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Merle Crawford
Anthony Di Benedetto
10th Edition

McGraw-Hill/Irwin Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 11

Sales Forecasting and Financial Analysis

Why Financial Analysis for New
Products is Difficult
Target users dont Biased internal
know. attitudes.
If they know they Poor accounting.
might not tell us. Rushing products to
Poor execution of market.
market research. Basing forecasts on
Market dynamics. history.
Uncertainties about Technology
marketing support. revolutions.

Forecasting the Demand For
Satellite Radio
In 2000: forecast for 2007 was 36 million
In 2001: forecast revised to 16 million.
By end of 2006: actual number of
subscribers = 11 million.

Source: Sarah McBride, Until Recently Full Of Promise, Satellite Radio Runs Into Static,
Wall Street Journal, August 15, 2006, pp. A1-A9.

Forecasters Are Often Right

In 1967 they said we would have:

Artificial organs in humans by 1982.
Human organ transplants by 1987.
Credit cards almost eliminating currency by 1986.
Automation throughout industry including some
managerial decision making by 1987.
Landing on moon by 1970.
Three of four Americans living in cities or towns by
Expenditures for recreation and entertainment
doubled by 1986.
Forecasters Can Be Very
They also said we would have:
Permanent base on moon by 1987.
Manned planetary landings by 1980.
Most urbanites living in high-rises by 1986.
Private cars barred from city cores by 1986.
Primitive life forms created in laboratory by 1989.
Full color 3D TV globally available.

Source: a 1967 forecast by The Futurist journal.

Note: about two-thirds of the forecasts were correct!

Commonly Used Forecasting
Technique Time Horizon Cost Comments
Simple Regression Short Low Easy to learn
Multiple Regression Short-medium Moderate More difficult to
learn and interpret
Econometric Short-medium Moderate to high Complex
Simple time series Short Very low Easy to learn
Advanced time Short-medium Low to high, Can be difficult to
series (e.g., depending on learn but results are
smoothing) method easy to interpret
Jury of executive Medium Low Interpret with
opinion caution
Scenario writing Medium-long Moderately high Can be complex
Delphi probe Long Moderately high Difficult to learn
and interpret

Forecasting Satellite Radio Sales
Using Purchase Intentions
In 2000, 213 million vehicles in U.S.
95% availability, 40% awareness.
Market potential = 213 million x 95% x 40% = 81 million.
Assume half can afford satellite radio = 40.5 million.
Percentage that will be among the first to try the new
technology = 16%.
Forecast for first year = 40.5 million x 16% = 6.4 million.
Projected yearly growth rate = 10%.
Assuming this growth rate, by end of 2006, expected
total sales = about 10 million.
Note: not too far from the attained number = 11 million!

Handling Problems in Financial
Improve your existing new products process.
Use the life cycle concept of financial analysis.
Reduce dependence on poor forecasts.
Forecast what you know.
Approve situations, not numbers (recall
Campbell Soup example)
Commit to low-cost development and marketing.
Be prepared to handle the risks.
Dont use one standard format for financial
Improve current financial forecasting methods.
Forecasting Sales Using Purchase
Use top-two-boxes scores obtained in concept testing,
appropriately adjusted or calibrated.
Example: Recall for hand cleanser from Chapter 9:
Definitely buy = 5%
Probably buy = 36%
Based on history, calibrate as follows:
80% of definitelies actually buy
33% of probablies actually buy
Forecasted market share = (0.8)(5%) + (0.33)(36%) =

Forecasting Sales Using Purchase
Intentions (continued)
The 16% forecast assumes 100% awareness
and availability.
Adjust downwards to account for incomplete
awareness and availability.
If 60% of the market is aware of the product and
has it available, market share is recalculated to
(0.6) (16%) = 9.6%.

Forecasting Sales Using A-T-A-R
Assume awareness = 90% and availability = 67%.
Trial rate = 16% (16% of the market that is aware of the
product and has it available tries it at least once).
RS = proportion who switch to new product = 70%.
Rr = proportion who repeat purchase the new product =
Rt = Long-run repeat purchase = RS /(1+Rs-Rr) = 63.6%.
Market Share = T x Rt x Awareness x Availability =
16% x 63.6% x 90% x 67% = 6.14%.

The following bar chart shows this procedure graphically.

