Game Manual

Help File
Conscious Capitalism
A. Introduction to Marketplace
1. Game Scenario
2. How to Win
3. Decisions to be Made by Quarter
B. Player Activities
1. Functional Organization of the Executive Team
2. Company Name
3. Goals and Strategic Direction
4. Executive BrieLngs
C. Market Research
1. Initial Research: Market Opportunity Analysis (MOA)
2. Types of Information Available
3. Stakeholder Survey
4. Interpreting the Survey Data
5. Understanding What Customers Value
W. Test Marketing: Feedback and Control
7. End User Feedback: Fast Tests
Y. Competitive Benchmark
D. Brand Management
1. Brand Management Decisions
2. Brand Design
3. Match Up BeneLts and Features
4. Consider the Price the Market Will Bear
5. Test Market
W. Brand Name
7. Brand Loyalty
Y. Research and Development
9. R&D Licensing
E. Advertising
1. Planning the Advertising Program
2. Ad Copy Design
3. Deceptive Advertising
4. Media Placement
5. Advertising Effectiveness
F. Sales OBce
1. Territory Development
2. Sales O^ce Management
3. Brand Selection
4. Brand Price
5. Costs of Production and Operations
W. Price Elasticity
7. Competitive Prices
Y. Price Rebate
9. Sales Order Priority
10. Sales Force Management
11. Number of Sales People
12. Target Market Specialty
13. Special Sales Force Programs
G. Human Resource Management

H. Manufacturing
1. Production Facility Location
2. Fixed Production Capacity
3. Financial Tradeoffs in the Capacity Decision
4. Scheduling Production Capacity
5. Lean Manufacturing
W. Demand Forecast
7. Selecting Brands
Y. Maximum Inventory
9. Unwanted Inventory
10. Operating Production Capacity
11. System Improvements
I. Accounting
1. Accounting Statements
2. Pro Forma
3. Activity Based Costing (ABC)
4. Financial Planning and Analysis
5. Earning a ProLt
W. Bankruptcy
7. Independent Auditor
J. Finance
1. Funding Sources
2. Equity
3. Debt Financing
4. 3 Month CertiLcate of Deposit
5. Depreciation
W. Financial Ratios
K. Guidelines for Preparing the Tactical Plan for the Business Plan
1. How to Proceed?
2. Working the Details
L. Guidelines for Preparing Pro Forma Financial Statements for the Business Plan
M. Balanced Scorecard
N. Glossary
1. Brand Components
2. Fatal Errors
A. Introduction to Marketplace
1. Game Scenario
2. How to Win
3. Decisions to be Made by Quarter
A vast array of decisions must be made to compete in Marketplace. These decisions are patterned after real-world
decisions made by new venture Lrms. Each decision has been limited to its most important dimensions in order to keep
the game manageable. Still, there is su^cient complexity and realism to challenge you to the maximum.
The real challenge in the game, and in real-life new ventures, is that you must continually make a large number of
concurrent strategic and tactical decisions. There is no rest from the advertising decision or the market development
decision while you solve the pricing decision.
You not only have to worry about the tradeoffs within each decision area, but you must also evaluate the tradeoffs
between decision areas. Part of the value of the Marketplace experience is learning to manage a dynamic and complex
world.
Marketplace will also give you practice in strategic and tactical decision making. After identifying your options, weighing
the advantages and disadvantages of each, you must commit yourself to a course of action.
The outcome of that action will always be uncertain, but you will Lnd that you can make educated guesses and learn
from the results of these decisions in the next quarter. You can then make adjustments so that even questionable
decisions can be managed (our hindsight is so much better than our foresight).
The content, context, and educational objective of each decision to be made in the simulation are reviewed in the
chapters found under the Help Lle icon. This help Lle contains a conceptual discussion of the decisions that you must
make. The material found here will help you become familiar with every step in the decision process.
The decisions are presented in approximately the order in which they would be executed in the real world, starting with
executive team formation, through market analysis, brand design, advertising, human resources, distribution,
manufacturing, and Lnancing.
This step-by-step process will help you organize your decision making while playing the game.
It is recommended that you Lrst review all the material found in each chapter in its entirety in order to get a feel for the
"whole" of the decision context. Next, sit down at your computer and work your way through each decision to be made. It
is important that you physically enter decisions and investigate the effects of alternate decisions. This form of "hands-
on" experience will help familiarize you with the consequences of your decisions.
Finally, the Decisions to be Made by Quarter section will help you organize your work throughout the simulation exercise.
Game Scenario
Your executive team is about to enter the microcomputer business. You will be responsible for introducing a new line of
microcomputers into Asia, United States, Latin America and Europe.
Within the PC industry, other Lrms will be entering the market at the same time as your division. To keep the scenario
simple, assume the microcomputer industry is in its introductory stage of the product life cycle. That is, there is no
history and there are no established competitors. Furthermore, assume that all competitors, including your own division,
will start with exactly the same resources and knowledge of the market.
All manufacturers will sell through company-owned sales o^ces in major metropolitan markets around the world. Your
target market will be the business sector. You will not be selling to the home market, and you will not sell through retail
stores. Thus, your marketing strategy will be tightly focused on direct sales to business customers.
There are three market segments to serve in the PC market. They are referred to as the Workhorse, Traveler, and
Mercedes segments. The accompanying chart illustrates the positioning of the three segments on the price and
performance dimensions. The size of each circle indicates the relative size of the market for each segment.
Market segmets
Each segment has different needs and wants and requires a

different market strategy to appeal to it. One of your Lrst decisions
will be to select two segments to target. Having selected your
target markets, you will develop, and then execute a very focused
strategy to proLtably serve each segment.
The Workhorse segment is the largest group of customers. They

want an easy to use PC for o^ce workers. It should also have a
modest price.
The Traveler segment wants a practical computer to use on the

road. Traveler customers are executives and sales people who
travel a great deal. This segment is also price sensitive.
The Mercedes segment is looking for a high performance computer to use in engineering and manufacturing
applications. Mercedes customers are willing to pay extra for the high performance.
Investment timeline
As the executive team, you will provide the seed capital (investment money) to start up your business. You can use this
money to build a production facility, open sales o^ces, and design brands. The executive team will invest 2,000,000 in
quarter 1, and 1,000,000 in each of the next two quarters. Up to an additional 5,000,000 will become available in quarter 4
from venture capitalists, for a total of up to 9,000,000.
Your executive team has the next year and a half (6 quarters or decision periods) to get this company off the ground.
Within this time frame, you should become a self-su^cient Lrm, earning substantial proLts from your operations.
Balanced Scorecard
A Balanced Scorecard will be used to measure your Lrm's performance. The team's total business performance will be
based upon its Lnancial performance, marketing effectiveness, market performance, investment in future, asset
management, human resource management and creation of wealth. Starting in quarter 3, the team can check its own
performance by viewing the Balanced Scorecard in the Performance Report section.
How to Win
The formula for success in business and marketing is very simple.

Make lots of people happy and you can earn a lot of money.
Here are the rules:
Find out what people want.

Give them what they want.
Tell them you have what they want (advertise).
Hire sales people to explain how you have the solution to their needs (distribution and sales force management).
Collect the money for a job well done.
Sounds easy, right?

Of course, there are a couple of things that get in the way.
First, not all customers are alike. One offer will not work for everyone. People have different tastes, preferences, needs,
etc.
As a result, many potential customers will wait until they Lnd the "right" solution for their needs. To paraphrase a famous
quote, you can satisfy some of the people all of the time, but never all of the people all of the time. So, demand may not
be as great as you would like or hope.
The way around this problem is to discover the differences in needs among your customers (market research), break the
customers down into smaller groups with similar needs (segmentation), and then develop a strategy for each group
(target marketing).
Second, everyone wants more for less. A lower price for the same goods should help in generating more demand and
taking business away from your competition.
Sure, you would like to sell for less, but you have to pay your expenses and earn a proLt.
One solution to this pricing dilemma is often found in larger sales volumes. If you can generate large sales volumes,
production costs per unit will usually drop dramatically. Lower costs for the goods sold will allow you to lower your prices
and/or increase your proLts.
How do you create larger sales volumes? Offer a better product at a better price and tell everyone about it (advertising
and sales force).
Third, there will always be someone that wants to make money in the same market as you. Competitors will always
emerge and try to take your sales and proLts.
How will they do this?
Smart competitors will study the customers' needs PLUS study what you have to offer (benchmark) and then create and
sell a better solution. Usually, they Lnd a group (segment) whose needs are not well served and then develop a superior
strategy targeted at that group.
Fourth, customers will always gravitate towards the better offer.
Your job is never done. You must always check your offer against the customers' evolving needs (satisfaction level) and
that of the competition (benchmark) and make sure you have the better product, price, promotion, and distribution.
In a nutshell, be the best at giving the customer what the customer wants. Then advertise to the customers about how
good you are at meeting their needs. This should create lots of sales that will drive down your costs and thus allow you
to offer good prices with good proLts.
Of course, it is not this easy, but this is the essence of business and marketing.
Keep these guidelines in mind as you compete in Marketplace. If you follow them, you will be successful. You will be a
winner in Marketplace!
Good luck!
Decisions to be Made by Quarter
Note: Be prepared to justify your decisions, and explain the rationale used to form them.
Quarter 1: Organize the Prm and setup shop.
Determine desired image of company

Designate a company name
Focus on process of working as a team to achieve goals
Assess team skills and work styles, then assign corporate responsibilities
Determine how to manage the organization and establish group norms
Review market survey results - evaluate segments, markets, and potential competition
Analyze market opportunities
Establish corporate goals and strategic direction
Select target segments
Write mission statement
Specify and rank order corporate goals
Establish strategic direction
Sell 2 million in stock to executive team (done automatically)
Create customer value - match components to beneLts
Design at least one brand for each target segment
Select test market
Open Lrst sales o^ce
Setup manufacturing operations
Invest in production capacity
Quarter 2: Go to test market.

Human resources
Establish sales force compensation package
Establish production worker compensation package
Sales o^ce management
Hire sales people - assign to segments
Open new sales o^ces (Optional)
Brand design
Revise brand designs for test market (Optional)
Advertising
Ad copy design
Media placement and ad frequency
Pricing
Designate brands available for sale
Set brand prices - price promotions
Set sales priority
Manufacturing
Estimate demand per sales person
Schedule daily production
Run production simulation
Invest in production capacity (Optional)
Purchase market research
Pro forma accounting
Project cash low
Quarter 3: Skillful adjustment and market expansion.
Evaluate Lnancial performance

ProLtability analysis
Evaluate market performance
Customer opinion - brand designs, prices and advertising
Market demand - by company, brand, and per sales person
Revise marketing tactics as needed, and continue test marketing
Brand designs
Brand prices, price promotions and sales priority
Sales force numbers and assignments
Compensation packages
Advertising copy
Media placement and frequency
Sales o^ce management
Open new sales o^ce (Optional)
Establish production plan for quarter
Review production results from previous quarter
Forecast demand by brand
Schedule daily operating capacity
Invest in production capacity (Optional)
Project cash low
Quarter 4: Invest in the future.

Use activity based costing (ABC) to evaluate proLtability of brands and sales o^ces
Competitor tactics - segments targeted and selection of marketing tactics
Conduct demand analysis to estimate brand, price, advertising, and sales force elasticity
Develop one year business plan
Goals - marketing, Lnancial and ownership
Marketing strategy
Manufacturing strategy
Financial strategy
Pro forma cash lows and Lnancial statements
Size of equity request, number of shares offered, and share price
Present business plan to venture capitalists and negotiate equity investment
Consider taking out conventional loan
Invest in R&D for new brand components
Begin global roll out of business plan
Revise marketing tactics as needed
Brand designs
Advertising copy
Sales o^ce management - expand market coverage
Open new sales o^ce(s)
Revise production decisions as needed - improve production economies
Project cash low
Prepare tactical plan
Quarter 5: Expand the business strategy.
Evaluate team performance - self assessment of roles played, contributions made, and adjustments needed
Evaluate performance - Lnancial, marketing, and market research surveys
Manage strategy
Unanticipated competitive moves
Financial capability
Skillfully adjust strategy
Marketing - make incremental changes in tactics
Review market research
Brand design - increase demand
Brand ratings
Continuously improve component selection (R&D)
Introduce new brands with new R&D components
Explore R&D licensing opportunities and strategic alliances
Human resources - motivate employees
Sales channels - expand market coverage
Open new sales o^ce(s)
Increase sales force
Revise sales force assignments - target most proLtable segments
Advertising - increase demand
Ad copy ratings
Pricing - increase demand
Revise production decisions as needed - improve production economies
Project cash low
Make adjustments to tactical plan
Quarter 6: RePne the business strategy.
Evaluate performance - Lnancial, marketing, team and competitive

Manage strategy
Unanticipated competitive moves
Financial capability
Skillfully adjust strategy
Marketing - make incremental changes in tactics
Revise marketing tactics as needed
Continuously improve brand features (R&D)
Advertising copy
Manufacturing
Fixed capacity
Scheduling options
Compute pro forma cash low
Make adjustments to tactical plan
Quarter 7: Report to the board.
Evaluate team performance - self assessment of roles played, contributions made, and adjustments needed
ProLtability analysis
Competitor tactics - segments targeted and selection of marketing tactics
Report to board on operations since presentation of business plan
Market and Lnancial performance
Valuation of the Lrm
Departures from plan, justiLcation
Present plan for the future
B. Player Activities
1. Functional Organization of the Executive Team
2. Company Name
3. Goals and Strategic Direction
4. Executive Briefings
This chapter focuses on the functional organization of the executive team. It begins with recommendations for
organizing your executive team in terms of functional assignments. There is also a description of how to record your
company name and team responsibilities in the decision template.
The balance of the chapter is devoted to possible discussion topics with the Chairperson of the Board. These topics will
be useful as you prepare for your regular executive brieLngs with the Chairperson (Instructor). They will also suggest
issues that you should be considering as you work through the exercise from one quarter to the next.
Learning Objectives: The primary objective of the team effort is to learn how to work with others in order to accomplish
business objectives. This team-based exercise will help you to understand how work gets done by dividing
responsibilities, depending upon others to carry out their assignments, and fulLlling one's own responsibilities.
At the same time, you will learn that conlict is inevitable because of differences in viewpoints, training, experience,
motivation, ability, perceptions of workload, and effort. Because you cannot walk away, you must Lgure out how to work
with others and move the organization forward to accomplish its tasks and excel in the market.
A second objective of the team effort is to develop your critical thinking skills in business. A very large part of the
learning that occurs in the Marketplace results from the team debates and interactions. High-level thought processes are
required to understand, inform, and persuade one's colleagues on a continuous stream of interconnected issues.
Concepts Emphasized
Organization: Division and assignment of tasks.
Team work: Pulling one's weight, helping others to accomplish their tasks, working for the good of the team rather than
focusing only on one's own needs and rewards.
Leadership: Figuring out where to go and how to get there, guiding the team, setting priorities, organizing the work, taking
initiative, helping others, and resolving conlict.
Time management: Setting priorities, organizing the work and completing it according to priorities, being e^cient in
working with others and in one's own work.
Con[ict management: Recognizing conlict, separating issues from personalities, working toward solutions based upon
business needs and consideration for the individual. Being willing to:
1. Consider other viewpoints.

2. Compromise.
3. Support team decisions.
4. Not dwell on the past but focus on the future.
Functional Organization of the Executive Team

One of your Lrst responsibilities in setting up your new venture will be to organize your executive team and assign
responsibilities. This task is critical because Marketplace requires more work than any one person can do.
It is not e^cient for everyone to participate in all aspects of the business. Ultimately, team organization and
management will determine team effectiveness and the team's satisfaction in working together.
Teams may have members rotate positions periodically, so that everyone experiences more than one decision area. The
advantage to this approach is that the participants develop a good feeling for all of the decisions to be made. It also
helps the team members to develop a common frame of reference.
Functional Roles
There are many ways to divide the team's responsibilities. Here are the possible executive assignment categories:
President - Overall Leadership: Coordinates all functional areas, participates in all areas, setting objectives,
organizing and assigning work, managing schedules and meetings, monitoring overall performance (balanced
scorecard), and managing the team to lead the industry.
Vice President, Marketing: Delivery of customer needs through brand design, pricing, and advertising.
Vice President, Sales Management: Distribution (location and timing of sales outlets) and sales force
management (number, targeting, and training).
Vice President, Manufacturing: Capacity planning, production scheduling, and quality improvement.
Vice President, Accounting and Finance: Financial performance, cash low management, proLt analysis, and
capital structure.
Vice President, Business Analytics: Analysis of market and operational data.
Vice President, Human Resources: Compensation plans and worker productivity.
There are many variations on this division of tasks. For example, in a Lve-person team the president would also be
responsible for one of the other management positions and the VP of Accounting and Finance could also perform the
role of Vice President of Human Resources.
You could have the leadership responsibility rotate through the team at appropriate points so that almost everyone
obtains leadership experience. The Lrst president could be responsible for organizing the team and the initial Market
Opportunity Analysis and strategy formulation. The second president could be responsible for the test marketing phase.
The third president could lead the development of the plan for the growth phase of your business, including a strategic
analysis and the preparation of the tactical plan, pro formas, and business plan. The fourth president could lead the
execution of the growth plan. Finally, the Lfth president could lead the strategic analysis of your work and performance
since the mid-term strategic analysis and business plan.
Other variations to the team assignments will depend upon the number of participants. If your group has four members,
consider assigning the President a VP responsibility, and combining the VP of Accounting and Finance with the role of
VP of Human Resources, and the VP of Marketing with the role of VP of Business Analytics.
Keep in mind that these guidelines are merely suggestions. Feel free to depart from these guidelines if individual
preferences, experiences, or workloads would allow a more equitable allocation of tasks. Also, do not hesitate to
reallocate responsibility if conlicts arise or the workload is unevenly distributed.
Team Management
Consider the following points about team management. First, very few new ventures succeed without strong leadership,
shared goals, a willingness to compromise, a strong work ethic, and a willingness to carry one's share of the burden.
You will have a very short time to organize your Lrm and bring it on-line as an effective, hard-hitting business enterprise.
None of you can do it alone. You must learn to work as a team with everyone pulling his or her weight in the same
direction.
Second, conlict within the team is inevitable. This is because you must make some tough decisions that are Llled with
uncertainty and risk. You will never have enough information or enough resources to do all that you want.
Furthermore, members of your executive team will have conlicting opinions on strategy, tactics, and resource
management. The ability to resolve conlict and the manner in which it is resolved may very well make the difference in
whether or not you can succeed in business.
Finally, time management will be vital to your success in playing Marketplace. There is more to do than you have time for.
Many teams get bogged down in executive committee meetings.
As a suggestion, the president should preside over each executive meeting, making sure that the discussion does not
wander from the business at hand. Each team meeting should begin with an agenda and a timetable. Meetings should
not last more than two hours. Long, drawn-out meetings are not productive and raise frustration levels about not getting
things done. The meeting should conclude with a set of action items for each executive. The outcome of these actions
should be reviewed at the start of the next meeting.
To facilitate the running of executive meetings, each team member should prepare his/her work in advance. The
executive should know the ins and outs, problems, and tradeoffs of his/her area of responsibility.
When the executive committee meets as a whole, each executive should have a plan of action to recommend to the
team. The executive should be prepared to thoroughly discuss the options open to the company and be lexible on the
Lnal decision of the executive team.
Company Name
Select a name for your enterprise. Start by deLning the image you wish your company to project. Keep in mind what the
name may mean to end-users, your competition, and potential investors.
A good company name is important in establishing a good Lrst impression. You can use it to inluence the expectations
of those who do not know you.
However, your competitive behavior and style of business will ultimately deLne your image and what your name will
come to mean. After all, while the words apple or google have no intrinsic value, Apple and Google have come to
represent highly professional organizations that tend to do things right.
Goals and Strategic Direction
Your company must decide the order of priority for corporate goals and your target market, as well as deLne the
company's mission statement and strategic direction.
At the outset of your business, the single most important set of decisions you will make involves deLning your
organization goals and strategic direction. In essence, you must choose the path you are going to take for the next few
quarters of your business.
The path will cause you to channel your energies, hopefully in a manner that will be productive for both you and the
organization. However, the further you go down that path, the more di^cult it will be to change direction. All of your
investments, both intellectual and Lnancial, will be pumped into an increasingly narrower and more focused set of
decisions.
The Lrst task is to analyze the market information from your market research. This market analysis will help you to
determine the available market opportunities. With this information as a backdrop, you must make decisions in the
following areas:
Corporate Goals: Your company should determine what is most important: proLtability of company as a whole (as
measured by retained earnings), return on investment to the Executive Team, or sales volume.
Target Markets: Your company should decide which market segments to target with your products and which
marketing efforts will most effectively reach those market segments.
Mission Statement: Your company should deLne the mission/purpose of your company, keeping in mind that the
mission statement may be read by customers, investors, and even your competition.
Strategic Direction: Your company should decide where it is headed in the future. What are your future goals for:
market size; geographic markets; competitive posture; and distinctive competency?
Through quarter 3, consider your goals and strategic direction to be tentative. As you gain experience through test
marketing, feel free to modify these initial decisions. However, by quarter 4, your strategic direction should be Lrmly
established. If not, you will probably not have an opportunity to catch up with the leading Lrms in your industry.
Players can sell to all segments in each quarter of sales, and, in most quarters, they will. Even though they are not
targeting a segment, a number of customers of the non-targeted segments may like the products offered and buy them.
Money made from sales to any segment will help revenues and, in turn, will positively affect certain areas of the Balanced
Scorecard, such as Lnancial performance.
The reason players have to designate which segments are their primary and secondary target segment is to enable the
Balanced Scorecard to evaluate their marketing performance. If the majority of a team's sales are in their primary target
market and the second largest amount of sales is in their secondary target segment, then they will have a good score for
marketing. In other words, they are meeting their marketing goals with brand and ad designs that are a good Lt for those
segments. If they have a large number of sales in segments that are not their primary or secondary choices, then their
marketing scores will be lower as they are not appealing to the segments they have targeted.
The balanced scorecard measures several factors of a Lrm's performance to get a rounded view of the company's overall
success rather than just Lnancial success. The players can see the full calculation for how the balanced scorecard is
determined in that section of their team software.
Executive Briefings
The Chairperson of the Board (Instructor) may meet periodically with each team. The Lrst meeting will be during the Lrst
or second quarter of play. During the rest of the simulation exercise, each team will meet with the Chairperson whenever
a set of decisions is to be submitted.
During these executive brieLngs, the team will review its:
Performance
Market analysis
Current decisions
Decisions for the future
Each and every member of the team must be prepared to defend the analysis and the logic behind all of the team's
decisions and plans.
See below for a list of possible discussion topics for meetings with the Chairperson of the Board during each quarter:
Quarter 1
Theme: Introduction and initial goals
All Team Members should:
Explain why you want the job and why you will be good at it.
Review team member selection and how each will help your company to excel.
What image does your company wish to project? After a year and a half of business, what do you want
competitors to say about your Lrm?
Give name of company and rationale for its selection.
President:
Establish speciLc, quantiLable corporate goals and the rationale for them.
Describe the strategic direction your executive team has established for the Lrm and the rationale for such
direction.
Business Analytics:
Name and describe each market segment (provide customer proLles).

Estimate market potential and demand of each segment. Explain assumptions.
Estimate market potential and demand of each metropolitan market. Explain assumptions.
Identify city chosen for test marketing. Explain choice.
Marketing:
Lay out initial strategy for market development (i.e., market entry sequence by segment and geographic area).
Justify.
Describe brands to be produced for chosen segments. Justify features selected.
Sales:
Describe expected sales strategies and tactics.

Lay out initial strategy for market development (i.e., market entry sequence by segment and geographic area).
Justify.
Human Resources:
List and describe the responsibilities assigned to each executive on the team.
Describe team norms and culture.
Production:
Describe and justify your production capacity decisions.
Finance:
Describe your current Lnancial status.

Describe how you plan to Lnance your initial operating investments and expenditures.
Quarter 2
Theme: Let's go to market!
President:
How are you beginning to accomplish your corporate goals?

What do you hope to accomplish in the test market?
How are you functioning as a team?
Business Analytics:
Estimate market demand by segment for each brand. Explain process.

What cities were chosen for test marketing?
Explain your marketing research plan for the test market.
Marketing:
Lay out your marketing strategy for each brand (i.e., marketing mix). Justify your decision.
Describe any new brands to be produced. Justify features selected.
Sales:
DeLne speciLc, quantiLable goals for the test market.

Describe sales strategy and tactics.
Do you plan to open any new sales o^ces for quarter 3? If so, why?
Human Resources:
Explain and justify your compensation decisions.

Explain your decision regarding the launch of an employee survey. Whether you have scheduled a survey or not,
justify your decision.
Production:
Describe and justify your production facility decisions, Lxed capacity.

Describe and justify your production scheduling decisions. What have been the results of your production
simulations?
Finance:
DeLne speciLc, quantiLable, Lnancial goals for the test market.

Describe your current Lnancial status. Prepare pro forma cash low, balance sheet and income statement for the
quarter.
Justify your pricing decisions. Show how all expenditures are accounted for in your Lnal selling price. Allocate
each expenditure (by proportion) against your sales Lgures.
Quarter 3
Theme: The results are in! What now?

President:
How did your performance compare to your corporate goals?

How do you assess your competition?
Are you planning any changes in your corporate goals and/or strategy?
What do you hope to accomplish in the market this quarter?
Business Analytics:
What was the market's reaction to your brands, advertising and prices? How do you compare to your competition?
How do in-store decisions affect market demand?
How do advertising and brand design affect market demand?
Revise estimates of market demand by segment for each brand.
Explain your marketing research plan for the market.
Marketing:
How did your performance compare to your business goals?

How are you revising your goals and strategy for the current market in response to the last quarters' test market?
Lay out your marketing strategy for each brand (i.e., marketing mix).
Estimate advertising impact and Lnancial effectiveness. Compare with your competitors.
Sales:
How did your performance compare to your market goals?

What was your demand per sales person for each test market? How did it compare to the competition? What
caused the differences?
Have your market experiences caused you to revise your goals, strategy, or tactics for the current quarter?
How strong is your position in each market? How can you improve it?
Describe your sales strategy and tactics for each geographic market.
Describe and justify your decisions to open sales o^ces.
Human Resources:
What was your employees' satisfaction level relative to other Lrms? What actions will you take to increase their
satisfaction?
If you administered an employee survey in the previous quarter, what did you discover from the results? Will your
Lrm be investing in studies to Lnd ways to improve operations?
Production:
Review your production facility operation in the previous quarter. How much was produced and sold? Was there
any unmet demand? What are your inventory levels?
How will you revise your daily production scheduling for the current quarter?
How is the reliability of your brands? How does it compare to your competition? What actions will you take to
increase your reliability judgment?
Finance:
How did your performance compare to your Lnancial goals? To other Lrms in the industry?
Are you revising your goals or strategy for the current market in response to the last test market?
Describe your current Lnancial status. How is it affecting your ability to achieve your corporate, marketing and/or
Lnancial goals?
Justify your pricing decisions. Using the Activity Based Costing information provided on the decision template,
evaluate the contribution of each brand and city to the proLtability of the Lrm. Show how all expenditures are
accounted for in your Lnal selling price. Allocate each expenditure (by proportion) against your sales Lgure.
Quarter 4
Theme: So, you want 5,000,000. Present your business plan to venture capitalists.
Prepare Tactical Plan for following quarters.

