Strategic review and analysis

Strategic Review

The performance of the company in the past four years is evidence of multiple errors on the part of previous management. It is evident that the previous management was unable to determine optimal price points for our products, was unable to understand the product life cycle and was unable to identify the demand drivers for each product and respond accordingly. This report will first outline my understanding of our past strategy. Then the report will outline the different areas where this strategy failed. Lastly, a prescription for a better strategy will be outlined that we believe will have yielded better results than were achieved under the previous management.

Previous Strategy & Analysis

The previous strategy was remarkably static. Over the course of the time frame 2006-2009, prices and R&D rates were not adjusted. Several key figures from the results are indicative of the problems inherent in this strategy. The first is the loss on the X5 in 2009. The key metrics for the X6 was the declining sales in 2008 and 2009 and what we believe are suboptimal profits (maximized in 2007 at $211 million). The key metric for the X7 is the 13% market penetration at the end of 2009, which is far too low for that point in the product life cycle.

The price points for the products were inappropriate, in particular for the X6 and the X7. The price for the X6 we believe was set too low. The reason for this claim is that this product is positioned at the high-end. The key demand driver for this product is the number and quality of its features. The audience for high-end handheld products has a low elasticity of demand. While the product sold well and generated profits consistently over the past few years, the product languished towards the back half of the product life cycle. We believe that this product's downturn was premature, and should only be occurring from 2008 onward at the earliest. The product's downturn was seen by previous management as a function of its selling price being too high, yet this is not the case.

The reason sales began to fall with the X6 so quickly into its product life cycle is that it no longer offered a strong value proposition (Kotelnikov, no date) to the consumer. The cost was too high for the level of utility offered. The product had too few features for its price. By increasing the number of features, however, the price point could have actually been held higher. This would have improved the profit per unit considerably. If R&D expenditure was doubled, for example, this would have added $6.67 million per year to the fixed costs associated with the X6. For this $6.67 million, the price could have been increased to $430 or even $450 in all likelihood. Consider the bottom line impact that would have had in 2008: even without any increase in sales, revenues would have increased $38.2 million, giving the bottom line a boost of $31.53 million. Clearly, increasing R&D costs and the price would have improved the value proposition and this would have had a significant impact on the bottom line.

Then the impact on sales must be considered. The typical product lifecycle would have seen sales increase strongly through the saturation point, then tail off rapidly thereafter. This should have carried the X6 to increasing sales through 2008 or even 2009. Instead, sales peaked in 2007. The demand for this product slumped at least one year earlier than it should have, because the product did not offer an up-to-date collection of features. Increasing R&D would have allowed us to deliver those features to the customer. The product life cycle should resemble a Bell curve with a cutoff for product discontinuation (QuickMBA.com, 2007); the objective of our strategy is to shift the peak of the bell, in particular with respect to profit, from 2007 to 2008.

The previous regime's one-size-fits-all approach failed with respect to the high-end X6 product, but the strategy also failed our low-end X7 product as well. The X7 finished 2009 with a market saturation of 13%, a total of just under 2 million customers out of a potential installed base of 15 million customers. Product life cycle theory indicates that there should have been a much steeper upward curve in sales over the four years since the introduction of the X7 product. However, the price is too high. The product has far fewer features than the X5, but is priced just 20% lower. Indeed, the rate of sales growth flatlined over the four years and then began to fall, contrary to what would be expected under a typical product life cycle growth curve. The product began to fall out of the growth phase with just 13% saturation -- this should not have happened until the product hit around 75 or 80% saturation.

The high price was clearly inhibiting the growth potential of the X7. That this was a failure of management to understand the dynamics of pricing strategy and of the value proposition can be evidenced in the markup for the X7. The variable cost of producing an X7 is $65, yet the product sold for $200. This is a markup of 207%. The markup for the X5 is 78.5% and the markup for the X6 is 60%. That the low-end product in the portfolio has the highest markup indicates that the previous management did not understand pricing strategy. Low end products must have low end prices, or competitors will undercut them. The consumer expects a product priced in the middle-end to have middle-end features, not low-end features.

Another catastrophic failure of the previous management was with respect to the X5. This product was far enough into its lifecycle that its performance was relatively predictable and changes were unlikely to have a strong impact on its performance over the four years. However, this product lost $21 million in 2009. This was predictable, given the profit trend of the product and its stage in the product life cycle. Yet management did not discontinue the product. The fixed costs associated with the X5 are double the fixed costs associated with the other products. Previous management failed to understand the nature of the contribution margin when dealing with this product (Investopedia, 2010). The high level of fixed costs demanded that sales be kept high for the X5 in order that it be profitable. My rough calculation shows that the breakeven point (AccountingCoach.com, 2010) for the X5 in 2009 was 696,972. Sales of the X5 in 2008 were at 766,149 but were on a steep downward trend having dropped 47% from the previous year. If this trend held, the expected sales for the X5 in 2009 would have been 390,735, far below the breakeven point. Yet management failed to discontinue the product. Thankfully, the sales decline was not as steep as it was in 2008, but the fact that this product was a money-loser in 2009 was entirely predictable.

Proposed Changes

Given the numerous catastrophic failures to apply fundamental management principles that occurred, this management team proposes that we would have made the following changes to the strategy over the course of the previous four years. In short, the X5 would have been discontinued after 2008; the X6 would have received more R&D investment and a price increase; and the X7 would have had its price reduced.

The X5 began 2006 in the growth phase of the product life cycle, with expectations for two more years of strong growth. At this point, R&D expenditure was probably not going to add much value to this product. The price point we have determined was fine. The major change would have been to discontinue the product when projected sales dropped below 700,000, as was the case in 2009.

The X6 would have received a boost in R&D spending by funneling development funds away from the X5 into the X6. This boost would have been matched by an increase in price. The exact price elasticity of demand is unknown for this product, but is expected not only to be low but to be reduced by increases in R&D. We would have tested a price of $450, which is only a 12.5% increase in price. It is important to understand that the objective with the X6 is not to maximize market share but to maximize profit. We believe that the point at which profit is maximized is higher than the point at which market share is maximized and intend to pursue this point.