Suppose that there is a 60% probability that the product will be a success on the market (that means, the probability of failure is 40%). If the product is a success, you will get a profit of $200,000, and if it is a failure, you will incur a loss of $100,000. Should you develop this product? How do you make a decision in this situation? Also, how can one come up with the probability of success (or failure)? Share your ideas/thoughts with the other students and comment on theirs.
Response 1For me, I would think that more information would be needed in terms of what would be considered success. To explain, would success simply mean that I make a positive profit or a profit that is at least $200,000 or more? Developing any product would mean that I would incur manufacturing and production/advertising expenses. All of these added components of consideration would be pertinent for helping me to decide whether or not to develop this product. Essentially, it’s going to come down to the probable numbers. Am I going to be willing to depend on a 60/40 probability? Or is making $80,000 even worth it? In making the decision, and after I have decided what I am going to constitute as being successful, I would generally send the formula for figuring out the probability, which is ultimately and obviously going to end up having $80,000 as my average profit if the numbers play out correctly. To keep it as clear and simple as possible, my function would appear as such: =($200,000 x 60%) + (-$100,000 x 40%) =($200,000 x 0.6) + (-$100,000 x 0.4) =$120,000 + (-$40,000) =$80,000 When unsung this probability function, I will still be aware that this isn’t always going to be exact, because it is based off of projected numbers that are of value now, the success expected percentage could change at any time. Anything in the life cycle of the product, should I decide to start developing it, could turn the numbers of success or failure for the worse. After considering the probability of actually being able to even earn 80k as my average profit, I don’t think that the investment would be worth it. I would need to to a profit well over half of what I’m putting in. The purpose of business is to make a reasonably revenue and a high marginal profit. This scenario reminds me of the old saying, “You get out what you put in.” However, when it comes to business, I’m not thinking of how much I really put in, I’m thinking of how I can make my money work for me. I want to make more than what probable, I want to surprise the probably as well as myself.
I believe we can’t deem an answer to this question right or wrong; it is a matter of risk in the business world after all, so we can still get the average profit in this case we got (more like the expected profit): Average profit= $200,000 x 60% + (-$100,000 x 40%) =$200,000 x 0.6 – $100,000 x 0.4 =$80,000 (Notice the convention that a loss is a negative profit) So, I believe that since the average expected profit in this case came out as a positive value, then we may decide on developing the product. The other part of the question I believe is unclear to me, because here it isn’t specified which probability of success we want to come up with, is it success of developing the product? Or is it success of making more sales? Or is it total generated revenue? If in general you want to calculate a probability of success, so it equals the ration between the number of outcomes from a given event (n) and the number of all possible outcomes (s). p= n/s At any point, if we get to know the probability of success, the probability of failure (q) is the complementary event and it can be calculated from the prob. of success (p) as follows: q = 1-p Again, the risk factors impacting “success” are fairly open-ended and depend on the uniqueness of the product or the business.
Response 3To determine whether the product should be developed, we first have to the expectation or expected value of profit. To do this, we must multiply the probabilities with the corresponding expected profit and loss. In this case we would multiply .60 x 200,000 = 120,000 and .40 x 100,000 = 40,000. Now we can subtract 40,000 from 120,000 to get 80,000. 40,000 is subtracted because it is considered to be a loss. $80,000 would be the expected profit and the possible loss of $100,000 is less than the possible profit of $200,000, therefore making the decision to develop the product would be a good option. In this scenario, the criteria for determining success or failure would be based on whether a profit or loss occurs, where profit is a success and loss is a failure. However, success and failure could be determined based on the individuals involved as well as the scenario presented. For example, I could consider a profit of $50,000 a success whereas someone else could consider a $50,000 profit a failure and determine that $100,000 profit is a success. Mathematically, success and failure can be measured by dividing the total number of favorable outcomes over the total number of events. Also, using binomial probability and the binomial formula could be a way of determining the probability of success or failure, even though this topic was not covered in our reading assignment for this week.
