Tiffany Rothstein, CEO, major shareholder, and founder of Arcsoft, sits in her office, contemplating the decision she fa

[answerhappygod]

Tiffany Rothstein, CEO, major shareholder, and founder of
Arcsoft, sits in her office, contemplating the decision she faces
regarding her company’s newest proposed product, Arcnet. This has
been a particularly difficult decision. Arcnet might catch on and
sell very well. However, Tiffany is concerned about the risk
involved. In this competitive market, marketing Arcnet also could
lead to substantial losses. Should she go ahead anyway and start
the marketing campaign? Or just abandon the product? Or perhaps buy
additional marketing research information from a local market
research company before deciding whether to launch the product? She
has to make a decision very soon and so, as she slowly drinks from
her glass of high protein-power multivitamin juice, she reflects on
the events of the past few years. Arcsoft was founded by Tiffany
and two friends after they had graduated from business school. The
company is located in the heart of Silicon Valley. Tiffany and her
friends managed to make money in their second year in business and
have continued to do so every year since. Arcsoft was one of the
first companies to sell software over the Internet and to develop
PC-based software tools for the multimedia sector. Two of the
products generate 80 percent of the company’s revenues: Audiatur
and Videatur. Each product has sold more than 100,000 units during
the past year. Business is done over the Internet: customers can
download a trial version of the software, test it, and if they are
satisfied with what they see, they can purchase the product (by
using a password that enables them to disable the time counter in
the trial version). Both products are priced at $75.95 and are sold
exclusively over the Internet. Users can “surf the Web”, accessing
information available worldwide. Users can also make files
available on the Internet, and this is how Arcsoft generates its
sales. Selling software over the Internet eliminates many of the
traditional cost factors of consumer products: packaging, storage,
distribution, sales force, and so on. Instead, potential customers
can download a trial version, take a look at it (that is, use the
product) before its trial period expires, and then decide whether
to buy it. Furthermore, Arcsoft can always make the most recent
files available to the customer, avoiding the problem of having
outdated software in the distribution pipeline. Tiffany is
interrupted in her thoughts by the arrival of Jeannie Korn. Jeannie
is in charge of marketing for online products and Arcnet has had
her particular attention from the beginning. She is more than ready
to provide the advice that Tiffany has requested. “Tiffany, I think
we should really go ahead with Arcnet. The software engineers have
convinced me that the current version is robust and we want to be
on the market with this as soon as possible! From the data for our
product launches during the past two years we can get a rather
reliable estimate of how the market will respond to the new
product, don’t you think? And look!” She pulls out some
presentation slides. “During that time period we launched 12 new
products altogether and 4 of them sold more than 30,000 units
during the first 6 months alone! Even better: the last two we
launched even sold more than 40,000 copies during the first two
quarters!” Tiffany knows these numbers as well as Jeannie does.
After all, two of these launches have been products she herself
helped to develop. But she feels uneasy about this particular
product launch. The company has grown rapidly during the past three
years and its financial capabilities are already rather stretched.
A poor product launch for Arcnet would cost the company a lot of
money, something that isn’t available right now due to the
investments Arcsoft has recently made. Later in the afternoon,
Tiffany meets with Reggie Ruffin, a jack-of-all-trades, and the
production manager. Reggie has a solid track record in his field
and Tiffany wants his opinion on the Arcnet project. “Well,
Tiffany, quite frankly I think that there are three main factors
that are relevant to the success of this project: competition,
units sold, and cost—ah, and of course our pricing. Have you
decided on the price yet?” “I am still considering which of the
three strategies would be most beneficial to us. Selling for $50.00
and trying to maximize revenues—or selling for $30.00 and trying to
maximize market share. Of course, there is still your third
alternative; we could sell for $40.00 and try to do both.” At this
point Reggie focuses on the sheet of paper in front of him. “And I
still believe that the $40.00 alternative is the best one.
Concerning the costs, I checked the records; basically we have to
amortize the development costs we incurred for Arcnet. So far we
have spent $800,000 and we expect to spend another $50,000 per year
for support and shipping the CDs to those who want a hard copy on
top of their downloaded software.” Reggie next hands a report to
Tiffany. “Here we have some data on the industry. I just received
that yesterday, hot off the press. Let’s see what we can learn
about the industry here.” He shows Tiffany some of the highlights.
Reggie then agrees to compile the most relevant information
contained in the report and have it ready for Tiffany the following
morning. It takes him long into the night to gather the data from
the pages of the report, but in the end he produces three tables,
one for each of the three alternative pricing strategies. Each
table shows the corresponding probability of various amounts of
sales given the level of competition (high, medium, or low) that
develops from other companies. The next morning Tiffany is sipping
from another power drink. Jeannie and Reggie will be in her office
any moment now and, with their help, she will have to decide what
to do with Arcnet. Should they launch the product? If so, at what
price? When Jeannie and Reggie enter the office, Jeannie
immediately bursts out: “Guys, I just spoke to our marketing
research company. They say that they could do a study for us about
the competitive situation for the introduction of Arcnet and
deliver the results within a week.” “How much do they want for the
study?” “I knew you’d ask that, Reggie. They want $10,000 and I
think it’s a fair deal.” At this point Tiffany steps into the
conversation. “Do we have any data on the quality of the work of
this marketing research company?” “Yes, I do have some reports
here. After analyzing them, I have come to the conclusion that the
marketing research company is not very good in predicting the
competitive environment for medium or low pricing. Therefore, we
should not ask them to do the study for us if we decide on one of
these two pricing strategies. However, in the case of high pricing,
they do quite well: given that the competition turned out to be
high, they predicted it correctly 80 percent of the time, while 15
percent of the time they predicted medium competition in that
setting. Given that the competition turned out to be medium, they
predicted high competition 15 percent of the time and medium
competition 80 percent of the time. Finally, for the case of low
competition, the numbers were 90 percent of the time a correct
prediction, 7 percent of the time a ‘medium’ prediction and 3
percent of the time a ‘high’ prediction.” Tiffany feels that all
these numbers are too much for her. “Don’t we have a simple
estimate of how the market will react?” “Some prior probabilities,
you mean? Sure, from our past experience, the likelihood of facing
high competition is 20 percent, whereas it is 70 percent for medium
competition and 10 percent for low competition,” Jeannie has her
numbers always ready when needed. All that is left to do now is to
sit down and make sense of all this. . . a) For the initial
analysis, ignore the opportunity of obtaining more information by
hiring the marketing research company. Identify the decision
alternatives and the states of nature. Construct the payoff table.
Then formulate the decision problem in a decision tree. Clearly
distinguish between decision and event nodes and include all the
relevant data. b) What is Tiffany’s decision if she uses the
maximum likelihood criterion? The maximin payoff criterion? c) What
is Tiffany’s decision if she uses Bayes’ decision rule? d) Now
consider the possibility of doing the market research. Develop the
corresponding decision tree. Calculate the relevant probabilities
and analyze the decision tree. Should Arcsoft pay the $10,000 for
the marketing research? What is the overall optimal policy?