Q.

Chris Dunphy, executive vice president for marketing and sales of Sumu Electronics, is
considering the possibility of introducing a new line of inexpensive wrist watches, which would
be oriented primarily toward young adults. The watch would have a plastic faceplate and
wristband and a variety of features, including an alarm, a chronograph, and the ability to store
and retrieve various split times. The watch has been designed to come in a variety of colors and
styles. The retail price of the watch is expected to be $19. At this price, Chris feels that there is a
substantial market for the watch. To help gain further information, Chris has hired a marketing
research firm to study the market potential for this new venture.

The marketing research team conducted a survey and a pilot study to determine the potential
market for the new watch being considered by Sumu. The team, realizing that there is market
risk associated with any new product, looked at the potential market on a five-point scale, the
marketing research team looked at a variety of production, or stocking, policies related to each of
the marketing segments. The stocking policies involve producing 100,000 to 500,000 watches.

The worst market scenario for Sumu was still expected to bring profitability through all stocking
ranges. (Remember, the worst-case marketing scenario was assigned a value of 1 on the five-
point scale.) The probability of having a 1-type market was estimated to be 0.10. A stocking
policy of 100,000 units was expected to return a net profit of $100,000 for Sumu. A stocking
policy of 150,000 units was expected to return only $90,000. Similarly, higher stocking policies
for a market potential of 1 were expected to yield lower profits. A stocking policy of 200,000
was expected to return $85,000 in net profits. The stocking policies of 250,000, 300,000,
350,000, 400,000, 450,000 and 500,000 were expected to yield net profits of $80,000, $65,000,
$50,000, $45,000, $30,000 and $20,000 respectively.

The next-best market scenario was categorized by the number 2. This market potential was
categorized as below average and the marketing research team estimated that the chance of
getting a below average market was 20%. The net profit for the beginning stocking policy of
100,000 units was estimated to be $110,000. The net profit for stocking 150,000 units was
$120,000. If Sumu stocked 200,000 units, the net profit would be $110,000. A net profit of
$120,000 would be realized if the stocking policy was 250,000 units. Stocking policies of
300,000, 350,000, 400,000, 450,000, and 500,000 would result in net profits of $100,000,
$100,000, $95,000, $90,000, and $85,000 respectively.

The marketing research team estimated that the probability of an average market was 50%. This
average market was coded with a 3 on the five-point scale. In general, profits were significantly
higher for all stocking policies with this average market scenario. As before, profitability figures
were estimated for all the stocking policies, ranging from 100,000 to 500,000 units. The net
profitabilities for this range are $120,000, $140,000, $135,000, $155,000, $155,000, $160,000,
$170,000, $165,000, and $160,000.

A good market potential for the watches was given a 4 on the five-point scale. The probability,
however, of a good market was relatively low. It was estimated to be 10%. Net profitability
factors for stocking policies that range from 100,000 to 500,000 units were estimated to be
$135,000, $155,000, $160,000, $170,000, $180,000, $190,000, $200,000, $230,000 and
$270,000.
 The probability of a very good market was estimated to be 10%. This market received a 5 on the
scale. Probability factors for this market, in general, were higher. The profitability factors for
stocking policies that range from 100,000 to 500,000 were $140,000, $170,000, $175,000,
$180,000, $195,000, $210,000, $230,000, $245,000, and $295,000.

(a) Determine the expected monetary values for each of the stocking policy alternatives.
(b) Which stocking policy do you recommend?
(c) Chris has just received information that the original probability estimations were not accurate.

Market 2 has a probability of 0.28 while market 5 has a probability of 0.02. Does this new
information change any decision?

Chris has also received new information about stocking 500,000 watches. The return given a
very good market is now estimated to be $340,000. What is the impact of the new probability
values [given in point c] and the new return for a very good market for stocking 500,000 units?

SOLUTION:
Event 1 Event 2 Event 3 Event 4 Event 5
Number
of
Watches Probability 0.100 0.200 0.500 0.100 0.100
100,000 Alternative 1 100,000 110,000 120,000 135,000 140,000
150,000 Alternative 2 90,000 120,000 140,000 155,000 170,000
200,000 Alternative 3 85,000 110,000 135,000 160,000 175,000
250,000 Alternative 4 80,000 120,000 155,000 170,000 180,000
300,000 Alternative 5 65,000 100,000 155,000 180,000 195,000
350,000 Alternative 6 50,000 100,000 160,000 190,000 210,000
400,000 Alternative 7 45,000 95,000 170,000 200,000 230,000
450,000 Alternative 8 30,000 90,000 165,000 230,000 245,000
500,000 Alternative 9 20,000 85,000 160,000 270,000 295,000