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Case 9-3 Brainy Business While El Nio is pouring its rain on northern California, Charlotte Rothstein, CEO major shareholder, and founder of Cerebrosoft, sits in her office, contemplating the decision she faces regarding her company's newest proposed product, Brainet. This has been a particularly difficult decision. Brainet might catch on and sell very well. However, Charlotte is concerned about the risk involved. In this competitive market, marketing Brainet also could lead to substantial losses. Should she go ahead anyway and start the marketing campaign? Or just abandon the product? Or perhaps buy additional marketing research information from a local market research company before deciding whether to launch the product? She has to make a decision very soon and so, as she slowly drinks from her glass of high-protein-power multivitamin juice, she reflects on the events of the past few years. Cerebrosoft was founded by Charlotte and two friends after they had graduated from business school. The company is located in the heart of Silicon Valley. Charlotte and her friends managed to make money in their second year in business and have continued to do so every year since. Cerebrosoft was one of the first companies to sell software online and to develop PC-based software tools for the multimedia sector. Two of the products generate 80 percent of the company's revenues: Audiatur and Videatur. Each product has sold more than 100,000 units during the past year. Customers can download a trial version of the software, test it, and if they are satisfied with what they see, they can purchase the product. Both products are priced at $75-95 and are sold exclusively online. Charlotte is interrupted in her thoughts by the arrival of Jeannie Korn. Jeannie is in charge of marketing for online products and Brainet has had her particular attention from the beginning. She is more than ready to provide the advice that Charlotte has requested. "Charlotte, I think we should really go ahead with Brainet. The software engineers have convinced me that the current version is robust and we want to be on the market with this as soon as possible! From the data for our product launches during the past two years, we can get a rather reliable estimate of how the market will respond to the new product, don't you think? And look!" She pulls out some presentation slides. "During that time period we launched 12 new products altogether and 4 of them sold more than 30,000 units during the first six months alone! Even better: The last two we launched even sold more than 40,000 copies during the first two quarters!" Charlotte knows these numbers as well as Jeannie does. After all, two of these launches have been products she herself helped to develop. But she feels uneasy about this particular product launch. The company has grown rapidly during the past three years and its financial capabilities are already rather stretched. A poor product launch for Brainet would cost the company a lot of money, something that isn't available right now due to the investments Cerebrosoft has recently made. Later in the afternoon, Charlotte meets with Reggie Ruffin, a jack of all trades and the production manager. Reggie has a solid track record in his field and Charlotte wants his opinion on the Brainet project. "Well, Charlotte, quite frankly, I think that there are three main factors that are relevant to the success of this project: competition, units sold, and cost-ah, and, of course, our pricing. Have you decided on the price yet?" "I am still considering which of the three strategies would be most beneficial to us. Selling for $50.00 and trying to maximize revenues-or selling for $30.00 and trying to maximize market share. Of course, there is still your third alternative; we could sell for $40.00 and try to do both." At this point, Reggie focuses on the sheet of paper in front of him. "And I still believe that the $40.00 alternative is the best one. Concerning the costs, I checked the records; basically we have to amortize the development costs we incurred for Brainet. So far we have spent $800,000 and we expect to spend another $50,000 per year for support." Reggie next hands a report to Charlotte. "Here we have some data on the industry. I just received that yesterday, hot off the press. Let's see what we can learn about the industry here." He shows Charlotte some of the highlights. Reggie then agrees to compile the most relevant information contained in the report and have it ready for Charlotte the following morning. It takes him long into the night to gather the data from the pages of the report, but in the end he produces three tables, one for each of the three alternative pricing strategies. Each table shows the corresponding probability of various amounts of sales given the level of competition (severe, moderate, or weak) that develops from other companies. TABLE 1 Probability Distribution of Unit Sales, Given a High Price (550) Level of Competition Sales Severe Moderate Weak 0.2 0.25 0.3 50,000 units 30,000 units 0.25 0.3 0.35 20,000 units 0.55 0.45 0.35 TABLE 2 Probability Distribution of Unit Sales, Given a Medium Price (S40) Level of Competition Sales Severe Moderate Weak 50,000 units 0.25 0.30 0.40 30,000 units 0.35 0.40 0.50 20,000 units 0.40 0.30 0.10 TABLE 3 Probability Distribution of Unit Sales, Given a Low Price ($30) Level of Competition Severe Moderate Weak Sales 50,000 units 0.35 0.40 0.50 30,000 units 0.40 0.50 0.45 20,000 units 0.25 0.10 0.05 The next morning, Charlotte is sipping from another power drink. Jeannie and Reggie will be in her office any moment now and, with their help, she will have to decide what to do with Brainet. Should they launch the product? If so, at what price? When Jeannie and Reggie enter the office, Jeannie immediately bursts out: "Guys, I just spoke to our marketing research company. They say that they could do a study for us about the competitive situations for the introduction of Brainet and deliver the results within a week." Page 394 "How much do they want for the study?" I knew you'd ask that, Reggie. They want $10,000, and I think it's a fair deal. At this point, Charlotte steps into the conversation. "Do we have any data on the quality of the work of this marketing research company? "Yes, I do have some reports here. After analyzing them, I have come to the conclusion that the predictions of the marketing research company are pretty good: Given that the competition turned out to be severe, they predicted it correctly 80 percent of the time, while 15 percent of the time they predicted moderate competition in that setting, with a prediction of weak competition only 5 percent of the time. Given that the competition turned out to be moderate, they predicted severe competition 15 percent of the time and moderate competition 80 percent of the time, with a prediction of weak competition just 5 percent of the time. Finally, for the case of weak competition, the numbers were 90 percent of the time a correct prediction, 7 percent of the timea moderate' prediction and 3 percent of the time a severe prediction." Charlotte feels that all these numbers are too much for her. "Don't we have a simple estimate of how the market will react?" "Some prior probabilities, you mean? Sure, from our past experience, the likelihood of facing severe competition is 20 percent, whereas it is 70 percent for moderate competition and 10 percent for weak competition," says Jeannie, her numbers always ready when needed. All that is left to do now is to sit down and make sense of all this