SLP 1 tablet scenario

SLP

Introduction

In the first SLP, there was no default information provided, so in order to evaluate the performance of the company, the defaults were entered in the "Make Decisions" tab for the four years. What follows is a discussion of those results.

Defaults

The default positions are an even split with respect to the R&D budget, and default prices as follows:

Model

Price

R&D

X5

X6

X7

These default positions over the course of four years yield a final profit of $1,513,237,527.

X5

The X5 in 2011 had the highest revenue of any product. However, it has a relatively flat slope, so the X6 eclipses the profit of the X5 by 2012. The peak revenue for the X5 is in 2013, and the revenue declines after that point.

The X5 is profitable for the four years, but the profits peak in 2013 and decline thereafter. This trajectory has implications as well. The company as a whole performs in line with the X5 and the X6, and sees its profit decline after 2013. By 2015, the company is still profitable, but the trajectory does not look good, and this is probably the reason that the old CEO was let go. The issue with the X5 is that it is fairly far along in the product life cycle. This has implications for things like R&D and pricing, which are the two major variables.

X6

The X6 is just a little bit further behind in the product life cycle than the X5, and ends up following roughly the same trajectory using the default settings. This product remains profitable throughout the four years, but peaks in 2013, and its decline brings the company down with it. The X6 appears to decline before its time, leaving market share on the table. This is an interesting factor that could relate to either of the key variables.

X7

The X7 is an interesting case, because for the first three years of the simulation, this product performs terribly. It starts to improve its performance by 2015, but at this point it is too little too late. The reality is that the failure of this product to launch properly is the biggest reason that the outgoing CEO is outgoing. At the end of the day, there was a lot of share left on the table with this product, and that clearly is a pricing issue more than anything.

Product Mix Factors

The product mix is the combination of products that a company brings to the marketplace (Suttle, 2018). How those products interact with each other in the market often matters. In this case, there are three products, and judging by the pricing each is in a different category of tablet. The X7 is the low end, the X5 is the mid-range and the X6 is the high end. This follows naturally the path of the tablet market itself. The first tablet, X5, is a good quality tablet. Consumers want more and better, so new features are added and the result is the X6. But then the tablet business starts to become commoditized and lower-end models emerge, such as the X7. So there is a natural logic to this.

There are some implications of the product mix in this simulation, however. The low end product does not need many new features or enhancements, and pricing is the key aspect of that product. As such, pricing should in theory be the key driver of sales. R&D should be relatively low, but so should the price.

The X6, as the high end model, should receive a fair bit of R&D in order to make sure that it has the most features possible. An abundance of features will help this product support its high price point. In fact, at whatever high price point is chosen, this product needs to have a lot of features. Consumers of high end products are often more concerned with features, and less price sensitive, whereas at the low end they can be very price sensitive.

Price Elasticity of Demand

This brings us to one of the key factors that should come into play here. Price elasticity of demand reflects the degree to which demand for a product changes given a change in the price (Investopedia, 2018). It is clear that for the X7 at least – and maybe the other two as well – the pricing is misaligned with the value. Nobody is buying the X7, and that means that it costs too much for what it is. There are two ways to solve this – plow a low of money into R&D, or lower the price. Lowering the price comes with it changes in demand. The general way that this works is that lower price equals higher demand. This is especially true for low end products, because consumers of those products are specifically motivated by price. It is important to understand the specific impacts of price on demand. Even for the X6 this might matter – a premium product should have low price elasticity of demand, which means that prices might be increased with minimal decline in demand, leading to a higher total profit.

Cost Volume Profit

The reason that understanding the price elasticity of demand is important is because of the concept of cost-volume-profit. This reflects change in demand brought about by change in price, relative to the cost structure of the product. Price elasticity of demand affects revenue, CVP adds cost into the equation, which is how profit is derived. Each of these products has a fixed cost associated with it. The price-demand equation has to yield enough revenue to cover the cost of producing and selling that product. Covering variable costs is one thing – you can't price below variable costs – but then the volume has to be considered because you also have to cover the fixed costs as well. Whatever your variable cost, you have to sell enough units to cover fixed costs, a concept known as the breakeven point. You cannot price below the breakeven point and still be profitable.

The other aspect to CVP that needs to be considered here is that when setting pricing, the optimal condition is to understand the relationship between cost, volume and profit so that profit can be optimized. That means understanding elasticity, of course, and then applying that to the cost structure of the different products. This is true here because all three products are in different segments of the market, and as such they should have completely independent relationships from one another (that is to say that one product will not cannibalize any of the other products).

Research & Development

R&D is the other major variable besides price. There are a couple of factors that contribute to the R&D decision-making. The first is the product life cycle. In particular the reality that products earlier in the life cycle need more R&D attention than those later in the life cycle, and the other fact that products where features are important need more R&D attention than the products where features are less important. For the X5,which is further along in the product life cycle and is not feature-dependent, this implies cutting R&D spending. But where to put the rest of the R&D spending is a different matter.

Clearly, the X6 will benefit from more R&D spending, in order to add new features. The market wants new features, the product competes on new features, and therefore adding them will benefit. The trade-off is that there is a fixed amount of R&D money for the company. This means that any money invested in the X6 will not be invested in the X7. The analysis that needs to take place is where the R&D spending will get the most bang for the buck. That's where looking at the default scenario matters. The default scenario shows that the X6 does fairly well, and but that there are still some unsold units. That is to say, not investing in R&D leaves money and market share on the table for the X6.

The X7 on one hand is not a feature-driven product. But the R&D money is going to be spent anyway, so it may as well be spend making the X7 the best product it can be. One arrives at this logic because the X7 has the greatest potential unit sales, and underperformed the most in the default simulation. If the X7 has the greatest potential then the company might wish to consider investing in R&D. Remember that over the past four years, this product underperformed miserably and cost the former CEO his job. Lowering the price and investing in R&D could create a positive scenario where this product becomes incredibly attractive in the market, and sells close to its potential. It is worth, if nothing else, analyzing whether investing in the X6 or the X7 is the best bet for maximizing profit.