Question

Green Acres Lawn Equipment (GALE), headquartered in St. Louis, Missouri, is a privately owned designer and producer of traditional lawn mowers used by homeowners. GALE provides most of the products to dealerships, which, in turn, sell directly to end users. In the United States, the focus of sales is on the eastern seaboard, California, the Southeast, and the south central states, which have the greatest concentration of customers. Outside the United States, GALE’s sales include a European market, a growing South American market, and developing markets in the Pacific Rim and China. The market is cyclical, but the different products and regions balance some of this, with just less than 30% of total sales in the spring and summer (in the United States), about 25% in the fall, and about 10% in the winter. Annual sales are approximately $180 million.

GALE has developed a prototype for a new snow blower for the consumer market. This can exploit the company’s expertise in small-gasoline-engine technology and also balance seasonal demand cycles in the North American and European markets to provide additional revenues during the winter months. Initially, GALE faces two possible decisions: introduce the product globally at a cost of $900,000 or evaluate it in a North American test market at a cost of $300,000.

If it introduces the product globally, GALE might find either a high or low response to the product. Probabilities of these events are estimated to be 0.6 and 0.4, respectively. With a high response, gross revenues of $1,800,000 are expected; with a low response, the figure is $500,000. If it starts with a North American test market, it might find a high response or a low response with probabilities 0.5 and 0.5, respectively. This may or may not reflect the global market potential.

In any case, after conducting the marketing research, GALE next needs to decide whether to keep sales only in North America, market globally, or drop the product. If the North American response is high and GALE stays only in North America, the expected revenue is $1,000,000. If it markets globally (at an additional cost of $200,000), the probability of a high global response is 0.8 with revenues of $1,800,000 ($500,000 if the global response is low).

If the North American response is low and it remains in North America, the expected revenue is $200,000. If it markets globally (at an additional cost of $600,000), the probability of a high global response is 0.1, with revenues of $1,800,000 ($500,000 if the global response is low).

Do a decision tree for this.

Answer 1

Expected payoff as follows:

• Global + High Response => $900,000 with probabilty of 0.6
• Global + Low Response => -$400,000 with probabilty of 0.4

Hence, Expected Payoff for Global = 900000*0.6 + (-400000)*0.4 = $380,000

Expected Payoffs for initally testing in North American (NA) market and then POTENTIALLY going global:

• NA High + NA ONLY = $700,000 with probabilty of 0.5 => $350,000
• NA High + Global High = $1,300,000 with probabilty of 0.5*.0.8 => $520,000 (A)
• NA High + Global Low = 0 with probabilty of 0.5*0.2 => $0 (B)
• NA Low + NA ONLY = -$100,000 with probabilty of 0.5 => -$50,000
• NA Low + Global High = $900,000 with probabilty of 0.5*0.1 => $45,000 (C)
• NA Low + Global Low = -$400,000 with probabilty of 0.5*0.9 => -$180,000 (D)

Hence, BETTER to Evaluate Product in North American Test Market initially before going global whose expected payoff (A+B+C+D) would be $385,000 and then:

• If NA response is HIGH, market globally (Expected payoff = A+B = $520,000)
• If NA response is LOW, drop the product (Expected payoff = C+D = -$135,000)

Let me know in case of any issues. Enjoy learning. Good luck!