A-T-A-R Model Results:
Bar Chart Format
70% 0.603
20% 0.0965 0.0614
Aware Available Trial Repeat
Bass Model Forecast of
Product Diffusion

The Life Cycle of Assessment

Calculating New Products
Required Rate of Return
% Return
Reqd. Rate
of Return

Cost of

Avg. Risk Risk on
of Firm Proposed
Real-Options Analysis in New
Product Value Assessment
Startup costs in Year 0: $70,000.
The cash flows for Years 1 through 4 are estimated to be
$40,000 in a high-demand scenario, or $10,000 in a low-
demand scenario.
The probabilities of a high- or low-demand scenario are
both 50 percent.
The product concept could be abandoned after Year 1,
and the equipment could be sold for $38,000.
Discount rate = 12%.

Real-Options Analysis
Cash flow in Year 1 for each demand scenario:
Demand Year 1 Year 2 Year 3 Year 4 Total

High 40,000 40,000/(1.12) 40,000/(1.12)2 = 40,000/(1.12)3 = $136,073

= 35,714 31,888 28,471
Low 10,000 10,000/(1.12) 10,000/(1.12)2 = 10,000/(1.12)3 = $34,018
= 8,929 7,972 7,118

Cash flow in Year 1 if option taken to abandon

project and equipment is sold:
Demand Year 1 Take Option to Total
Abandon and Sell
Low 10,000 38,000 $48,000

Therefore the project would be abandoned after Year 1.

Real-Options Analysis (continued)
Now assess NPV for each demand scenario, assuming project is
abandoned after Year 1 if demand is low.
Demand Year 0 Year 1 Year 2 Year 3 Year 4 Total

High -70,000 40,000/(1.12) 40,000/(1.12)2 = 40,000/(1.12)3 = 40,000/(1.12)4 = $51,494

= 35,714 31,888 28,471 25,421
Low -70,000 48,000/(1.12) -$27,143
= 42,857

Expected value of investment is:

(0.5)($51,494) + (0.5)(-27,143) = $12,176
Since this expected value is greater than zero, the firm should make the

Source: Edward Nelling, "Options and the Analysis of Technology Projects," in V. K. Narayanan
and Gina C. O'Connor (eds.), Encyclopedia of Technology & Innovation Management, Chichester,
UK: John Wiley, 2010, Chapter 8.

Hurdle Rates on Returns and Other

Hurdle Rate
Product Strategic Role or Purpose Sales Return on Market Share
Investment Increase
A Combat competitive entry $3,000,000 10% 0 Points
B Establish foothold in new $2,000,000 17% 15 Points
C Capitalize on existing $1,000,000 12% 1 Point

Explanation: the hurdles should reflect a products purpose,

or assignment. Example: we might accept a very low
share increase for an item that simply capitalized on our
existing market position.

Hoechst-U.S. Scoring Model

Key Factors Rating Scale (from 1 - 10)

1 . 4 . 7 . 10
Probability of Technical <20% probability >90% probability
Probability of Commercial <25% probability >90% probability
Reward Small Payback < 3 years
Business-Strategy Fit R&D independent of R&D strongly supports
business strategy business strategy
Strategic Leverage "One-of-a-kind"/ Many proprietary
dead end opportunities

Source: Adapted from Robert G. Cooper, Scott J. Edgett, and Elko J. Kleinschmidt. Portfolio Management
for New Products, McMaster University, Hamilton, Ontario, Canada, 1997, pp. 24-28.

Specialty Minerals Scoring Model
Management interest
Customer interest
Sustainability of competitive advantage
Technical feasibility
Business case strength
Fit with core competencies
Profitability and impact

Manufacturing Firm Scoring Model
Net Present Value
Internal Rate of Return
Strategic Importance of Project (how well it
aligns with business strategy)
Probability of Technical Success

Note how in each of these examples, the model contains

financial as well as strategic criteria.

A Tool for Concept Evaluation

Strategic Fit
Does the concept fit with corporate vision?
Customer Fit
Does the concept allow the customer to better meet consumer needs?
Consumer Fit
Does the concept satisfy an unmet consumer need?
Market Attractiveness
Is the concept unique relative to competition?
Technical Feasibility
Is the concept feasible and protectable?
Financial Returns
Will the project break even soon?

Source: Erika B. Seamon, Achieving Growth Through an Innovative Culture, in P. Belliveau, A.

Griffin, and S. M. Somermeyer, The PDMA Handbook 3 For New Product Development, Wiley,
2004, Ch. 1.