Prepare pro forma cash low for the following quarters.
Describe and justify your R&D decisions.
Describe and justify any System Improvement actions undertaken.
Quarter 5
Theme: Departures from the business plan.
President:
What is your position in the market?

What is your competition up to now?
What trends are beginning to take shape in the market? How will they affect you?
Are you on target with your business plan? Any departures? If yes, why?
How do you assess your team's performance? What are your strengths and weaknesses? What changes must be
made to become a high-performance team?
Business Analytics:
Are there any changes in the market that will affect you?
What is the market's reaction to your brands, advertising and prices? How do you compare to your competition?
How do in-store decisions affect market demand?
How does advertising and brand design affect market demand?
Forecast market demand by segment for each brand.
What is your marketing research plan?
Marketing:
Are you on target with your marketing goals?

Are you revising your goals, strategy and/or tactics in response to competitive or customer decisions? If yes, how
and what is the anticipated effect?
Lay out your marketing strategy for each brand (i.e., marketing mix).
Describe and justify your R&D decisions.
Sales:
How is your market performance comparing to your market goals? Compare your demand/sales person Lgures
with your competitors. Who is ahead and why?
Have your recent market experiences caused you to revise your goals, strategy and/or tactics in dealing with your
geographic markets?
Describe your most recent tactics and how they are helping or hurting you in achieving your objectives.
Human Resources:
Describe the effectiveness of your compensation packages and their effect on your employees' satisfaction.
If you are starting sales incentives and promotions programs, justify your investments.
What are your plans to increase employee morale and reliability?
Are you investing in system improvement actions? How do your efforts compare to other Lrms?
Production:
Review your production facility operation in the previous quarter.

How will you revise your production scheduling for the current quarter?
Are you investing in system improvement actions? How do your efforts compare to other Lrms?
What are your plans to increase employee morale and manufacturing productivity and reliability?
Finance:
Describe your current Lnancial status. How is it affecting your ability to achieve your marketing and Lnancial
goals?
Evaluate the Lnancial performance of each brand and sales o^ce. Allocate relevant costs and revenues using
Activity Based Costing. Which are the winners or losers?
How must your marketing strategy change in light of your Lnancial performance?
Quarter 6
Theme: Preparing for the big push.
President:
What is your position in the market?

How does your performance compare to your stated goals?
Any surprises from your competition? The customers?
Are you on target with your business plan? Any departures? If yes, why?
What are your current plans for community outreach and being a good neighbor?
Business Analytics:
Are there any changes in the market that may affect you?
Can you quantify the effect of brand design, pricing, advertising, and various in-store decisions on customer
demand?
Forecast market demand by segment for each brand.
What is your marketing research plan?
Marketing:
Are you on target with regard to your marketing goals?
What are you doing to accomplish your end of year objectives?
Lay out your marketing strategy for each brand (i.e., marketing mix). How do they all Lt together into the "Big
Picture"?
Describe any new brands to be produced. Justify decision.
Sales:
How does your market performance compare to your market goals?

Lay out your sales force strategy for each geographic market (i.e., marketing mix). How do they all Lt together into
the "Big Picture"?
What are you doing to win the necessary support you will need from the rest of the executive team to achieve your
year-end sales objectives?
Human Resources:
Describe the effectiveness of your compensation packages and their effect on your employees' satisfaction.
If you are starting sales incentives and promotions programs, justify your investments.
What are your plans to increase employee morale?
Are you investing in system improvement actions? How do your efforts compare to other Lrms? What is the
impact on your employees' morale?
Production:
Review your production facility operation in the previous quarter.

How will you revise your daily production scheduling for the current quarter?
What are you doing to prepare the production operation for the big push in quarter 6?
Finance:
Describe your current Lnancial status. How is it affecting your ability to achieve your marketing and/or Lnancial
goals?
Evaluate the Lnancial performance of each brand and sales o^ce. Allocate relevant costs and revenues using
Activity Based Costing. Which are the winners or losers?
How must your business strategy change in light of your Lnancial performance?
Quarter 7
Theme: Rating your performance.
Review Balanced Scorecard.

How does your company compare to the competition?
Did you achieve your objectives?
What should you have done differently?
Prepare a Lnal report of the company's position and present to investors.
C. Market Research
1. Initial Research: Market Opportunity Analysis (MOA)
2. Types of Information Available
3. Stakeholder Survey
4. Interpreting the Survey Data
5. Understanding What Customers Value
6. Test Marketing: Feedback and Control
7. End User Feedback: Fast Tests
8. Competitive Benchmark
Initially, your company should conduct marketing research to determine:
1. The structure of the market.

2. The market requirements of customers.
3. The strengths and weaknesses of competitors.
This is known as a Market Opportunity Analysis (MOA). An outside research Lrm will collect the data that you will require.
The raw data is available as early as Quarter 1. You should begin the task of interpreting the survey data.
As a starting point, prepare a market proLle for each segment. Look for patterns within and between the segments to
begin to understand what customers value.
Construction of your MOA is a continuing process which will be updated as new information such as end-user feedback
and competitive benchmark results become available in future quarters.
One of the objectives of your continuing MOA must be to develop market forecasts of market potential, market demand,
and/or brand/sales outlet demand. In your Lrst sales quarter, you will be able to conduct test marketing on your product
and other marketing tactics. In the following quarter, you will receive data on customer opinions and competitive tactics.
This test market data should enable you to skillfully adjust your tactics in order to better serve the needs of the market
and outsmart your competition.
Learning Objective
The primary objective of the MOA effort is to give you experience in the study and evaluation of market opportunities.
The starting point of all marketing effort is the determination of the needs and wants of the available markets and an
estimation of the market potential of each segment. The Lrm must then evaluate the relative cost to serve each segment
versus its Lnancial attractiveness.
The ultimate objective is to select one or more target markets for development. The target market decision, in turn,
strongly affects all subsequent marketing decisions, including brand design, pricing, advertisement, media planning, and
distribution. Thus, the Lrst step in the process of strategic planning is Market Opportunity Analysis.
Concepts Emphasized
MOA: The identiLcation and assessment of market opportunities based upon an analysis of:

Market analysis: Sorting through and evaluating the information and ascertaining the strategic implications of the
Lndings.
Laddering and means-end hierarchy: Interpreting the data in terms of the linkages between beneLts and features and
beneLts and values desired.
Forecasting: Prediction of market potential and demand based upon market data and one's assumptions regarding:
1. The accuracy of customer purchase intentions.

2. The ability of their industry to serve the market.
3. The comparative advantage of your Lrm versus your competition.
Initial Research: Market Opportunity Analysis (MOA)
A market opportunity analysis (MOA) is the identiLcation and assessment of market opportunities.
An MOA provides the foundation for designing an effective strategy to capitalize on one or more of the identiLed
opportunities. At this stage in the development of your industry, it is not possible to seriously evaluate your potential
competitors. Just like your company, they are all entrepreneurial Lrms without a track record.
After some quarters, you should be able to judge their strengths and weaknesses and use this information in your
strategic and tactical planning. For now, you must focus on the end-users. They are your ultimate boss, and you must
ascertain what it will take to make them happy.
Your initial MOA should begin with an analysis of your potential customers. The marketing research data that you have
available are patterned after the real-world. The data has been modiLed and simpliLed in order to facilitate its use in the
simulation. Since the market modeled in the simulation is based upon this information, it is important for your Lrm to
analyze the data.
To begin your MOA, read the topics below to learn more about:
Types of Information Available

Interpreting the Survey Data
Understanding What Customers Value
Types of Information Available
There are several types of initial market information that the outside market research Lrm has collected for you. The
major categories are customer needs and wants, use patterns, media preferences, price willing to pay, market size, and
industry employees compensation.
The market data will be reported for the market as a whole. Data for individual cities will not be provided. Only market
size estimates are available for each city. Each type of information is discussed in detail below.
The Lrst part of the market survey seeks to determine what beneLts are sought by each major market segment. Potential
customers are asked to review a list of beneLts and rate their relative importance on a scale from 1 to 100. These values
are then standardized with a mean of 100.
Values between 100 and 110 are well within the norm for the population. They represent minimum performance
requirements for a segment, but do not indicate anything unique about the segment.
It is not until the rating score exceeds the norm that the beneLt becomes an important factor in distinguishing between
segments. You will want to be especially sensitive to the high scores because your Lrm must provide that beneLt in order
to appeal to the segment.
The second part of the survey will provide you with a proLle of the product use of each segment. The proLle includes
information on the different categories of customers, and their speciLc uses or applications for the product. The
information is scaled in the same fashion as the beneLt list, where the mean is equal to 100. Look for distinguishing
factors that are well in excess of 100.
The third type of information to be obtained is the media preferences of the decision makers. (Please note the decision-
maker is responsible for the decision to purchase the product, but may not be the user of the product.) The responses
are standardized with a mean of 100. Again, look for distinguishing factors that are well in excess of 100.
The fourth type of information you will receive is data on the price the customer would consider paying for the ideal
brand.
The Lfth piece of information that will be provided to you is an estimate of total market potential for the next twelve
months. This number is computed for you by multiplying:
the percent of customers who intend to buy

(x) the number of potential customers in each segment
(x) the number of units that a customer is likely to buy in the next 12 months
Please be cautious in using this market information. At best, these estimates are very rough projections. Buying
intentions are notorious for being wrong about actual purchases. The actual purchase rate will ultimately depend upon
how well the product is designed, priced, and distributed, as well as the condition of the economy and how well you and
your competition serve the market.
The Lnal piece of information you will receive is data on employee compensation. To help you make your Lrst
compensation decisions, the Human Resource Department will provide you with the results of a survey showing the
typical salary, health beneLts, vacation, and pension contribution for your industry. Your human resource department will
monitor the compensation packages and productivity levels of all of the Lrms in your industry. Each quarter, you will learn
the salary and beneLts offered to employees by each competitor. Industry experts predict that the Lrms that offer the
best compensation package will tend to have the most productive workers.
Stakeholder Survey
Reputation relects the amount of esteem that your Lrm has earned in the eyes of stakeholders — that is its customers,
employees, suppliers, investors, competitors, and community. To be held in high esteem, your executive team must be
reliable, credible, trustworthy, and responsible. A Lrm that is held in high esteem is more likely to have greater goodwill
and higher sales.
Your reputation is a subjectively determined measure obtained by surveying all of your stakeholders. It ranges from 0 to
100. It takes time to develop a good reputation. Starting out in the 60s, a good score would be in the high 70s by the end
of 6 quarters of business.
The stakeholder survey is conducted in a similar fashion as the brand, ad, price, and reliability research. SpeciLcally, your
marketing research Lrm is hired to conduct personal interviews among a representative sample of stakeholders, in all
segments, in all trading areas where products are sold. In each case, the respondent is not asked to justify his or her
rating, as that would substantially increase the cost.
Also, respondents make their reputation judgments based upon everything a company does for all stakeholder groups. It
can be based upon personal experience, news reports, employee conversations, and even rumor. It is a holistic
assessment of everything you do or do not do. It encompasses everything evaluative about a company. Think about the
reputations of Amazon, Apple, Exon, or Tata; the underlying factors are not easily parsed out.
For clues, study the data on customer satisfaction, employee morale, compensation satisfaction, reliability, productivity,
wealth creation, and the actions that you take for the beneLt of all stakeholders. All of these factors inluence the
reputation that you have earned in the market. But how they are known and integrated within each of us is very di^cult to
know.
To repeat, reputation relects the amount of esteem that your Lrm has earned in the eyes of its customers, employees,
suppliers, investors, competitors, and community. Stakeholder impressions can be colored by your Lrm’s prominent
brands and advertising; employee experiences; corporate success, productivity, and responsiveness; and a willingness to
improve outdated systems and processes. Let these things be your guiding lights.
Interpreting the Survey Data
The interpretation of research data is more art than science. The marketing research Lrm will give you data. Your
analysis and interpretation of the data is needed to convert it into information. Your objective should be to look for
patterns in the data. These patterns should help you understand the overall structure of the market and the subtleties of
each segment.
As a starting point, you receive a market proLle for each segment. Take each section of the survey and summarize the
distinguishing characteristics of each segment.
Once you have a proLle of each segment, look for the patterns within and between the segments. There are no statistical
techniques to help you here. You will have to draw upon your natural insight and creativity. The patterns exist; it is only a
matter of discerning them.
After you have a good mental picture of the segment, give it a name, for example, "the sensory segment" as in toothpaste
users. A name will make it easier to think about the segment and discuss it with your teammates. Choose a name that
embodies the image you have of the segment. To help you out, we have given each segment a tentative name (see the
Game Scenario).
Also, Lnd a picture that conveys the type of people who use the product and how they use it. Attach it to your proLle.
(Look in magazines that carry related ads.) Marketers for new Ford cars have used this technique to help them visualize
their target customers.
In planning for a new car, they assembled a large collection of pictures depicting their target customers and how they use
their cars and placed them on a large bulletin board. Executives would stop by and study the board when they were trying
to resolve di^cult problems. They even held meetings in front of it. Their objective was to make sure they think of their
customers as real people and not as abstractions or tables of numbers.
As noted above, the marketing research Lrm recommends that you study the information on price willing to pay and
potential demand in each segment for all markets. By multiplying price willing to pay times potential demand, you would
obtain an estimate of the Lnancial potential of each market and segment. This information would be very helpful in
selecting your initial target segments and sales outlet locations.
As a word of caution, never forget the difference between market potential and market demand. Market demand will
always be less than market potential. The rate at which market potential is converted into actual sales demand will
depend upon the quality and quantity of the industry's total marketing effort. Your share of that demand will, in turn,
depend upon the quality and quantity of your marketing efforts relative to your competitors'.
As a Lnal note on market surveys, keep in mind that respondents are not infallible in their responses to a researcher's
questions. On occasion, they may not give a response that relects their true position on an issue because they are either
unable or unwilling to do so. As a consequence, it is extremely important that you include market testing in your MOA.
That is, design your brands and ads and set your prices in a fashion that your market survey suggests is best for your
target markets; then see how the market reacts to them. Customers' reactions (actual purchases) are better indicators of
their motives than their words.
Thus, a complete MOA should include a market survey and test marketing. To obtain test market feedback on your
market offering, you will want to purchase Market research.
Understanding What Customers Value
Once you have organized your data by market segment, your interpretative work has just begun. It is necessary to further
translate this data into useful information. SpeciLcally, the data regarding customer needs is very helpful in
understanding the beneLts and costs perceived in the use of the product.
But, this data tells you almost nothing about which components can deliver the beneLts desired or avoid the costs
feared. Also, the data barely touches on the values desired through product use. Customers do not buy components or
features; they buy beneLts. At a higher level, these beneLts help users to accomplish their goals and to realize certain
values or end states.
It is your job to Lgure out how to deliver the value desired. A good way to start is to apply the logic behind the means-end
hierarchy. Take the most important beneLts desired by each segment and speculate on which components or services
will be necessary to deliver these beneLts.
Draw ladders downward linking the beneLts with the features or components (also referred to as attributes) which can be
built into a new product at the production facility. Next, extend the ladder upwards and speculate on the values being
sought through these beneLts.
For each segment, you need to build several ladders linking the available components to the beneLts desired and then up
to the values to be served. Once all of the ladders have been built for each of the important beneLts, try to bring them
together into a coherent whole.
The ladders and the overall means-end hierarchy will be useful in designing your new brands. In fact, this information is a
prerequisite to brand design decisions. It will form the foundation of the Quality Function Deployment (QFD) techniques
to be used in designing brands.
Test Marketing: Feedback and Control
You must recognize that you do not operate in a vacuum. In every case, your marketing decisions are judged on both an
absolute and a relative basis. On an absolute basis, you must satisfy the needs of a target segment if you hope to sell
that segment any product. The more closely you match your market offer to the needs and wants of your marketplace,
the greater will be the interest in your brands.
But your potential customers do not stop with this evaluation. They also compare your market offer to the offer of your
competition. On a relative basis, the better offer will earn the larger share of the business. Thus, it is imperative for you to
periodically check on your competition and compare their marketing programs to your own.
To obtain feedback on your marketing plan, you need to survey your customers and monitor your competition. Your
marketing research Lrm offers two types of test market research that might be of interest - End-User Feedback and
Competitive Benchmark data.
The market research data should be purchased during the test market phase, and periodically thereafter. If your company
wants to subscribe to these services, you must budget for the expenditure during the current quarter. The information will
be collected during the current quarter and will be made available to you at the start of the next quarter of business. If
you purchase Market Research in the current quarter, you will be given a copy of each brand design and rating in the
following quarter.
It is not possible to collect market research data and deliver the results during the same quarter. Events are still in
progress throughout the quarter. It is not until all decisions are Lnalized and submitted to the instructor that the data
collection can begin. As a result, you will always be working with information that is one quarter old.
End User Feedback: Fast Tests
The end-user feedback is in the form of fast tests. The fast tests give you a summary judgment or evaluation of currently
available brands, prices, and advertising copy from your customers' viewpoint. They are labeled Brand Judgment, Price
Judgment and Ad Judgment.
See below for more information on:
Brand, Price, and Ad Ratings

The Source of Fast Test Data
The Use of Fast Test Data
Brand, Price, and Ad Ratings
The brand judgment provides an indication of how closely a brand matches the needs of each market segment. All of the
brands sold in a particular geographic market are rated by several panels of local buyers. Each brand will receive a rating
of between 1 and 100 from each market segment.
A rating of 100 indicates that a brand satisLes all of the needs of the segment. A score of less than 100 indicates that
the brand design is deLcient in some respect. The lower the score, the lower the interest in the brand and the lower the
sales from that segment.
The price judgment is obtained in the same way. The price of every brand in the local market is evaluated by the same
panels of current buyers. Each price is given a score of from 1 to 100 by each of the segments. A good rating is 95 or
higher. Ratings of 100 would indicate the market might actually be willing to pay more.
For the brand judgment, a score of 70 is the minimum needed to serve the market. At this level, customers will begin to
give serious consideration to buying the brand. The score, however, suggests that the market will respond vigorously to
further improvements in brand design.
A judgment score over 90 is considered very good. Demand should increase exponentially as brand ratings climb above
the 70 score minimum, all other things being equal. However, it is not enough to have a high score on one variable; both
dimensions (price and design) must be satisLed simultaneously to win market favor.
Ad Copy Judgments can also be obtained under the fast test program. The ratings represent a summary judgment of the
appeal of an advertisement to each market segment. The consumer panels are asked to evaluate each one of these ads.
For each ad, you will be given a simple rating score that may vary from 1 to 100. A separate rating is obtained from each
segment. The higher the rating, the more appealing the ad is to a market segment. End-users seem to be very demanding
in their evaluation of a Lrm's advertisements. Ratings in the 70s are di^cult to obtain. A rating over 80 is generally
considered to be very good.
The Source of Fast Test Data
To help you visualize how the numbers are derived, it is useful to review the marketing research procedure. SpeciLcally,
your marketing research Lrm has been hired to conduct personal interviews in each trading area that you select for study.
Potential customers are presented with the actual brands, prices, and full color copies of all ads.
The customers evaluate every brand for sale in that market, the price of each brand, and all advertisements that have
been run in any media. As they evaluate each brand, price, or advertisement, they can compare one to another. For
example, when they are conducting the brand judgments, they are permitted to physically examine each brand.
After the brand evaluations are completed, a price card is positioned in front of the brand and the judgments are taken. In
the case of the magazine ads, the tear sheets are mounted on stiff cardboard and presented to each subject in a
different random order.
The end-user is then permitted to sort through the ads until all ads have been rated. (Due to the comparative procedures
employed, the ratings could change as new brands and advertisements are introduced into the market and the evaluation
set is enlarged.)
In each case, the end-user is not asked to justify his or her rating. To expand the study and collect customer opinion
regarding these evaluations would substantially increase the cost.
In addition, the research Lrm has reservations about the accuracy of customer opinion for this application. It is felt that
customers make their purchase decisions based upon the whole package (gestalt) of what is offered rather than an
analysis of individual components or ad beneLts. (The whole is greater than the sum of the parts.)
A sample of subjects is recruited from each market-segment group. Every brand, price, and ad is rated by each sample.
This procedure allows a rating to be computed separately for each segment. Thus, the same price, brand design, or
advertisement may receive a high rating from one segment and a low to moderate rating from the remaining segments. If
your target marketing efforts have been successful, the high ratings should appear in the segment(s) targeted.
The Use of Fast Test Data
To obtain insight into the relative appeal of different features or ad beneLts, it will be necessary for you to apply
deductive reasoning. That is, simultaneously compare several brand designs and their respective ratings.
Ideally, look for two brands that have everything in common except for one or two features. A comparison of the brand
ratings with slightly different brand designs should suggest the relative importance of one feature over another. Because
each segment has a different set of needs, this analysis must be conducted separately for each one. Ad ratings can be
analyzed in the same fashion.
The end-user feedback will be useful in different ways at each stage in your market development. During the test-
marketing phase, the fast tests will be invaluable in testing your assumptions of what the end-user is actually looking for
in a brand, price, or advertisement.
The initial market survey represents a good starting point, but it operates at the abstract level. During test marketing,
customers deal with reality. They can see and touch the Lnal product in its entirety. Their judgments at this point are
closer to their true attitudes. Consequently, the fast tests will provide you with better information to deduce which feature
or beneLt is more appealing than another.
During the introductory phase of the market, you will probably encounter little direct competition. In markets with little
competition, the various judgments are important in terms of their absolute scores. They indicate how closely your
decisions have matched the needs of the market.
As you enter more competitive markets during the growth phase, you should probably turn to relative evaluations of
brand judgments, price judgments and ad copy judgments. In markets with multiple competitors, market share will be
determined more by relative performance than by absolute performance.
This is because the shortcomings of a brand are accentuated when there is a better brand to compare it with. Thus, a
difference in brand scores of Lve points (an 85 versus a 90) can have a disproportionate effect on the crossover to the
better brand. The same is true for price and ad judgments.
During the maturity phase of the market, you will Lnd that the decision-making of all competitors will be greatly reLned.
Poor designs will be phased out, prices will be in line with consumer expectations and the basic ingredients of a good ad
will be widely known. The competitive focus will be on distribution (maximizing showroom exposure), production
(achieving economies of scale), advertising (justifying and allocating large budgets), and price (achieving greater
production economies through small market-share gains).
In this market, the role of the various fast tests will diminish. It will serve more as a monitoring function to track any
unexpected shifts in market opinion.
Competitive Benchmark
The marketing research Lrm offers its competitive benchmark research in addition to its end-user feedback. By using the
competitive benchmark service, you can learn about the competitive environment.
Data can be obtained relative to the demand by segment for every brand in the market, the sales channel decisions, and
the advertising decisions of every competitor.
Essentially, this information will tell you what your competitors did during the previous quarter in any market in which you
might be interested. The competitive benchmark data allows you to keep track of what is happening in the market. That
is, you can obtain a complete record of all of the decisions that were made in the public arena.
For comparison purposes, the end-user feedback research provides qualitative information whereas the competitive
benchmark research provides quantitative data. By combining these data, you should be able to ascertain the strengths
and weaknesses of your own Lrm and your competition.
Brand Demand, Sales Channel Decisions, Sales Force Plans, Advertising decisions
The brand demand data contains estimates of market demand in the selected geographic market. Demand information
is obtained for each brand on the shelf and is broken out by segment. That is, you can observe how many units of a
particular competitor's brand were demanded by each speciLc segment.
Please note that the Lgures represent market demand and not actual sales. A Lrm's production facility may or may not
have had su^cient capacity to satisfy demand. If the Lrm did not have su^cient capacity, actual sales would be less
than demand. Any unmet demand would result in customer ill will. There is no practical way to obtain actual sales
information since this information is proprietary.
The brand demand data also includes local and total market summaries for each company. SpeciLcally, the number of
units demanded by segment is added across all sales channels opened and across all brands on the market. Thus, a
company can observe how many units each segment demanded.
The local and total market summaries are also used to compute market share information. Each company can determine
its market share by segment and for the market as a whole. Finally, the total market summaries can be used to compute
the proportion of each Lrm's total demand that is derived from each of the market segments. This information will
indicate the relative importance of each segment to a company.
You can also obtain information on the sales channel and sales force decisions of every competitor. You can Lnd out
which brands are carried in the showrooms, their sales priority, prices, and whether or not a rebate accompanies any
brand. You can also determine which companies have sales channels open in the city, the size of their sales force and
how many sales people are trained in each segment's needs.
Another type of data that you can obtain is the competitor's advertising program. The ad plans contain information on
the quantity and also quality of their ad campaigns. You can determine what message is being conveyed, its frequency,
its media outlet and its geographic target for every competitor.
Now that you know what data is available, read below to learn about the use of Competitive Benchmark Data. If you can
discover patterns in the decision-making process of end-users and competitors, you will have substantially improved
your odds of succeeding in Marketplace.
Use of Competitive Benchmark Data
The most direct application of the competitive benchmark data is simply keeping track of what is happening in the
market. Too often, young executives are attuned to only what they do to generate business for the company. It is almost
as if the rest of the world does not count.
Then they are heard to complain that the market is not responding to their marketing efforts or that it is over-responding.
What they have failed to realize is that a large portion of their success or failure can be attributed to the actions of their
competitors.
For example, when a company did not observe the expected jump in demand after cutting the price by 20 percent, was it
because competitors also cut their prices on comparable brands? If a sales volume is not experiencing any growth, but
the rest of the industry is doubling sales, the team needs to know that the other competitors have twice as many brands,
twice as many salespeople, and twice as many sales channels in operation.
If the bottom falls out of the market, could it be that everyone scaled back their marketing efforts by raising prices,
reducing sales forces, and cutting back on advertising because there was not enough capacity to meet expected
demand? Was the blitz ad campaign of one company counteracted by the blitz ad campaign of another?
These examples may seem obvious, but too many executive teams do not know why their sales are lat, decreasing, or
even increasing. To determine the effectiveness of their decisions, each team must include the decisions of its
competitors in its analysis. In almost every case, the investment in marketing research is worth the price.
When you receive your marketing research, you will be overwhelmed with numbers. The answers to your questions will
not jump out at you. It will take work to Lnd them. Multiple regression, discriminate analysis, analysis of variance, and
linear programming do not seem to work. They are usually not helpful because there are too many variables working at
the same time, and because many of the relationships are curvilinear.
Most statistical packages assume linear relationships. The key to the analysis is Lnding patterns in the data. Compare
one situation with another. If at all possible, Lnd situations that are nearly identical. If all other things are equal (ceteris
paribus), then it is possible to isolate the effect of a change or difference on a single variable.
For example, if two Lrms in the same market carry a brand with the same features, give it the same sales priority (or
close) and a similar price; then the only major difference between the two cases should be the Lrms' advertising efforts.
To eliminate the effect of sales force, it is suggested that you divide the brand demand by the number of salespeople in
the sales channel.
A company with six salespeople will always generate more demand than one with two, all other things being equal. It is
also suggested that you avoid comparing Lrms that carry vastly different numbers of brands. A Lrm with a wide selection
of brands is likely to generate more total demand than a Lrm offering only one or two brands, even though sales of each
brand might be less if sold individually.
The company might also try different prices and observe the combined effect of differences in brand design and pricing.
Or the company might try vastly different sales priorities and observe the combined effect of design and sales priority.
Obviously, the task becomes more di^cult if more than one variable at a time is affecting sales.
If you wish to determine the relative importance of different design features to a segment, Lnd similar brands being sold
in the same geographic market and compare their brand judgments. If you get lucky (it happens often because more
than one competitor will target the same market), two or three brands will enter the market with only one or two features
that are different. The same is true for advertisement.
As you undertake your marketing research, keep Lve points in mind.
1. Try to set up or Lnd situations in which only one variable is different. Sales managers are able to experiment with
their use of sales priorities, brand selection, prices, and sales force allocation. A sales manager can manipulate
key variables and study their effect on demand. Alternatively, you can engage in experimentation by identifying
situations where only one, or at most two variables are different.
2. You want to look for patterns in the data. A 10 percent price difference may have very little effect on demand for
the high-performance segment, but it could have a sizable effect on the price-conscious segment. The single best
source for discovering these patterns is the city competitor proLles. If you have purchased all of the available test
market data, a special report can be printed that details individual brand demand (by segment) as well as brand,
price, and ad judgments.
This data also includes the media schedule, sales force plans for the city, and the key indicator of demand per
salesperson. The goal is to determine what causes the sales per salesperson for one competitor to be higher or
lower than another. Are there differences in prices, brand judgments, or media plans that might explain the
differences? Does one competitor have more brands targeted to a segment, or more service personnel?
Whatever the sources of differences in demand, the competitor proLles will help you Lnd important clues. Look
for patterns in the data. If you can determine how the market is responding to the decisions of your company and
your competitors, you will have a signiLcant advantage over the competition.
3. You can learn as much from the decisions of others as you can from your own. There is a good chance that one of
your competitors executed a decision that you were considering. By studying the effect of their decision, you can
gain some insight whether or not it was a good course of action. In the same vein, do not limit your market
research to only the cities in which you are represented, especially during the test market phase. Many valuable
lessons may be lost if you focus on only your marketing efforts.
4. Plan on investing some time in reviewing the marketing research. The learning will not come easy. You must
display a considerable amount of insight and creativity to discern the patterns in the data and Lgure out how to
use them to your advantage. Every time you go back and review the data, you can learn something more.
5. Keep in mind that the computer model is logical. When you become frustrated because you cannot Lgure out why
something is happening the way it is, remember that the world of Marketplace is based upon logic. There are no
random events; everything is cause and effect.
It is all patterned after the basic principles of marketing found in most introductory textbooks. In a sense, the
computer model is unrealistic because it is totally logical, but that is the way computers are. (The seemingly
illogical and random part is provided by the players.) To make the programming task manageable, the real world
had to be simpliLed and logically organized. What makes the analysis task di^cult is the large number of decision
variables that are simultaneously inluencing events.
In a sense, your research task is to reverse engineer the Marketplace model - that is, to Lgure out what is in the black box
and how it works through the study of what is observable. You might argue that this approach is unfair or unrealistic, but
is it not what you must do with real consumers and industrial buyers? From the study of their decisions, you try to
determine what makes the customer tick. What goes on in their minds (the black box)? What is motivating them to
action? What is more important - price, state of the art technology, a high sales priority, or something else?
The key to market research in the real world is the discovery of patterns in the decision making of the end user and
competitors. If you can discover these patterns, you will have substantially improved your odds of succeeding in the real
marketplace.
D. Brand Management
1. Brand Management Decisions
2. Brand Design
3. Match Up Benefits and Features
4. Consider the Price the Market Will Bear
5. Test Market
6. Brand Name
7. Brand Loyalty
8. Research and Development
9. R&D Licensing
After completing your market opportunity analysis (MOA), you are asked to make the following brand management
decisions:
Brand design
Brand name
Research and Development
Learning Objective:
The primary objective of the brand management effort is to help you understand the relationship between the abstract
benePts sought by customers and the physical components which can be produced in the production facility.
Consumers buy sex appeal, speed, less work, relaxation, excitement, and so forth. The production facility cannot deal
with these abstractions. As a brand or marketing manager, you must tell the production division what speciLc
components are to be built into each brand.
The entire organization depends upon your ability to evaluate whether component X or component Y provides the right
amount of the desired beneLt. Moreover, will the Lnal selection of components satisfy the complete set of needs of the
customer while keeping the Lnal price within his or her price sensitivity constraints?
A secondary objective of the brand management effort is to help you realize the interdependence between the brand
design and production scheduling. Working to maximize customer satisfaction by providing multiple brand designs will
cause stress in the production facility by negating economies of scale in purchasing and causing lost capacity utilization.
The desire to maximize customer satisfaction must be balanced against the desire to minimize production costs.
Concepts Emphasized
Brand design: Selection of production components which provide the desired level of an abstract beneLt while remaining
within the price constraints of the target market.
Quality Function Deployment (QFD): A technique for systematically matching features to beneLts.
Brand labeling: Selection of a brand name designed to project a deLned image, purpose, or beneLt of a brand.
Target marketing: Selection of individual segments for market development.
Differentiated marketing strategy: Development of a unique marketing strategy for each segment.
-versus-
Mass marketing strategy: Development of a generic marketing strategy designed to appeal to multiple segments.
Decision-making: Evaluation of the pros and cons of available investment options, and making a commitment of
resources to an uncertain future.
Brand Management Decisions
Brand management includes Brand Design, Brand Name, and Research and Development decisions. Your task is to
interpret the abstract beneLts which end users say they want in a brand and select features or components that will
provide the desired beneLts.
During the early stages of market development, this task is Llled with risk. Both you and the consumers lack su^cient
experience to know for sure what will or will not meet their needs. It is not until the consumer sees and uses the physical
product that he or she can truly judge the value of the offer. As the product assortment grows and consumers make their
choices from among the available brands, the relative attractiveness of the available features should become clearer.
Brand Design
Initially, your company should conduct marketing research to determine:

