined it should be discontinued might be warranted.

The R&D trade-off should have reflected in higher profitability for the beneficiary of that decision, the X6. This was the case. With no other variables changed (i.e. price), the X6 earned significantly more money, and still finished with 100% market saturation. Thus, the decline in the revenue of the X5 was lower than the increase in the profit of the X6, and the other difference was really the shift in R&D funding. As a result, that decision appears to be justified.