Sberry: Company information
Sberry manufactures products which have a short lifecycle due to technological obsolescence. It aims to keep each product in production for at least 18 months so that it can recover the high cost of product development and make an acceptable profit before the product becomes obsolete. Sberry has always manufactured its products in its home country of Deeland, from where all materials are also sourced.
Sales opportunity in Kayland
An opportunity has been identified to export one of three newly developed products, Red, Blue and Green, to Kayland, due to citizens’ increasing levels of income there. The rate of technological obsolescence is slower in Kayland than in Deeland. The estimated levels of demand, selling prices and costs of the three products are shown in Appendix 1.
Stakeholders’ views on the risks of the Kayland opportunity
Three of Sberry’s key stakeholder groups, employees, directors and shareholders, have been consulted for their views on the proposal to export to Kayland and, in particular, on which of the three newly developed products to export there.
The employees have a cautious approach to the proposal following the recent failure of another product launch. That product was withdrawn as it breached poorly understood safety regulations and a number of employees lost their jobs as a result.
The directors, all of whom are individually wealthy, have served on the board for many years and are keen to earn the large bonus which is currently offered solely on the total profit made by the new product over its lifecycle.
The shareholders neither avoid nor seek risk, but they are keen that the company considers the external environment in Kayland in order to maximise performance there, whichever of the products is chosen to be exported. They have asked for a PEST* analysis of the environment in Kayland to be produced. A first draft of this has indicated that the exchange rate between the Deeland dollar (D$) and the Kayland dollar (K$) is a key economic factor which may affect performance.
*Political, economic, socio-cultural and technological
Appendix 1
Estimated levels of demand, selling prices and costs of the three newly developed1 products
Red Blue Green
Total demand (units)2 50,000 60,000 160,000
Selling price (K$)3 8·00 9·00 6·00
Total unit cost (D$)4 2·40 3·00 2·50
Notes to the appendix
1 Development costs are sunk costs and can be ignored.
2 The estimated product life of each of the three products is the same and the total demand is for the whole life of the product.
3 The current exchange rate between the D$ and the K$ is D$1·00 = K$2·00. Sberry’s finance director has estimated that over the life of the product there is a 75% probability that the average exchange rate of the D$ will strengthen by 10% against the K$, and a 25% probability that the average exchange rate of the D$ will weaken by 10% against the K$.
4 At the current exchange rate, 50% of the total costs for each product is for materials which are imported from Kayland and invoiced in K$. There will be no opening or closing inventory, whichever of the three new products is chosen.
Required:
Advise which of the three newly developed products each of the three key stakeholder groups would choose to export to Kayland based on their respective risk appetites.
Employees
Employees are cautious about the proposal to export to Kayland, and are risk averse. They would use the maximin rule, which is the choice of product with the best of the lowest outcomes. In this case, this is Blue.
Directors
Directors are paid a high bonus dependent on profitability of the product chosen. As they have served on the board for many years, there appears to be little chance that they would be removed by making a poor choice. They are risk seekers, and will use the maximax rule, that is, the choice of product with the best possible outcome. In this case, this is Green.
Shareholders
Shareholders are risk neutral. They will choose the product with the highest expected value; in this case this is also Blue, which has an expected value of D$82,728.
Total profit
Explain the problems of using the risk and uncertainty analysis techniques which you have used in part (a).
Sberry’s three key stakeholder groups will use different criteria to make decisions on the Kayland opportunity according to their attitude to risk and reward. The maximin and maximax rules and the expected value can be used to determine the decisions which each group will make.
Maximin and maximax rules
The maximin rule, the choice with the best of the lowest outcomes, which would be preferred by the employees, can be an excessively risk averse approach. As Sberry’s products have short product lives, it must constantly develop new products, so some commercial risks will have to be taken.
The maximax rule, which the risk-seeking directors prefer, has the problem that it may be overly optimistic. Product choices with the maximum reward or profits may also be riskier, and could mean that directors take risks which exceed the shareholders’ risk appetite so as to earn high bonuses.
A problem with both of the maximin and maximax rules is that they both ignore the probability of the outcome actually occurring.
Expected value
The expected value approach is a long run average which can be applied to decisions which are repeated many times. The actual expected value is not a possible outcome and will never occur in practice. Though Sberry may have developed many products, it has no experience of forecasting exchange rates and so the expected value approach may be inappropriate.
The expected value approach relies on estimates of probabilities, such as for average exchange rates. These may be subjective or difficult to make, which limits the value of this approach.
Advise the shareholders how analysing the external environment in Kayland using a PEST analysis can help Sberry maximise its performance there. You are NOT required to produce a PEST analysis.
Identifies opportunities or threats
Analysing the external environment in Kayland will allow Sberry to identify opportunities and threats. It can maximise performance by taking actions to exploit opportunities, such as developing the new products to take advantage of growing income levels and the slower rate of technological obsolescence in Kayland.
A draft PEST analysis has indicated that the exchange rate between D$ and K$ is a key economic factor affecting performance. By identifying this, Sberry can act to maximise performance, such as by analysing the effect of exchange rates on profits of the new products or hedging against adverse exchange rate movements. A thorough analysis of safety regulations in Kayland may prevent the problems which occurred with the failure of the previous product launch.
Identifies CSFs, KPIs and helps set targets
PEST analysis can help identify critical success factors (CSFs) and key performance indicators (KPIs). Having identified product safety as a legal factor affecting performance, a CSF may be to abide by safety regulations in Kayland. The number of breaches of safety regulations would be a suitable KPI.
The PEST analysis can be used to set targets appropriate for the environment in Kayland. A CSF for Sberry is that it produces products for long enough to recover their development costs and make an acceptable profit. A target for the KPI of length of time in production could be 24 months in Kayland, where technical obsolescence is slower, rather than the target of 18 months in Deeland.