Sam Nash is the head of new product development of Forever Young (FY). Nash is currently considering Enhance, which would be FY’s next major product in its beauty/cosmetics line and its estimated unit cost is currently $144.
Enhance represents a new direction for FY. All FY’s current products are cosmetics applied to the skin by the consumer. In contrast, Enhance is inserted via needle into the skin by a nurse after an initial meeting with a doctor. FY planned to sell Enhance at cost plus 20% to physicians. FY used an estimated treatment cost to patients of $432 to provide a financial incentive to physicians. Each treatment will last three months. Enhance is an animal-based product that fills out the skin so that fewer wrinkles are observable.
Nash, however, questions the economics of this product because FY has failed to budget for any litigation costs, which Nash estimated as $132 per unit. At present, the costs recognized are research and development, manufacturing by a third party, marketing, distribution, and a small amount for customer support. Nash’s main concern is with recognizing in the current costing proposal potential future litigation costs (such as the costs of lawyers and expert witnesses in defending lawsuits against Enhance). He points to the litigation with breast implants and notes that a settlement of more than $4.8 billion is being discussed in the press. He also notes the tobacco company litigation and those proposed billion-dollar settlements. Elisabeth Savage, the CEO and president of the company, disagrees with Nash. She maintains that she has total confidence in her medical research team and directs Nash not to include any dollar amount for potential litigation cost in his upcoming presentation to the board of directors on the economics and pricing of the Enhance product. Nash was previously controller of FY and has a strong background in finance. His current job represents his first non-finance position, and he views himself as potential CEO material.
1. What reasons might Savage have for not wanting Nash to record potential future litigation costs on the product in a presentation on Enhance’s economics and pricing?
2. Suppose Savage asks Nash to give her an “off-the-record” presentation on the possible magnitude of the potential litigation costs of Enhance. What is the new unit cost including the estimated litigation costs? What should the new selling price to physicians be to maintain the triple-the-cost target? What is the percentage decrease in the margin physicians could expect per unit assuming the cost to the patient cannot be changed?
3. After hearing Nash’s presentation (see requirement 2), Savage directs Nash to drop any further discussion of the litigation issue. He is to focus on making Enhance the block-buster product that field research has suggested it will be. Nash is uneasy with this directive. He tells Savage it is an “ostrich approach” (head-in-the-sand) to a real problem that could potentially bankrupt the company. Savage tells Nash to go and think about her directive. What should Nash do next?