This is known as a Market Opportunity Analysis (MOA).
After you have completed your MOA, your next step is to design a few brands to put on the market. To accomplish this
task, you must: Match up Bene;ts and Features that are attractive to your target market, Consider the Price the Market Will
Bear, and Test Market to Discover the Performance Response Curve.
Through your selection of features and their accompanying costs, you must position each brand favorably relative to your
target market. Choose two segments which you consider to be the most attractive, and design a brand or two for each
segment. It is generally recommended that you avoid designing more than two brands until you receive the results of
your Lrst test marketing efforts.
Your Lrm will be given a set of standard features from which to begin designing brands. The company will later have
additional options which can be obtained with su^cient investment in R&D. Your job is to pick and choose the features
that will appeal, in combination, to your target segment(s). You have several options under each component area.
Each market segment evaluates each component or feature in light of its needs. In some cases, a feature will fall short of
the requirements of one segment, while in another case, it may provide more capability than is needed. Without providing
too little or too much in the way of performance, your goal is to match up the features to the needs of the market.
The role you are fulLlling is that of a brand manager. To help you visualize the responsibility, imagine that you are in a
committee meeting with the engineering staff. Your task is to provide the engineering staff with a speciLcation sheet
(spec sheet) on the product you want them to make in the production facility. This spec sheet lists each component or
feature that will go into the product you intend to test market. You must decide on the exact features. You cannot hedge
your bets. You must commit to the design that you think has the best chance of succeeding.
This responsibility is always di^cult and Llled with risk. As you will discover, it is even more di^cult and risky for a Lrm
that does not have any market experience.
Note the cost to design or modify a brand. You can modify the same brand multiple times in the same quarter and you
will only be charged once. So, if you create brand "A" in quarter 3 and then decide to modify brand "A" while still in quarter
3, you will only be charged once, but if you modify brand "A" once and brand "B" once, you will be charged twice. If you
enter the brand design screen and decide you do not want to design/modify the brand, then use the cancel option so that
you will not be charged.
If you modify a brand that was designed in a prior quarter, you must change the name because it is new brand. The only
exception to this rule is if the brand was created in the current quarter. For example, if you design a brand in quarter 4
and then decide to modify it while still in quarter 4, then you do not have to change the name. You must change the name
for any brand you modify that was designed in a previous quarter.
There are a few important reasons for why the brand name must change when you modify an existing brand. First, it is a
signal to the market that you have made a change, and hopefully, an improvement on the prior edition. To help the market
know that you have purposely modiLed an existing brand, you might give it an extension like 200, Plus, Max, or XL,
anything that will differentiate the upgraded brand from the prior model. You can create an entire product line with
numeric extensions like Apple does with its iPhones. Each new edition has a nigher number to indicate that it is better
than the one that came before.
You can work in the opposite direction as well. For example, you might take out less important features of a highly
successful model to appeal to the lower end of the price performance spectrum. The addition of an extension such as,
Light or Fun Edition, lets the market know that you are offering many of the same beneLts as the high-priced model but at
a lower price.
You may wish to continue selling the earlier edition. If it had good performance ratings, the market might very well wish
to continue buying it, especially if it was marked down a little from a new improved model.
Having multiple brands derived from the same core features enables you to create a product line. You can offer a good
(earliest model), better (previous model), and best (the newest model) edition to appeal to multiple points on the price
performance spectrum.
It is also necessary to change the brand name for accounting and production purposes. The new model needs to have its
own Stock Keep Unit (SKU) identiLcation so that all costs and revenues can be properly allocated to the new model.
Finally, a new name will avoid confusion in the market and within the company. When performance ratings, costs, and ad
messaging change based upon different features, people will wonder what caused the change. The model is not the
same as before, so what is different? The confusion could well work against the goals that you have for the revised
model.
As a matter of good business practice, when you modify an existing brand, change the name to indicate that the new one
is different in some way from the model from which it originated.
Match Up Benefits and Features
Your market opportunity analysis is very important to your understanding of what a customer wants in a product. This
information should help you decide what features to build into your brands in order to satisfy these wants. Many
executives have di^culty coming to grips with this responsibility.
The problem is that customers buy beneLts, not features. Every day, the executive must deal with components - their
design, costs, production, availability, compatibility, etc. In most cases, the customers do not care if the manufacturer
includes component A or component B. All they want to know is, will it do the job?
For this reason, you must understand the value, utility, or beneLt of each and every component or feature that could be
built into your brands. You cannot design a brand without this knowledge.
For your Market Opportunity Analysis, we recommended that you start with the beneLts (wants and needs) most desired
by a target segment and then speculate on the features or components which would provide these beneLts. For the
Brand Design decision, we recommend that you undertake the lip side of that task. That is, start with the features and
speculate on the beneLts delivered by each.
Start by doing some homework in the real world on the product category. Find out the usefulness of each feature and to
whom it would be of use. Not everyone will Lnd each feature to be equally desirable. Then, take the list of the features
available to you and write a brief description of what need is fulLlled or beneLt provided by each feature. You are
essentially building a ladder from features to beneLts.
Next, match up the list of beneLts provided with the list of beneLts sought. This matching process should enable you to
identify which features are likely to appeal to which segments. While the exercise is not foolproof, it should provide you
with a logical basis for designing brands.
While matching up beneLts and features, you must also Consider the Price the Market Will Bear.
Consider the Price the Market Will Bear
Your brand design decision must also include consideration of the price the market is willing to pay. There is always a
price/performance trade-off. Higher performance features will generally cost more than lower performance features. Will
the target market pay for the additional capability?
Your MOA should help you to determine how sensitive your target market is to price versus performance. Consider
establishing a price point for each segment and then designing a brand within that constraint. A good rule of thumb is to
multiply your total materials cost for the component times two or three to obtain an estimate of what the brand would
retail for. (See the total component cost on the brand design screen.)
If the projected brand price is higher than you think the market will bear, you should consider scaling back the design to
Lt the price. In some cases, you may even be able to add features and stay within your price objective. This issue of
pricing will be discussed in more depth under the topic of Brand Price, but it cannot be ignored during your brand design
efforts.
Test Market
After you have completed your initial brand designs, it will be necessary to test market your brands and your suggested
brand prices. Remember that your market survey is based upon an abstract evaluation of theoretical beneLts. Until your
customers see, touch, and use your product, there is no way to know for sure how attractive they will Lnd it.
To bring this point home, suppose you were asked what you would like to have in a candy bar. You could probably tell the
researcher how much you liked caramel, chocolate, nuts and so forth. A manufacturer might then develop four or Lve
versions of your "preferred" candy bar. In a taste test, there is a good chance that the one you "really" like is different from
the one they might have predicted from your survey responses.
Until they combine the ingredients into a particular formula and you taste it, they are simply making an educated guess
about your preferences. In the same vein, the market survey will help you make a good educated guess, but it is still
necessary to test market your brands to determine true consumer preferences.
You should start with the expectation that you will have to revise your initial brands within the Lrst six to nine months.
With so little experience in this market, you will be lucky to have a highly rated brand right from the Lrst.
As a point of comparison, Apple Computer withdrew its pioneering Lisa brand from the market within seven months and
introduced the far more successful Macintosh line. It is not uncommon for a new venture Lrm to upgrade its products
almost immediately after launch. It is virtually impossible to have fully anticipated all of the ways in which a product can
be used (or misused). The objective of your test marketing will be to learn what you did right and what needs to be
improved and then to quickly revise your design to better match end-user requirements.
Another caution to keep in mind is that more is not always better. Some executives might think they could appeal to
lower-end segments by simply cutting the price on a brand with extra features. This tactic will not always work.
To illustrate the point, suppose you placed a scientiLc calculator with 36 special function keys on sale alongside a
standard four-function calculator. Both are sold for the same price. You would Lnd that a good number of customers
would purchase the simpler machine. That is because there is a hidden price in the more complicated calculator.
Customers must spend the time to Lgure out how to work with it. They might also worry about hitting the wrong keys or
in the wrong order. The scientiLc calculator could be intimidating. The point is that for some segments simplicity will be
one of the beneLts sought. Consumers would not necessarily rate the more sophisticated brands as better.
To further illustrate this important point, consider the seven hypothetical response functions:
1. More of a feature is always better. This is the assumption most engineers and product managers make; and in a
large number of cases it is true. For example, a faster processor on a PC will create increasing excitement and
product use among calculation (engineers) and data intensive (order processors) end-users. Greater miles per
gallon, battery life, insulating capability and rpm are almost always desired. However, it is wrong to assume that
more of a feature is always better. Some consumers have different response functions where more does not add
value and may even detract from it.
2. More of the feature will add value to a brand up to a point, but then it ceases to add anything more. For example,
TV manufacturers have found that the addition of stereo sound to a TV created lots of enthusiasm (almost 90% of
all primary TVs sold today have stereo sound). However, adding further sound capability (adding a broader range
of sound reproduction or more powerful speakers) creates no further excitement or additional sales. Some
consumers feel this way about modem speed or storage capacity on a hard drive. Others reach a plateau with the
number of channels on cable TV, the number of speeds on a bike, the horsepower of an engine or the durability of
a fabric.
3. More of the feature will add value, up to a point and beyond that point, more of the feature will detract from the
experience or enjoyment. For example, romance in a movie can be enjoyable, but too much romance can be
overbearing. And, attentive waiters and waitresses can be an asset to a restaurant, but they can quickly become a
nuisance to customers if they constantly interrupt the dinner conversation. And, the amount of carbonation, syrup
and water in a fountain drink all have tight tolerances where too much or too little is undesirable.
4. A little of a feature is just right, more only takes away value. Some consumers do not want anything more on a
calculator than the basic four functions: addition, subtraction, division and multiplication. Each additional function
only adds to confusion and frustration. In other cases, increasing the number of gears on a bicycle, the length of a
manual, the amount of fat in prepared foods or the number of commercials on a TV show will reduce satisfaction
for some consumers.
5. Any amount of the feature is bad. Some consumers feel this way about violence in a movie or TV show. Other
consumers are turned off by: sugar or caffeine in soft drinks, the use of prepared foods in a restaurant, plastic
wrapped fruits and vegetables in the produce department or polyester in clothes.
W. Little interest until threshold is crossed. In cases of many new products, interest remains low until the
capabilities of the product reach a critical level. For example, the personal computer did not become a household
tool until Windows 95 made it easy enough for the average person to use it. Similarly, the Internet did not achieve
widespread adoption until Netscape came on the scene and made very easy to browse the World Wide Web.
7. The presence of some features in a product can have no effect on consumer excitement. Adding high grip pedals
or high grip tires to a bicycle is not likely to cause even a ripple of excitement in customers who are only
concerned about a bike that is comfortable or easy to ride. Other consumers might be indifferent to colorful
brushstrokes, lights, or decals.
In the current exercise, one of your tasks is to ascertain what the response function looks like for different features for
different segments. You can deduce segment preferences and response functions by studying end-user reactions to the
various brand offerings on the market. Try to determine if more or less of a feature improves end-user judgments. Keep
in mind that end-user preferences may or may not match your expectations or prior assumptions. In fact, what you think
makes sense is not important. The objective is to give the end-users what they want, not what you think they should
want.
Comment:
The goal of marketing is to select features that add value to end-users. This goal must be balanced against the goal of
minimizing production costs in order to be able to offer competitive prices and realize substantial proLts for the Lrm.
Therefore, a secondary goal of marketing is to determine which features add the greatest value and which add the least.
If you Lnd indifference between alternate models of the same component, or one is only slightly preferred, perhaps the
model which is used in other brands should be selected. Thus, marketing must understand these response functions so
that they can recommend features which can be standard across multiple brands and which must be unique.
Brand Name
At the same time, you are developing your brand portfolio, it is important to choose a brand names. Even though this
decision will not affect demand generation in Marketplace, it should not be taken lightly. A name can help or hinder
communication. A well-chosen name may convey the totality, essence, image or even, simply, the function of the brand.
The brand name might attract attention and serve in a promotional capacity, or it can be a clever play on words that
makes people smile or otherwise stop to notice the name. For example, Excel is a spread sheet program by Microsoft
that says nothing about the product, but might communicate to the user that the user can "excel" by using the product.
Other names that denote excellence might include the Intel Pentium computer chip, InLnity automobiles or Craftsman
power-tools.
Fun brand names include PlayStation (a video game console), Red Robin or Swiffer. Brand names which convey the
activity or functional use of the product include the Fitbit (a small activity tracking device worn on your wrist, intended to
help users get into shape), Mr. Clean (household products) or Dunkin Donuts.
Sometimes, brand names have no meaning whatsoever, but develop an identity from use. A good example of such a
brand name is Kleenex tissues. And Lnally, many companies use numbers or letters in their brand names to indicate the
difference between later versions and early ones (ex. Windows 11 versus Windows 10), or between economical models
(iPhone 13 Pro Mini) and full performance models (iPhone 14 Max).
A brand name will project an image of the Lrm. Careful attention to the name can ensure that the right kind of image is
projected.
Finally, brand recognition can also help boost sales. If a previous brand named "Titan" had good sales, and you now want
to modify the brand to include new R&D, you will want to retain at least 60% of the original name so that customers will
recognize it as a continuation of the "Titan" line. You could name it "Titan II", "Titan 200" or something similar. This will
not guarantee you any sales, but it does improve your chances by playing off the loyalty already created with the original
"Titan" brand. Having extensions such as these will enable you to create a "product line" that is recognized as have a
common core value plus a signal that there are important differences between models.
Brand Loyalty
Brand loyalty is expressed as positive feelings towards a brand and a desire to purchase it now and in the future. Brand
loyalty is acquired by providing products that meet and exceed the customer's needs and wants. It can be built up
through
1. brand designs that deliver the most value,

2. pricing that Lts the customer's pocketbook,
3. advertising that appeals to their needs and wants,
4. informed and responsive sales and service personnel, and
5. quality manufacturing.
Brand loyal customers are less price-sensitive and less affected by competitor product enhancements, advertising
appeals, service enticements, and quality improvements.
But loyalty is not unassailable. It can get strained and even overcome if competitors have signiLcant advantages in any
of these areas.
There are also lessons here for you as you challenge competitors. For you to weaken the brand loyalty of their brands,
you must be substantially better in value, price, advertising, sales and support, and quality. Small improvements over
what your competitors offer will not cause many of their customers to switch their loyalty to you.
Research and Development
Initially, you have a modest set of components with which to design new brands. Through research and development
(R&D), you can add new features.
The R&D features are expected to cause considerable excitement in the market. In every case, they are capable of
outperforming a currently available component or providing a beneLt that is not now available. If incorporated into new
brand designs, these features could make existing models virtually obsolete within certain market segments.
R&D is necessary as both an offensive and a defensive tactic. As an offensive weapon, R&D-based brands will facilitate
your efforts to capture market share from competing brands with older technology. Moreover, if you are the Lrst on the
market with state of the art technology, you will enjoy certain pioneer advantages in the form of customer loyalty. As a
defensive weapon, you may have to match your competition in order to keep from losing business to superior brands.
Investment Schedule for R&D
To bring the new features out of the lab and into the production, you must invest in the necessary R&D. The exact cost for
completing the R&D for any project is determined by the degree of di^culty inherent in the project and the speed at which
you want the work completed.
These costs can be determined by experimenting with the two investment options on your decision template. You can
opt to have the project completed in one quarter (recommended) or in two quarters. As you will see, you can speed up a
project to be ready in the next quarter by investing more money and placing more engineers on the project. However, you
pay a price in e^ciency. Or, you can have your engineers work on the R&D for two quarters and save money. Expanding
the project to two quarters will put less pressure on your engineers and you will not need to assign so many of them to
complete the project.
As you experiment with the two R&D investment options, you will also discover that you cannot afford to undertake all
projects at the same time. You must choose the best two or three projects in which to invest. This, in turn, presumes that
you have selected your target markets and you know the value of each R&D feature to each segment. Thus, your R&D
decision must be made in concert with your target market decision and your other Brand Design decisions.
R&D Development Strategies
There are several strategies that you can apply in selecting your research projects.
Invest in Technologies to BenePt One Segment. You can make all of your investments in projects that beneLt
your primary target segment. This strategy could give you a strong technology advantage in that segment but
would put you in a weaker position in your secondary segment.
Invest in Technologies that BenePt Different Segments. You can pick projects that beneLt different segments.
For example, one project could exclusively beneLt your primary segment and a second project could exclusively
beneLt your secondary segment. Each project would add value to the relevant segment but add no value to
another segment. With this strategy, you would advance your bike designs in two segments, but the designs would
not be as strong as having 3 new brand features in one segment.
Invest in Technologies that BenePt Multiple Segments. You can pick projects that beneLt both your primary and
secondary segments at the same time. If you can Lgure out which projects have value in multiple segments, then
your R&D investments could be quite e^cient. However, these projects might not be as valuable as projects that
are speciLcally targeted to a single segment.
License Technology to a Competitor. You can license technologies to your competitors and recoup part or all of
your investment. Any technology that you develop in one quarter, can be licensed to a competitor in the next
quarter. The licensing fee is typically 50% of the development cost. If you sell two licenses, you can receive 100%
of your investment.
License Technology from a Competitor. You can purchase licenses from competitors, often for 50% of the
development cost. It would have to be a technology that the competitor developed in one quarter.
Cross License with a Competitor. You can enter in cross licensing deals where your Lrm and another develop
separate technologies and swap them for one-half the difference in the cost.
R&D Licensing
You have the opportunity to license technology to your competitors. If you license an R&D feature that you have acquired,
you will be able to recoup some of your investment.
To license a technology, you must negotiate the terms with the Lrm that would like to buy it. In particular, you must
decide on which technology to license and the licensing fee. The licensing fee for R&D is a one-time expense and the
payments cannot be spread over multiple quarters.
There are also special terms that might be negotiated. For example, you might limit the resale of the technology to a
third-party or restrict its use in a particular segment. You may wish to add a Lnancial penalty if the contract is broken by
the other party.
Cross-licensing is also possible. You could offer one R&D feature in return for another. There are many different licensing
agreements that are possible.
Here are the minimum conditions that must be fulPlled:
The contract is written by the Lrm that owns the R&D feature and is granting the license.
The seller chooses the technology and the Lrm that is to receive the license.
The seller enters the licensing fee and any special terms that both parties have agreed to.
The minimum licensing fee is 1.00. It is not possible to write a license at zero cost to the buyer.
The seller sends the contract to the buyer in the current quarter for review and approval.
The buyer reviews the contract and either accepts or rejects the terms and conditions of the license.
The buyer must electronically approve the contract and accept the terms before the contract will be executed.
Once the contract is accepted by the buyer, it is non-revocable. In other words, it cannot be undone.
The exchange of technology and money will occur at the start of the quarter indicated in the contract.
Warning: No verbal agreements are acceptable. Only those conditions that are in writing can be enforced. Once the
proposed contract has been sent to the potential buyer, it cannot be revoked or modiLed.
Here is how the licensing works:
A contract that is written in the current quarter will be executed in the next quarter. That is, the money and technology will
be transferred during the processing of all team decisions at the end of each quarter. The transaction will appear on the
books in the next quarter. Thus, there is a one quarter delay in transferring money and technology. It is not possible to
pay in advance for a new technology.
To illustrate the licensing process, suppose Team A invests 2,100,000 in a new R&D feature. Once the feature is available
for Team A to use in new brands, Team A can then license the new feature to any one of its competitors.
Suppose now that Team B wants to license the new R&D feature from Team A for 1,000,000. Team A will write a license
agreement to Team B. Team B will incur the licensing expense and receive the new technology in the following quarter.
Team A will receive the licensing income in the following quarter as well.
E. Advertising
1. Planning the Advertising Program
2. Ad Copy Design
3. Deceptive Advertising
4. Media Placement
5. Advertising Effectiveness
Effective advertising is an important component of your marketing mix. Planning the advertising program for your Lrm
will require you to consider the following:
Ad copy design
Media placement
Advertising effectiveness
Learning Objective
The purpose of this advertising effort is to force you to think through the tradeoffs inherent in advertising and promotion
planning and to see how advertising relates to the broader strategic decisions of the Lrm. To succeed at advertising
design, you must understand what each segment wants in a product and then design an ad that effectively appeals to
those needs.
The advertising decision must be judged against the Lrm's other investment options. With limited resources, would it be
better to spend the next 100,000 on advertising, or could a higher payoff be realized by investing in additional Lxed
production capacity, R&D, or new sales outlets?
Similarly, how much weight should be given to advertising within the marketing strategy of the Lrm? In terms of marginal
returns, which is more important: expanded advertising, further brand development, lower prices, or more sales people?
The size of your advertising budget relative to other expenditures implies a certain set of priorities. To make effective
decisions, you must know your investment options, estimate their payoffs, and consciously establish your strategic
priorities. You will Lnd that these priorities will change as your Lrm and the industry pass through the introductory stage
of the product life cycle, to the growth stage, and on into maturity.
Concepts Emphasized
Ad copy design: Identifying and prioritizing beneLts to be stressed in an ad message.
Media selection: Selecting the right media to achieve the greatest market exposure for a given target market.
Media budgeting: Determining the size of the budget based upon consideration of available resources, competitive
expenditures, target advertising-sales ratios, and advertising objectives.
Advertising effectiveness: Advertising impact and effectiveness of advertising expenditures.
Market positioning: Establishing an image [in part, through ad copy design] relative to target market needs and wants.
Promotional mix: Deciding on relative emphasis of advertising, sales force support and rebates.
Strategic decision making: Determining the relative emphasis of advertising versus important asset investment options,
and other elements of the marketing mix. Learning to make commitments in the face of uncertainty.
Planning the Advertising Program
Advertising is an important part of the marketing mix. It can be used to inform, persuade, and reinforce the market
relative to the qualities of your Lrm, your brands, and your distribution system. An effective ad campaign can help you to
outsell your competition, even if some of your brands are not perfectly positioned relative to the needs of your
customers.
Effective and sizable investments in advertising also create barriers to entry. If the price to overcome your name
recognition and buyer loyalty is su^ciently great, competitors will have to think long and hard before they challenge you
in your markets. In short, advertising can make or break an otherwise effective marketing strategy.
The major disadvantage of advertising is that it is an expense, and not an asset. Once it is spent, you have nothing
tangible to show for it. There is no tangible product, sales channel, or production facility to show to investors.
There is simply a higher probability that customers will buy your product; and it is very di^cult to quantify how that
probability has changed as a result of advertising. Given the serious cash low problems of new ventures, most
entrepreneurs have great di^culty investing in advertising, no matter how important it is.
The advertising decision with which you are faced is composed of three parts: Advertising Copy Design, Media
Placement, and Advertising Effectiveness. For advertising copy design, you must select which beneLts you wish to stress
in your ads and the priority to be given to those beneLts in terms of message emphasis. Media placement includes the
selection of speciLc media in which to place your advertisements, and the number of insertions for each ad during the
planning period. Advertising effectiveness consists of estimating how well you are reaching your target markets,
especially in relation to your competition, and how you can improve the advertising response.
Ad judgment and media effectiveness are segment-speciLc. A good ad placed in the wrong media outlet will be
ineffective, and vice versa. You must design the right message and place it in the right media outlet in order to persuade
each segment.
The size of your company's advertising investment compared to that of your competitors will also inluence total
advertising effectiveness. If your competition outbids you for the attention of your customers, they will take market share
away from you.
With patronage advertising, the objective is to attract customers to the company without reference to a particular brand.
The emphasis is on the company as a whole. You are able to inluence the number of customers being drawn from each
segment by altering the relative emphasis of your advertising to match the media and message preferences of the
different segments.
Once the customers have selected your Lrm as one of their preferred suppliers, brand advertising takes over. The
different brands compete for the attention of the customers who are now predisposed to buy from your Lrm. Brands that
have higher name recognition or have been pre-sold will have higher sales potential.
Ad Copy Design
The copy design decision begins by reviewing the needs and wants of your target market and then designing an
advertising message that should appeal to the segment. To help visualize this responsibility, imagine you are working
with the account representative from your newly employed ad agency.
The advertising agent is skilled in the mechanics of copy preparation and media placement. He or she also has access to
the creative talents of copywriters, graphic designers, photographers, models, and so forth. However, you know more
about your particular business than the account rep or anyone else at the ad agency.
You must provide the agency with the content of the advertisements. You must decide on the message or theme to be
conveyed. The ad agency will then take your guidelines and create an attractive advertisement that conveys the intended
message.
The Marketplace decision template lists the possible beneLts that are thought to be important to various market
segments. To assist the advertising agency in copy preparation, you must select and prioritize the beneLts you want
stressed in your ads. You must decide what is the most important point you want conveyed in an ad.
You must then decide on the second most important beneLt, the third most important, and so on. Taken in combination,
the selection and order of beneLts should serve to position your Lrm and products to match the needs and wants of your
target markets.
If you are unsure about how advertisements are designed, try studying ads for real brands in current periodicals. In most
cases, you will Lnd an ad contains a multifaceted message. That is, several major and minor points are addressed in the
ad. These points highlight needs of the consumer or beneLts of the brand or company.
You can almost rank-order the different points made in the ad by the size of type and their placement on the page (i.e.,
large bold letters at the top versus small letters in the lower right). You should also see the identiLcation of a speciLc
brand or company name. The name is probably not the most important point in the message.
There is probably some key beneLt that gets top billing. All of these factors combine to create a message to a targeted
audience. Again, visualize the marketing or brand manager who approved the content of these ads. You will be fulLlling
that responsibility.
As you design each ad, keep in mind that the importance of the beneLts will vary by segment. An ad designed to one
segment will not appeal to other segments.
Thus, you must design a separate ad for each segment to be targeted. Past experience also suggests that ads should
not convey too many beneLts in the message. As the number of beneLts increases, ad clutter goes up, and message
effectiveness goes down.
Finally, placement of the brand name in the number 1 or number 2 position in an ad will not work as well as you might
think. No one knows your brand or what it stands for in the early quarters of your business. As an attention getter, it is
less effective than a very important beneLt that a segment is looking for. The importance of including the brand name in
the ad is that you want customers to associate the brand name with these beneLts. Therefore, lead the ad with beneLts
that the customers want most and include the brand name lower in the list to build the association between the brand
and the beneLts desired by the segment.
In summary, you must build the content of an ad by manipulating three variables at the same time:
1. What to say in the ad (which beneLts are important to a target segment).

