The Acme Company is trying to decide whether to market a new product.
As in many new-product situations, there is considerable uncertainty
about whether the new product will eventually be popular. Acme believes that it might be wise to introduce the product in a regional test market before introducing it nationally. Therefore, the company's first decision is whether to conduct the test market. Acme estimates that the net cost of the test market is $100,000. We assume this is mostly fixed costs, so that the same cost is incurred regardless of the test market results. If Acme decides to conduct the test market, it must then wait for test market results. Based on the results of the test market, it can then decide whether to market the product nationally, in which case it will incur a fixed cost of $7 million. On the other hand, if the original decision is not to run a test market, then the final decision - whether to market the product nationally - can be made without further delay. Acme's unit margin, the difference between its selling price and its unit variable cost, is $18. We assume this is relevant only for the national market. Acme classifies the results in either the test market or the national market as great, fair, or awful. Each of these results in the national market is accompanied by a forecast of total units sold. These sales volumes (in 1000s of units) are 600 (great), 300 (fair), and 90 (awful). In the absence of any test market information, Acme estimates that probabilities of the three national market outcomes are 0.45, 0.35, and 0.20, respectively. In addition, Acme has the following historical data from products that were introduced into both test markets and national markets: 1. Of the products that eventually did great in the national market, 64% did great in the test market, 26% did fair in test market and 10% did awful in the test market. 2. Of the products that eventually did fair in the national market, 18% did great in the test market, 57% did fair in test market and 25% did awful in the test market. 3. Of the products that eventually did awful in the national market, 9% did great in the test market, 48% did fair in test market and 43% did awful in the test market. The company wants to use the decision tree approach to find the best strategy. It also wants to find the expected value of information provided by the test market. Solution: Company's first decision - Conduct the test market and then launch nationally Fixed Cost of Test market $100 ('000) dollars Fixed Cost of National market $7,000 ('000) dollars Company's second decision - IF No test market - Market the product nationally Unit Margin $18 dollars Chances Great Fair National market units sold (1000s of units)600 300 USING CONDITIONAL PROBABILITIES TEST MARKET PROBABILITIES should know how to calculate Prob. Great Test Market 0.369 Prob. Fair Test Market 0.4125 Prob. Awful Test Market 0.2185 P(TG) = P(TG/NG)* P(NG) + P(TG/NF) * P(NF) + P(TG/NA)* P(NA) = (0.64)(0.45) + (0.18)(0.35) + (0.09)(0.20) = 0.3690 Test market probabilities given the National Mkt prob. Natl Great Natl Fair Great Test Market 0.64 0.18 Fair Test Market 0.26 0.57 Awful Test Market 0.1 0.25 NATL MKT PROBABILITIES WITHOUT TEST MKT Natl Great Natl Fair 0.45 0.35 USING BAYE'S RULE National market probabilities given the Test Mkt prob. Natl Great Natl Fair Great Test Market 0.7805 0.1707 Fair Test Market 0.2836 0.4836 Awful Test Market 0.2059 0.4005 FALSE 0 FALSE Nat'l Market Launch Decision? 0 74 TRUE -7000 Test Market? Acme Marketing New Product No No Yes 36.9% 0 TRUE Chance -100 796.76 41.25% 0 21.85% 0 Expected Value of Sample Information EVPI = EMV with perfect information (no negative payoffs) - EMV (original launch) with FALSE 0 Yes Great Test Market Fair Test Market Poor Test Market No TRUE Nat'l Market Launch Decision? 0 1710 TRUE Test Market? 1710 FALSE 0.0% 0 0 EVPI= EVPI No Yes Yes The Acme Company is trying to decide whether to market a new product. As in many new-product situations, there is considerable uncertainty about whether the new product will eventually be popular. Acme believes that it might be wise to introduce the product in a regional test market before introducing it nationally. Therefore, the company's first decision is whether to conduct the test market. Acme estimates that the net cost of the test market is $100,000. We assume this is mostly fixed costs, so that the same cost is incurred regardless of the test market results. If Acme decides to conduct the test market, it must then wait for test market results. Based on the results of the test market, it can then decide whether to market