New Products and Risky Situations

When the color TV market began to develop rapidly, the need for new capacity was apparent, but how fast would the market develop? Could existing facilities for black and white TV be converted? Would market shares remain stable? Would color TV repeat the growth pattern of black and white TV? Similar uncertainties occurred in other new products such as pocket calculators and microwave ovens.

Market uncertainties might also occur in mature products that have enjoyed stable growth, because of impending technological innovations or political uncertainties. Imagine the market uncertainties in the mechanical calculator field when solid state electronics became practical. The design of an electronic desk calculator became an obvious objective. What would an electronic desk calculator cost? Would the mechanical calculator become completely obsolete or would the electronic model be expensive, leaving a market for mechanicals? Suppose a shipping company regularly did a substantial business from the West Coast to the East Coast of the United States and in Europe. What effect would the closing of the Panama Canal have on operations and capacity needs?

If demands are uncertain, lead times can be important. It may take considerable time for planning, for obtaining government permits that involve environmental impact studies, and for construction. The length of these lead times becomes of even greater importance when planning for products with uncertain demand. Events can occur within the lead times that change the logical alternatives.

Capacity planning in these situations requires an assessment of the risks. The effect of the probability that risky events will occur must be accounted for. If the market is uncertain, a probabilistic prediction of the market provides basic data.

An example>

Suppose that we are planning future capacity for a product that is in the rapid development phase. Present annual capacity is 20,000 units. New competition is becoming very aggressive, but the enterprise expects to retain its market share. The sales department feels that market share could be increased with aggressive promotion. Estimates of the total market vary, with some feeling that growth might be explosive in the next four to five years. On the other hand, there is the additional uncertainty concerning continuing technological innovation that could stunt the growth of the current line. Thus, expected, optimistic, and pessimistic market predictions are made and assigned probabilities each might occur.

The optimistic requirements are based on the assumption of 40 percent annual growth; the expected, on 20 percent annual growth; and the pessimistic, on only 10 percent annual growth. (Capacities have been rounded).

Strategies: Three alternative strategies are developed, each designed with the three market assumptions in mind. The variable costs of production are the same as for the present capacity because no new process technology is involved. The three alternatives are

1. Install new capacity in 1989, 1990, and 1991 in increments of 15,000 units.
2. Install new capacity in 1989, 1990, and 1991 in increments of 5000 units.
3. Make no capacity additions.

The 15,000 unit capacity additions require an investment of $800,000 each and the 5000 unit additions require an investment of $300,000 each, reflecting an investment economy for the larger units. The operating costs per unit are the same for both sizes of capacity additions. Given each of the three strategies, the outcomes will depend on which requirements schedules actually occur. When requirements exceed capacity, sales are lost, so the cost of lost contribution of $50 per unit must be taken into account in evaluating the alternatives.

For each of the three strategies, any of the three market assumptions could occur with the stated probabilities.