CVP analysis and year plan strategy development

Tablet SIM III

The results of the last analysis were promising, but ultimately there are strict limitations as to the usefulness of cost-volume-profit analysis.

With the X5, the results were successful for the most part, and the X6 also sold to saturation. The X7 sold nowhere near saturation, and therefore money was left on the table. This is where the bulk of the analysis will be conducted. A few extra dollars can be squeezed out of the X5, and the X6 has some room for profit enhancement as well.

The strategy that I had formulated was as follows:

Discontinued

The X5 sold out and was highly profitable. The biggest question here is whether or not the X5 will sell out in 2014 at a higher price, from which greater profit can be derived. Using data collected from multiple simulations, the demand curve for 2014 has the following results. At a price of $265 (no decrease), total unit sales are 650,260. Thus,

$265

$250

Units

650,260

703,068

Revenue

$172,318,900

$175,767,000

The costs are the same under this scenario, so the $250 price is more profitable. The demand curve needs to be charted, in order to set a maximum price for profit in 2014 for this product. This curve tells us that revenue in the final year is maximized at $225. The volume at this level is 791,081. Sales by this point, given the strategy in the first two years, are capped at 703,068, so the point of maximum profit is going to be the highest price that allows us to sell that many units. A further analysis of the curve reveals that this point is P = $257.

For the X6, the product will benefit from determining the point of maximum profit. While X6 can be optimized with more R&D, this product is not the top priority in terms of opportunity cost. Therefore, the 50%, 50%, 0%, 0% will be assumed for the X6 in order to determine the point of profit maximization for the entire four-year period. The sales are expected to reach saturation in this scenario.

The objective of this analysis is a little bit different, since it is assumed the entire 5,510,000 units will be sold over the course of four years at $440, with $420 in the last year, since that is what occurred in the first run. Thus, the key is to see if more money can be made selling out in three years. To sell out in three years, it appears that 1.83 million units will need to be sold in each year. This implies a price of $421 or lower. The default scenario under Joe Schmoe, however, did not deliver this result at $420, to clearly lower is the way for this product. The demand curve must shift a little bit over different price points, so we do not know enough about the demand curve at this point to attempt to sell out the X6 in three years. Therefore, the strategy of selling this product out in four years at $440 seems most reasonable.

The X7 has the most potential, and is not going to sell out. Therefore, the point of profit maximization should be relatively easy to calculate using CVP analysis. If the slope of the demand curve is 232,547 units for every dollar decline in price, the optimal profit point is $117. At this point, the contribution is $57 for every unit sold, and the expected sales are 13.258 million units, which is quite close to saturation. This assumes a linear demand function. If the function is curved, then this price will probably not deliver the maximum profit, because sales will be nowhere near the 13.258 million mark over the four years.

Basically, the new strategy makes use of two key tools. The first is the CVP analysis. This tool provided me with some basic information to use as a starting point. First, it helped to make a determination about the moment in time when it made the most sense to stop the X5. With the X5, it was also determined the optimal price point in the final year. This is important for maximizing the performance of the X5 in that final year. A sellout of the product, defined as 100% saturation, was expected, but the key to find the highest price point at which this product would achieve saturation.

With the X6 and the X7 the same principle is applied. The analysis begins with estimating the demand curve, and then applying a CVP analysis to that. The result is that the optimal price for profit might actually be $474. Thus, this is the price that we are going to set in order to pursue the point of maximum profit.

For the X7, the demand function is critical, because the product has 15 million potential units of sales, most of which remain unsold at the end of 2015 to the detriment of firm performance. Thus, the objective of the firm is to sell much closer to saturation of this product, but within the context of setting the price at the point of profit maximization. Once the slope of the demand curve is established, the demand for each price level can be estimated. Armed with this knowledge, the total contributions can be plugged into a CVP analysis to find the price point that delivers the maximum profit. It is believed that this is $117.