MARKETING SPECIALISTS, LTD. Grace Choi was considering her situation. She had been asked to provide marketing service to Maxim Pharmaceuticals, which wanted to introduce a new product line in Eastern Europe. Grace’s company, Marketing Specialists Ltd., had provided such service for a variety of consumer companies since its inception in 1989 and was known for its high-quality and successful marketing plans. ‘Maxim's new products were a line of over- the-counter consumer drugs aimed at relieving cold and allergy symptoms. The formulation was fully approved by the appropriate agencies of the target countries, and a suitable marketing plan (including development of a brand name appropriate for the product and the target countries) had been developed and approved by Maxim. Although detailed studies had been done, the cost of the marketing project was uncertain. The best guess seemed to be €4,000,000, but the study team thought the cost could be as low as €3,700,000 or as high as €4,600,000, Grace had asked them to give het probabilities, and they had finally settled on the following probabilities: Cost Probability €3,700,000 0.25 4,000,000 0.60 €4,600,000 os TL All that remained was to consider how Marketing Specialists would be paid for its services Maxim had indicated that it would be willing 0 consider two possibilities: (1) cost plus 20% of the Cost, or (2) a commission on sales over the next 5 years at an agreed-upon rate. The first option woul Pay 120% of the cost in three equal installments, after 6, 12, and 18 months. The commission is set 15% and would be paid at the end of each ye" based on that year’s sales. An additional provision of the commission arrangement was that the ‘0% commission could not exceed €7,000,000- In discussing the issue with other principals # Marketing Specialists, Grace had found considera®l®support fo the commision arrangement on the sronds tha, ifthe marketing plan was sncesfl the company would be rewarded for its high-qalty work, ‘On the ther hand, ithad been pointed ot hat the fst ‘option avoided the down side; the product "bombed (Gov sales) Marketing Specialists would sil have cnt hack a eat ts cost. “Analysis of the commission option required some understanding of how sales wer likely to develop over the next S-year period, Taking sales over the en ‘years asa hase, Grace estimated that about 10% ‘would occur in the ist yea, 15% i the second yea, ‘nd 25% over each ofthe as 3 years. The real ‘uncertainty was not what proportion would occur each year, but toal sles over the ete 8 years In ‘onsitation with her analysts, Grace had developed the folowing probabil forecast of aks over $ years Sales Probability 25,000,000 0.410 30,000,000 0.38 50,000,000 04s €70,000,000 oat However, this was nota complete picture. ‘One ofthe special features ofthe plan that Marketing Specialists had developed was thatthe cos of the marking projet indicated something about the potential als If dhe cost turned eu to below it ggested that sales were mot likely tobe low In Contras if cost turned out t high, sles were more likely to be high. This feature was appealing to Marketing Specials’ lets because not only was the ‘ost an indication (albeie imperfect of farare sales it tlbo meant that more would be invested in the marketing of products that were more atractive, In thinking through the probabilities more ‘areflly, Grace and the analysts eame up withthe folowing three probability tables: cost equals €3,700,000: Sale Probability €25,000.000 0.10 0000000 oss €50,000,000 0.30 ©70,000,000 0.05, ase Studios 178 I cos equals €4,000,000 Sales Probability 25,000,000 0.10 €30,000,000 0.30 50,000,000 0.80 70,000,000 0.10 cost equals €4,600,000. Sales Probebiiy €25,000,000 0.10 30,000,000 os esoo00000 0.50 €70,000,000 025 Ie caeuating he ne presen vale ofcash-low steams, Marketing Specialists used a dicount at of 12%, Questions 1. Construct a decsion-ree model ofthe Cost Plas 1nd Commission options for Grace Choi Linked trees work well for this problem. For exch ‘option, create a able chat ealeslaes the net present value given the marketing costs and the Sear sales. 2. Whatare the EMV and standard deviations of bath options? Does one option dominate the other? What ithe probably thatthe payments fromthe Cos Pls option would be higher than the payments from the Commission option? Which ‘option would you recommend to Grace and why? 3. Using either Excel Goal Seek function or simple talandertor, find the break-even Commission rate, that the commission ate ‘ha resus in the EMV(Cost Plus) = EMV (Commission). Would you recommend the ‘Commission option st the breske-even ste?