PDA SIM Time Normal Time

PDA SIM Time Normal

Time Warp 3 begins with the four-year plan that was devised during the last cycle. This plan is as follows:

Year by Year Decisions: Pricing & R&D Allocations

PRODUCT

DECISION

Price

R&D %

Discontinue?

Price

R&D %

Discontinue?

Price

R&D %

Discontinue?

The successes at maximizing the X7's contribution were valuable, but the impacts of other products were less the focus of earlier time warp rounds. The new four-year plan continued to downplay the importance of the X5 product, largely because of its position in the product life cycle. In addition, increasing the economic value added (EVA) of the X5 was determined to come at a cost to EVA on the other products -- the opportunity cost of sending R&D money to the X5 was too great.

CVP analysis was used to help with a number of elements of the new strategy. One of the best uses for CVP analysis is to help determine the optimal product mix. The X6 needs to be feature-rich in order to attract buyers. However, the X7 also needs features to attract buyers even though it is a low-end product. The potential EVA for the X7 is great, since the potential market is 15 million users. Because the X7 has the highest markup of the three products, the X7 can see a sharper price reduction while retaining a positive contribution margin. The optimal contribution margin will balance contribution and sales. Sales can be estimated using the price elasticity of demand slope.

In the first time warp round, a slope of price elasticity of demand was determined for both the X7 and the X6. This latest plan incorporates price points driven by that elasticity analysis and the CVP analysis upon which the elasticity analysis was based. The research and development figures are as yet unchanged. The performance of the products is strong, relative to potential performance (highest scores achieved in the simulation run). Therefore, there is considerable risk with respect to making dramatic changes to the R&D allocations. In addition, the positions of the X6 and X7 along the product lifecycle, combined with the one year delay between a change in the R&D allocation and the sales impact of that change, means that any negative impacts of change cannot easily be undone. Risk aversion with respect to the R&D allocation strategy continues to play a role in the strategy.

Time Warp 3 was more successful than was Time Warp 2. The last run delivered a total net economic value of $1.849 billion but Time Warp 3 delivered an economic value of $2.113 billion. The strategies that were employed were largely successful. In adjusting the price of the X6, the product sold out, which did not happen last time. The sellout delivered the maximum economic value, at least given the level of R&D allocation that the product received.

The X7 continued its stellar performance, with the product delivering $530 million of the $628 million the company made in the final year of the simulation. By the end of 2009, the X7 had reached a saturation level of 47%, commensurate with its position roughly two years behind the X6 on the product life cycle. The X7 appears headed for success as well. The X5 continued to perform well, although the assume continues to be that maximizing X5 performance will result in reductions in the performance of the other two products, lowering the total EVA for the three products over the four years.

As the high scores on the PDA simulation indicate, there is still some room for performance improvements. While the contribution margins of the X6 and X7 appear to be maximized, that only holds for the levels of R&D investment. A shift in the R&D investments levels, therefore, is critical to maximizing profit over the four years. This requires a greater understanding of how R&D affects demand for the two products. The X6 clearly benefits from a high level of R&D, but this impact may wane as it reaches total saturation. The X7 sales still have potential as well, and they benefit from R&D investment. Consumers love getting a great product for cheap.

There will not be a next step, but if there was, a shift in the R&D strategy would need to be conducted in order to deliver even greater success. However, the current strategy was a strong one. The use of the contribution margin analysis provided the basis for this assessment because it allowed for more intelligent pricing of the products. Once the demand curves for the X6 and X7 were understood, the contribution margin was used to set the optimal sales level to maximize contribution. The initial use of this tactic, just for the X7, delivered results that were vastly superior to those of the original time warp, and the results were substantially better than those delivered under the Joe Schmoe regime.

The effectiveness of the CVP/demand curve strategy for maximizing contribution was highlighted in this time warp, because the strategy was also applied to the X6. The strategy maximized the economic impact of the X6 product as it followed through saturation. The results are strong, showing not only a good, consistently improving economic value, but a maximization of market share without selling at too low a price, which is something that could have occurred with the X7 in particular. The 14.2% improvement over an already-strong score in the time warp indicates that the latest strategy was superior, and delivered superior results.

The company's initial performance was terrible. At first, simply cleaning up the glaring mistakes of the Joe Schmoe regime was enough to succeed. The company stabilized, and made money in 2009. The price points set for the X6 and X7 were a better match for the positioning in the market that the company was trying to achieve. Leaving so many millions of potential X7 sales on the table because of the $200 price point was a key issue that needed to be addressed right away.