2. How much to say in the ad (how many beneLts to mention in the ad).
3. The priority of the content (what should be given top billing, second, and so forth).
Long ads are not necessarily better than short ads. Experimentation will be necessary to optimize the ad design. The
addition or deletion of a beneLt or the rearrangement of the message priorities could make a noticeable improvement.
Even modest improvements in ad design can greatly extend your advertising expenditure. For example, by improving an
ad's rating from 60 to 90 (out of a possible 100 rating points), your advertising effectiveness jumps by 50% ((90-60)/60).
Alternatively, better ad designs will allow you to spend less on advertising with the same effectiveness.
In making the ad copy design selection, be certain that you can document the beneLts you select. In other words, do not
engage in Deceptive Advertising because you may be subject to penalties.
Note the cost to design or modify an ad. You can modify the same ad multiple times in the same quarter and you will
only be charged once. So, if you create ad "A" in quarter 3 and then decide to modify ad "A" while still in quarter 3, you will
only be charged once, but if you modify ad "A" once and ad "B" once, you will be charged twice. If you enter the ad design
screen and decide you do not want to design/modify the ad, then use the cancel option so that you will not be charged.
Deceptive Advertising
In designing your ads, be careful to select claims that you can document. All ad claims must be supportable by the
market research data for the region or city in which the ad is run. For ads that do not mention a brand name (Company
Ad), you must have at least one brand that satisLes the claim. To design an ad for a speciLc brand, choose "Mention
brand name" from the ad features list. This will allow you to select a speciLc brand to be mentioned in the ad. To design a
company ad, do not choose "Mention brand name".
Ties (or having the same conditions) will allow two or more Lrms to make a superlative claim. The only exception is the
claim "More reliable than any other PC", only one company is allowed to make this claim. If more than one company is
tied for the highest reliability rating then neither company can use this speciLc claim.
For example, if you run an ad in quarter 4 which includes the claim "Lowest price in town", then you must be able to
document that your company has a brand available for sale in quarter 4 that is priced as low as any competitors' brands
were in quarter 3.
It is permissible to test market any conceivable ad copy during the Lrst quarter of sales without the worry of a deceptive
advertising lawsuit. Starting with the second quarter of sales, all claims must be supportable.
Note: Include any applicable rebates for price comparisons.
Caution: All ad claims must be supportable by the market research data for the region or city in which the ad is run. If a
brand is modiLed, any market research data based on the original brand is not valid for the newly modiLed brand.
Ad Claim Requirements
The following list contains all of the possible ad claims and the corresponding technical requirements for each claim.
Mention brand name: There are no speciLc requirements for this claim.
Bargain prices under market avg.: All brands must be priced as low as the average price of all competitor brands
in the previous quarter.
Lowest price in town: Brand must be priced as low as all competitor brands were in the previous quarter.
Rebate - special price deal: A rebate must be offered for the brand.
Technical leader, most R&D: Company must have as many R&D components in their brands available for sale than
any other company had in the previous quarter.
High speed/execution time: There are no speciLc requirements for this claim.
Many bundled applications: Brand must include at least 2 software packages.
Most powerful PC on market: Brand must have as powerful a processor as any competitor brand had in the
previous quarter.
Largest data storage on market: Brand must have as large a data storage as any competitor brand had in the
previous quarter.
New and improved brand: Can be used once per brand when introducing a new brand design or modiLcation.
More freedom, long battery life: Brand must include "Battery: Long-life lithium (laptop)" or better component.
Local sales and support: Company must have sales o^ce staffed by a sales person trained in the "Support"
specialty.
Global sales/service,all 4mkts: Every region must have at least four sales o^ces, each staffed by a sales person
trained in the "Support" specialty.
Feature oBce applications: Brand must include "O^ce software: O^ce" or "O^ce software: O^ce upgrade"
component.
More productive oBce upgrade: Brand must include "O^ce software: O^ce upgrade" component.
Business graphics applications: Brand must include "Other software: Bus. graphics" component.
Bookkeeping applications: Brand must include "Other software: Bookkeeping" component.
Database applications: Brand must include "Other software: Database" component.
Presentation applications: Brand must include "Other software: Presentation" component.
Engineering applications: Brand must include "Other software: Engineering" component.
Manufacturing applications: Brand must include "Other software: Manufacturing" component.
More secure (viruses, attacks): Brand must include "Other software: Security suite" component.
Power management low carbon footprint: Brand must include "Other software: Power Management"
component.
Easy to use, simple design: There are no speciLc requirements for this claim.
Easier on wrists-comfort keyboard: Brand must include "Keyboard & mouse: High comfort" component.
Smart backup system: Brand must include "Special features: Auto backup system" component.
Fail-proof data storage: Brand must include "Hard drive: Fail-proof ultra cap." component.
Easy on eyes with larger screen: Brand must include "Monitor: 19" standard (desktop)", "Monitor: 21" high res.
(desktop)", "Monitor: 32" wide screen (desktop)" or "Monitor: 17" advanced (laptop)" component.
Work tiny detail, high resolution: Brand must include "Monitor: 21" high res. (desktop)" or "Monitor: 32" wide
screen (desktop)" component.
More productive with wide screen: Brand must include "Monitor: 32" wide screen (desktop)" component.
Very easy to use - touch screen: Brand must include "Special features: Touch screen" component.
Sustainable packaging: Brand must include "Packaging: Sustainable" component.
Environmentally responsible: Company must have invested at least in two of the Environmental improvement
actions during previous quarter.
Good neighbor, help community: Company must have invested at least in three of the Good neighbor
improvement actions during previous quarter.
Leader in Conscious Capitalism: Company must have achieved the largest number of Total Conscious Capitalism
Actions on the Conscious Capitalism Scorecard during previous quarter.
Above average Conscious Capitalism: Company must have achieved more than the average number of Total
Conscious Capitalism Actions on the Conscious Capitalism Scorecard during previous quarter.
More reliable than average PC: Company reliability rating must be as high as the average for all competitors in the
previous quarter.
More reliable than any other PC: Company reliability rating must be higher than all competitors were in the
previous quarter. Ties are not allowed for this claim.
Highest rated brand, Traveler: Brand must have been the highest rated for the Traveler segment in the previous
quarter.
Highest rated brand, Mercedes: Brand must have been the highest rated for the Mercedes segment in the
previous quarter.
Highest rated brand, Work Horse: Brand must have been the highest rated for the Workhorse segment in the
previous quarter.
Portable design: Brand must include "Case: Standard (laptop)", "Case: Slim - no lead (laptop)" or "Case: Slim
stylish - no lead (laptop)" component.
Slim portable design: Brand must include "Case: Slim - no lead (laptop)" or "Case: Slim stylish - no lead (laptop)"
component.
New stylish design: Brand must include "Case: Stylish - no lead (desktop)" or "Case: Slim stylish - no lead (laptop)"
component.
Link PCs with network/internet: Brand must include "Networking: Standard" or "Networking: High speed"
component.
High speed network/internet: Brand must include "Networking: High speed" component.
Picture of engineers/scientists: There are no speciLc requirements for this claim.

Picture business professionals: There are no speciLc requirements for this claim.
Picture of business travelers: There are no speciLc requirements for this claim.
Lawsuits
You are free to challenge any ad that a competitor places in the media (excluding the ads for the Lrst quarter of sales).
The process begins when you issue a formal complaint to the Federal Trade Commission (instructor) that a competitor
has engaged in false advertising. At the same time you present the FTC with the complaint, you must submit a copy to
the president of the Lrm(s) named in the complaint. The complaint must be Lled within 24 hours of the quarter being
processed (or as speciLed by the instructor). The complaint can only address ads that were run in the previous quarter,
any ads that were run prior to that have passed the due date required for Lling. Each claim must be Lled in a separate
email.
In the lawsuit, the plaintiff must provide the following information for each claim:
name of the company being sued

name of the ad being cited as false
name of the brand linked to the ad
where the ad was placed (name of media)
quarter in which the ad was run
the speciLc claim which is believed to be false
the reason the claim is false (the facts which make the ad false)
The defendant has 48 hours after the quarter has been processed, to respond to the claim (or as speciLed by the
instructor).
If the defendant wishes to challenge the lawsuit, then the following information must be provided:
name of Lrm Lling the lawsuit

name of the ad being cited as false
name of the brand linked to the ad
where the ad was placed (name of media)
quarter in which the ad was run
the speciLc claim which is believed to be false
the reason the claim is true (the facts which make the ad true)
The FTC will then review the charge(s) and the defense. The FTC will deliver their ruling prior to processing of the current
quarter. Their decisions are Lnal.
Penalties
If a team is found guilty of multiple deceptive advertising claims in the same quarter, it shall be penalized as a single
offense. The FTC reserves the right to adjust these penalties as it deems necessary for fair game play. Using a claim
which has been previously prohibited as the result of a deceptive advertising penalty is itself considered deceptive
advertising and is subject to further prosecution.
If the Lrm is found to be guilty of deceptive advertising, then, the penalty will be as follows:
First offense:
The defendant will not be allowed to make the claim for the next 4 quarters. No other penalty is allowed.
Special note: If a company's Lrst offense occurs during the last quarter of the game, it shall be penalized as the
second offense.
Second offense:
The defendant will be Lned an amount equal to 5% of its total revenues for the quarter in which the false ad was
run. The money will be distributed to the other teams in the industry in such a way as that each team will receive
1/n of the Lne, where n equals the number of Lrms in the industry. The Lrm Lling the winning lawsuit will receive
2/n of the Lne. Also, the defendant will not be allowed to make the claim for the next 4 quarters.
Third offense:
The Lne will be 10% of the defendant's total revenues for the quarter. Also, the defendant will not be allowed to
make the claim for the next 4 quarters.
Fourth offense:
The Lne will be 20% of the defendant's total revenues for the quarter, and so on.
Note: These are the default FTC rules provided as a guideline for the instructor. The instructor may choose to modify
these rules to Lt the particular needs of each game.
Media Placement
The second step in the advertising decision is media planning. The decision template lists examples of different media
that are available to you for communicating to your target markets. Your market opportunity analysis should tell you
which media are more effective in reaching the different segments. After selecting the right media for a particular market
segment, you must decide which ad to run and how many times the ad will run.
You can count on your ad agency to review and select the best media outlets in each category. For example, the agency
will discover the best Business Magazines or the best Trade Journals and place your ads in the top 3 or 4 outlets in that
category. Furthermore, the ad agency will try to avoid saturation in any single magazine. Thus, if you want to place 12
insertions in New Venture Magazines in a given quarter, the ad agency will spread them out so that the ad will appear
every 3rd week in each of the top 3 magazines. As a general rule, the ad agency will select magazines that run weekly.
As you prepare your media plan, you need to worry about media saturation. It is possible to wear out the persuasive
appeal of an advertisement if it is run too many times in the same media category. For example, if you were to run the
same ad 36 times in Sport Magazines, it would appear weekly in the top 3 magazines. This would be too much for the
market to endure. It would be better to create 3 different advertisements and run them a dozen times each or to go to
other media choices that are high on the list for the targeted segment.
Another consideration to keep in mind as you plan your media budget is that your target customers read more than one
type of magazine. They may read general news, leisure and entertainment, or sport magazines. As you expand your
budget, consider more than the highest rated magazine. Exposure in multiple contexts will increase the probability of the
message getting through the clutter of the media and the customer's natural defenses against advertising.
As a general rule, the more often you advertise, the more likely you will move a potential customer through the
awareness, interest, decision, and selection sequence.
However, this rule has three limitations:
1. After a certain point, additional insertions start to result in diminishing returns.

2. The ads must be on target, both in design and placement, to be effective.
3. Your advertising will be judged against the quality and quantity of advertising of your competition. If your
competition does a better overall job than you do, they will capture a larger share of the market.
The ultimate decision that you must make in media planning is how much to invest in advertising. Authors of marketing
textbooks usually identify four methods of setting advertising budgets: all you can afford, competitive parity (i.e., the
same amount as your strongest competitors), percentage of sales (i.e., 5% of projected sales), or objective and task.
Theoretically, the objective and task method is the most attractive because you must spell out your objectives,
assumptions, and the expected payoff of the amount of money invested. Practically speaking, the Lrst three methods
help to establish benchmarks for comparison between brands and competitors and should be part of the decision.
A Lnal point to consider in advertising planning is your Lrm's advertising effectiveness. The Lrst sales outlet to enter a
city will generally encounter buying resistance on the part of the end-user. Local buyers do not know who you are, what
you have to offer, or why they should buy from you.
When you are the new kid on the block, it will usually take a quarter or two for customers to become familiar with your
sales outlet and the brands you carry. Heavy advertising will prove wasteful. A more moderate budget is preferred in
order to move potential customers from the awareness stage to a purchase decision. Later entrants into the market
should not experience this startup problem, although they must overcome the buyer loyalty built up by the pioneering
Lrm.
Breakdown of media discounts
Media cost = Cost per insertion * Number of ad inserts^ (Elasticity for frequency discount)
Elasticity for frequency discount = 0.90
Sample Calculations:
1. Sample media cost per ad insert = 5,000

Number of insertions = 10
Total media cost = 39,716.41
Ending cost per insertion = 3,971.64
2. Sample media cost per ad insert = 5,000
Number of insertions = 100
Total media cost = 315,478.67
Ending cost per insertion = 3,154.79
Advertising Effectiveness
It is important to estimate how well you are reaching your target markets, especially in relation to your competition. While
it is di^cult to estimate advertising impact and Lnancial effectiveness, it can be done with a little work. To obtain an
estimate of major media advertising Lnancial effectiveness, divide the estimate for major media impact by the
advertising budget, this will provide an estimate of major advertising Lnancial effectiveness.
To estimate impact for major media advertisements, multiply the media preferences rating (found in the Media
Preferences report), by the frequency with which the advertisement is run, times the judgment rating of the
advertisement.
Major media impact of an advertisement = media preferences rating

