MT631
LECTURE # 7
OUTLINE

Limitations of Decision Process as Currently Defined
Assumed independence between revenue and cost

Extensions to situations where demand is dependent on choice alternative
Example with multiple prices
  • Probabilities on demand
  • Expected demand (in units) for specified price and external influence (Economic condition)
  • Graphic presentation
    • Multiple revenue lines with one cost line
    • Plotting expected demands gives curvilinear revenue for each stated external situation
  • Matrix presentation
    • Cell values are expected profits for each price and external condition
    • Computed by placing the expected demands into appropriate profit (quick kill) equations
  • Expected monetary value for each alternative
    • Requires estimates of probabilities on external conditions
    • Computed as a weighted average (sum of probabilities * cells across rows)
Expected value of perfect information (EVPI)
  • Expected value of certainty
    • Identification of preference line
    • Viable and non-viable alternatives
    • Computed as sum of probabilities * preferred cells across columns
  • EVPI computed as (expected value of certainty minus expected monetary value of the preferred course of action)

The Ms-Tique Case
Based on Soft & Silky's sales performance through 1990, results from the focus group studies, and the performance of analogous products, should the aerosol container concept be pursued further?
  • Pros...
    • PLC considerations
    • Untapped markets
    • Positive consumer intentions toward concept
    • Strong evidence with analogous products/situations
  • Cons
    • High potential for negative cannibalism
    • Retailer turnover and margin difficulties
    • No evidence of beneficial price elasticity (for lower priced aerosol cans)
What are the economics of the tube and each of the cans?
  • Requires a "chain rule" backwards allocation of retailers' and jobbers' margins to determine Ms-Tiques' selling price
  • Subtracting the per unit cost of goods from each of the packages' price gives the per unit contribution (contribution toward fixed costs, then profits)
  • For comparison purposes then compute the contribution per ounce for each package
  • Bottom line is that the tube offers more contribution per oz than either of the aerosols. The evidence here is that for every existing tube user that converts to an aerosol package, Ms-Tique Loses (the cannibalization is detrimental).
Develop and resolve the appropriate Payoff Matrix for the choice dilemma
Choice
Alternatives		Estimated DemandExpected
Monetary
Value
Low
P=.3		High
P=.7
5.5 Ounce
Aerosol Can		$19908$33358$29323
11 Ounce
Aerosol Can		-$5301$49999$33409

Example of Cell Value Calculation (Low Demand, 5.5 Oz Aerosol Cell)

5.5 Tube volume is..................4900000 * $.149 = $730100
Cannibalized volume is.............. 472587 * $.125 = $ 59073
Net new volume is.................... 250000 * $.125 = $ 31250
Less original forecast...............5372587 * $.149 = $800515
Incremental Contribution..................................... = $ 19908

Expected value of certainty = (.3*19908 + .7*49999) = $40971.7
Expected value of perfect information = 40972 - 33409 = $7563

Concerns Regarding the Analysis
Sensitivity of outcome to validity of forecasts and estimates of probabilities
Inconsistencies between forecasts and focus group information
Irrational pricing given obvious value added with aerosol package

The listings above are to provide structural assistance to your study. They
are not attended to be inclusive of every item/topic that was presented
in the lecture period.

Additional Study Questions and Drill Exercises
At its root, the problem with the stated situation for Ms-Tique is more of a pricing error than a packaging problem. Compute the retail price for the 5.5 oz. aersol can that would eliminate the negative cannibalization between the two different 5.5 oz. packages.

Factor the retail price for the 11 oz. aerosol can by the same proportional increase as for the 5.5 oz. aerosol above and then recompute the incremental profit contributions that you would expect for the "low demand" conditions. You must assume that unit demands are unchanged by these price changes.

FOR THE DRILLS ABOVE, INCLUDE BOTH RETAILER AND JOBBER MARGINS.

The EMV calculations, like all expected values, are sensitive to the estimated probabilities. Using the original data given in the case, compute the critical probability where the rational choice changes. (This exercise asked you to determine the minimum change in the probabilities on high and low demand that would be required to alter your current choice of the 11 oz.can over the 5.5 oz. can.)