Response 4Suppose that there is a 60% probability that the product will be a success on the market (that means, the probability of failure is 40%). If the product is a success, you will get a profit of $200,000, and if it is a failure, you will incur a loss of $100,000. Should you develop this product? Yes. How do you make a decision in this situation? Evaluate the expected value. That number is positive. We need more information on the definition of success on the market. Is that related to the number of products sold, the market share vs. competitors, gross profit per item sold, or some other metric? Expected value (Lial, 2011) is found by multiplying each value by its probability, and then subtract the loss from the profit. E[value] = 200,000*(.6) – 100,000(.4) = 120000 – 40000 = 80000 Also, how can one come up with the probability of success (or failure)? Scenario: Bring product to market All possible outcomes are: Probability of Success on the market – 0.6 Probability of Failure on the market – 0.4 The product will either be a success or it will be a failure – A or B These outcomes cannot occur at the same time so they are mutually exclusive. With this binomial investment decision, the probability of success and failure can be shown as: P = probability of success 1-P = probability of failure Let’s say that we have 3 products to bring to market. The number of trials is 3 because we have 3 products. The probability of success for any of the three products is 0.6. If we assume that we will have 2 successes, then we can calculate the cumulative binomial probability (Binomial Calculator: Online Statistical Table, 2014), which is the probability associated with the assumed 2 successes.
|Probability of success on a single trial|
|Number of trials|
|Number of successes (x)|
|Binomial Probability: P(X = 2)|
|Cumulative Probability: P(X < 2)|
|Cumulative Probability: P(X < 2)|
|Cumulative Probability: P(X > 2)|
|Cumulative Probability: P(X > 2)|
Response 5Refer to the new product development example in the overview of this module. Suppose that there is a 60% probability that the product will be a success on the market (that means, the probability of failure is 40%). If the product is a success, you will get a profit of $200,000, and if it is a failure, you will incur a loss of $100,000. Should you develop this product? How do you make a decision in this situation? Also, how can one come up with the probability of success (or failure)? Share your ideas/thoughts with the other students and comment on theirs. I want to launch new kind of umbrella with reflectors on it so that if a person is walking in the rainy dark night or early in the morning and a car approaches from behind a walking person can be seen easily. If probability of success is 60% which is not bad and I am making a profit of $200,000 then it is a good idea to launch this product. Probability of success is more than the probability of failure. So I have more chances to make a profit if I launch this special umbrella. However, I think considering only probabilities of success or failure, will not be enough. There are other factors need to be considered as well while making a decision about launching a new product. Other factors such as how much I would need to invest in developing this product, how much I have spent in market research, or product design and market demand, who are the competitors and how does my product differ from my competitors etc. Such factors play an important role in making decisions in such situation. The other product I am interested in launching is a special customized cotton mattress (my old idea of starting a mattress business). Studying probabilities of success and failures, will surely help me in making a decision whether to launch the product or not. If probability of success is 60%, and I am making a profit of $200,000, in general, it is a good idea to launch a product. But since this product is not a small product and therefore needs a good amount of investment. When I think about this product, probability of failure concerns me more because 40% is closer to 50% which is equivalent to a coin toss and so I have to either wait or work things out to increase my chances of making my product a success and thus, make profits. To answer the second part of the discussion, I would say, in general we can use complement rule to know the probability of success or failure. Such as probability of success would be P(S) = 1 – P(F). For example, P(S) = 1- 0.4 = 0.6 or 60% Similarly, probability of failure would be P(F) = 1 – P(S). For example, P(F) = 1- 0.6 =0.4 or 40% P(S) : Probability of Success P(F) : Probability of Failure