* the number of times the advertisement is run
* the judgment rating of the advertisement
By repeating these steps with different media plans, you can compare the advertising effectiveness of each and
determine which plan will provide the best return for the advertising expenditure.
Equally important, you can compare your advertising impact and Lnancial effectiveness to your competitors. You may be
surprised that the Lrm with the largest advertising budget may not have the most effective advertising campaign.
Please note, advertising impact and Lnancial effectiveness must be computed separately for each segment. That is, it is
segment-speciLc.
F. Sales Office
1. Territory Development
2. Sales Office Management
3. Brand Selection
4. Brand Price
5. Costs of Production and Operations
6. Price Elasticity
7. Competitive Prices
8. Price Rebate
9. Sales Order Priority
10. Sales Force Management
11. Number of Sales People
12. Target Market Specialty
13. Special Sales Force Programs
Distribution is one of the least understood elements of the marketing mix. Most of us can relate to brand design, pricing,
and advertising decisions because they impact upon us as consumers of household and personal goods. It is rare for
most of us to have any experience with distribution.
When we walk into the grocery store, we assume that the detergent, milk, cereal, or whatever else we want will be there,
because it has always been there. Who thinks about how it got there or why one brand is on the top shelf and another is
on the bottom, or why one brand is on special but not another, or even why one brand is carried but not another? It is the
job of marketers to worry about these decisions and many more like them.
There are two components to distribution or sales o^ce decisions. First, you must consider Territory Development by
evaluating the sales potential of each city in the world market and decide upon your preferred order of entry.
Second, you must make Sales O^ce Management and Sales Force Management decisions by deciding what brands to
carry, prices, and sales force size and allocation.
Learning Objectives
The primary objective of the sales oBce management effort is to force you to deal with demand management. Your
market orientation can profoundly affect the complexity of your sales o^ce decisions and potential payoffs. If you
consider only the consumer's viewpoint, the task of making sales o^ce decisions is manageable. Through careful study
of the relative contribution of each decision to sales and proLtability, it is possible to Lnd the right combination to
maximize short-term and long-term proLts.
A second objective is to give you experience in sales oBce planning. Brand assortment selection, price determination,
priority setting and sales staff planning are all common selling activities. While limited in comparison to real-world
decision-making, they provide a realistic experience in dealing with the basics of the Sales Force Management.
A third objective is to give you experience in translating customer needs and wants into brand-design speciPcations.
Sales o^ce managers are essentially buying agents for the end-user. Their job is to anticipate and understand end-user
needs and assemble an assortment of brands that will satisfy these needs. Successful sales o^ce managers cannot
afford to simply take what is offered. They must be able to recognize a strong performer from the rest and possibly
become involved in the brand-creation decision itself.
Finally, the objective of the pricing effort is to give you experience in making pricing decisions which simultaneously
consider consumer preferences, competitive pressures, proPtability, and return-on-investment variables. The pricing
exercise should help you to understand the multidimensional nature of the pricing decision. Too often, business people
consider only one variable at a time. They might begin by focusing on markups over cost, or what the market will bear. At
other times, they may concentrate on competition. A few may consider the margin - volume tradeoff and a target return
on investment. All of these variables must be considered simultaneously.
Concepts Emphasized
Sales oBce management: Manipulation of brand assortment, pricing, sales priorities, and sales force strategies to
accomplish sales and proLtability objectives.
Financial strategy: Margin versus turnover operation.
Brand evaluation: Assessing end-user needs and determining the best brand designs to satisfy needs.
Brand assortment: Depth of product line.
Forecasting: Predicting unit sales by brand based upon market potential, current market performance, the predicted
decisions of competitors, and an evaluation of one's own performance versus the predicted performance of others.
Inventory management: Consideration of the opportunity costs of lost demand versus the costs of holding inventory for
safety stocks.
Sales/production coordination: Coordinating production with planned sales events such as manufacturer price rebates
and blitz ad campaigns.
Postponement: Maximizing decision lexibility and minimizing risk by waiting to see what happens.
-versus-
Speculation: Early commitment of resources in order to gain a cost advantage and a jump on competition.
Cash-[ow management: Understanding the sources and uses of money and how various business decisions affect the
availability of cash.
Pricing strategy: Role of price to achieve corporate objectives relative to customer, competition, and proLtability
considerations.
Pricing tactics: Penetration pricing, skim-the-cream pricing, price lining, and so forth.
Price computation: Overhead and variable costs, cost allocation among brands, margins.
Financial accountability: Return on investment requirements and need for continued corporate Lnancial support.
Pricing economics: Monopoly [only brand with new technology], oligopoly [one or two competitors], or monopolistic
competition [everyone has it, use other variables to differentiate brand].
Price elasticity: The responsiveness of a market segment to a change in price.
Demand management: Manipulation of sales variables to control demand relative to supply and to maximize proLtability
across available brands.
Decision-making: Evaluation of the pros and cons of available investment options and a commitment of resources to an
uncertain future.
Territory Development
Your territory development decision is among the more straightforward decisions with which you are faced. Each city has
a different sales potential or number of prospective buyers. In addition, there are differences in the composition of the
market segments.
One metropolitan area may have a greater proportion of one segment than another city. These differences in market
composition will inluence the sales volume of the different brands on the market.
Your MOA should provide you with a rough estimate of the sales potential by segment and by geographic market.
Determine which markets have the highest concentrations of potential customers in your target segments. With this
information, you should be able to establish a priority list of geographic markets.
As you enter these markets, keep in mind that actual sales will be less than market potential, especially in the early
stages of the industry's product life cycle. Unit demand will depend upon how well the needs of each target market are
fulLlled.
There are other concerns beyond market size to keep in mind as you open sales o^ces. The Lrst is operating expense.
The better markets tend to have higher operating expenses. These include the setup costs (leasehold improvements,
o^ce equipment, furniture, and supplies), quarterly lease rates, and sales force salaries. Thus, the greater market
potential of these markets must be balanced against the greater cost of serving them.
The second factor affecting the location decision is competition. Territories with high demand are likely to attract more
companies, and competition is expected to be stronger. Markets with lesser demand may attract fewer competitors.
Another competitive consideration is that early entrants will have the pioneering advantage of building unchallenged
customer loyalty, but they pay a price in low initial sales due to a lack of customer awareness of the product category.
Late entrants into the market avoid the delays in market recognition but may require one or two quarters to overcome the
brand loyalty factor.
In summary, the territory development decisions are inluenced by market potential, competition, operating expenses,
and advertising economies. The sales appeal of the larger markets must be balanced against the higher overhead to
enter and compete in these markets. Finally, each Lrm should have a basic plan regarding the sequence of markets to be
entered. As information becomes available regarding the decisions of the other companies, this plan should be revised.
Identify the top markets by segment and then decide upon the order of marketing. Decide which sales o^ces will be
open in quarter 2, which will be open in quarter 3, and so forth. When you are Lnished with this priority list, you should
have a timeline of sales o^ce openings by quarter.
As you enter each new market, you will want to address Sales O^ce Management decisions. These decisions can
inluence demand.
Sales Office Management
Brand Design, Brand Pricing, and Advertising Effectiveness are the most important variables affecting demand. A design
that meets the needs of the target market and is priced within their spending limits should be a good sales performer. A
weak design or too high a price will result in a signiLcant reduction in demand relative to market potential.
Advertising is also very important because it is necessary to create awareness of a brand and its want-satisfying
capability for the end-user. Even a good design with an acceptable price cannot achieve its full potential without solid
advertising support.
You can inluence demand by your Sales management. Brand Selection, Pricing, Sales Order Priority and Sales Force
Management can have an incremental effect on demand. A top sales order priority and sales people with technical
training could favorably help the sales of a brand by 20 percent to 40 percent. In addition, Price Rebates can provide a
substantial short-term stimulant to demand.
You have complete lexibility to adjust your sales force by metropolitan market. You can adjust the total number of
salespeople and the relative emphasis they place on different segments.
When allocating your sales people, the Lrst number entered is the total pool of staff available. Subsequent numbers
determine the number of people who will be trained for either speciLc market segments or support. Specialized people
will spend 70% of their time either selling to a speciLc market or performing support, whichever the case may be. The
remaining 30% will be spent selling to all segments evenly. Unassigned sales people will divide their time selling to any
and every one and are less e^cient in sales to any particular market segment but are more likely to meet needs you may
not have planned for.
Brand Selection
One of your most important sales o^ce decisions is the selection of the brands to be sold. If you do not offer what your
customers want, they will not call for a sales presentation or visit your sales o^ces.
Mechanics: Essentially, the Brand Selection decision is the speciLcation of which brands will be sold through your sales
o^ces. Any brand designated for sale must also be given a brand price and assigned a sales priority.
Be careful about moving brands into and out of a market. Brand loyalty increases the longer a particular brand is sold.
This loyalty is lost if you remove the brand for even a single quarter.
Brand Price
All sales to the end-users are through your sales channels. You must establish a sales price for each brand. When setting
the price, you must consider:
1. Cost of manufacturing and operations - for each brand, you are given the value of Cost of Goods. This cost
encompasses all the expenses related to a number of units sold.
2. Price Elasticity - how price sensitive is your target market?
3. Competitive Prices - what price are your competitors going to charge?
Costs of Production and Operations
Your production costs include materials, labor, and production overhead. The cost of materials represents the largest
share of your production costs. Materials costs are variable and are determined by the production volume.
Each feature has a different material cost. These costs drop as your production volume increases. Since some features
cost more than others, the features which you decide to include in your brand design directly affect unit production costs.
Carefully review production costs as you design each brand. They will establish a price loor for the brand, assuming you
intend at least to cover your variable costs.
In addition to production costs, your prices should cover your company overhead expenses, often referred to as General
Sales and Administration (GSA). Overhead includes interest on loans, R&D, engineering, marketing research, advertising,
lease payments, or sales force salaries and training, to name a few.
Interest, marketing research, engineering, leases, and sales force salaries tend to support all brands equally. These
expenses can be allocated to each brand in proportion to its production volume.
Some GSA expenses should not be allocated to a brand simply based upon the number of units produced. For example,
the size of your investment in R&D and advertising will vary by brand.
Therefore, these expenses, and others that vary by brand, should be allocated to individual brands based upon actual
expenditures. The technique of allocating expenses to their correct activity is termed Activity Based Costing (ABC). An
ABC analysis is provided in the brand proLtability section of the template under brand management.
Your price should also include a target proLt level. Low-volume, high-ticket brands usually include more proLt than high-
volume, low-price brands. Keep in mind that your net proLts will determine your ability to expand from internally
generated funds and are a measure of your success. Many executives fail to price for future growth.
Price Elasticity
Your pricing decision should also consider what the market will bear. All segments are responsive to lower prices.
However, some are less sensitive than others. To some segments, a ten percent difference in price will have little bearing
on demand. In other cases, the difference could cause a substantial switch from one brand to another.
It is very important to test and know the Price Elasticity (sensitivity) of your target segments. This knowledge will help
you to decide whether to use penetration pricing (deep price cuts), Price Rebates, or skim-the-cream pricing (premium
prices).
In addition to segment-speciLc price sensitivity, it is believed that the total market will expand as prices drop. Thus, as
your prices drop, expect more potential customers to shift into an active buying mode. The rate at which customers enter
the market as prices drop will vary by market segment.
Competitive Prices
The Lnal consideration in setting prices is the action of your competitors. If they price below you, they can expect a larger
share of the market, all other things being equal. The size of this brand switching will be dependent upon the sensitivity
of the segment to pricing issues and the size of the difference.
Keep in mind that your Lrm will develop a company price image. If your Lrm's average price is below the competition, the
price differential should help in generating more demand and taking business away from your competition.
You should also recognize that this price sensitivity extends to your own product line. Your lower-priced models will be
more attractive than your higher-priced brands for any given market segment. Even if no other competitor is in your sales
area, your brands will compete with each other for market share.
Again, test the market's sensitivity to prices. Also, determine if the added sales volume is worth the decline in gross
margin due to the lower price.
As a planning tool, you might wish to prepare a price worksheet for each brand you carry. The worksheet would include
the identity of the target market, suggested brand price, price sensitivity of the target market, predicted price judgment,
brand prices of comparable competing brands, and a breakdown of your direct variable costs, and advertising.
It would also include a sales volume estimate and a total proLt contribution (proLt margin * sales volume) for each
brand. This worksheet should help you to visualize the different variables affecting your pricing decision and ensure that
they are a conscious part of the decision. It will also be a good resource for your marketing plan and to use in meetings
with the chairperson of the board.
Note: The price judgment ratings are based on the Lnal price after any rebates.
Price Rebate
Price rebates are a short-term stimulant to market demand. Rebates are popular amongst price sensitive customers and,
as a consequence, they are good tra^c builders for sales outlets. Among price sensitive customers, rebates create
excitement and encourage them to buy immediately. This inclination can be relected in the price judgments. A brand
with a rebate can achieve a better price judgment compared to a brand with regular price cut of the same amount.
But, this does not work with the price inelastic segments. For these customers, a rebate suggests something negative,
like the store is trying to unload unwanted inventory. Price judgments can actually get worse when you offer rebates to
these segments. Therefore, consider using rebates with the price sensitive segments and avoid them with the value-
driven segments.
A down side of a rebate program is that you may be borrowing from future sales. Some of your customers may have
been intending to buy at a later date. Rebates simply encourage them to act sooner. In addition, a large proportion of the
customers would have made their purchases without a rebate. Also, while your price image will be improved in the
quarter of the sale, it will deteriorate in the quarter the rebate is removed, as customers perceive a price increase.
Rebates in the order of 100 to 300 are typical for price-sensitive customers.
You can expect that 50 percent of all sales made during the quarter in which a rebate of this magnitude is offered will
result in a rebate request. The farther that you increase the rebates above this range, the more likely the customers are to
claim the rebates.
Disproportionally large rebates will also affect customers' perception of price. In other words, if you price a product too
high and also offer a large rebate on it, you should not expect your customers to perceive the actual price they pay as the
full price minus the rebate. Your customers will have to come up with the cash to cover the full price before they receive
the rebate later. Buyers will tend to ignore unusually high rebates and will be discouraged from making a purchase if the
price seems too high.
Sales Order Priority
Once you have decided which brands to carry in your showroom, you must then decide on the sales priority for each
brand. The sales priority is a clear indicator to the sales staff regarding management's interest in selling one brand over
the other.
The brand given the number one priority will be pushed the hardest by the sales people. A brand given a number two
priority would be promoted hard by the sales staff, but not as hard as the number one brand. A brand with a number 10
priority would be almost ignored by the sales staff. Customers would have to come looking for the brand and be
determined to not accept any substitutions.
The sales order priority will also be used in establishing the shelf locations in your showroom. A good shelf location will
improve the visibility of the brand, encourage closer inspection, and may even stimulate impulse buying. Thus, the same
brand will sell in larger quantities in a high-tra^c location near the front of the showroom than in an out-of-the-way spot
in the back of the showroom, all other things being equal.
Sales Force Management
Your next Sales Channel decision is sales force management. You must decide the Number of Sales People to employ in
each sales outlet, and where to focus their efforts.
It is critical to hire and place sales people based upon the demand and proLt potential of each market and segment.
Number of Sales People
The number one decision to make in Sales Force Management is how many salespeople to employ in each city. Demand
is thought to be directly affected by the number of salespeople that you place in a market. As you add salespeople, unit
sales will increase, but at a decreasing rate.
The support people will spend 70% of their time supporting the products and 30% in sales. Their role is to enhance sales
to segments concerned with after sales support for their products. As the demand from sales outlets grows, so should
the number of support people and overall sales people. One support person in each sales o^ce may be su^cient to
begin with, but as sales rise, more than one support person will probably be needed to be able to adequately provide after
sales support and satisfy the customer needs.
There is a Lnancial cost for adjusting the size of your sales force from quarter to quarter. It is costly to Lnd and hire new
sales people. The cost of recruiting new sales people escalates as the number of sales people increases because of the
di^culty of Lnding qualiLed people. Similarly, it is costly to lay sales people off. Also, the market is a little sensitive to a
decrease in the sales staff. From the customer's viewpoint, a reduction in staff generally indicates a drop in service.
There are practical limits to the number of sales people you can employ in a market. After a while, they begin to get in
each other's way. The number of sales people to hire will depend upon the market potential of the city and the quality of
your brands, prices, and advertising relative to market needs and competition.
In the early stages of the market, you can assume that each sales person will sell between 30 and 70 units per quarter.
Initially, a conservative approach would be to estimate that each salesperson sells 50 units in a given quarter.
Caution: These starting Lgures for demand estimates are based upon the averages. Demand can be less or greater than
the estimates given here if your marketing efforts are well below or above the average.
As you gain experience in the market and reLne your marketing decisions, the number of sales per salesperson will
increase and the sales curve will likely move upward. Later, when you introduce new technology and substantially invest
in advertising and sales training, the curve is likely to shift upwards again. Just how high the curve will move will depend
on the size of the target segment and the marketing decisions made by you and your competition.
As you can ascertain from this discussion, the number of units sold per sales person is a critical number to watch. Be
certain to compute this Lgure for each segment in each city and compare it to your competition's estimate in order to
gauge the effectiveness of your marketing efforts.
Target Market Specialty
One particularly important dimension of the sales force decision stems from their market training. You can favorably
inluence the sales of a brand by having some of the sales staff receive special training on speciLc segment's needs.
The training program has a modest cost per salesperson. With this training, your salespeople will be more
knowledgeable about a particular segment's needs, more persuasive in closing the deal, and provide better support to
the customer after the sale is complete.
The designation of a Target Market Specialty will also direct the salesperson when making outside cold calls. If a
salesperson has received training to specialize in the Workhorse segment, then he or she will look for customers that Lt
the proLle of the Workhorse segment and largely ignore the other segments.
To illustrate this point, imagine a salesperson driving through a major market looking for new business. He or she might
stop at all of the small businesses but bypass most of the production facilities or engineering Lrms. The latter
businesses are in the Mercedes segment. The salesperson is not well equipped to sell to these segments and therefore
he or she tends to ignore them.
Overall, the specialized sales person can still be expected to support all the brands carried, but he or she will be targeted
toward a speciLc segment. In any case, the more sales people you assign to speciLc segments, the more effective your
total marketing effort will be, versus your competition.
A second important option of the target market decision is whether to allocate one or more sales people to a
service/support role. Certain segments are concerned about after-sale support. They want to have someone available to
help with installation and troubleshooting, should problems develop. You can enhance your sales to these segments by
assigning sales people to this service role. The beneLt is spread across all segments concerned about sales support.
These service support personnel do little direct selling; however, they do enhance the selling potential of your other sales
personnel.
Special Sales Force Programs
In additional to Lnancial incentive programs, you can undertake three company-wide sales support programs. The Lrst is
a professional training program where salespeople can develop skills related to teamwork, interpersonal relations,
making presentations, and proposal writing.
The professional training is also designed to further develop the sales forces' understanding of business practices and
methods and keep them informed about the latest philosophies and theories of business. The effect of this kind of
training is much more di^cult to measure but is thought to add to the professionalism of the sales force, which
enhances the company's reputation among your customers.
The second support program that you can offer is a company-wide sales contest. In this case, the contest is for a special
vacation trip for the top performers among your sales staff. These vacation contests are strong motivators, especially for
the more expensive and exotic vacations.
The disadvantage is that the incentive to excel can decline in the quarter following a sales contest. The staff works hard
to close their pending deals and exhausts their sales leads during the contest period. These contests must also be
coordinated with the production facility to insure that daily production schedules are properly balanced.
The Lnal support program is the demonstration kit. These kits are notebooks containing professional presentations
designed to sell product. The advantage of preparing a demonstration kit is that the sales argument can be carefully
thought through, scripted and illustrated to show company products in the most favorable light. They also help to
standardize the sales pitch by the sales force, thus avoiding ill-conceived presentations.
While these demonstration kits enhance the selling power of the sales staff, they do not provide a sudden boost to sales.
They are more likely to add to the professionalism of the staff and enhance the company's image. Over time, these
beneLts add to the marketability of your products and customer loyalty.
G. Human Resource Management
Human Resource Management entails recruiting the best employees, satisfying their needs, and motivating them to
excel. The primary vehicle available to you to recruit, satisfy, and motivate employees is the compensation package that
you offer them. The package includes an annual salary, health beneLts, vacation time, and a contribution to the
employees' pension fund.
Each quarter, you must decide how much to pay your employees. You are free to set different compensation packages
for the sales people, production supervisors, and production workers. Worker expectations and industry norms are
different in each case. You must also estimate the productivity level of the sales people and production workers
considering your compensation packages and your expectations of your competitors' adjustments.
To help you make your Lrst compensation decisions, the Human Resource Department will provide you with the results
of a survey showing the typical salary, health beneLts, vacation, and pension contribution for your industry.
Each quarter, the Human Resource Department will also survey employees of your industry as to which areas of their
employment package they would like to see improved. In the early quarters, they will most likely want to see signiLcant
improvement in their salary base. As salaries improve, they will begin to shift their focus to other things such as their
health beneLts, vacation time and pension contributions. These changes will be relected in the survey results.
Finally, your Human Resource Department will monitor the compensation packages and productivity levels of all of the
Lrms in your industry.
Each quarter, you will learn the salary and beneLts offered to sales people, production supervisors, and production
workers by each competitor. Industry experts predict that the Lrms that offer the best compensation package will tend to
have the most productive employees. This is very important.
This will mean that each sales person will sell more units during the quarter, all other things being equal. For example, a
Lrm that is on the bottom of the pay scale might have sales people that generate 30 units per sales person while a Lrm at
the top of the pay scale might have employees that generate 70 units per sales people, assuming everything else is the
same.
The same is expected for production workers. If you pay the lowest wage in the industry, your effective operating
capacity might drop by 30% or more. For example, if you have 30 units scheduled per day, the effective capacity could be
as low as 21 units per day. You will have as many employees as every other Lrm with an operating capacity of 30 units
per day, but your production employees will not work as hard. With lower productivity, the labor content of each unit
produced goes up, in turn, driving up the total production cost of each unit.
The importance of the compensation package and its effect on employee motivation and productivity cannot be
emphasized enough. Unhappy employees do not work as hard or as effectively. Unhappy sales people do not generate as
much revenue. Lower revenues and higher costs can strangle a company.
Over time, there will be upward pressure on compensation packages. Initially, the pressure will come from employees
who simply want a better paying job. Later on, it will result from employees being able to move to better paying jobs with
the competition. After all, who can fault anyone from moving to another company to obtain a higher salary? When they
move, you will be left with less skillful and motivated personnel.
What is the best compensation package? It is hard to know. At the very least, you should strive to be near the top of the
industry. Do you need to offer the best package of salary, health beneLts, vacation time, and pension contribution? This,
you will have to discover.
As a word of caution, do not overemphasize the results of the employee surveys. There are lots of problems with survey
research. It is very di^cult to obtain a true reading of how people feel by asking them questions in a survey. Rather, their
actions are better indicators of their true feelings than words. Thus, look at how employees respond to the packages that
are offered. Their productivity levels will be a good indicator of their motivation. Look at how productivity changes with
different packages, in addition to the survey results.
H. Manufacturing
1. Production Facility Location
2. Fixed Production Capacity
3. Financial Tradeoffs in the Capacity Decision
4. Scheduling Production Capacity
5. Lean Manufacturing
6. Demand Forecast
7. Selecting Brands
8. Maximum Inventory
9. Unwanted Inventory
10. Operating Production Capacity
11. System Improvements
Your manufacturing strategy and decisions will focus on investments in Lxed production capacity and production
scheduling to meet projected quarterly demand.
Learning Objective: The purpose of the manufacturing decisions is to introduce you to some of the trade-offs inherent
in production planning, and to see how they relate to the broader strategic decisions of the Prm.
As your Lrm gains experience in the market and is better able to predict events and demand, you should be able to work
through these trade-offs more quickly. You will also become more comfortable making the necessary decisions. Finally,
you will Lnd that your preference for decision lexibility over cost savings will shift as the product moves out of the
introductory stage through the growth stage and into the maturity phase of its life cycle.
Concepts Emphasized
Forecasting: Predicting unit sales by brand based upon:
1. Market potential.
2. Current market performance.
3. The predicted decisions of competitors.
4. The evaluation of one's own performance versus the predicted performance of others.
Production planning: Determining the timing and size of production investments.
Financial management: Allocation of a scarce resource among production scheduling, inventory investment, and living
within a budget.
Cash [ow: Understanding the sources and uses of money and how various business decisions affect the availability of
cash.
Inventory management: Consideration of the opportunity costs of lost demand [including the need for safety stocks]
versus the costs of holding inventory.
Postponement: Maximizing decision lexibility and minimizing risk by waiting to see what happens
-versus-
Speculation: Early commitment of resources in order to gain a cost advantage and a jump on competition.
Decision making: Evaluation of the pros and cons of available investment options and making a commitment of
Production Facility Location
Due to very favorable economic incentives from the government, the microcomputer and electronics industries are
gravitating to the industrial areas around Shanghai, China. Thus, your production facility will be in the Shanghai area. You
will not be able to change the production location or add new production facilities later. However, you can increase the
Lxed production capacity as your demand grows over time.
Fixed Production Capacity
Your Lrst production-related decision concerns the size of the production facility - Lxed capacity. There are two kinds of
production settings, Lxed capacity and daily operating capacity. Fixed production capacity determines the maximum
number of units your production facility can produce each day. Operating capacity determines the number of workers to
employ, and thus, the number of units that are produced each day. Operating capacity must always be less than Lxed
capacity.
The decision to increase Lxed capacity has a one-quarter delay. In other words, if you decide to increase Lxed capacity in
quarter 3, the change in Lxed capacity will not actually be completed until the start of quarter 4. You will not be able to
begin producing the additional units until that time. Thus, it is important to always be looking into the future and
forecasting your demand requirements one or two quarters out.
Once a production line is in place, the Vice President of Manufacturing can decide how much of that Lxed capacity to
schedule for daily production in the current quarter. It is possible to adjust operating capacity up or down by adjusting the
number of workers employed.
A key driver in determining demand will be the number of sales outlets that you operate. As you expand distribution, plan
on adding more Lxed capacity. As you add new brands and new sales people, also consider production facility
expansions.
Financial Tradeoffs in the Capacity Decision
A major factor affecting your decision to increase Lxed capacity is the amount of cash available to pay for the increase.
As you will discover, you will rarely have enough equity capital to satisfy all of your operating requirements. Therefore,
you must decide how much to invest in Lxed production capacity by considering other investment opportunities.
You can minimize your cash low requirements by adding capacity in small steps. That is, if you increase Lxed capacity in
smaller, frequent purchases, you will reduce the amount of equity capital tied up in assets. The unused cash will give you
greater lexibility to respond to unexpected opportunities or problems. If too much of your equity is tied up in Lxed
assets, you may be unable to quickly respond to events in the marketplace.
The problem with smaller purchases of Lxed production capacity is that they are also more expensive in the long run.
They have a higher overhead because of the need to repeat the front-end work of planning and initiating the production
facility addition and the tail-end work of debugging the production line and cleaning up the area.
Larger, less frequent capacity acquisitions avoid much of this extra overhead cost. Consequently, a large, single, one-time
acquisition of Lxed production capacity is less expensive than two acquisitions of half the size. However, the costs of a
one-time Lxed capacity increase very rapidly after a certain level because of the need to quickly Lnd land for production
facility expansion. Your challenge is to balance short-term lexibility against signiLcantly greater, long-term cash outlays.
Scheduling Production Capacity
You must make the following decisions to schedule operating capacity each quarter. You must:
1. forecast demand
2. decide which brands to produce
3. decide the maximum inventory to carry from one quarter to the next
4. decide the operating capacity of the production facility
Each of these decisions is described below, but Lrst, it is necessary to describe the lean manufacturing system that is
employed in your production facility.
Lean Manufacturing
Your production facility is setup for lean manufacturing, or just-in-time production and delivery. The goal of lean
manufacturing is to produce only the quantity of goods that is demanded by customers, and no more. This is
accomplished through the pull manufacturing system. That is, if brand A is being pulled out of the warehouse at a faster
rate by customers than Brand B, then A should be produced more often than B. There is no need to produce large
quantities of Brand B because it is in less demand.
The advantage of the pull system is that there is no need to precisely forecast the demand for any single brand, just the
total assortment of brands. If certain brands are sold more often than others, then the production facility will produce
those brands in larger quantities.
The pull system avoids the age-old problem of forecasting at the brand level. All brand forecasts will be wrong. There will
either be more demand than expected or less. The forecasts will never be just right.
Therefore, the task becomes to forecast total demand, without worrying about individual brands. Of course, there is still
risk in forecasting total demand, but at least it is distributed across the assortment of brands.
Another critical aspect of lean manufacturing is the decision to send workers home if there is no immediate need for
what they could produce. This is probably a surprising aspect of modern manufacturing practice.
Lean manufacturing practitioners argue that it is better to send workers home with full pay than to continue the
production and storage of inventory. This line of thinking is counter-intuitive to many people. Is it not better to run the
production line and keep employees working for the money they are being paid? In most cases, the answer is no. There
are four main reasons for this conclusion.
First and foremost, excess inventory uses up cash. Building inventory takes money out of the bank and puts it in boxes in
the warehouse. Money is expensive and di^cult to obtain. Few Lrms have surplus cash sitting in the checking account.
Second, inventory is composed mostly of material cost and only a small amount of labor and overhead. For example, the
materials cost of a microcomputer might represent 70% to 80% of the Lnal cost of goods. Labor and overhead might
represent only 20% to 30% of the cost. While you cannot delay the labor and overhead costs, the materials cost can be
delayed until a later time when demand is better understood or anticipated.
Third, there is the risk that the market may not desire a new brand. In the early stages of a business, there is considerable
uncertainty about what customers really want. There is a high probability of producing something few customers will
buy. To build inventory of an unproven brand, can be a waste of valuable resources.
Last, the products in storage could become obsolete. As time goes by, better products will enter the market and/or
customer preferences will change. If a product becomes obsolete, the Lrm might need to sell the inventory at a steep
discount in order to get rid of it and recover some of its cost.
There are circumstances in which the buildup of inventory might be acceptable. If a product has a proven track record
and is certain to sell in the future, then small quantities of inventory may not represent much risk. Furthermore, if
production capacity in the next quarter will be insu^cient to meet projected demand, then it might be acceptable to build
inventory in anticipation of the demand. Of course the better solution would be to add capacity rather than inventory.
The bottom line is that you must apply the basic principles of lean manufacturing in your production facility. Some of the
decisions that must be made will make you uncomfortable until you gain some experience and better understand the
system.
Demand Forecast
The key to estimating demand is to estimate the number of units each sales person is likely to sell. Multiply this number
by the number of sales people employed for the quarter to obtain an estimate of the total demand.
In your initial test market, the market will not know who you are or anything about your brands. Also, there is a high
probability that some of your tactics will miss the target and need to be revised. Thus, you should be conservative in your
estimate. As a guide, each sales person will probably sell between 30 and 70 units. A safe estimate for the Lrst sales
quarter is 50 units per sales person.
Demand should rise as you gain experience in the market and improve your brand designs, advertising and sales force
management.
Here are a number of questions you can ask yourself as you prepare to estimate the demand per sales person in quarters
3 and beyond.
Did you change your target market segments? Are you targeting a bigger segment than last quarter? Yes? Demand
should go up. No? Demand should go down.
Did you raise prices? If yes, demand should go down. If you lowered prices, demand should go up. If you changed prices,
the magnitude of the effect on demand will depend upon the elasticity of the target segment. Is the segment price-
sensitive? Yes? Demand should be greatly affected. No? Demand should be moderately affected.
Did you improve your ad designs? Demand should go up.
Did you increase advertising frequency? Demand should go up. Compared to your competition, did you increase it a lot?
Yes? Demand should go up a lot.
Did you increase the number of sales people? A lot or a little? Adding a lot of sales people to a market at one time can
reduce the marginal contribution of the new ones. Thus, demand per sales person should go down.
If you add new brands, will the new brands add just 2 or 3 points to your brand judgments? Yes? Demand should go up a
little. Are you likely to add 5 or more points to your brand judgments? Yes? Demand should increase a good amount.
Have you increased your brand selection? Do you have more brands to offer each segment (micro segmentation)?
Demand should improve.
Did you increase your compensation to your sales people? Are you leading the industry? Yes, demand should improve by
a good amount. Are you in the middle of the pack? Yes? Demand should not be affected too much.
Which of the above do you think will have the greatest impact on demand? Change in target segment, change in brand
design, change in prices, change in sales people, change in sales force compensation, change in ad copy, change in
advertising frequency? If one of these tactics has more of an effect on demand than another, did you put more emphasis
on it?
With all of this qualitative information, you are now ready to make an educated guess as to the impact on demand per
sales person. The more you do to stimulate demand, the greater the unit demand per sales person. The better your
marketing tactics are compared to your competition, the greater the unit demand per sales person.
If you do very little to increase your demand creation activities, your demand will probably decline. This is because your
competition almost certainly upgraded their efforts. If you increased your efforts at the same rate as they did, then your
demand per sales person will likely remain stable.
If you are looking for a nice formula to estimate demand, you will not Lnd one. Forecasting requires good knowledge of
the market and educated guessing about how well you meet customer needs and how well you surpass the competition.
Selecting Brands
Each quarter, you must decide which brands to produce. As you grow your Lrm, you will need to manage your portfolio of
brands. Some will become rising stars while others will become cash cows and still others will become dogs and need to
be discontinued. This is where marketing and manufacturing must be in sync. Choose which brands to produce and their
maximum inventory based upon their importance to your marketing plan and their potential proLtability to the Lrm.
Maximum Inventory
Each quarter, you must decide on the maximum inventory to be held in storage at the end of the quarter. The decision
revolves around the risk inherent in forecasting demand and a desire to keep the production facility running if demand
falls short of the operating capacity scheduled.
In setting the maximum inventory, there are three possible scenarios to consider. First, you might have done a good job in
forecasting demand and the operating capacity is more or less equal to actual demand. In this case, the ending inventory
will be near zero, and thus there is no need to worry about the value of the maximum inventory.
Second, demand might exceed the operating capacity (marketing did a much better job of creating demand than
