Question

A company has developed a new type of mosquito repellant. The technical success is clear, but as with any new product the commercial success is risky. Because of this, they would sometimes test-market a product first, and then make a decision about national marketing after the test-market results had come in; at other times they would proceed directly to national marketing. On some occasions, they would abandon the product without even test-marketing it. The test-marketing would cost about $600,000. If successful (probability 0.4) there would be revenues of $200,000; if unsuccessful the revenues would only be $50,000. Should the test market be successful, a followup national campaign at a cost of $2,500,000 would have a 70% chance of success with a revenue of $9,000,000, otherwise it would be a failure with a revenue of $750,000. Should the test market be unsuccessful, a followup national campaign would have only a 0.2 chance of success (with the same cost, and the same revenues for success and failure). A national campaign not preceded by a test campaign would have a 45% chance of success. It would cost $3,000,000, and would produce a revenue of $9,500,000 if successful, but only $875,000 otherwise. (a) Draw and solve a decision tree for the situation (using payoff nodes where appropriate), and state the recommendation clearly. (b) If the $3,000,000 figure in the last paragraph were changed to $4,000,000, what would be the revised recommendation

Answer 1

a)

Decision tree is as follows:

Recommendation: In the decision tree, we see that EMV of national marketing is the highest of all.

Therefore, the company should proceed directly to national marketing without test campaign

Expected Monetary Value of this strategy = 4,756,250 - 3,000,000

= $ 1,756,250

------------------------------------------------------------

b)

In this case, the revised decision tree is shown below

Revised recommendation: the company should carry out a test marketing campaign, and if it is successful, then they should proceed for a follow-up campaign, otherwise no follow-up campaign.

Expected Monetary Value of this strategy = 1,990,000 - 600,000

= $ 1,390,000