This paper presents a strategic review of a company's handheld product portfolio — the X5, X6, and X7 — over the four-year period from 2006 to 2009. The paper critiques the previous management's static pricing and R&D strategy, identifying failures in value proposition management, markup structure, and product life cycle timing. Specific problems examined include the premature sales decline of the X6 due to insufficient R&D investment, the overpriced low-end X7 that severely limited market penetration, and the failure to discontinue the loss-making X5 before it turned unprofitable. A revised four-year strategy is then proposed, with adjusted price points and R&D allocations for each product, along with a recommended discontinuation schedule.
The company's performance over the past four years is evidence of multiple errors on the part of previous management. It is evident that the previous management was unable to determine optimal price points for its products, unable to understand the product life cycle, and unable to identify the demand drivers for each product and respond accordingly. This report first outlines an understanding of the past strategy, then identifies the different areas where that strategy failed, and finally prescribes a better strategy that would have yielded superior results.
The previous strategy was remarkably static. Over the period from 2006 to 2009, prices and R&D rates were not adjusted. Several key figures from the results are indicative of the problems inherent in this approach. The first is the loss on the X5 in 2009. For the X6, the key metrics are the declining sales in 2008 and 2009 and what appear to be suboptimal profits — maximized in 2007 at $211 million. For the X7, the key metric is the 13% market penetration at the end of 2009, which is far too low for that stage in the product life cycle.
The price points for the products were inappropriate, particularly for the X6 and the X7. The price for the X6 was set too low. This product is positioned at the high end of the market, and the key demand driver for it is the number and quality of its features. The audience for high-end handheld products has a low elasticity of demand. While the product sold well and generated consistent profits, it languished towards the back half of the product life cycle. The previous management attributed the product's downturn to its selling price being too high — but this interpretation was incorrect.
The real reason sales began to fall so quickly into the X6's product life cycle is that it no longer offered a strong value proposition to the consumer. The cost was too high for the level of utility offered — the product had too few features for its price. By increasing the number of features, the price point could actually have been held higher, improving profit per unit considerably. If R&D expenditure had been doubled, this would have added approximately $6.67 million per year to the fixed costs associated with the X6. For that investment, the price could likely have been increased to $430 or even $450. Consider the bottom-line impact in 2008 alone: even without any increase in unit sales, revenues would have increased by $38.2 million, boosting the bottom line by $31.53 million. Clearly, increasing R&D costs and price together would have strengthened the value proposition and had a significant impact on profitability.
The impact on sales volume must also be considered. A typical product life cycle would see sales increase strongly through the saturation point, then tail off rapidly thereafter. This trajectory should have carried the X6 to increasing sales through 2008 or even 2009. Instead, sales peaked in 2007 — at least one year earlier than they should have — because the product did not offer an up-to-date feature set. Increasing R&D would have delivered those features to the customer. The product life cycle should resemble a bell curve with a cutoff for product discontinuation (QuickMBA.com, 2007); the strategic objective should have been to shift the peak of that curve — particularly with respect to profit — from 2007 to 2008.
The previous regime's one-size-fits-all approach failed not only with the high-end X6 but also with the low-end X7. The X7 finished 2009 with a market saturation of 13%, representing just under 2 million customers out of a potential installed base of 15 million. Product life cycle theory indicates there should have been a much steeper upward sales curve over the four years since the X7's introduction. However, the price was simply too high. The product has far fewer features than the X5 but was priced only 20% lower. The rate of sales growth flatlined over the four years and then began to decline — contrary to what would be expected under a typical product life cycle growth curve. The product began to exit the growth phase with just 13% saturation; under normal circumstances, this should not have occurred until approximately 75–80% saturation was reached.
The high price clearly inhibited the X7's growth potential. That this was a failure of management to understand pricing strategy and value proposition is evidenced by the markup structure. The variable cost of producing an X7 is $65, yet the product sold for $200 — a markup of 207%. By contrast, the markup for the X5 was 78.5% and for the X6 was 60%. The fact that the lowest-end product in the portfolio carried the highest markup indicates that the previous management did not understand the fundamentals of pricing strategy. Low-end products must carry low-end prices, or competitors will undercut them. Consumers expect a product priced in the mid-range to offer mid-range features — not low-end features at a premium price.
Another serious failure of the previous management concerned the X5. This product was far enough into its life cycle that its performance was relatively predictable and changes were unlikely to have a strong impact over the four-year window. Nevertheless, this product lost $21 million in 2009 — an outcome that was entirely predictable given the profit trend and the product's life cycle stage. Yet management did not discontinue it.
The fixed costs associated with the X5 are double those of the other products. The previous management failed to understand the nature of the contribution margin when dealing with this product (Investopedia, 2010). The high level of fixed costs demanded that sales volumes remain high for the X5 to remain profitable. A rough calculation shows that the breakeven point (AccountingCoach.com, 2010) for the X5 in 2009 was 696,972 units. Sales in 2008 were 766,149 units but were on a steep downward trend, having dropped 47% from the prior year. If that trend had continued, projected sales for 2009 would have been approximately 390,735 units — far below the breakeven point. Yet management failed to discontinue the product. Thankfully, the actual sales decline was not as steep as in 2008, but the fact that the X5 would be a money-loser in 2009 was entirely foreseeable and should have been acted upon.
Given the numerous failures to apply fundamental management principles, the following changes to the strategy are proposed for the four-year period. In short: the X5 would have been discontinued after 2008; the X6 would have received greater R&D investment and a price increase; and the X7 would have had its price reduced.
The X5 entered 2006 in the growth phase of its product life cycle, with expectations of two more years of strong growth. At that stage, additional R&D expenditure was unlikely to add significant value to this product. The existing price point was appropriate. The principal change would have been to discontinue the product once projected sales dropped below 700,000 units, as was foreseeable for 2009.
The X6 would have received a boost in R&D spending, funded by redirecting development resources away from the X5. This investment would have been paired with a price increase. While the exact price elasticity of demand for this product is unknown, it is expected to be low — and to decrease further as R&D raises perceived value. A price of $450 would have been tested, representing only a 12.5% increase. It is important to understand that the objective with the X6 is not to maximize market share but to maximize profit. The profit-maximizing price point is higher than the market-share-maximizing price point, and that is the target this strategy pursues.
The X7 is a low-cost product and should be priced accordingly. The company finished 2009 with 87% of the potential market for this product untapped. Given this large untapped market, a saturation pricing strategy should have been adopted (Porter/QuickMBA.com, 2007). Price points anywhere from $100 to $150 should have been considered — not the $200 that the previous management maintained. As with the X6, the profit-maximizing price is not necessarily the same as the market-penetration-maximizing price. However, it is worth noting that the previous management's performance with this product was so poor that virtually any price point within this range would have dramatically outperformed what was achieved. A reduction to $150 would have been a sound starting point in 2006, providing a clearer picture of price elasticity of demand and enabling data-driven price optimization in subsequent years. R&D expenditure was not considered essential for this product, though maintaining a 33% allocation would have allowed for incremental feature improvement over time, lending the X7 a competitive advantage over other low-end handheld devices.
"Breakeven analysis and missed discontinuation decision"
"Four-year revised pricing and R&D recommendations"
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