expected). In this case, there will be stock outs (unhappy customers and lost revenue), but no ending inventory. Again,
the issue of maximum inventory is not a problem.
Third, and most important, demand might be less than the scheduled operating capacity (an overly optimistic forecast).
In this case, the production manager will build product until the maximum inventory level is obtained for each brand in
production. Once the maximum is met, then the production line will be shut down and the production workers will be sent
home for the balance of the quarter, with full pay.
In the Lrst two cases, the value set for the maximum inventory will not affect the performance of the Lrm. In the last
case, the decision revolves around whether to keep the production employees working or to send them home. If they are
sent home, you must still pay their salaries and any overhead that the production facility incurs. The salaries and
overhead will appear in the cash low and income statement as excess capacity costs. If you decide to continue running
the production line, then these costs will not appear in the Lnancial statements as an expense. However, they will appear
in the balance sheet as inventory and the cash account will be reduced by the same amount.
Excess capacity is the difference between scheduled production and actual production as affected by demand and
manufacturing constraints. Excess capacity is counted in both the cost paid for unutilized production space as well as
labor. For example, if 25 units a day are scheduled and 25 units a day are produced, the excess capacity is zero. If 25
units a day are scheduled and only 20 units a day are produced, the excess capacity is 5 units per day (20%).
Unwanted Inventory
Ideally, your goal is to move your products through the production line to the warehouse and on to the customer quickly,
but occasionally you may Lnd that a brand did not sell as expected and it piles up in the warehouse. In that case, you may
want to discontinue the brand and sell the left-over inventory to the secondary market. It takes one full quarter to sell the
unwanted inventory.
Operating Production Capacity
The Lxed capacity sets the maximum number of units the production facility can produce on the assembly line. The
operating production capacity is the number of units actually scheduled for production. By setting the operating capacity,
you effectively tell the production manager how many workers to hire for the quarter and for how long to operate your
production facility each workday.
Your operating capacity cannot exceed your Lxed capacity. If the Lxed capacity is 50 units per day, then the operating
capacity can be no more than 50 units per day.
For example, you may have increased Lxed production capacity enough to produce 50 units per day. However, demand
might be projected to be no more than 30 units per day. You would set your operating capacity at 30 units per day or
1950 units for the quarter. (30 units per day times 65 working days per quarter).The operating capacity could never be
more than 50 units per day. The Lxed capacity is 50 units per day, meaning that 50 units is the largest number of units
the production facility can produce per day.
You can adjust the operating capacity from quarter to quarter as you make changes in your marketing and sales strategy.
The operating production capacity determines the number of workers on the assembly line. If you expect demand to rise
in any given quarter, you can immediately hire more workers and increase the operating capacity. If you expect demand
to fall from the previous quarter, you can lay off part of your workforce and leave part of the production facility idle.
If you anticipate that demand in the next quarter will exceed the current available Lxed capacity, then it will be necessary
to add more Lxed capacity for the next quarter. Remember, it takes one full quarter to add Lxed production capacity.
To determine your daily operating capacity, take your forecasted total demand for all brands and then divide it by 65 days.
Add about 10% to your forecast as a safety stock. The resulting Lgure will give you an estimate of what you should set
your daily operating capacity for the current quarter.
When making the operating capacity decision, there are three costs that must be considered: the cost to employ
production workers per unit (direct labor cost), the overhead cost per unit of capacity, and the expense to change
operating capacity.
The production facility is not operating e^ciently when too little of the production line is used, as well as when the
production facility is at its maximum peak. Experimentation with the operating capacity will be necessary to Lnd the
optimum level of capacity utilization.
As your operating capacity increases, your unit labor and overhead costs will decrease. Lower production costs will
improve proLt margins and/or the Lrm's ability to offer lower prices to your customers.
Unfortunately, there is a limit to the decrease in labor and overhead costs for any given Lxed capacity. As your operating
capacity approaches your Lxed capacity, labor costs and overhead costs will actually increase again. The reason the
costs increase is that the production facility loor gets crowded with people and materials. It is hard to move people and
materials around, and thus ine^ciencies surface and cause cost to rise. Your labor and overhead costs will reach their
maximum when the operating capacity is equal to Lxed capacity.
System Improvements
System improvements represent a diverse set of actions that you can take to improve the lives of a variety of
stakeholders.
Your system improvement work must be taken in three stages; an Employee Survey, Follow-up Studies, and Improvement
Actions.
Employee Survey. Your employees have eyes and ears everywhere. They can be one of your best sources for identifying
problems and opportunities. It might be valuable to ask your employees for suggestions on how to make your company
better. You will probably discover how to improve product reliability, employee productivity, product design, environmental
impact, and even a marketing campaign.
You can survey your employees in the Lrst quarter of sales or a future one. The results will be available in the following
quarter.
Follow-up Studies. After your employees have identiLed a number of issues that might deserve further attention, you can
hire outside consultants to undertake more extensive follow-up studies.
You will need more speciLcs before you can act on your employees' suggestions. You have to decide which of these
areas of concern deserve further investigation. A follow-up study will provide you with additional information on each
topic and a list of actions that could be taken if there are any problems or opportunities. Some of these actions could be
expensive but some might not require any expense whatsoever.
Note that these issues cut across functional lines, but mostly concern human resources and manufacturing. It would be
prudent for HR and Manufacturing to work together in deciding which of these studies to fund.
Improvement Actions. If you undertook the Employee Survey and contracted for the Follow-up Studies, you will then have
an opportunity to act on your priorities. The follow-up studies will identify several actions that can be taken to improve
your production process, employee lives, the environment, the community, as well as other areas of the Lrm. These
actions will be listed under Improvement Actions.
You will Lnd that the Improvement Actions are quite expensive. The process requires continual discovery of smaller and
smaller problems.
You will have to decide on which actions to implement initially and over time. Each action has a setup cost, an expansion
cost, and an operating cost that is dependent upon whether the action is related to Lxed capacity, operating capacity, or
number of workers.
To achieve the full beneLt of a system improvement, you must continue to invest in that action for several quarters.
Importantly, every investment should result in improvements to your production process, employee morale, customer
satisfaction, reputation, and sales.
I. Accounting
1. Accounting Statements
2. Pro Forma
3. Activity Based Costing (ABC)
4. Financial Planning and Analysis
5. Earning a Profit
6. Bankruptcy
7. Independent Auditor
Review the following topics to help make wise decisions regarding your accounting and Lnancial planning:
Accounting Statements
Pro Forma
Activity Based Costing (ABC)
Financial Planning and Analysis
Earning a ProLt
Bankruptcy
Independent Auditor
Learning Objectives: The primary objective of the accounting information is to help you to learn to work within a
budget. Students often complain that the Marketplace requires too much accounting and Lnance. Some feel that they
should not have to worry about cash low requirements in a marketing or new venture class.
In contrast, executives who are familiar with the simulation think it is one of its strongest assets. Every executive is faced
with more opportunities and problems than can be handled with available resources. This condition forces choice and
the analysis of options. Proper assessment of the risks, payoffs, and cash low requirements lie at the core of executive
decision making. The ability to work successfully within a budget while maximizing Return on Investment is vital to every
executive.
A second objective is to help you understand cash [ow and how it impacts the decision making and liquidity of the
Prm. Surprisingly, many new executives do not really understand cash low and how it impacts/constrains decision
making and the pursuit of business opportunities. Many new ventures in the real world fail because of this lack of
understanding. Sound management of the Lrm's cash position can make the difference between a "winner" and an "also
ran" in the business world.
A third objective is to help you understand the importance of evaluating the proPtability of your business decisions
through the use of Activity Based Costing. You should learn to allocate revenues and expenses to their proper activity in
order to assure the proLtability of your brand and sales channel decisions.
Concepts Emphasized
Cash [ow: Understanding the sources and uses of money and how various business decisions affect the availability of
cash.
Financial statements: Understanding how revenues and various expense and investment decisions affect the income
statement and balance sheet.
Pro forma analysis: Projecting the Lnancial impact of expense and investment decisions and revenues on the income
statement, balance sheet, and cash-low statement.
Activity Based Costing: Proper allocation of revenue and expenses to the relevant demand-creating activities.
Accounting and Pnancial concepts: Assets, liabilities, liquidity, margins, turnover, leverage, ROI, payback, and so forth.
Decision making: Evaluation of the pros and cons of available investment options and making a commitment of
Accounting Statements
To help you in your accounting and Lnancial planning, your accounting Lrm has prepared a set of interconnected
Lnancial statements. As you make your business decisions, the accountants will automatically post the expenses or
investments to the accounting ledger and adjust your current quarter cash low statement, income statement, and
balance sheet accordingly.
Starting in the second quarter, the accounting Lrm will show a historical record of your Lnancial decisions and
performance for later analysis. This historical information will be invaluable in assessing the quality of your decisions
given actual market conditions and not just anticipated conditions. Careful review of this Lnancial information relative to
your prior planning and forecasting should help you to adjust your knowledge base and thus your decision-making
process.
In your Lrst sales quarter, you will also be able to project your cash lows for the current and all future quarters. These
Pro Forma Lnancial statements will enable you to explore the Lnancial impact of alternative business scenarios before
committing yourself to any one course of action.
Finally, your accounting Lrm serves the role of Independent Auditor. It has the legal right to refuse to certify your Lnancial
statements if it concludes you are placing your Lrm at risk with overly aggressive expenditures. It will set limits on the
amount of spending you can do in any quarter in order to protect the equity in your Lrm (reduce the risk of Bankruptcy).
Production costs and cost of goods sold (COGS) are very similar, but relate to the difference in time and activity with
regard to the disposition of inventory. When inventory is produced in the production facility, the Lrm incurs production
costs. The inventory sits in the warehouse and the value of the inventory is based upon the cost to produce it. Thus, the
balance sheet shows the inventory according to the cost to produce it.
Once a unit of inventory is sold, it has to be expensed. At that point, the classiLcation for the unit is changed to cost of
goods sold. There is no change in its value, only its designation. This is done for accounting purposes.
Another way to look at it is from the viewpoints of the cash low statement, balance sheet and the income statement. For
example, the production facility might produce 1000 units at a unit production cost of 2000. Thus, the cash low
statement would show that 2,000,000 had been spent on production. Until these units are sold, they will sit in the
warehouse as inventory. On the balance sheet, they will appear as Lnished goods inventory. Their value is 2,000,000 or
2000 for each of the 1000 units.
As time goes by, various units will be sold and the inventory will be drawn down. Suppose 10 units are sold on the Lrst
day, then the accounts must expense these 10 units. The cost of these 10 units will appear on the income statement as a
"cost of goods sold". The unit value is the same as when they were produced or sitting in the warehouse. However, now
the units are sold.
The remaining 990 units are still sitting in the warehouse and they are valued on the balance sheet at their product cost.
It might appear to be semantics, but it helps accounts keep track of inventory and expenditures.
Pro Forma
Current Quarter
The pro forma accounting statements for the current quarter permit you to tentatively enter decisions and observe the
effect on your cash lows, income statement, and balance sheet. They are essentially a budgeting tool.
You are free to make and change any of the tactical decisions in your Lrm up until the time you submit them for
processing. Almost every decision you make affects your Lnancial position by increasing or decreasing the available
cash in your checking account. Some of the decisions are simultaneously relected on the income statement as a current
quarter expense (media advertising, sales force salaries, etc.), while others change the cash to another asset on the
balance sheet (the purchase of additional production capacity or a 3-month certiLcate of deposit). Still other decisions
change the cash account on the asset side of the balance sheet while simultaneously changing either a liability or equity
account on the debt/equity side of the balance sheet (taking out or repaying an emergency loan, etc.).
The important point is that the current quarter Lnancial statements are adjusted with almost every business decision you
make. Statements will change automatically as you change the decisions you are making in the template. Therefore,
think of the current quarter cash low statement, income statement, and balance sheet as pro forma worksheets to help
you in your planning for the current quarter.
To complete the cash low analysis for the current quarter, you will need to run the production simulation and load the
results into the cash low statement. There are a number of production related cash lows that will not be realized until
after your decisions have been submitted for processing and the results are posted to the accounting statements for the
period just ending. Since it is not possible to know the future, you can make some educated guesses about demand and
run them through the production simulator. With whatever numbers you forecast, the production simulation will operate
exactly as it would during processing. Thus, you can see what your production costs might be as well as the number of
units produced and sold for the forecast you made. You can try different forecasts and study their potential effect on
production operations.
The results of the production simulation can be loaded into the Pro Forma cash low statement, income statement, and
balance sheet. Thus, you can see how your production operations could play themselves out in your cash lows, net
income and balance sheet.
It is recommended that you investigate the Lnancial implications of several different demand scenarios by running them
through the production simulation. Observe the effect of your demand projections on production operations and your
Lnancial position. Are you satisLed with it? If not, Lgure out what must be changed in your planned tactics, make the
changes, rerun the simulation and then load the results again into the cash low statement. Even when the numbers are
acceptable, try a different demand or operating scenario and rerun the simulation. Continue in this fashion until you
understand how your decisions are likely to play out in the Lnancial accounts.
It is particularly important to forecast your cash position at the close of the books for the quarter. It is absolutely
imperative to end the quarter with a positive cash position. If you overestimate demand and insu^cient revenue is
generated from sales, then an emergency loan will be taken out for the Lrm to cover the deLcit. As a general rule, your
pro forma cash balance should be at least 300,000 in the early quarters and probably more than 500,000 later on.
Keep in mind that the pro forma is nothing more than an educated guess as to the likely Lnancial outcome of all of your
business decisions. In every case, your forecast will be wrong. You will either generate more cash than you planned or
less. You can only hope that your decisions are good and your forecast is reasonable. After that, you have to sit back and
wait to see what really transpires.
To place this condition in a real-world context, every Lrm must commit its resources in the pursuit of sales even before it
is known what the sales are likely to be. It is not until the books are closed at the end of the accounting period that the
Lrm knows for sure that a positive cash position has been realized and a proLt made.
Once you are satisLed with your decisions and their Lnancial effect on the Lrm, you can submit your decisions for
processing. After the game administrator processes your decisions, they become locked in place and are no longer
reversible.
Future Quarters
During the Marketplace business simulation, you must prepare a business plan for the international market rollout. To
complete this task and determine your funding needs, it will be necessary to develop pro forma cash low projections and
Lnancial statements. (See Chapter Guidelines for Preparing Pro Forma Financial Statements for the Business Plan.)
Cash low planning must be integrated into the business planning process. It is an iterative process whereby you must
Lrst develop a plan of action. Next, you must estimate the cash receipts, disbursements, and funding needs to activate
the plan.
If the plan cannot sustain the cash low capabilities of the Lrm, then you must adjust the plan and the related estimates
of receipts, disbursements, and funding needs. This iterative process continues until your business plan and cash low
can sustain one another.
Thus, the Lrst step in preparing a Lnancial plan is to prepare your strategic plan relative to geographic market entry, sales
force expansion, new product development, advertising, production capacity, etc. Using the tactical plan within the
Marketplace software, you can lay out the tactics of your strategic plan on a quarter-by-quarter basis. For guidance on
how to prepare the tactical plan, please review the chapter on Tactical Plan Guidelines within this help Lle.
With your tactical plan in hand, the next step will be to project all of the related receipts and disbursements from your
business operations. A set of step-by-step guidelines has been prepared to help you through this process. These
guidelines are labeled, Cash Flow Guidelines, and can also be found within this help Lle.
Understand the Connections between Tactics and Cash Flows. As you prepare both your tactical plan and your pro
forma Lnancial statements, always be watchful for the interactions among your decisions. As you add new sales outlets,
you will necessarily add new sales people. As you add new sales people, the cost of your sales force will go up
proportionately. And as you add new sales outlets and new sales people, demand should go up.
The rate at which demand will increase will depend upon the level and quality of your advertising and the addition of new
brand features. If demand goes up, then you must plan production runs to meet demand. In turn, you must purchase Lxed
production capacity at least one quarter in advance. And so forth.
Always keep in mind that demand will not increase without your Lrm taking proactive steps to develop that demand. This
means that you must reLne products, reLne the ad copy, expand advertising budgets, lower prices, introduce new
features, or enter new territories.
Investors Look for the Correspondence between the Plan and the Financials. You are likely to present your business
plan and pro forma Lnancial statements to outside investors. The investors will be looking for detailed plans and
Lnancial projections for several quarters into the future.
Experienced investors know how plans and Lnancial statements work together. They will look at the correspondences
among the tactics, expenditures and revenues. For example, if the investor sees that sales are increasing at a rapid rate,
but the advertising expenditures or the new product introductions are not timed to that expansion, they will rightfully ask
what is driving the increase in demand.
If you are planning a geographic market expansion in a given quarter, the investor would expect to see a jump in market
demand to correspond with that market entry. Similarly, if you anticipate a blitz advertising campaign, the investor would
also expect to see a corresponding increase in demand.
The important point is that your Lrm's sales Lgures in both units and currency amounts should correspond to your
business decisions. Where they appear to be independent, it causes serious concern on the part of the investor as to how
well you are capable of planning your Lrm's future and reasonably anticipating the market's reaction to these plans.
Thus, everything is tied to everything else. The secret to strategic and tactical planning is to recognize which tactical
decisions drive other tactical decisions and how all of these are related to cash lows. The tactical and cash low
guidelines will help you with this process. Be sure to use them.
Determine the Need for Additional Equity or Debt. One very important purpose of the cash low analysis is to determine
your Lnancial position for each and every quarter throughout the planning horizon. That is, you must determine if you will
be Lnancially solvent given your anticipated disbursements and revenues.
It is easy to determine if you will need outside capital to keep your business alive. After you have estimated all of your
cash lows for any quarter, simply look at the bottom of the cash low statement. If your ending cash position is negative,
then you must seek alternative sources of funds or you must change your plans.
For most new ventures, there is a greater cash outlow than inlow simply because there is a lag between your market
investments and the market's response to these investments. For example, you must pay for the new Lxed production
capacity a quarter before you can use that capacity to produce more goods. Or, you must hire engineers and task them to
develop new product features before they can be built into new products and generate sales.
The proLts from current sales are seldom su^cient to pay for this necessary expansion. In short, you can expect cash
shortfalls in the early stages of a Lrm's growth. Through the pro forma cash low spreadsheet, you can determine how
much you will need to borrow from the bank or acquire from venture capitalists in order to make a go of your business.
Keep adding new equity or loans until there is a cash surplus in every quarter. And, when these surpluses become large,
start paying the loans back so that you do not have unnecessary cash.
Perform Sensitivity Analysis. In closing this section, it is always important to conduct sensitivity analysis on your
forecast and Lnancial plan. Investors will assume that your most likely case is in reality an optimistic case. Their
experiences have demonstrated time and time again that it takes longer to develop a market than the entrepreneur ever
anticipates or it is less proLtable due to price competition or a rise in costs. Thus, the investor is likely to ask if you have
explored alternate scenarios in the preparation of your business plan and pro forma Lnancial statements.
For example, what if the market prices become very competitive two quarters out and you are forced to reduce your price
by 10% in order to generate the same unit demand. What would happen to your net income, cash low, and funding
requirements?
Alternatively, what if you learn that a competitor is planning to introduce some new technology a quarter earlier than your
own scheduled introduction and you must speed up the R&D investment. How would that affect your cash low position?
In short, you should investigate alternate market scenarios and project their impact on your Lnancial position in the
future. As a management team, you should be ready if any of these scenarios materialize.
Historical Quarters
At the end of each quarter, the pro forma Lnancial statements will be replaced by the actual transactions that
materialized from the Marketplace simulator. That is, all of your decisions and those of your competitors will be run
through the Marketplace simulator and demand will be computed based upon your relative success in attracting
customers. These demand numbers are then fed through your production operations and all of the accounting ledger
items are updated according to the real events. The closeout Lnancial statements are then posted to your team Lle and
made available to you at the start of the new quarter. These statements can be found within the Performance Report
menu item within the software.
This Lnancial information for the quarter just ended will be invaluable in assessing the quality of your decisions given
actual market conditions and not just anticipated conditions. Careful review of this Lnancial information relative to your
prior planning and forecasting should help you to adjust your knowledge base and thus your decision-making process.
The Lnancial statements also provide you with a historical record of your past decisions and results. Again, you want to
look for patterns in how well you have been able to make business decisions and realize Lnancial gains. If there are
recurrent problems (insu^cient cash, low gross margins), delve into the causes and try to correct the decisions that are
inhibiting your Lrm.
Activity Based Costing (ABC)
Given the di^culty of starting up a new business, it is imperative to know precisely the proLtability of each brand. Activity
Based Costing is a valuable tool for evaluating the contribution of each market activity to the Lnancial vitality of the Lrm.
The objective is to assign each activity and cost related to the creation of a sale to the brand or market that generated
the sale.
For example, suppose 300,000 was spent in total advertising. Should this cost be charged to the overhead of the Lrm as
a selling expense? If yes, then every unit sold would effectively carry the same advertising burden. But, what if we know
that 200,000 was spent on Brand A and 100,000 was spent on Brand B.
Wouldn't it make more sense to charge Brand A with the greater advertising burden? We can similarly charge each brand
with its relevant demand creating costs (such as advertising, rebates, R&D, etc.) as well as the cost to produce it. When
all of the revenues and costs are properly allocated, we can discover which brands are making the greatest contribution
to the proLtability of the Lrm.
As part of their support function, your accountants have prepared an ABC analysis on each brand. At the very least, this
analysis will help you to evaluate the proLtability of all of your demand generating activities. However, it will not tell you
what to do. You may elect to retain a brand that has a low contribution to proLts if it helps you to accomplish other
objectives, such as having a full product line or greater economies in purchasing components for all brands.
Or you may realize that it will take time to build the business and a new brand or market may not become proLtable for a
few quarters. Regardless of the reason, if you are losing money, you should know it. If you are making more money on
some brands, then perhaps you should reallocate some resources to take further advantage of these gains.
Financial Planning and Analysis
Financial planning is very important to your success in Marketplace. Research indicates that poor cash low
management is one of the major reasons for the failure of new ventures.
Cash low problems can be traced to underutilized sales outlets, unused capacity, investments with long payback
periods, and unnecessary expenditures. In each case, the resources of the Lrm are tied up for an extended period of time,
thus limiting the entrepreneur's lexibility to respond to the events of the marketplace.
The basic problem with which you must deal is this: do you commit your resources early in order to get a jump on the
competition or should you hold back until you see how the market develops? If you commit early, you will lose lexibility
to respond to new developments. A little experience may also help you to avoid serious errors. If you wait too long, you
may never catch up. You must discover the right balance between liquidity and a competitive head start.
Part of your Lnancial planning must include future quarter cash low projections. As a suggestion, create pro forma cash
low tables, income statements, and balance sheets for two quarters into the future. In order to facilitate this Lnancial
planning, in Q4 the pro forma cash low template will allow you to start entering projected data for future quarters.
After you have made your cash low projections, explore various "what if" scenarios by budgeting alternate investment
options, sales projections, advertising expenditures and so forth. Extend these "what if" scenarios two quarters into the
future to study their probable impact on your future Lnancial position. Consider most likely, worst case, and optimistic
scenarios.
You will probably discover that your cash position is more limited than you originally thought. Most of your spending
options have hidden overhead expenditures and hidden long-term commitments. Just thinking through the cash low
projections should help to determine how current decisions will impact future operations and options.
From this analysis, determine how much money can be safely invested in longer-term, potentially higher-payoff
opportunities versus investments in short-term, liquid assets. Also, determine which investment options provide the best
balance between lexibility and Lnancial return.
Return on investment (ROI) considerations must also be part of your Lnancial planning and analysis. Look at proLt
margins, turnover, ROI, and so forth, of both your investment options and current operations. Are you allocating your
resources in proportion to the Lnancial return?
It is surprising how many executives cannot tell an investor how much bottom-line proLt can be traced to each brand or
sales outlet or how the proLtability analysis is inluencing other business decisions, especially marketing efforts.
Payback considerations are also very important for new venture Lrms. For any given investment or expenditure, you must
ask when it will be paid back. Without an established income stream, the turnover of cash is very important. The faster it
is paid back, the more quickly it can be used for other investments or expenses.
Finally, entrepreneurs often overlook the difference between cash low and income. If the income statement shows large
sales volumes and a proLt on every sale, the entrepreneur may conclude that everything is rosy. However, if the market is
growing, the cash from current sales will not be su^cient to pay for the increase in capacity required for the next quarter
and the business will Lnd itself short of cash to pursue new opportunities or Lght off new threats.
Earning a Profit
It is not unusual to show losses during the start-up phase of your company. During the Lrst three quarters of play, you will
likely experience negative income as you incur the normal start-up costs of any new venture.
Contributing to the problem will be the low gross margins coming from limited brand sales during the test market phase.
Also, your cost of goods sold is unusually high due to the low production volumes.
The proLtability challenges continue later, but for different reasons. After the business plans have been accepted, you will
initiate the market development programs that you have laid out.
Your executive team is "growing the company" which is a very resource intensive period of time. From a cash low point
of view, you are Lnancing Lxed production capacity and demand fulLllment capabilities as you expand markets and
product lines. If you are smart, you will anticipate this condition when preparing your business plan and Lnancial request.
Otherwise, you must Lnance tomorrow's growth with yesterday's revenue.
In terms of proLtability, you will Lnd your net income dropping precipitously during the test market phase. These losses
are also due to the need to "grow the company". SpeciLcally, you must expense the set-up costs of the new sales outlets
and the research and development costs. It is generally not possible to cover these growth expenses out of revenues
because of the pressure on prices in the marketplace.
An acid test of your Lnancial management is to compare operating expenses to operating revenue. First subtract the
growth expenses from your statement of current expenses. The balance is your operating expense. Next, compare the
gross margin of all sales to your operating expenses. Does the gross margin exceed your operating expenses? The
answer should be a resounding yes! If not, then you are not managing your demand creation activities proLtably.
When you spend money on advertising, lease expenses, sales force expenses, etc., it should be with the intention of
creating su^cient demand to cover the cost of these expenses. After the test market phase, you should be earning a
proLt on every unit you sell, excluding your growth expenses. If you do not have a positive income from normal
operations, then you are pricing below your costs. In all likelihood, you are paying too much attention to market share and
not enough to proLtability.
Pricing is critical during the market development phase of the business. There is a tendency to cut prices to be
competitive; unfortunately, the tendency is to cut them below costs. This could be very detrimental to your Lrm. It is
important to recognize that pricing is not the only way to gain sales. Your team would be better off pricing higher and
spending some of that money on sales people and advertising in order to create demand. A low price will not bring
people into the business. You need sales people and advertising to create interest in your product and price.
Bankruptcy
A Lrm is technically bankrupt if its cumulative losses exceed its common stock investment. More speciLcally, bankruptcy
occurs when the sum of the retained earnings and the common stock is a negative number. Stated differently, the
management has used up all of the equity of the Lrm when the negative value of the retained earnings exceeds the value
of the common stock.
Why Bankruptcy Occurs
The primary cause of bankruptcy is having the unreasonable expectation that the industry is locked into the growth
phase of the product life cycle. The executive team thus reasons it can count on increasing revenue to pay for substantial
investments.
This expectation emerges as a result of market growth in the early quarters. The underlying assumption is that the
market growth is driven by forces outside the company and will continue unabated. This is a faulty assumption. The truth
is that the market is driven by the collective decisions of the industry's participants.
There is no growth curve built into Marketplace. If demand is growing, it is because the Lrms are introducing new
products, expanding into new markets, hiring new sales people, developing better advertising campaigns, and lowering
prices. If a Lrm's demand is increasing relative to others, it means that, for now, it is doing a better job than the
competition.
Executive teams are often shocked when demand drops off sharply. Sudden loss of demand may be caused by many
factors, including:
1. A curtailing of marketing efforts across the entire industry (usually due to a lack of supply).
2. The entrance of a new competitor in the Lrm's market.
3. A major market push by a competitor (usually accompanied by new brand designs, lower prices, and/or better
advertising).
4. A miscalculation of the effectiveness of one's own marketing decisions (brands are weaker than hoped).
The fundamental problem is that the executive team bets that demand will grow and budgets large expenditures in
anticipation of this growth.
A second cause of bankruptcy is when an executive team fails to realize that R&D expenditures are treated as an
expense rather than an asset. R&D expenditures of two, three and four million are relected on the bottom line, causing
large losses that are accumulated in retained earnings. If proLts from continuing operations do not offset the expenses,
the negative retained earnings Lgure can quickly exceed the common stock Lgure. As a rule of thumb, the Lrm should
not spend more in R&D than it receives in venture capital as a result of the business plan.
A surprising (for some) side effect of declining retained earnings is a loss of borrowing power. The clever executive team
that invested early in R&D may Lnd itself without the debt capacity it anticipated. It therefore becomes technology rich
and cash poor, and is unable to produce su^cient quantities of the brands containing the new technology.
How to Avoid Bankruptcy
There is no reason for a team to roll the dice on the future. Demand is entirely logical. The executives must ask
themselves what they have done in the way of market stimulation to ensure that their demand Lgures are reasonable.
Have they increased advertising at a faster rate than their competitors?
Do they have new sales outlets, more sales people, or lower prices? Are there other forces at work which could cause
demand to soften (mass reduction of marketing by the rest of the industry)?
A simple and conservative test is to compare the projected gross margin to the Lrm's projected expenses. First, multiply
last quarter's demand per sales person * the number of sales people scheduled for the current quarter * the average
selling price of all brands carried.
Second, multiply the projected number of units sold * the historical production cost. This will give you an estimate of the
production costs. Third, subtract the production costs estimate from the revenue estimate to give you the gross margin
estimate.
Finally ask: Is the gross margin a number larger that the negative cash position at the end of decision-making? And is the
gross margin su^cient to cover most, if not all, costs so that retained earnings do not decline prematurely? If the answer
is no in either case, then expenditures should be curtailed.
How to Get Out of Bankruptcy
Bankruptcy is a clear signal that the executive team has not managed its Lnancial resources wisely. It has essentially
failed the test of the market. However, the team cannot walk away from the business.
Like any failed Lrm, it must Lgure out how to get itself out of this mess. In this way, it can redeem its reputation in the
Lnancial community.
A bankrupt Lrm will Lnd that it has no additional borrowing capacity. Therefore, debt is not an option. The executive team
must curtail all unnecessary expenditures and stimulate proLt-building demand.
The only way a Lrm can pull itself out of bankruptcy is by focusing its energies and resources on its best opportunities.
The Lrm must adopt the earlier recommendation of focus, excel, and expand with success.
To initiate the refocusing effort, the executive team must decide which two segments represent its best option in the
market. All marketing activities must be focused on these two segments, and all other market development activities
must be placed on the back burner.
The same is true for production. The only brands to be produced must be targeted at the chosen segments. Production
of all other brands must be stopped or slowed to a trickle.
Curtailing marketing efforts will only exacerbate the problem. It is easy to be caught in a downward spiral of cutting
selling expenses which reduces demand which requires further cuts in selling expenses. The best approach is to
stimulate demand.
Advertising must be reworked in light of the above constraints. Advertising and sales force should be pumped up to
create demand and put cash into the checking account. Reducing prices is not wise since it will only reduce margins, and
probably retained earnings. Non-price techniques must be emphasized to create demand. In all cases, the anticipated
revenue must be su^cient to pay for all expenses.
The above recommendations will not result in an instant return to good Lnancial health. They will have to be employed
for two or three quarters. Only after the Lrm is solidly in the black should it resume its market expansion activities.
Independent Auditor
There is an independent auditor whose mission is to keep your team honest and solvent. It will not allow a team to spend
all of its equity on new business development to the point that it places the team at risk. This auditor forces more
conservative action. Thus, teams with big plans or poor Lnancial management may have di^culty doing everything they
desire.
Your independent auditor requires that your team remain solvent. It therefore requires that you maintain a minimum
amount of equity at the end of each quarter. You must have an equity balance of 10% of your common stock in the
current quarter plus retained earnings from the previous quarter.
Stated another way, you can spend 90% of your common stock plus retained earnings. Keep in mind that debt and cash
has nothing to do with keeping your Lrm out of bankruptcy. You may be able to borrow substantial money based upon
last quarter's retained earnings. However, your limit in the current quarter is not based upon debt, but net equity.
Suppose your common stock plus retained earnings is something like 1,500,000. If you were to spend 1,800,000 on sales
and marketing, all of it would be expensed and your retained earnings would likely be more negative than your equity
investment is positive. You would have EXPENSED all of the equity that you, your team and the venture capitalists have
invested in your company. At that point, your company is bankrupt.
Your independent auditor will place limits on what you can spend on new business development. If you receive a fatal
warning about overspending, you must cut some of your expenses. If you are receiving this warning, then you are
dangerously undercapitalized. You are cutting it too close from a Lnancing point of view. Your auditor will be right in
refusing to let you close the books until you resolve this issue.
J. Finance
1. Funding Sources
2. Equity
3. Debt Financing
4. 3 Month Certificate of Deposit
5. Depreciation
6. Financial Ratios
Strategic planning and execution of your strategy require strong Lnancial management skills. The management of
resources usually translates into the management of money. You must anticipate the timing of disbursements and
receipts relative to the execution of your business plan.
Cash low is almost always a constraint on any Lrm or organizational unit. It imposes restrictions on current operations
and the development of new opportunities. It forces choices among high-priority alternatives. Enhancing your ability to
manage cash low will allow you to accomplish more with the same resources.
Initially, the Lnancial resources available to your Lrm will be limited to the equity that your executive team can invest.
Cash lows from sales will be insigniLcant during the start-up phase as you focus primarily on test marketing and
development. As the company grows, Lnancial planning will become increasingly important.
At the end of the Lrst year, you will be able to go to the Lnancial community with a business plan and negotiate common
stock investments by venture capitalists. You will also be able to borrow money from the bank on a line of credit. In
addition, your sales will increasingly generate cash as you expand your product offering and sales territories.
The income statement, balance sheet, and cash low statement are provided to help you manage the Lrm and report your
current status to the Lnancial community. You will discover that these statements integrate all aspects of the Lrm's
business.
You can immediately see how your decisions impact the various accounts and the Lrm's proLtability. As you plan your
future, you can also project your receipts, disbursements, and funding requirements several quarters into the future by
preparing pro forma statements.
Finally, several analytical tools are provided to help you evaluate the proLtability of your brands, markets, and company.
With these Lnancial tools, you should be able to skillfully adjust your strategy and resources to maximize the proLtability
of your brands, markets, and company. Your focus must always be on long-term bottom-line proLtability. Remember that
as investors, your goal is to maximize your return on investment.
First consider:
1. The Lnancial options available to you.

