PDA SIM II
The strategy for the second simulation derived on the basis of two main principles. The first is that the X7 has the highest potential upside, so sales should be encouraged by lowering the price. The second is that the X5 is going to be on the downslide by the time this year's R&D investment kicks in, so that investment is best put to other uses. The strategy used is as follows:
Year by Year Decisions: Pricing & R&D Allocations
Price $250
Price $250
Price $250
Price n/a
R&D %
R&D %
R&D %
R&D %
Discontinue-N
Discontinue? N
Discontinue? N
Discontinue? Y
Price $450
Price $450
Price $450
Price $450
R&D %
R&D %
R&D %
R&D %
Discontinue? N
Discontinue? N
Discontinue? N
Discontinue? N
X7
Price $150
Price $150
Price $150
Price $150
R&D %
R&D %
R&D %
R&D % 100
Discontinue? N
Discontinue? N
Discontinue? N
Discontinue? N
The results of the strategy are: a net income of $1.812 billion. This strategy was significantly more successful than the default strategy, which yielded a profit of $1.165 billion. The difference was $647 million, the improvement 55.5%. The majority of the success, however, came from the X7 strategy. This yielded sales improvements of $619 million from $174 million to $794 million. The strategy to increase the price of the X6 to increase profit was only marginally successful. Profit over the four years only improved $12 million. The X5 improved but only because it was discontinued for the final year. As a result of having its R&D stripped, it earned $3.45 million this time out. Given that the X7 was the beneficiary of this R&D money and that product earned $619 million more, I would argue that is a good use of opportunity cost.
The strategy for the X5 will remain basically the same. Lowering the price might squeeze an extra couple of units out of this product, but it finished at 98% saturation so there is little upside to making such a move. The focus of the SLP 3 run will be in other areas. The X6 strategy was barely effective. While the premium price deterred some customers, the higher margins accounted for that. Sales could be improved by adding to the R&D, but if that comes at the expense of sales in the X7, it would not be worth it. For the X6, pricing strategy is key. The X6 price increase came at a cost of 1 million customers over the default scenario. If price elasticity is in a straight line, that is 20,000 customers for every $1 of price increase. The contribution margin on the X6 is 62.5%. So for every $1 in revenue, contribution increases 37.5 cents, so you lose $7,500 in contribution for every $1 you increase the price but you gain. This hints that price elasticity of demand is relatively low for this product, perhaps lower than previously believed. Increases in price will result in reduced sales figures but can be expected to bring in more profit as well. It is not expected, however, that elasticity is perfectly linear. It is worth testing the upper bound here, to see how high a price can be supported by the market.
With the X7, the most important number is the final market saturation figure of 37%. There is room for growth here. The cost of goods sold is $65. Thus, $65 is the lower bound on pricing for the X7. We just need to find the point that maximizes profit -- this may not be saturation. We knocked $50 off the price and grew the sales by 5.388 million, so roughly 107,760 new customers for every dollar off. This can be used to find what should be the optimal price (if elasticity is linear, which it probably is not). Peak revenue is at around $105-106; peak contribution at $138-137 (see Appendix a), which gives us another million or so units. So the price will be set there for the X7.
The strategy for the SLP 3, therefore, will be as follows:
Year by Year Decisions: Pricing & R&D Allocations
2006
2007
2008
2009
X5
Price $250
Price $250
Price $250
Price n/a
R&D % 1
R&D % 1
R&D % 0
R&D % 0
Discontinue-N
Discontinue? N
Discontinue? N
Discontinue? Y
X6
Price $450
Price $450
Price $460
Price $460
R&D % 32
R&D % 32
R&D % 0
R&D % 0
Discontinue? N
Discontinue? N
Discontinue? N
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