the product nationally, in which case it will incur a fixed cost of $7 million. On the other hand, if the original decision is not to run a test market, then the final decision - whether to market the product nationally - can be made without further delay. Acme's unit margin, the difference between its selling price and its unit variable cost, is $18. We assume this is Acme classifies the results in either the test market or the national market as great, fair, or awful. Each of these results in the national market is accompanied by a forecast of total units sold. These sales volumes (in 1000s of units) are 600 (great), 300 (fair), and 90 (awful). In the absence of any test market information, Acme estimates that probabilities of the three national market outcomes are 0.45, 0.35, and 0.20, respectively. In addition, Acme has the following historical data from products that were introduced into both test markets and national markets: 1. Of the products that eventually did great in the national market, 64% did great in the test market, 26% did fair in test market and 10% did 2. Of the products that eventually did fair in the national market, 18% did great in the test market, 57% did fair in test market and 25% did 3. Of the products that eventually did awful in the national market, 9% did great in the test market, 48% did fair in test market and 43% did The company wants to use the decision tree approach to find the best strategy. It also wants to find the expected value of information provided Chances are great, fair or awful test market Chances are great, fair or awful national market Range names: NatlMktCost: B29 Awful 90 If TG,TF and TA : Test Mkt Outcomes T = Any of the Test Mkt Outcomes If TG=Great Test Market, then P(TG) = P(TG/NG)* P(NG) + P(TG/NF) * P(NF) + P(TG/NA)* P(NA) = (0.64)(0.45) + (0.18)(0.35) + (0.09)(0.20) = 0.3690 Natl Awful 0.09 0.48 0.43 Natl Awful 0.2 Natl Awful 0.0488 0.2327 0.3936 0.0% 0 45.0% 0.0% 10800 3800 Market Outcomes 74 35.0% 0.0% 5400 -1600 20.0% 0.0% 1620 -5380 Range names: NatlMktCost: B29 TestMktCost: B28 UnitMargin: B33 Great Nat'l Market Fair Nat'l Market Poor Nat'l Market FALSE 0.0% 0 -100 Nat'l Market Launch 2330.243902 78.0488% 28.8% 10800 3700 TRUE Market Outcomes -7000 2330.243902 17.0732% 6.3% 5400 -1700 4.878% 1.8% 1620 -5480 TRUE 41.25% 0 -100 Nat'l Market Launch -100 28.3636% 0.0% 10800 3700 FALSE Market Outcomes -7000 -1048.072727 48.3636% 0.0% 5400 -1700 23.2727% 0.0% 1620 -5480 TRUE 21.85% 0 -100 Nat'l Market Launch -100 20.595% 0.0% 10800 3700 FALSE Market Outcomes -7000 -2075.652174 40.0458% 0.0% 5400 -1700 39.3593% 0.0% 1620 -5480 0.0% 0 No Yes Great Nat'l Market Fair Nat'l Market Poor Nat'l Market No Yes Great Nat'l Market Fair Nat'l Market Poor Nat'l Market No Yes Great Nat'l Market Fair Nat'l Market Poor Nat'l Market 45.0% 45.0% 3800 3800 Market Outcomes 1710 35.0% 35.0% 0 0 20.0% 20.0% 0 0 Great Nat'l Market Fair Nat'l Market Poor Nat'l Market The Acme Company is trying to decide whether to market a new product. As in many new-product situations, there is considerable uncertainty about whether the new product will eventually be popular. Acme believes that it might be wise to introduce the product in a regional test results of the test market, it can then decide whether to market the product nationally, in which case it will incur a fixed cost of $7 million. On the other hand, if the original decision is not to run a test market, then the final decision - whether to market the product nationally - can be made without further delay. Acme's unit margin, the difference between its selling price and its unit variable cost, is $18. We assume this is Acme classifies the results in either the test market or the national market as great, fair, or awful. Each of these results in the national market is accompanied by a forecast of total units sold. These sales volumes (in 1000s of units) are 600 (great), 300 (fair), and 90 (awful). In the absence of any test market information, Acme estimates that probabilities of the three national market outcomes are 0.45, 0.35, and 0.20, respectively. 1. Of the products that eventually did great in the national market, 64% did great in the test market, 26% did fair in test market and 10% did 3. Of the products that eventually did awful in the national market, 9% did great in the test market, 48% did fair in test market and 43% did The company wants to use the decision tree approach to find the best strategy. It also wants to find the expected value of information provided P(TG) = P(TG/NG)* P(NG) + P(TG/NF) * P(NF) + P(TG/NA)* P(NA) = (0.64)(0.45) + (0.18)(0.35) + (0.09)(0.20) = 0.3690