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Keeping Score: Financial Analysis and Performance Metrics

Cannibalization Analysis

What is Cannibalization?

Cannibalization results when the sales of a new product in part come from sales taken away from other products sold by that firm. Cannibalization most commonly occurs when a firm introduces a new flanker brand or line extension into the same product line in which it already has brand representation. For example, when Proctor & Gamble introduces a new brand of laundry detergent into its extensive line of detergents, some sales for the new brand will highly likely come at the expense of one or more of P&G’s existing brands of laundry detergent. In other words, the sales of P&G’s existing brand of laundry detergents will be cannibalized to support sales of the new brand.

The effects of cannibalization can be good or bad, depending on the overall effect on profitability for both the new brand and the cannibalized brands. Determining the effects on profitability are relatively easy. Let’s examine a simple example of how it works. Assume two brands of mouthwash produced by the same firm (P&G?). Relevant price and cost data for these brands are below. Brand A is currently sold at $1.00 per unit with associated variable costs per unit of $.60. Brand B, the new brand to be introduced, sells for a little less, say $.95 per unit. Its costs per unit are the same as for Brand A i.e. $.60 per unit. Note that the resulting unit contribution for Brand B (price minus unit variable costs) is $.35 which is $.05 less than the unit contribution for Brand A. This means that for each unit of Brand A that is cannibalized by Brand B, the firm loses $.05 in contribution.

	Brand A		Brand B
Price	$      1.00		$      0.95
Unit Variable Costs	$      0.60		$      0.60
Unit Contribution	$      0.40		$      0.35

Assume that management anticipates that when Brand B is launched, 20% of its sales will come from sales that would have been for Brand A. In other words, 20% of Brand B’s sales will be cannibalized from the sales of Brand A. The net effect of this cannibalization on profits is easily found by comparing the contribution (gross profit) assuming Brand B is not launched (and therefore no cannibalization occurs) with the contribution (gross profit) expected from the launch of Brand B with the expected level of cannibalization.

Here is how the analysis proceeds. First, compute the expected contribution from the sales of Brand A with no cannibalization (i.e. Brand B is not launched). Assume that Brand A’s sales without the introduction of Brand B are expected to be 1,000 units. Since the unit contribution for Brand A is $.40 per unit, the overall resulting contribution (gross profit) will be 1,000 x $.40 = $400.00. Easy!

Next, compute the expected contribution dollars assuming that Brand B is launched and the expected level of cannibalization occurs. Here is how this part proceeds. Assume that Brand B is expected to sell only 500 units initially and that 20% of these sales will come from Brand A (i.e. 20% of 500 equals 100 units that will be cannibalized from Brand A.). The table below summarizes the computations. Since 100 units will be cannibalized from Brand A’s sales, the brand will now sell only 900 units. Since the profit per unit (unit contribution) is $.40, the resulting total contribution dollars from the sales of Brand A will be 900 x $ .40 = $360.00. Brand B is expected to sell 500 units in total, with 100 of these units being cannibalized from Brand A. Therefore, Brand B’s contribution dollars will be 100 units x $.35 = $35.00 plus 400 units x $.35 = $140.00 for an overall contribution of $535.00.

The net change in contribution dollars if Brand B is introduced is $535 - $400 = $135. Thus, contribution dollars are expected to increase by $135 with the addition of Brand B to the product line of mouthwashes. Should the new brand be launched? The answer is clearly YES. Had overall contribution dollars declined due to cannibalization then the decision would have been NO.

	Unit Sales		Unit Contribution		Contribution
Unit Sales of Brand A (with cannibalization)	900	x	$0.40	=	$         360.00
Unit Sales of Brand B (cannibalized from A)	100	x	$0.35	=	$            35.00
Unit Sales of Brand B (not cannibalized)	400	x	$0.35	=	$         140.00
Total					$         535.00

You should also be aware by now that cannibalization will only be problematic, potentially reducing dollar contribution, if the unit contribution for the new product is less than the unit contribution for the old product. The greater the difference between the unit contributions the greater the impact will be of any cannibalization of the old brand by the new brand. You can verify this for yourself if you have built a spreadsheet to run your calculations.

Now It’s Your Turn. Show Us What You Have Learned.

Returning to our running case for Shannon’s Brewery introduced in the market share exercise, assume that Shannon’s is considering the introduction of a new craft beer called Irish Stout that will be derived from its award winning Irish Red. Initially, Irish Stout will only be sold “on premise” at the brewery. Currently, pints of Irish Red consumed on premise sell for $5.00 per pint with unit variable costs of approximately $2.75 per pint. Variable costs are predominantly comprised of the costs of ingredients and utilities that directly affect the brewing process. The new craft beer will be positioned at a slightly higher price, $5.25 per pint and its unit variable costs will be about $3.25 due to the higher cost of some ingredients. The relevant price, cost, and margin data are below.

	Irish Red		Irish Stout
Price	$      5.00		$      5.25
Unit Variable Costs	$      2.75		$      3.25
Unit Contribution	$      2.25		$      2.00

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Question 1

Shannon’s Irish Red averages on premise sales of 1,200 pints per month. What is the anticipated profit (contribution dollars) per month associated with sales of Shannon’s Irish Red assuming that the Irish Stout is not introduced. Express your answer to the nearest dollar. Do not include the dollar sign.

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Question 2

Assume that Shannon’s estimates that the sales of the new Irish Stout will be about 250 pints per month, but 25% of these sales will be cannibalized from sales of Shannon’s Irish Red. Compute the total combined increase in contribution dollars for both Irish Red and Irish Stout expected with cannibalization . Express your answer to the nearest dollar. Do not include the dollar sign.

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Question 3

1. Let’s stretch a little on this one. Assume Shannon’s Irish Red sells 1,000 pints per month in the absence of any cannibalization. Assume also that the new Irish Stout will sell 500 pints per month. The relevant price and cost data are:

	Irish Red		Irish Stout
Price	$      5.00		$    4.98
Unit Variable Costs	$      2.75		$ 3.25

What will be the maximum percentage cannibalization that can exist before the overall change in contribution dollars becomes negative? Express your answer in percentage form to the nearest percent e.g.; 99.49% rounds down to99%; 99.50% rounds up to 100%. Do not include the % symbol.

Answer 1

Ans 1) calculation of contribution

Particulars	calculations	Amount
Sales	1200*5	6000
Variable cost	1200*2.75	3300
Contribution	(5-2.75)*1200	2700

Ans 2) Calculation of increase in contribution

	Unit Sales		Unit Contribution		Contribution
Unit Sales of Brand Irish red (with cannibalization)	1137	x	2.25	=	2558
Unit Sales of Brand Irish Stout (cannibalized from Irish red)	63	x	2	=	126
Unit Sales of Brand Irish Stout(not cannibalized)	187	x	2	=	374
Total Combined contribution					3058
Increase in contribution			=3058-2700		358

Ans 3)Calculation of contribution per unit

	Unit(Irish Red)	Unit(Irish Stout)
Sales Price	5	4.98
Unit Variable Costs	2.75	3.25
Contribution	2.25	1.73

Calculation of  percentage cannibalization

Contribution of Irish stout=250*173=432.5

it should cover under 2700

therefore

Contribution for Irish red=2700-432.5=2267.5

Contribution in units=2267.5/2.25=1007.7 unit i.e 1008 unit

unit cannibalized =1200-1008=192 units

calculation in percentage=192/250*100=76.8% rounded to 77%