Warp the Four-Year Strategy Set

¶ … Warp

The four-year strategy set out in SLP 1 as follows:

Year by Year Decisions: Pricing & R&D Allocations

PRODUCT

DECISION

Price

R&D %

Discontinue?

Price

R&D %

Discontinue?

Price

R&D %

Discontinue?

A number of underlying theories contributed to this strategy. The first was an identification of product life cycle. The X5 was at the peak of the growth phase for 2006, the X6 was beginning the growth phase and the X7 was still in the introductory phase. The different demand drivers for the products were considered -- where the products were positioned in the marketplace. It was determined that at its phase of the product life cycle, there was little that could be changed about the trajectory of the X5. The X6 was driven by features, so the R&D was increased for that product in response to that need. The price was increased as well to reflect the increase in features. The X7 was set for a cost leadership strategy. Pricing of the X7 was deemed to be penetration pricing, at the $200 tag was too high to grow the market quickly. Thus, the price was reduced.

A contribution margin analysis determined that the X5 had a high level of fixed costs. Therefore, it would need to be discontinued earlier in the product life cycle than either of the either two products. This point was following 2008. The X7 had by far the highest contribution margin, meaning that there is significant room for price cuts, so 25% was taken off in an attempt to spur sales.

The SLP2 simulation run tests these different strategies to find out their effectiveness. The result was that the final score was 1,849,569,369. This is significantly higher than Joe Schmoe's cumulative four-year score. An evaluation of the changes will illustrate why the performance was better.

With the X5, few changes were made. The price was not changed. The R&D investment was removed, which would be expected to have two impacts. The first impact is that the product would be immediately more profitable as its costs would be reduced. By 2007 and 2008, however, the lack of new features would hurt new sales. The concept of opportunity cost, however, was applied so this slight decline in profits is only relevant in relation to the results of the X6, which received those R&D monies. The major issue with the X5 product under Joe Schmoe's tenure was the loss in 2009, which reduced total firm revenues for that year. By discontinuing the product for that year, I immediately improved company-wide revenues for 2009.

Overall, my strategy was better for the X5. For the years that were run, my total profits came to $197 million, which was over $18 million more than what Joe had achieved. The minor impact of the lost sales due to the decrease in R&D was easily overcome by the profits that the X6 saw as the result of that R&D investment. The X6 increased in profit by $201 million. The X7 saw the biggest success, a direct result of building a much higher market share. With this product I outperformed Joe by $697 million over the four years.

The expected response to the increase in price on the X6 was a decrease in sales but an increase in profits. It was believed that a feature-rich product would have a relatively low price elasticity of demand. The previous management team had understood that the utility was low, but assumed a policy of price reduction in response. I viewed the solution to low utility was to improve the product. This would allow us to raise the price and still see strong sales. This is what occurred. It was hypothesized that a price in the range of $430-$450 would see profit optimization. The $450 was tested and it showed a clear improvement over the X6 performance under Joe Schmoe despite a decline in unit sales. It was believed profit would increase by $31.53M in 2008; in reality this came out to an increase of $144.87M in 2008 and $64.061M in 2009, both figures far better than expectations. The key to future improvement of the X6 will be finding the optimal point for the price of this product. Armed with some information about its price elasticity of demand, that point can be determined with more accuracy. It is worth noting that the product achieved 96% saturation even at the $450 price range, compared with Joe's 98% at $400.

The X7 saw a lower price in order to stimulate sales. It finished 2009 under Joe Schmoe with 13% market saturation and profits in 2008 and 2009 of $53.8 million and $91.7 million respectively. The lower price was intended to stimulate significantly stronger demand, as there are 15 million potential customers. Joe Schmoe only reached 2 million of these. With the lower price, I reached nearly 5 million customers for a market saturation of 32%. While this is a fairly small number, it is a significant improvement over Joe's numbers. Profits under my strategy were $176.6 million in 2008 and $348.5 million in 2009. Clearly, where Joe was unable to move this product beyond the introduction stage, I was able to push it into the stronger growth stage. It is possible that if the X7 can be moved up a year in the product life cycle by 2009, the four-year profit could be much higher than the current level even. This would give the product a saturation rate over 50%. There is still significant contribution margin (the variable costs are $60 per unit and the selling price is $150 per unit) to cut the price and spur further sales.