MKT5610 Chap.7 Product Strategy and Line Extension Economics
Product Strategy and Line Extension Economics
The topic where the course becomes arithmetic
The course materials are explicit that break-even analysis is a tool to be comfortable with because it recurs in almost every case analysis, and the in-class exercise on product strategy is built on exactly that.
It supplies an existing line with a price, a variable cost, a fixed cost and a volume, a proposed second line with its own costs, a fixed-cost saving from sharing resources, and two candidate prices with different volumes and different proportions of sales taken from existing buyers.
Everything in the answer is a difference between two worlds
The company with the new line and the company without it.
Anything unchanged between them is irrelevant however large it is, so the existing line's original fixed cost does not enter and only the amount by which it falls does. Revenue does not enter either, because revenue is not money the company keeps.
The temptation to use big familiar numbers is how this calculation goes wrong, and it goes wrong in the direction of approving the launch.
Cannibalisation is a margin question, not a volume one
A cannibalised unit is not a lost unit. The company still sells to that buyer and still earns the new line's contribution.
What it gives up is the old line's contribution on the same buyer, so the charge is the difference between the two contributions.
What this chapter covers
- 01
Break-even analysis as a recurring tool across case work
- 02
The incremental frame, and what a big familiar number is doing in it
- 03
Contribution per unit against fixed cost recovery
- 04
Cannibalisation charged as forgone contribution rather than as lost units
- 05
Why a higher price can win by taking less from your own line
- 06
Break-even volume, and its two blind spots
- 07
Reporting a close decision with the thresholds that would reverse it
Decide a line extension on incremental profit
- 2Compute new contribution.
- 3Charge the cannibalisation at the old line's contribution.
- 2Compute incremental fixed cost, net of the saving.
- 2Combine, and report the threshold that would reverse the answer.
Key terms
- Incremental Profit
- The difference a decision makes between the world with it and the world without it: new contribution, less contribution destroyed elsewhere, less the fixed cost the decision causes.
- Unit Contribution
- Price less variable cost. It is the amount each sale adds towards fixed costs and profit, and it is the quantity a cannibalisation charge is computed from.
- Cannibalisation
- The share of a new product's volume taken from the company's own existing line. It costs the difference between the two unit contributions, not the old price and not the unit.
- Break-Even Volume
- Incremental fixed cost divided by unit contribution. It converts an argument about forecasts into an argument about one threshold, which is easier to have a defensible opinion about.
- Shared Fixed Cost
- A fixed cost that falls on an existing line because a new line absorbs part of it. It reduces incremental fixed cost and therefore makes a launch more attractive, which is the direction most often reversed by mistake.
- Blended Contribution
- Unit contribution adjusted downward for the share of volume that is cannibalised. It is one of two honest ways to make a break-even figure account for cannibalisation.
- Sunk Overhead
- A cost identical in both worlds, such as head office expense. It belongs in no part of an incremental calculation however prominently it appears in the case.
Product Strategy and Line Extension Economics FAQ
Why is revenue not part of this calculation?
Because revenue is not money the company keeps, and the decision turns on what is left after the variable cost of producing each unit. Revenue is also the largest and most prominent number in a problem of this shape, which is exactly why it is the most common wrong starting point. Begin from unit contribution instead and the four quantities that matter fall out in order.
Does cannibalisation always argue against a line extension?
No. If the new line and the old one carried the same unit contribution, cannibalisation would cost nothing at all, because the company would earn the same margin from the same buyer through a different product. The charge is the difference between the two contributions multiplied by the switched units, so cannibalising into a higher margin is a gain and cannibalising into a lower one is the loss the arithmetic warns about.
Can a higher price beat a lower one even though it sells fewer units?
Frequently, and the exercise is built to produce that result. A higher price sells less, which reduces new contribution, and it usually draws a smaller proportion from your own buyers, because people who switch at a small price gap do not switch at a large one. The two effects pull opposite ways and there is no general rule about which dominates, so both prices have to be computed and compared.
What does a break-even figure not tell me?
Two things. It is a volume, so it says nothing about how long that volume takes to arrive, and a line that breaks even at 37,000 units reaches that in a year or in four. And it assumes unit contribution holds across the whole range, which stops being true as soon as the volume requires a discount, a second shift or a larger pack. Quote it as the start of an argument.
Assessment move
Rebuild the calculation with your own group's product before the store opens, even with rough figures. You need four numbers: your unit contribution, the fixed cost of starting, the volume you expect, and what proportion of it would have bought your other item anyway. Most groups discover that the third number is the only one they have thought about.
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