2. The information provided in the Lnancial statements.
3. The analytical tools which can be used to evaluate your Lrm's performance.
4. The need for careful Lnancial management.
5. The conditions and remedies for bankruptcy.
With this information, you will be in a better position to achieve high levels of proLt and market performance.
Learning Objectives: The primary objective is to help you understand the relative advantages and disadvantages of
alternate sources of capital. There is no perfect source of capital, as each has its unique costs and beneLts and these
must be understood. Also, multiple sources are likely to be needed and the relative mix must be managed as the Lrm
progresses through its different stages of development.
Concepts Emphasized
Financial Management: Allocation of a scarce resource (Cash), and living within a budget.
Financial Accountability: Return on investment requirements, and the need for continued corporate Lnancial support.
Postponement: Maximize decision lexibility, and minimize risk by waiting to see what happens.
-versus-
Speculation: Early commitment of resources in order to gain a cost advantage, and a jump on competition.
Funding Sources
There are three major sources of funds for your company: Equity investment, Debt Financing, and sales revenue. For
most of the Lrst year in business, you cannot count on sales revenue and no Lnancial institution will lend you money until
you have proven your creditworthiness. Therefore, your initial capitalization must all come from the executive team.
Sales should pick up substantially during the third and fourth quarter. It is expected that you should begin to show a
positive net income by the end of the Lrst year.
At the end of your Lrst year in business, you will have the option to issue common stock to venture capitalists. You will
also be able to take on debt in the form of a bank line of credit.
Equity
The Lnancial analysts have determined that you will need 2,000,000 in cash for the Lrst quarter of business and
1,000,000 in cash each for the second and third quarters of business (4,000,000 in total). After test marketing, your Lrm
will probably need another 5,000,000 in equity Lnancing and possibly an equal amount in debt Lnancing.
In anticipation of these two rounds of Lnancing, forty thousand (40,000) shares of common stock have been authorized.
Your instructor may authorize an additional 50,000 shares of stock for the venture capital round of Lnancing.
The initial stock value is 100 per share. This value may change during quarter 4 depending upon the performance of your
team and your negotiations with the venture capitalists.
Closely-held common stock
You and the other members of the executive team must invest the initial 4,000,000. You are expected to raise this money
by pledging your own personal assets and Lnding family members and friends to back you. You may issue forty
thousand shares of common stock to yourself and the other members of the executive team in exchange for the
4,000,000 investment.
Your Lrm has been authorized to accept two million (2,000,000) in equity capital in the Lrst quarter and another
(1,000,000) in equity capital in both the second and third quarter. You will receive the equity investment into your cash
account and common stock to members of the executive team will be automatically issued.
Until the stock has been issued, the money will not be added to your checking account and balance sheet. You have
complete authority to invest this money as you see Lt. You are expected to invest this money wisely.
Your Lrst round of Lnancing will provide su^cient funding to set up your production facility, open a few sales o^ces and
test market your products and ideas. The Lnancial analysts do not expect you to make a proLt in this phase of your
business.
If anything, you are expected to lose from 200,000 to 600,000 each quarter due to your start-up expenses and low
economies of scale. Your primary goal in the Lrst 3 quarters is to learn enough about the business so that you can
develop a successful business plan for the second year and beyond. With the business plan, you will be able to approach
the venture capital market for your second round of Lnancing.
Venture capital
At the end of your Lrst year in business, you will have the opportunity to approach the venture capital community for
additional equity funding. They expect you to prepare a comprehensive business plan and submit this plan for their
review in quarter 4.
Your business plan should include a market analysis, a market development strategy, a pro forma income statement and
balance sheet and a cash low budget for the next 4 quarters of business. It should also include a historical record of
your prior decisions and your market and Lnancial performance to date. SpeciLc guidelines on how to prepare a tactical
plan and pro forma projections can also be found in this help Lle.
As part of the business plan, the venture capitalists also expect a request for additional equity capital. The Lnancial
request should include the total amount of the Lnancial request, the number of shares of stock which you are willing to
sell to the venture capitalists and the stock price which you are asking. The suggested stock price is 70 to 120 per share.
For your part, keep in mind that common stock will grant ownership and voting rights to the venture capitalists. If you sell
more shares of common stock than owned by the executive team, the venture capitalists would gain legal control of the
Lrm. To be sure, most are not interested in managing a young Lrm; they are effectively investing in your team to manage
it well.
The venture capitalists will probably want to negotiate the terms of the sale of your company's stock. The price they are
willing to pay will depend upon their assessment of your performance to date, the soundness of your business plan and
your potential proLtability in the future.
In terms of the amount of the investment, do not expect a free ride. Several new ventures are to be evaluated and funded.
An investment in your business will come at the expense of an investment in another one. In such a competitive
environment, you must demonstrate how investment in your company would be more proLtable than their investing in
someone else's company.
Also keep in mind that venture capitalists are not likely to give you everything you wish. Your future investors will
purposely place Lnancial constraints on you. They want you to prove yourself before they invest substantial money. With
insu^cient cash, you will be forced to make choices.
They want to know how you make decisions, the outcome of these decisions and what you have learned in the process.
They are also convinced that the marginal return on their investment will drop if they give you unlimited money. A
resourceful executive team ought to be able to accomplish a great deal with the limited money they give you. In fact, it
may even work harder and smarter with Lnancial constraints.
Consult your instructor about the structure of the venture capital negotiations and the issue of common stock. The
additional equity will be available in Q4.
Debt Financing
Another source of funds for your business is debt. There are two types of debt: conventional bank loans and emergency
loans.
Bank Loans
At the end of your Lrst year in business, you will be able to borrow money from the bank on a short-term basis. The bank
will set up a line of credit that you can borrow against at any time you wish. The line of credit is equal to one and one-half
times the equity of the Lrm (common stock plus retained earnings from the previous quarter) minus any current debt
(conventional loan and emergency loan).
*Borrowing capacity = [1.5 (CSq-1 + REq-1) - (CLq + ELq-1)] where q = current quarter.
The interest for a bank loan is determined by the amount of debt capacity utilized. As your use of debt increases relative
to your Lrm's debt capacity, the interest rate will slide upwards. Conversely, if you sell stock or add to your retained
earnings, then your debt capacity will increase and your interest rate will decline.
Warning: The bank is highly risk adverse and will automatically call in (reduce) your loan in part or whole if your debt
capacity declines due to unusual or extended losses. This can become a serious problem during quarters 5 and 6 as a
result of the large expenditures in R&D which hurt the current retained earnings. If debt capacity declines and you have
not made provisions for the disbursement to the bank (a forced payback of part or all of your loan), your cash lows may
be in jeopardy and you may incur an emergency loan.
Emergency loans
Sound Lscal policy is an absolute must in any organization. The banks and other creditors will not allow your Lrm to
engage in deLcit spending. That is, you cannot spend more money than you take in from sales, loans, or equity
investments. In simple terms, you may not end the quarter with a negative cash position. If you do, your bank has the
authority to take out an emergency loan from a loan shark on your behalf to correct the situation.
The emergency loans are covered by a loan shark. A loan shark is a very tough businessman who charges an exorbitant
interest rate, requires repayment in the next quarter, and takes an equity position in your company in exchange for
keeping your Lrm from becoming insolvent. The quarterly interest rate depends on the size of the emergency loan that
your company owes. It is calculated as 5% plus an additional 0.5% for every 1,000,000 borrowed. The interest rate may
go as high as 25% per quarter (100% annually).
If you experience an emergency loan, you must take immediate action to eliminate it. If you are in Quarter 4 or later, you
might be able to take out a bank loan.
Perhaps the best course of action is to spend your money more carefully. You will still need to develop new brands,
advertise, hire sales people, add new sales outlets, purchase additional capacity, and so forth. These are all necessary
expenses to sustain and grow your business. But you must discover which brands, segments, and markets are
contributing the most to your revenue and bottom line. These areas need to receive more Lnancial support while weaker
options should receive less. Apply Activity Based Costing principles to help you decide where to spend your money for
the best return.
The chairperson of the board (instructor) has the authority to impose restrictions on your Lrm's activities or to take
independent action (change your decisions) if you are not able to eliminate the emergency loan within a couple of
quarters.
The loan shark requires an equity position in your company in return for the favor of honoring the checks marked
"insu^cient funds" by the bank. For each 100 that he places in your checking account, he will take one share of stock in
your Lrm. If you have a 100,000 emergency loan, he will take 1,000 shares of stock. A 1,000,000 loan will cause the loan
shark to take 10,000 shares of stock.
The stock owned by the loan shark causes a dilution of your stock and hence its value to yourself and the venture
capitalists. In other words, your share of the company will decline with the use of emergency loans.
Emergency loans will be repaid automatically as soon as your company has positive cash at the end of a quarter.
However, the loan shark will keep his shares of stock forever.
Conventional bank loans
Be careful with conventional bank loans. In Marketplace, debt is not available until the 4th quarter. Most entrepreneurs
would not have access to bank Lnancing until they have established themselves and proven their Lnancial accountability.
There is considerable risk in taking out conventional bank loans.
SpeciLcally, the bank may recall the loan if a company's debt capacity declines in a later quarter. For example, suppose a
Lrm has a 3,000,000 debt capacity in Q4 and borrows the entire 3,000,000. Then in Q5, the company has a net income
loss of almost 1,500,000 as a result of its investments in R&D for new features. In Q6, the Lrm's debt capacity will drop to
near zero as a result of the loss in Q5. The bank will ask the Lrm to pay back 50% of the loan. This will take 1,500,000 out
of the company's cash account.
As the Lrm will be unexpectedly forced to pay 1,500,000 to the bank (in quarter 6), in addition to the income loss of
1,500,000 (in quarter 5), the company will Lnd that its cash account is suddenly 3,000,000 short of the Lrm's
expectations.
In another scenario, the team might not have an income loss, but encountered a 1,000,000 emergency loan in Q5.
Perhaps they were too optimistic in setting their daily production schedule and ended up with costly excess capacity or
overspent in opening new sales outlets or investing in R&D.
In this case, the emergency loan takes precedence over the regular bank loan. In Q6, the team's debt capacity will drop by
1,000,000 (the 1,000,000 emergency loan took a large share of the debt capacity). As a result, the bank will call in part of
the loan and take the money out of the cash account.
The team faces triple jeopardy if it experiences an emergency loan after having taken out a bank loan. First, it is forced to
repay a large portion of the bank loan (the money comes out of the cash account). Second, it loses the ability to borrow
money (the emergency loan erases much of the debt capacity).
And third, the loan shark is expecting the emergency loan to be repaid in the current quarter. Repayment will require a
realignment in expenditures and/or an increase in revenue to generate the positive cash low.
Of course, careful Lnancial management is the way to avoid these problems. You must Lnd the balance between risk
taking and insolvency. If you take risks, be prepared to accept the consequences.
3 Month Certificate of Deposit
Commercial banks and other institutions in the marketplace offer a 3-Month CertiLcate of Deposit that allows you to
invest cash and earn a 1.5% quarterly interest rate.
Depreciation
Depreciation is used to allocate the cost of assets other than land that will beneLt a business for more than one year
over the asset's service life. These tangible Lxed assets which are depreciated include: buildings/production facilities;
machinery; equipment; furniture and Lxtures; and motor vehicles.
The amount of annual depreciation expense recognized for an accounting period (in this case a quarter) depends on the
choice of depreciation method and estimates of the useful life and salvage value of the asset. For the purposes of
Marketplace, the straight-line depreciation method is used rather than accelerated depreciation. The straight-line
depreciation method spreads the expense evenly each quarter. For your business, long-term assets will be depreciated
over 6 years, or 24 quarters.
Financial Ratios
Liquidity Ratios
Quick Liquidity Test Ratio = (Cash + 3 Month CertiLcate of Deposit) / (Conventional Bank Loans + Emergency Loan)
The company's Quick Liquidity Test ratio relects the company's ability to meet its near-term obligations, and it is a major
measure of Lnancial health. It shows whether the company can use its liquid assets (current assets – cash and CD) to
cover its short-term debt obligations (current liabilities). Creditors and investors look for a ratio greater than 1 in their
analysis. The higher the ratio, the better.
Activity Ratios
Fixed Assets Turnover = Revenues / Net Fixed Assets
Total Assets Turnover = Revenues / Total Assets
The Activity Ratios measure how effectively a company is using its assets to generate revenues and cash.
The Fixed Asset Turnover ratio measures the company's ability to generate sales from its investments in plant, property,
and equipment. It is computed by taking Revenues divided by the Net Fixed Assets (current quarter Net Fixed Assets =
previous Net Fixed Assets + production facility set up cost + Lxed capacity expansion - depreciation). If this ratio is low
compared to the industry average, it could mean one of two things: either the company's sales are relatively low or
investments in plant, property, and equipment are high. It could also be that the company made a recent large investment
that will eventually pay off over several quarters, but revenues are not yet relecting this payoff.
The Total Assets Turnover ratio measures how effective management is at using both short term and long-term assets
(Cash, CD, Sinking Fund, Net Fixed Assets). Everything else being equal, the larger this ratio, the better. A company with a
high Total Asset Turnover ratio can operate with fewer assets than a less e^cient competitor, and so it requires less debt
and equity to operate. Shareholders look at this ratio to Lgure out their relative potential returns. However, there is one
caveat: while generating lots of sales (and therefore revenues) is a good thing, a high turnover ratio does not necessarily
result in more proLt.
Leverage Ratios
Debt ratio = (Loans / Total Assets) * 100
Debt to Paid-In capital = (Loans / (Common Stock + Retained Earnings)) * 100
A company's leverage relates to how much debt it has on its balance sheet, and it is another measure of Lnancial health.
Generally, the more debt a company has, the riskier its stock is.
The Debt ratio measures the proportion of debt a company has compared to its assets. It is an indicator of a company's
debt load. It can be understood as the proportion of a company's assets that are Lnanced by debt. If this ratio is larger
than 100%, it implies that the company has more debt than assets. If it is lower than 100%, it suggests that the company
has more assets than debt. This ratio is a good indicator of the risk of a Lrm.
The Debt to Paid-In Capital ratio measures a company's total liabilities against its total capital (common stock + retained
earnings). It refers to how much a company's operations is Lnanced by its debt versus its capital. One may think that a
lower ratio is always better. But a company may have assumed a large amount of debt to expand the business. In that
case, a higher level of debt may be justiLed if a company can show positive earnings and steady cash low.
The higher this ratio, the riskier the company from an investor's standpoint. That is because in extreme cases, such as
bankruptcy, there may not be anything left for stockholders after the debt holders are satisLed.
ProPtability Ratios
Gross ProLt Margin = (Gross ProLt / Revenues) * 100
Net ProLt Margin = (Net Income / Revenues) * 100
Return on Assets = (Net Income / Total Assets) * 100
Return on Paid-In Capital = (Net Income / (Common Stock + Retained Earnings)) * 100
The ProLtability ratios are particularly important. Analyzed over time, they describe if a company's performance is getting
better or worse, if the company is making money, and how proLtable it is compared to its competition.
The Gross ProLt Margin ratio measures the difference between a company's sales (Revenues) from goods and how
much it must pay to supply these goods (Cost of Goods Sold), expressed as a percentage of Revenues. Generally, the
higher the gross proLt margin, the more of a premium a company charges for its goods.
The Net ProLt Margin ratio measures how much net income is generated as a percentage of revenues. The net proLt
margin shows the actual proLt generated by each dollar in revenue collected. It is important to have a positive net proLt
margin ratio, especially in later quarters. But the net proLt margin ratio cannot be analyzed in a silo. It must be interpreted
in conjunction with the other indicators as it incorporates a lot of different components that distort it somewhat. Overall,
it is a good indicator of a company's ability to effectively manage its operations and overhead costs.
The Return on Assets ratio measures how well a company has used its total assets to generate earnings. It shows how
proLtable a company is in relation to its total assets. The higher the return, the better the proLt performance. It is often
used to compare a company's performance versus its competitors.
Finally, the Return on Paid-in Capital ratio expresses the proportion of proLt generated relative to the capital invested in
the Lrm by stockholders. The larger the ratio, the better it is. A negative ratio would suggest that the company's earnings
are too low. This ratio is of paramount importance to current and prospective stockholders as it reveals how well the
resources of the Lrm are being used.
If any of these ratios luctuate signiLcantly over time, it may be a signal of inconsistent or poor management practices.
K. Guidelines for Preparing the Tactical Plan for the Business Plan
1. How to Proceed?
During the fourth quarter of play, it is customary to prepare a business plan for three quarters into the future.
This business plan will include:
1. an analysis of the market,

