7 Pages Posted: 23 Jun 2009
This note develops a variety of approaches to sensitivity analysis within the context of a promotional decision regarding a consumer product. Analyses include the development of optimistic/pessimistic scenarios, one-at-a-time sensitivity analysis with a presentation in the format of a tornado diagram, and threshold (break-even) values.
WHAT IF . . . ?
A proactive decision maker should not limit the evaluation of an alternative to a single estimate of its potential performance, but should acknowledge explicitly the uncertainties that affect that performance. The consideration of the spectrum of possibilities to which an alternative's performance may be subjected can lead to a better understanding of the risks involved in pursuing the alternative. That understanding can in turn motivate the search for new alternatives that reduce those risks.
This note will present approaches for exploring and presenting the sensitivity of performance to changes in assessments. These methods will assist in identifying and communicating the key drivers of performance so that future analysis can be focused on them and creative attention directed to reducing their effects.
The following example will be used to develop and illustrate the language, tools, and techniques of this note:
Suppose you are the product manager for a children's breakfast cereal. A special holiday trinket was recently developed, and you are considering including the trinket in your product's 28-ounce box during the two months preceding the holiday season. The trinket has performed extraordinarily well in a full battery of children's preference panels and is expected to result in a 12 percent increase in volume. Children's test panels are notoriously unreliable, however, and the increase could be anywhere between 8 and 14 percent. Without the trinket, sales of the 28-ounce box during the two-month period are forecasted to be 6.5 million boxes, plus or minus 2 percent. The production process and the distribution system are sufficiently flexible to permit production to match demand. The trinket will cost $ 0.10 per unit, if the supplier who has worked on its development can resume production in a timely fashion after a recent fire. Fortunately, alternative sources have been found, but at a premium of either $ 0.010 or $ 0.015 per unit, depending on the final selection of the alternative vendor. The trinket will be featured on the front and back of the box and the alteration to the box's artwork is anticipated to cost $ 125,000. Neither the art layout nor the production modifications have been finalized, and it is believed the final cost could range from 20 percent higher to 5 percent lower than the initial estimate. The 28-ounce box has a unit contribution of $ 1.48 per box. Would you include the trinket in the boxes for the holiday season?
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Keywords: break-even analysis, sensitivity analysis
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