Response 6The decision tree above lists the events that can occur from producing vs not producing this particular product. The decision tree also lists the probability of these events occurring, and what each events impact will be. If we were to analyze the decision tree, and focus solely on the facts given, than the answer would be yes. Yes, we would take our chances on producing this product because the estimated monetary value of producing this product is a positive number. Estimated monetary value is calculated by multiplying the probability of an event occurring, times what the impact will be, and adding these values together. The decision tree above shows a total of 10 lines. 6 lines link producing a product to success, and 4 lines link producing a product to failure. This shows that there is a 6 out of 10 chance that the product will be a success if produced and a 4 out of 10 chance that the product will be a failure if produced. This gives us probabilities of .6 or 60% that the product succeeds and .4 or 40% that the product fails. Estimated monetary value of producing the product= Probability of product succeeding (.6) x impact of product succeeding ($200,000) = $120,000 Probability of product failing (.4) x impact of product failing (-$100,000)= $-40,000 $120,000 + $-40,000= Estimated monetary value of producing this product is $80,000. This is $80,000 better than not producing the product at all, which gives us an estimated monetary value of 0. Actually, our estimated monetary value will remain positive as long as our chances for success stay at 34% or higher. At 34% our EMV is $2,000. With that said, if we focus on these numbers alone than the answer is yes, we would produce this product. But there are many other factors we should consider. Example: what are the costs of starting this product up vs not starting it up, are there costs associated with discontinuing an existing product to make way for the new product etc. All of these factors are not included in the question. If the question asked: based on these values alone would you produce the product? The answer would be yes. The answer would be maybe, if other factors were to be considered. We can also incorporate addition rules of probability to determine the likelihood that either of these events will occur. The two events (product succeeding/product failing) are mutually exclusive, because they cannot occur at the same time. So the two events, event a: product succeeding, and event b: product failing are mutually exclusive because they cannot occur at the same time. We can use the addition rule to probability to determine the likelihood of either of these events occurring. Addition rule: When two events, A and B, are mutually exclusive, the probability that A or B will occur is the sum of the probability of each event. The decision tree shows us we have a 6/10 chance for success and a 4/10 chance for failure for launching a product. Addition rule: P(A or B)= P(A) + P(B) or P(A or B)= 6/10 + 4/10 = 10/10 or 1, meaning there is a 100% chance that one of these events will occur.
Response 7Loss of $100,000 would mean that $100,000 is invested. A profit of $200,000 would really not be a large profit margin. First I would suggest that I would need to know more information about the investment and the product before making an educated decision. However, given the information at hand one could make a decision. One would need to know how much is invested. Simply if there stands to be a 40% chance that if the product fails then the company will lose $100,000, then one could suggest that the company is investing $100,000 or the loss would not occur. If the profit is to be $200,000 and the chance is 60% then that would be $200,000 more than the $100,000 initial investment. Profit being more than the investment, and the investment is already established as $100,000. Now one would ask is it wise to spend $100,000 to only gain $200,000 after everything is sold from the product? I would say that the profit margin is very low. The product costs too much to be sold at such a low price. If the company were to gain a much greater amount say, $900,000+ for the initial investment especially based off of a 60% chance of success, then I would say the company should certainly invest in the product. However, with the current information that we have, I would suggest that the profit is not enough to warrant the high chance of failure.
I do not believe we have sufficient information to decide whether to develop this product. As others have mentioned, we need to know how much was invested. I would also like to know what percentage of the company’s capital this investment represents. So, I will mention a few different scenarios that come to mind. If the company has $100,000 working capital, 40% chance of complete failure would be too high. If my company has $1,000,000 and invested a smaller portion, I would consider it a bad investment. I would be more inclined to make the product if the initial investment required all of my capital. If my company had $100,000,000 I would not hesitate to take the chance. In determining probability of success, there are four factor in particular that I would consider:
- Need for the product. To refer back to my previous week’s example of making outboard motors, what percentage of the population have a need for my product?
- Competition. How many other products are there in the market?
- Market saturation. What percentage of the market currently owns a similar product?
- Market satisfaction. Not a perfect descriptor, but, I’d want to know how people feel about their current product. This would lead me to what percentage could be influenced to buy a new model.
- Need this product. Either they don’t have one. Or they are dissatified with the one they currently use.
- What is the probability these people would buy mine over someone else’s.
- Calculate the anticipated revenue from these sales.