¶ … performance of Joe Schmoe was improved upon significantly. However, in some ways this was easy because Mr. Schmoe made a number of glaring errors in his analysis. Much of the success of the past four years is attributed to simply rectifying those mistakes. The next four years will be more challenging. There is still room for improvement, however. To analyze the performance of the past four years and decide on a strategy for the next four years, the same basic tools will be used as before.
The X5 is the safest performer. It is in the maturity stage of the product life cycle at the beginning of 2006 and will head into maturity for 2008. This product does make a few million in 2008, so as long as that slim margin of success is maintained, there is no reason to discontinue the X5 prematurely. Indeed, because the R&D allocation is the minimum 1% at that point, there is little likelihood that there will be any impact on the other products no matter what is decided for the X5. For the purposes of this simulation, it is worth noting that because of the product life cycle and lack of changes in the R&D situation, the X5 product is more or less on cruise control at this point. A shift in the price could increase sales somewhat. Under the last program, the X5 finished at 98% saturation, so technically this could be improved upon. However, it is worth considering that a price drop to attract those remaining 94,000 customers would need to be very small if it is to be profitable. Thus, changes to the X5 are not being considered at this point. No change is likely to make a profound difference to the performance of the company. Therefore, the X5 program will be identical to what was proposed for the last simulation run:
X5
2006
2007
2008
2009
Price
$250
$250
$250
R&D
1%
1%
1%
Discontinue?
N
N
N
Y
X6
The X6 has been the strongest product both under Joe Schmoe and in the last simulation as well. This product enters 2006 in the growth stage of the product life cycle and ends with saturation at the end of 2009. Thus, almost all of the product's sales occur during the four-year period of the simulation. As a result, careful planning should be used. The cost-volume-profit analysis indicates that for the last simulation, a contribution of $190 was earned on the sales, and the product finished at 100% saturation. This indicates that the best way to improve profits is to increase the price further, thereby increasing the margin.
It is critical to remember price elasticity of demand, however. An increase in price will have an impact on sales. Consumers of the X6 are more sensitive, however, to changes in the quality of the product. The quality of the product is highly influenced by the R&D allocations. For this product in particular, the allocations in 2006 and 2007 are critical, since those will be the ones that keep the product competitive in 2008 and 2009. By 2008, R&D investments are going into a product that will be in the decline stage of the product life cycle when the R&D output shows in the finished product. R&D investment in 2009 is essentially irrelevant because of the time lag. R&D allocation represents a tradeoff between the different products. In the last simulation, R&D allocation was taken from the X5 and given exclusively to the X6. This resulted in the X6 reaching 100% saturation despite the price increase. This indicates that perhaps the ideal price for the X6 is slightly higher than the $440 that was set for the last simulation, at least for this R&D allocation program. If the R&D allocation program is unchanged for this product, then the price could perhaps be set higher, at $450. This gives a four-year program for the X6 as follows:
X6
2006
2007
2008
2009
Price
$450
$450
$450
$450
R&D
66%
66%
66%
66%
Discontinue?
Whereas adjustments to price and R&D could have a slight impact on the bottom line by way of contribution margins, the X7 can flat out contribute with sales growth. It's the difference between selling cars in the United States where everybody already has one and selling cars in China where a billion people do not have one. The X7 is the biggest potential product for this company. The objective at the outset of the last simulation was to bring this product from the introduction stage to the maturity stage. The CVP analysis showed that a lower price was easily possible, since the margins being charged on this product were unreasonably high. The market agreed -- with a lower price the X7 performed well. But it only got to the growth stage, and 10.3 million units remained as potential customers. The more of these can be captured the better this product -- and the company -- will perform.
The CVP analysis is a good starting point. It lets us know that we can sell the product at a very low price. It is profitable (not including R&D allocation) at $70 per unit. Undoubtedly, it will reach saturation at that level. But the objective, ultimately, is not saturation but rather to maximize profit. This is where CVP analysis must be combined with price elasticity of demand analysis, to find the point that has the best combination of price, contribution, demand and profit. The slope line only has two points -- that identified by Joe Schmoe during his tenure and that identified by the last simulation. The slope line indicates that the ideal point of profit is around $135 or $136. At this price point, sales will not be maximized, but profit over the four years will be. The slope and ideal price point will change if the R&D allocation changes, because the product will be more appealing, but in this case the R&D allocation for the other products has remained unchanged and therefore it must remain unchanged for the X7 as well.
It is possible that if changes are made to the R&D allocation for the X7 a higher price point can yield an even better profit in the long run. There will inevitably be an impact on the profitability of the X6, however. Perhaps if the results of the current plan are not satisfactory, this analysis could be undertaken. However, given the tools we have now and the information we have now, we know that the profit of the X7 over the four years can be improved -- and the saturation as well -- simply by lowering the price further, spurring higher sales as a result. Thus, the four-year plan for the X7 is as follows:
X7
2006
2007
2008
2009
Price
$136
$136
$136
$136
R&D
33%
33%
33%
34%
Discontinue
N
N
N
N
Conclusion
The combined strategy for the four years encompasses a number of tools and techniques. These are the same ones that were used in the previous simulation, but the greater amount of information we possess today, having gone through the Time Warp means that our results should be refined as well. By making adjustments to the price of the X6 in order to improve the contribution margin and by lowering the price of the X7 in order to spur higher sales and higher profits as a result, it is believed that this strategy will deliver a result superior to that recorded last time. That benchmark score is $1.833 billion, so these results will be measured against that.
It should be noted that the successful application of these techniques is dependent on the stable level so R&D allocation. It is entirely possible that these levels are not ideal -- they have not been tested to determine how sensitive customers are to given R&D levels. As a result, it is possible that the results of this next round could be improved upon again. However, the effectiveness of any tool used is constrained by the quality of the inputs, in this…
