Case Study 3: Maytech Ltd.

Group SF

CASE FACTS:

Column1 Product P Product Q

Selling Price per unit $ 40.00 $ 50.00
Variable Prod Costs per unit (20.00) (28.00)
Variable Non-Prod Costs per unit (2.60) (2.00)
Contribution Margin $ 17.40 $ 20.00

States of Nature:

Column1 Does Nothing Introduces Comparable Product Introduces Superior Product

P: Sales Units 25,000 15,000 10,000
Q: Sales Units 30,000 10,000 6,000
P: Addtl Transpo (gram/km) 5,000 2,000 1,000
Q: Addtl Transpo (gram/km) 3,000 2,500 1,500
P: Addtl Invoicing (invoice equivalents) 300 200 100
Q: Addtl Invoicing (invoice equivalents) 200 150 100
Probability of Competitor Reaction 20% 50% 30%

REQUIRED:

1 Incremental Contribution Margin:

Competitor States of Nature

States of Nature Does Nothing Introduces Comparable Product Introduces Superior Product
P: Sales Units $ 435,000 $ 261,000 $ 174,000
Q: Sales Units $ 522,000 $ 200,000 $ 120,000

2 Full Budget Report (Residual Income Format) under the competitor "Does Nothing" state of nature if Product P is introduced

Product P Does Nothing

Revenue $ 1,000,000
Variable Prod Costs (500,000)
Variable Non-Prod Costs (65,000)
Product Contribution Margin $ 435,000
Segment Related Variable Costs
Transportation (4,000)
Debtors (15,000)
Invoicing (360)
Sales Commissions (40,000)
Segment Contribution Margin $ 375,640
Fixed Costs:
District Office (18,000)
Advertising (40,000)
Promotion (Competition) (15,000)
Salesperson's Salary & Travel (60,000)
Other Segment Fixed Costs -
Segment Controllable Margin $ 242,640
Depreciation etc. (12,000)
Net Segment Margin $ 230,640
Fixed Corporate Investment Charge (14,400)
Residual Segment Margin $ 216,240
3 Which Product Maytech Ltd should Launch -- BASED ON PAY-OFF MATRIC UNDER RISK

Competitor States of Nature

Product P Does Nothing Introduces Comparable Product Introduces Superior Product Total
Revenue $ 1,000,000 $ 600,000 $ 400,000
Variable Prod Costs (500,000) (300,000) (200,000)
Variable Non-Prod Costs (65,000) (39,000) (26,000)
Product Contribution Margin $ 435,000 $ 261,000 $ 174,000
Segment Related Variable Costs
Transportation (4,000) (1,600) (800)
Debtors (15,000) (9,000) (6,000)
Invoicing (360) (240) (120)
Sales Commissions (40,000) (24,000) (16,000)
Segment Contribution Margin $ 375,640 $ 226,160 $ 151,080
Probability of Competitor Reaction 20% 50% 30%
Expected Value $ 75,128 $ 113,080 $ 45,324 $ 233,532
Assuming Maytech can heavily rely on these assigned probabilities, using this risk matrix supports introduction of Product P based on higher expected value by $14,746.
However, if there is uncertainty, regret matrix (#4 below) shows that Product Q gives lower regret total; hence, Product Q is the better choice.

Competitor States of Nature

Product Q Does Nothing Introduces Comparable Product Introduces Superior Product Total
Revenue $ 1,500,000 $ 500,000 $ 300,000
Variable Prod Costs (840,000) (280,000) (168,000)
Variable Non-Prod Costs (60,000) (20,000) (12,000)
Product Contribution Margin $ 600,000 $ 200,000 $ 120,000
Segment Related Variable Costs
Transportation (2,400) (2,000) (1,200)
Debtors (22,500) (7,500) (4,500)
Invoicing (240) (180) (120)
Sales Commissions (60,000) (20,000) (12,000)
Segment Contribution Margin $ 514,860 $ 170,320 $ 102,180
Probability of Competitor Reaction 20% 50% 30%
Expected Value $ 102,972 $ 85,160 $ 30,654 $ 218,786

4 Which Product Maytech Ltd should Launch -- BASED ON PAY-OFF MATRIX UNDER UNCERTAINTY

1st Criterion: Pessimissm-Maximin

States of Regret

States of Regret Does Nothing Introduces Comparable Product Introduces Superior Product Regret Total
Product P $ 375,640 $ 226,160 $ 151,080 $ 752,880
Product Q $ 514,860 $ 170,320 $ 102,180 $ 787,360
Product with higher segment contribution
margin Q P P
Launch Product P as it will yield higher contribution margin than Product Q in the worst situation of each product ($151k vs $102k)

2nd Criterion: Optimism-Maximax

States of Regret

States of Regret Does Nothing Introduces Comparable Product Introduces Superior Product Regret Total
Product P $ 375,640 $ 226,160 $ 151,080 $ 752,880
Product Q $ 514,860 $ 170,320 $ 102,180 $ 787,360
Product with higher segment contribution
margin Q P P
Launch Product Q as it will yield higher contribution margin than Product P in each product's best situation ($376k vs $515k)

3rd Criterion: Regret Matrix (i.e., use maximin approach in all states of regret)
States of Regret

States of Regret Does Nothing Introduces Comparable Product Introduces Superior Product Regret Total
Product P $ 139,220 $ - $ - $ 139,220
Product Q $ - $ 55,840 $ 48,900 $ 104,740
Product with higher segment contribution
margin Q P P
Product Q gives lower regret total versus Product P by $34,480. Using this analysis, company should launch Prouct Q.