Transcript

NARRATOR:

A company is planning on launching a new product. It was thinking of launching in June next year but believes that a rival is also considering launching a similar product. The company is considering bringing the launch forward to the end of this year. This will cost an extra 3 million euros to do, and the company believes it will have a 0.8 probability of beating the rival to the market. If, however, they wait until June, the probability of beating the rival falls to 0.2.

To make the decision easier, the company assumes that sales will be high, medium, or low. If the company launches before its rival, the probability of high sales is 0.6, and medium, 0.25. If it launches after, the probability of high sales falls to 0.35 and medium rises to 0.45. If the rival launches first, then the company could undertake a sales promotion costing 1.5 million euros but would change the probabilities of high sales to 0.5 and medium to 0.4.

The financial impacts are that high sales would be worth 9 million euros, medium, 5 million euros, and low, 1 million euros. So should the company launch this year or next? That's the big decision-- this or next. It'll cost an extra 3 million to launch this year. We'll note that for when we work out the expected value.

If we go up this branch, we need to take 3 million euros of the expected value. The company believes it will have a 0.8 probability of beating the rival to the market if it launches this year. So beat rival, yes or no, 0.8 here, therefore, this must be 0.2. If, however, the company waits until June next year, the probability of beating the rival falls to 0.2. So here we also put beat rival, yes or no branches, and it's 0.2 for yes and 0.8 for no.

So now we go to what type of sales we've got. We have three types-- high, medium, and low-- and the probabilities from this particular branch are 0.6, 0.25, and therefore, because they must all equal 1, 0.15. And then the values here are 9 million euros, 5 million euros, and 1 million euros.

If the company doesn't beat the rival to the market, then it has the opportunity to undertake a sales promotion. So this is a decision node. If it does the promotion, it will cost 1.5 million euros. And the sales will now have different probabilities; 0.5 for high, 0.4 for medium, and, therefore, 0.1 for low, but the end values will stay the same. If the company doesn't undertake a sales promotion, the probabilities are 0.35 for high, 0.45 for medium, and 0.2 for low. And again, the end values stay the same.

Now we move to launching the product next year. The sale nodes here are identical to the three at the top. They've all come after the "beating the rival" node. It's just the probabilities of getting there have changed. So this node here, with the one beside it, is the same as this node in terms of its expected value. It's just this one has 0.8 chance of it happening, whereas this one has a 0.2 chance. So whatever this expected value is, we put the same down here and the same with these.

Now let's work out the expected value at node one, which is 0.6 times 9 plus 0.25 times 5 plus 0.15 times 1, which is 6.8 million euros. We can also do the second node, 0.5 times 9 plus 0.4 times 5 plus 0.1 times 1 minus the 1.5 million to undertake the promotion. So we see that the expected value of undertaking a promotion is 5.1 million euros.

We'll put 6.8 on node one, and this will also be 6.8. Node two is 5.1, and so this is 5.1 as well. Now, we can work out the third sales node, where we didn't undertake a promotion. To work out this expected value, it's 0.35 times 9 plus 0.45 times 5 plus 0.2 times 1. There's no cost to deduct for this one, so the expected value is 5.6 million euros.

Node three's expected value can go here and also here. The company needs to decide whether to undertake a sales promotion. If they do, the expected value is 5.1 million euros. And if they don't, the expected value is 5.6 million euros. So based on these figures, the decision will be to not do a promotion.

Now we can go to node four. Remember, we're going right to left, and the expected value here is 0.8 times 6.8 plus 0.2 times 5.6, which is 6.56 million euros. And then node five is 0.2 times 6.8 plus 0.8 times 5.6. So node five is 5.84 million euros, and node four is 6.56 million euros.

Now, the only problem with node four is to get there, the company had to spend 3 million euros. So, in fact, the true cost here is the 6.56 minus the 3, which is 3.56 million euros. So the expected value of this route is 3.56 million euros, and the expected value of this route is 5.84 million euros.

So the company's strategy will be, first of all, not to bring the launch forward-- to launch the product next year. And if a rival beats the company to the market, it will not do the sales promotion.