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CVP Analysis
The best way to approach this situation is to understand some basic concepts. First, each product has fixed costs. Thus, the fixed costs are going to exist in every year a product is sold. This has ramifications for the X5 in the final year.
The second factor that needs to be considered is cost-volume-profit analysis. This technique is used to determine the contribution to fixed costs that each product makes. Thus, CVP is used to find the price point at which the profit is maximized. The key point to remember is that as the price falls, volume increases. The company cut sell all the product by cutting the price to the variable cost level, but that will not deliver any profit. But there is a point at which profit is going to be maximized, and that is the point at which the company should price each product. Then, the only decision left to make will be with respect to the R&D investment.
Strategy
The X5 is selling well, and the X6 is entering into the growth phase. The X7 is launching and it is important to build market share quickly with that product. The more it sells, the better the bottom line will be. It is a high-volume, low margin product. The strategy utilized over the four years is as follows:
Year by Year Decisions: Pricing & R&D Allocations
PRODUCT
DECISION
2011
2012
2013
2014
2015
X5
Price
$250
$195
$195
$195
R&D %
33%
0%
0%
0%
0%
Discontinue?
NO
NO
NO
NO
YES
X6
Price
$340
$340
$340
$340
$340
R&D %
34%
34%
34%
0%
0%
Discontinue?
NO
NO
NO
NO
NO
X7
Price
$195
$120
$120
$120
$120
R&D %
33%
66%
66%
75%
Discontinue?
NO
NO
NO
NO
NO
2012
The...
This was driven by successes with the X5 and X6 products. The X7 is still in the growth phase and arguably could have seen stronger performance. The X7 lost money on the year. But the other two products both generated considerable income and made some market share gains. That is to be expected, but there is a question of whether sales were too much. With slim margins, these products were still profitable, but it seems that perhaps there was some money left on the table here, even though on the surface it looked like a good year. I am starting to doubt my strategy.
2013
In 2013, the company earned $492,784,534. The X5 actually lost money -- it had maxed out its sales last year and there was little left. So it will be cut going forward. The X6 was profitable, at $183,579,258. There remains some potential for this product. The X7 earned $21,363,404, and this was with sales of 1.1 million. There are still a lot of sales on the table for this product, so it will be interesting to see if the sales pick up rapidly over the next two years. At this point, that will be critical for success.
2014
In this year, the X6 earned just $7,365,846. It is not unexpected, since the price has been cut pretty far to generate sales. We will be cutting this product, as there is little else that we can squeeze out of it. The X7 earned $139,271,351. This product will be the only product left in the lineup. Despite being offered at a very low price, it has only reached 11% saturation, which means a lot of money has been left on the table thus far. Moving units will be essential, but the price will remain the same, to keep the way that we are executing the plan as close to the strategy as possible.
2015
In this year, we only had one product remaining. The cumulative score was $1,179,223,655, which is a terrible score. The final profit on the X7 was pretty good - $539,801,834 but it is clear that we did not make enough money on the other products early on. The good news is that saturation of the X7 was up to 27%, but the bad news is that we cut costs a lot to generate sales for the X7, but could not generate enough to account for the way that the company mishandled the X5 and X6.
Review and Implications
The first thing noticed here is that the sales figures did not match…
References
Investopedia (2014). Definition of cost-volume-profit analysis. Investopedia. Retrieved December 4, 2014 from http://www.investopedia.com/terms/c/cost-volume-profit-analysis.asp
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