2. a set of business objectives to proLtably serve the market,
3. a strategy to achieve the objectives,
4. a tactical plan to realize the strategy, and
5. a set of pro forma Lnancial statements that summarize the Lnancial transactions and outcomes of the strategy
and tactical plan.
The focus of this chapter is on how to prepare a tactical plan once the overall objectives and strategy have been
formulated. The tactical plan lows from the strategy. It represents the details of how the strategy is to be executed. It
lays out the speciLc actions that must be taken and the order in which they must be executed.
To facilitate the preparation of your tactical plan, a template has been prepared within the Marketplace software. It is
essentially a strategy worksheet. It is designed to help you think through the activities and outcomes that are necessary
to realize the Lrm's objectives and strategy.
There are many advantages to using this strategy worksheet to help prepare a business plan. First, it is comprehensive. It
includes all of your important tactical decisions. Thus, you are forced to think through all of the details.
Second, it is integrative. It is laid out so that you must consider the linkages between one tactical decision and the next.
Integration is necessary because decisions cannot be made in isolation; you must follow each one through to the other
parts of the organization to fully understand their Lnancial and organizational impact.
Third, it is time-sequenced. It forces you to think about how decisions are linked over time. Every decision is dependent
upon prior decisions and sets the stage for future decisions. The strategy worksheet will help you see how the past
affects the present and how the present must be managed to shape future possibilities.
Fourth, it is Lnancially animated. Wherever possible, tactical decisions are linked to investments, expenses and revenues.
These can be imported directly into the pro forma cash low statement and from there, into the pro forma income
statement and balance sheet. Thus, you will be able to see if the plan is Lnancially viable.
Fifth, it is organized. All the relevant decisions and linkages have been considered and mapped out for you. It is a
worksheet/template that effectively guides you through a very di^cult, and often bewildering, task.
Last, it nourishes a mental discipline that is invaluable in business. It is organized, comprehensive, integrative, time-
sequenced, and Lnancially-driven.
How to Proceed?
Working out the details of a tactical plan is like solving a mathematical equation. You must often work both sides of the
equation to Lnd a solution.
For example, you can start with the present quarter, make your decisions and Lnancial projections and then move to the
next quarter. When the second quarter in the future is complete, move on to the third one, and so on. Or, you can start at
the end of your planning horizon and work your way backwards in time to the present.
If you start in the current quarter and work your way forward, the tactical plan works like a layered cake. That is, this
quarter's decisions will be built upon the layer of decisions and outcomes of the prior quarter. And as you make new
decisions this quarter, you will build the layer upon which the next quarter will rest.
Conversely, you can follow the old adage about vision, and "Start with the end in mind." This means you start with the end
goal and determine what must be put in place before you can achieve this goal. For example, to achieve your goals by the
end of quarter 8), what must be done in quarter 5? What segments should you be in; how many sales outlets should be
operational; how many brands will you need to carry, how much production capacity will you need? Similarly, what must
be done in quarters 4 to set things up for quarter 5? And, so on.
Practically speaking, it is easier to work forward than backward. This is because the near term is more tangible and has
fewer unknowns. Once you get out a few quarters, anything can happen; it is all educated guesswork. Thus, it is
recommended that you start with your decisions for quarter 5 and move forward in time.
Most of the quarter 5 decisions will be comparatively easy because you have already made them a couple of times. And,
you have a complete set of marketing, operational and accounting data from quarter 4 upon which to rely.
Next, move to quarter 6. Although there is no new data upon which to make decisions, you will have put in place many
activities that will shape your quarter 6 decisions. You are merely following through on your quarter 5 actions. For
example, if you opened a sales outlet in quarter 5 for quarter 6, you know you have to staff it, select and price brands, and
advertise to draw customers in. These decisions are natural extensions of the current quarter decisions.
Once you move out 2 or more quarters into the future, it becomes more uncomfortable to plan your Lrm's tactics. For this
reason, you should view them as tentative. As the marketplace advances into future quarters, feel free to adjust the plan.
However, it is good to have a plan for these future quarters so that what you want to happen, has a good chance of
actually happening.
When you reach the Lnal quarter of your planning period, step back and assess your satisfaction with the pace and
progress of your Lrm. At this point, you are "starting with the end in mind." And, it is easier to make adjustments with the
whole plan before you. Are you moving at the right speed? Are you as big or as focused as you had originally desired? If
not, adjust the end results and work backwards to make sure your prior decisions support the Lnal results.
Of course, you cannot fully evaluate the tactical plan until you prepare your pro forma Lnancial statements for the same
time period. Will your tactics result in the cash, revenue and proLt objectives you have set for yourself and the investors?
Can you afford to do all that you have planned?
It is not uncommon to experience an "oops" when the tactical plan is translated into the pro forma Lnancial statements.
More likely than not, the plan is too ambitious given the available resources. Thus, the plan must usually be scaled back
until it can sustain and be supported by the projected cash lows and proLtability. The tactical plan and pro forma
statements must be synchronized in order to have a realist strategy.
Working the Details
It is recommended that you start with the current quarter and move forward one quarter at a time.
Current Quarter
The completion of the tactical plan for the current quarter is very simple. Here is how it is done.
First, make all of the current quarter decisions in the normal fashion. Second, go to manufacturing and run the
production simulation. Third, go to the pro forma cash low statement, choose <Modify> and then <Load Data>. This will
cause the software to load into the cash low template all of the Lnancial transactions that are associated with your
tactical decisions. The software will also load the revenue and production costs generated by the production simulation.
Be sure to save the data.
Fourth, go to the Tactical Plan, choose <Modify> and then <Load Data>. This will cause the software to load a summary
of your tactical decisions plus relevant Lnancial information from the pro forma statements into the tactical plan.
This is all you have to do to prepare the tactical plan for the current quarter.
For better viewing of the tactical plan details, save the data and then return to the tactical plan. Upon your return, you will
Lnd the information formatted for ease of viewing. Scroll up and down and left and right to view the historical data plus
the current information.
The current quarter tactical plan will serve as your foundation upon which the subsequent quarters will be built. Keep in
mind that these decisions are not set in stone. You may discover the need to adjust a tactical decision in the current
quarter in order to set up a decision that you want to make in the following quarter. For example, you may want to
produce 6,000 units in quarter 6 as a result of the new brands and new sales outlets that you have scheduled. Because it
takes one quarter to add Lxed production capacity, you would have to schedule a production facility expansion in quarter
5. You may not realize this need until you start to make the decisions in the quarter 6. This "ah ha," is precisely why you
plan.
Future Quarters
Once the current quarter is more or less complete, move to the next quarter. As you work through each quarter, start at
the top of the tactical plan and work your way down through each row in the table. Think of each row as a separate step
in the planning process. The sequence of decisions/entries has been organized within the template so that each one
builds upon the prior ones.
For example, Step 1 is the selection of target segments. This is your most important decision because many other
decisions cascade down from this one, including the selection of sales outlets, R&D, brand designs, advertising media,
pricing, etc. All of these decisions depend upon the selection of your target segments.
Step 2 is the selection of sales outlets. It depends upon the target markets and it, in turn, impacts many other decisions.
The more sale outlets you have, the more sales people, advertising, production, etc. you will need. You are also asked to
estimate the cost to open and operate your sales outlets. This information will be used in your cash low projections for
the quarter.
After your sales outlet decisions, you must make your brand decisions, followed by pricing decisions and advertising
decisions. How aggressive will you be in offering new technology, an assortment of brands, price points and advertising?
This aggressiveness is relected in your budgets and is also used in the cash low projections.
Consideration of the sales force is next. This set of decisions depends upon the targeting and distribution decisions you
made earlier. How many will you employ, what will they be paid and how much demand are they likely to generate? Again,
this information will be used in generating Lnancial information for the cash low projections.
And, the number of outlets and sales people greatly shape your estimates for demand. Demand, in turn, drives revenue
projections and many of the manufacturing decisions. And your funding requirements and decisions will be driven by all
of the prior decisions.
The number of tactical decisions that must be made can be daunting. Further advice is available by clicking on the "?"
associated with each line item in the tactical plan. When the "?" is selected, a pop-up window will appear that contains a
brief description of the nature of the decision or information to be entered in a cell.
Decisions On Debt and Equity
Save this set of decisions for last. There are several additional steps that must be taken before you can arrive at an
estimate of your Lnancial needs.
Here is the recommended procedure. First, complete all of the entries in the tactical plan for the planning horizon.
Second, go to the pro forma cash low statement, choose <Modify> and then <Import Tactical Plan Data for Future
Quarters>. This action will cause all of the Lnancial information created within the tactical plan to be imported into the
pro forma Lnancial statements for the quarters beyond the current one.
Third, inspect the cash low projections to determine if there are any cash shortfalls and, if yes, when and how much. You
will have to choose between equity and debt and then determine the timing and amount of each source of money.
Fourth, return to the tactical plan and enter the amount of equity and debt that is desired for each quarter.
Fifth, return to the pro forma cash low statement, choose <Import Tactical Plan Data for Future Quarters> in order to
update the Lnancial statements.
Sixth, inspect the cash low statement to be sure the ending cash position is positive for each quarter in the planning
horizon.
Last, check the pro forma balance sheet to make sure that the sum of the retained earnings and common stock (net
equity) is positive for all quarters. If it is not positive, then your Lrm will be bankrupt. This is unacceptable. It will be
necessary to take on more equity or reduce expenditures.
As noted before, the tactical plan cannot be prepared without simultaneously completing the pro forma Lnancial
statements. When both sets of documents are completed, print them out and lay them side-by-side. Together, they
represent the tactical details of your strategy and how it will be translated into revenue and wealth for the owners. Study
the documents to make sure they are internally consistent and viable as a means to achieve your objectives.
L. Guidelines for Preparing Pro Forma Financial Statements for the Business Plan
Need For Financial Planning
You cannot formulate a realistic strategy and tactical plan without working through the Lnancial issues. There are many
reasons for preparing pro forma Lnancial statements. Here are Lve to consider.
First, you need to play out your decisions to see if they turn out as Lnancially positive as you hope. Will you meet your
Lnancial goals? Will you be solvent over the course of the planning horizon? Most Lrms discover that their appetite for
growth exceeds their available resources. That is, the tactical plan cannot be supported by the projected cash lows and
net income. Thus, the pro forma Lnancial statements will help in the evaluation of the strategy and tactical plan.
Second, outside investors need pro forma statements in order to evaluate the executive team. They want to know if the
executive team can manage the Lnancial resources of the Lrm. Has the executive team carefully thought through the
Lnancial ramiLcations of their strategy and tactical decisions? Are the two linked in a logical, mutually supportive way?
Are there errors in the Lnancial transactions that are reported (a certain killer for further funding)? Investors can
ascertain a great deal about the quality of an executive team by studying its pro forma Lnancial statements.
Third, investors want to assess the Lnancial attractiveness of the investment. What are the cost of goods, marketing
expenses, research and development expenditures, overhead, asset investments, etc.? What is the pattern of these
expenses over the planning horizon? What do these patterns suggest regarding the tactical emphasis of the Lrm during
its next phase of development?
Also, when is the Lrm expected to break even, turn a proLt and create positive cash lows? How much proLt and cash can
be generated? Are these numbers realistic for the industry in which the Lrm is competing? Are there risky aspects to the
revenue and expense projections?
Every investor knows that the business plan and pro forma statements will not be realized as they are presented.
Nevertheless, the pro forma statements can help the investor assess the potential gain and risk in his or her investment.
Last, the pro forma projections are necessary to determine the value of the Lrm. With the information contained in the
Lnancial statements, it is possible to estimate how much the company will be worth at various points in the future.
If the projected value is high, the Lrm will be much more attractive to investors. If you are projecting signiLcant wealth,
you will also have a stronger position in negotiating the amount of equity to sell in return for the investment. If the
valuation is low, you may need to rethink your business plan or aspirations for outside funding.
There are many questions that pro forma Lnancial statements can help answer. Pro forma Lnancial planning is a
necessary component of any business plan, and well worth the time and effort to prepare.
Working the Details
Let us consider now the preparation of the pro forma Lnancial statements. Here, the focus is on the cash low statement.
This is because the income statement and balance sheet can be derived from the entries in the cash low statement.
Additionally, cash is a critical resource in a startup venture. There never seems to be enough. It is always the constraint
on the Lrm's activities and ambitions. The cash low statement helps you to keep track of the money lowing in and out of
the Lrm, and thus the Lrm's solvency and potential to grow.
Fortunately, once you complete the tactical plan, almost all of the numbers required to Lll in the pro forma statements are
available. The tactical plan was designed with this purpose in mind.
For example, in Llling out the tactical plan, you estimated your average selling price and the projected number of units
sold. Revenue can be estimated by multiplying the two numbers together. Similarly, production expenses can be
estimated by multiplying the average production cost times the projected production volume. And, sales force salaries
can be estimated by multiplying the number of sales people times their projected average compensation, and so forth.
Hopefully, you can see the logic of how these numbers are derived as you work through the tactical plan. It requires a
considerable amount of educated guessing, but there is almost no other way when you are projecting the future. And, of
course, you can develop your own process and enter a different set of numbers into the cash low statement if you are
not satisLed with the proffered logic and assumptions.
This chapter contains basic instructions on how to complete the pro forma Lnancial statements for the current quarter
and future quarters.
Current Quarter
The preparation of your pro forma statements for the current quarter is comparatively easy. This is because the
accountants post all of your disbursements to your Lnancial statements as you make your decisions. What is missing
from the pro forma statements are the revenue, production and cost of goods sold estimates. As you should know by
now, these numbers can be obtained by running the production simulation.
For the current quarter, here is the recommended procedure. First, analyze your Lnancial, marketing and operational data.
Second, reevaluate your strategy. Third, make all of your tactical decisions. Fourth, project your demand by brand and run
the production simulation. Fifth, load the production simulation data into the pro forma cash low statement. Sixth, check
the ending cash position and then your income statement and balance sheet.
The objective of the pro forma analysis is to observe the effect of your tactical decisions, production plan and demand
projections on your Lnancial position. Are you satisLed with it? Start by looking at the cash low statement, then the
income statement and Lnally the balance sheet.
Cash [ow statement
Are you projecting a positive cash balance for the end of the quarter? This is the critical question. If not, Lgure out what
must be changed in your tactics, make the changes, then rerun the production simulation and check your projected
Lnancial position again.
If you are short of cash, perhaps you need to sell more equity or borrow some money from the bank. Alternatively, it
might be necessary to scale back on your expansion plans. Should you open fewer sales outlets, reduce production
facility expansions or cut back on research and development? Or, can you expand your marketing efforts and bring in
more revenue?
Income statement
After you have checked your cash low statement, check your income statement. All of the revenues and relevant
expenses will be loaded into the income statement for you based upon the cash low statement. The cash low
statement includes investments in Lxed assets and equity and debt transactions. These are not included in the income
statement because they relate to the longer-term and are treated differently. The income statement focuses on short-
term receipts and expenses.
Chances are, the Lrm will have net losses because you are making many costly expansion decisions as you prepare the
Lrm to be a better competitor in the future. Is the loss acceptable given your pace of expansion?
A good indicator of the strength of the Lrm is the operating proLt after your investment decisions have been added back
in. The investments that beneLt the future but which are expensed in the current quarter include research and
development, new sales outlets, and quality improvements. Add these expenses back to the operating proLt on the
income statement. This will tell you if you are making a proLt on current operations.
In other words, given your projected revenue and all the costs required to generate that revenue in the current quarter, can
you expect a proLt? Most Lrms should be positive by quarter 5. A few strong Lrms will be positive by quarter 4.
If you are not making a proLt on current operations, something is seriously wrong and needs to be corrected. What can
you do? Perhaps, you are in the wrong segment and it is not generating su^cient demand to drive down production
costs. Should you add a third segment that could improve production volumes and lower cost of goods? Should you
reallocate your marketing money to more effectively create demand? Do you need more advertising or more sales people
or should they be moved to markets that generate a better marginal return?
Balance sheet
After you have analyzed your income statement, turn to your balance sheet. All the numbers are important, but special
attention should be given to the ending cash position (discussed above) and your retained earnings and inventory
position.
Retained earnings will normally trend downwards during your early quarters of operation. This is because your
investments in the future fall to the bottom line and cause substantial losses. These losses are then subtracted from
your retained earnings.
The worry is that your cumulative losses (retained earnings) could exceed the investment money from the executive
team and outside investors. At that point, you are bankrupt and severely constrained in your Lrm's operations.
Watch your retained earnings Lgure carefully. It should never be more negative than the value of the common stock.
As you plan for the current quarter, be sure to leave yourself a margin of safety in the net equity of the Lrm (common
stock + retained earnings). Unexpected bad conditions could occur in the market. Perhaps the market will not grow as
fast as you hope. Or, your competition might be more aggressive than you anticipated. Or, your business decisions may
not be as effective as you planned.
Be prepared for the unexpected. Do not let your retained earnings sink so low that the viability of the Lrm is threatened.
Leave a cushion in your net equity. The sum of your common stock plus retained earnings probably never should drop
below 500,000.
Next, look at your projected inventory position. If the inventory value is near zero, than you are either over-stimulating
demand or under-producing. If you cannot satisfy demand, then why spend so heavily in creating it? Shift your resources
to expanding supply and scale back on marketing until you can satisfy the demand created.
If your projected inventory is more than 500,000, then you clearly are not creating enough demand or you have scheduled
too much production. Both are bad and need to be corrected.
Worst-Case Scenario
Finally, run a worst-case scenario. Assume that things can go wrong. Reduce your demand by 25% to 40% but assume
that everything else stays the same. Rerun the production simulation and load the data into the cash low. Check your
ending cash, proLtability, and retained earnings. You want to have at least 300,000 in both your net equity and projected
ending cash position under your worst-case scenario. Will you be solvent at the end of the quarter if your worst
nightmare occurs? What can you do to prepare for this potentiality? Borrow money, cut expansion plans, try to create
more demand, or what?
The purpose of the pro forma planning is to help you anticipate what could happen in the future. Do not wait until the
unexpected happens, anticipate and act based upon the probable and potential outcomes.
Future Quarters
Mechanics of Making Pro Forma Projections
The tactical planning worksheet has been augmented to help in the preparation of your pro forma Lnancial statements. If
you have worked through the tactical plan for each quarter in the planning horizon, then you have already estimated most
of the numbers needed in the pro forma cash low statement.
Here are the steps to take to prepare the pro forma statements.
First, complete the tactical plan for each quarter in the planning horizon beyond the current one. If you are in quarter 4
and you want pro forma statements for the remaining quarters, this means completing the tactical plan for quarters 5
and 6.
Second, import the Lnancial data from the tactical plan. Go to the pro forma cash low statement and click on the button
labeled, <Import Tactical Plan Data for Future Quarters>. This action will transfer your projected revenues and planned
expenditures into the cash low template. For example, you will see that the advertising, sales force, sales outlets, and
production numbers that you worked out in the tactical plan are now in the cash low statement.
Third, review the entries in the pro forma cash low statement. While most of the entries come directly from the tactical
plan, there are several ledger items that do not have a counterpart in the tactical plan. To facilitate your work, these items
are estimated for you based upon other entries that you have made. These items can be overwritten if you do not like the
entries made in your behalf.
The items computed for you include the following:
Shipping costs: an average shipping cost was computed for the last quarter of business. This average was multiplied by
the projected number of units to be sold to obtain an estimate of the total shipping cost in future quarters. In all
probability, your shipping costs will be a little lower as your shipping volumes increase.
Marketing research: the amount that has been budgeted for the current quarter has been applied to future quarters.
Cost of goods sold: it was assumed that you would sell everything that you produced in future quarters. This estimate is
overly optimistic since it assumes perfect forecasting. A more realistic estimate is that the cost of goods sold will be
less than the production cost and that there will be some inventory left over after each quarter. You may wish to reduce
the cost of goods sold number at the bottom of the cash low statement in order to relect this probable condition.
Taxes: taxes are estimated based upon the projected net income (the tax rate is 40%).
Interest: Interest expense is estimated based upon the size and type of loan.
If you change any of the above values, do not click on the <Import Tactical Plan Data for Future Quarters> button. The
importing action will erase and overwrite any other entries you have made.
Fourth, Lll in the missing values in the cash low statement with reasonable numbers. Most of the missing ledger items
will not signiLcantly affect cash low or net income.
Fifth, determine how much is needed in the way of debt or equity Lnancing. Once all of the above entries have been
made, look at the bottom of the cash low template to determine if your cash position is negative (very likely). If it is
negative in any quarter, save your decisions and go to the tactical plan worksheet and enter the amount of equity or debt
that you would like to add to your balance sheet.
In a sense, the equity and debt entries represent your balancing numbers for Lnancial planning. They are added after all
other entries have been made and it is possible to determine how much money is needed and when. Thus, keep adding
equity (quarter 4 only) and debt until your net equity and cash are positive for Q4 and all future quarters.
Depending upon the aggressiveness of the plan, your Lrm will need to obtain between 5,000,000 and 9,000,000 in equity
and debt. The maximum equity that is available is 4,000,000. The maximum debt will depend upon your debt capacity
which is determined by your net equity of the quarter before. There are guidelines in the next section to help you decide
how much money to take from either outside investors or lenders.
Sixth, determine whether or not you have reached your Lnancial goals. Check your income statement and balance sheet.
When do you achieve positive cash lows? When does the Lrm turn proLtable? Are the proLts great enough to attract
outside investors? What do the projections suggest for the valuation of the Lrm at the end of the planning horizon? Are
you satisLed with the predicted results of your efforts?
Typically, your Lrst pass through the pro forma Lnancial statements will result in an unsatisfactory assessment. You will
probably discover that your business plan is beyond your Lnancial capability (the symptoms are negative equity or
negative cash, even after taking 5,000,000 from the venture capitalists and borrowing money from the bank). When you
make this discovery, you will have to scale back on some of your business development plans and then redo the cash
low statement.
Alternatively, you may discover that your Lnancial projections are too modest to attract outside investors. You may not be
aggressive enough to appeal to investors who are looking for very high rates of returns.
In any case, you will need to work back and forth from the tactical plan to the cash low template to the balance sheet,
back to the tactical plan and back to the cash low template and balance sheet, until you obtain a business plan that is
supported by the cash low and proLt projections.
Equity Funding
Your instructor will determine the maximum amount that can be obtained from outside investors. The software is
programmed for the venture capitalists to give each Lrm 5,000,000 in Q4. Typically, this is the maximum equity offered. If
you are required to present your business plan to potential investors and negotiate the size of the equity investment, the
amount could be less than 5,000,000.
Note: the number of shares of common stock and the stock price determine the amount of equity sold. The default
values are 50,000 shares at 100 per share. If you are able to negotiate a higher stock price, then you will not have to sell
as many shares to obtain the money desired. If your business plan and negotiations do not go well, then you will probably
have to sell more shares of stock at a lower price.
The amount of equity to be sold is for you to determine. The author designed the simulation so that at least 3,000,000 in
equity will be required. Taking less than 3,000,000 will make it di^cult for your Lrm to succeed. This is because the Lrm
will need to make sizeable investments in R&D, new distribution outlets, etc. All of these activities must be expensed in
the current quarter and thus fall to the bottom line on the income statement and retained earnings on the balance sheet.
Here is how this works. Suppose that your Lrm has lost money during each of the Lrst three quarters and the total losses
equal 2,000,000. As a result, your retained earnings Lgure at the end of quarter 3 is a minus 2,000,000. (Remember that
the retained earnings Lgure in quarter 3 is the sum of the net income for quarters 1 to 3.) Assume further that the
executive team invested 4,000,000 over the Lrst three quarters. Consequently, the net equity is 2,000,000 (4,000,000 in
common stock - 2,000,000 in retained earnings).
Finally, assume that the Lrm is breaking even on current sales. That is, the cost to generate and serve the Lrm's demand
exactly equals the revenue generated.
Under these circumstances, any money spent on research and development or new sales outlets will appear as losses on
the income statement. (There are no proLts from operations to pay for them.) These losses will be added to the retained
earnings, thus further reducing the net equity of the Lrm.
The maximum loss that the Lrm can sustain is 2,000,000, or the net equity as of quarter 3. If any more is spent on R&D
and sales outlets, then the Lrm will be bankrupt. At this point, the losses will exceed the investment by the executive
team.
2,000,000 is not very much to spend on new business development. You might be able to acquire one R&D project, but
probably no new sales outlets. If you want to invest in two or three R&D projects and open several new sales outlets, then
you will need to raise outside money in the form of new equity.
Debt will not help you solve this problem because it is not part of the equity base of the company. If you borrow
3,000,000 from the bank and still have losses of more than 2,000,000, your Lrm is bankrupt. In this case, the cash does
not determine bankruptcy, but the size of the cumulative losses (retained earnings) compared to the amount of common
stock. If your cumulative losses are 4,000,000 and your equity is 4,000,000, there is nothing left of the owner's
investment. At this point, the lenders have all the risk. It is their money that is subsidizing the Lrm. Technically, they own
everything that is left in the company.
This point about the role of debt versus equity is very important. Many people make the mistake that debt can be used to
compensate for losses that exceed the equity investment in the Lrm. This is not true.
Before you consider how much money you want to borrow, determine how much equity you will need in order to maintain
a positive equity position at the end of every quarter in the planning horizon. That is, the sum of the retained earnings and
common stock must always be positive.
Here is how to determine how much equity you will need. First, complete your tactical plan. Include all of your new
business development expenses. Second, import the Lnancial data from the tactical plan into the pro forma cash low.
Third, check the income statement. If you are projecting losses, you know there will be a need for new equity to cover
these losses. Fourth, go to the balance sheet and check the retained earnings. This number should trend downwards for
the Lrst quarter or two and then slowly head upwards as the new investments turn into new sales and proLts.
Fifth, add together the retained earnings and common stock for each quarter. If all the numbers are positive, then you do
not need any equity. More likely, the sum will be negative for one or more quarters. Choose the quarter in which the Lrm
will experience the greatest negative equity (largest negative number). This is how much equity your Lrm will have to sell
at a minimum.
Let's return to the above example to illustrate this point. Recall, the Lrm wants to invest 5,000,000 in new business
development in quarter 4. Assume you will breakeven on sales and so you will not have any proLts to pay for the new
business expenses. Thus, your losses for the quarter will be 5,000,000. In quarter 3, your retained earnings Lgure was a
minus 2,000,000. If you add a further loss of 5,000,000, your retained earnings in quarter 4 will be a minus 7,000,000.
Up to this point, the executive team has invested 4,000,000. The sum of the negative retained earnings and the equity is a
minus 3,000,000 (4,000,000 - 7,000,000). Thus, you will need at least 3,000,000 in new equity. 3,000,000 in new equity will
bring the net equity to zero on the balance sheet.
Actually, there is a need for more than 3,000,000. The external auditors require that you maintain a reserve of equity in
the event that things go badly for the Lrm. The auditors are risk adverse because they know that one in Lve Lrms will go
bankrupt if they are not restrained. To protect all investors and lenders, they require that you maintain a reserve of at
least 10% of the available equity. Thus, if the Lrm has 2,000,000 in net equity in quarter 3 and it takes in 3,000,000 more
in quarter 4, then the available equity in quarter 4 is 5,000,000. The auditors will restrict investments in new business
development to 90% of 5,000,000 or 4,500,000. Thus, to invest 5,000,000, the Lrm will have to take in 3,500,000. This will
leave 500,000 in net equity after the investment (10% of 5,000,000).
In light of all of these considerations, it is not unusual for a Lrm to require at least 3,750,000 in new equity. The norm is
probably 4,000,000 and an aggressive Lrm will need the full 5,000,000. This is because there are so many expansion
opportunities that it will be easy to use up 6,000,000 to 7,000,000 for new business development.
If you do not see a need for 4,000,000 to 5,000,000 in equity, you may not have a strong enough plan or you are
undercapitalizing your Lrm. Think of your competitive disadvantage if your competitors take 5,000,000 and you take only
3,000,000.
On the other hand, if your Lrm has done well in its Lrst three quarters of business and has retained earnings greater than
a minus 1,000,000, then you might not need a full 5,000,000.
Typical Problems Stemming from Equity Decisions
There are certain problems that can befall a team if it is not careful in making its equity decision. In most cases, the team
does not take all the capital available and ends up being under-funded. These problems relate to tactics regarding
majority ownership and R&D investment and overly optimistic demand projections.
Taking equity Lrst, there are a couple of different problems that might surface in selling equity to outside investors. For
one, an executive team may not want to give up control of the Lrm. Thus, it might not want to sell more than 49% of the
stock, perhaps its limit might be 40%. The risk inherent in this equity strategy is that the Lrm could be undercapitalized. It
may not have enough capital to deal with a downturn in the market, unexpected advances by competition or new
opportunities in the market. Although the executive team might have a bigger piece of the pie, insu^cient capital could
result in a much smaller pie.
A way around this limitation is to prepare a very good business plan and demonstrate good team skills and business
savvy during the venture capital negotiations. If you can sell the stock at a price that is higher than the 100 paid by the
executive team, then it will be possible to sell fewer shares and maintain control. A stock price of 120 or higher would be
very helpful in this respect.
Another problem involving equity is that a team may Lnd itself faced with unfavorable venture capital options. Perhaps
the business plan was not well received or the presentations and negotiations did not go as well as hoped. If the
proffered stock price were signiLcantly less than 100 per share, then the team would have to give up control of the Lrm.
Rather than give the venture capitalists the satisfaction of winning the negotiations or because the team does not want
to give up control, it may choose to take in less equity. This is a serious mistake. Again, if the competition has 5,000,000
in new equity and you have 3,000,000, your Lrm will have a major disadvantage.
Turning to R&D decisions, there are various expenditure tactics that can also cause problems. One has to do with large,
quick investments in R&D and sales outlet expansions. In order to get a jump on the competition, many teams will make
large expenditures in R&D and new sales outlets during quarter 4. The goal is to have almost everything in place within
one quarter. The problem is that some teams will use up all of the available investment money in one large gulp and then
Lnd themselves with no Lnancial cushion to launch a solid marketing campaign or deal with an unexpected decline in
demand. This "Lrst-mover advantage" can work, but usually it requires that the team obtain the maximum equity
investment possible.
A second R&D tactic that can cause problems is a decision to spread the payments out over two quarters. The objective
is to reduce the total amount of the investment. In some cases, team will do this to reduce the amount of equity that
might be required to complete the development program. This strategy is very viable and many teams successfully
employ it.
However, there is one set of circumstances that will always result in failure. This is when the team chooses to sell a
relatively small amount of equity stock and simultaneously tries to take on too many projects. Rather than pursue 2 R&D
projects, it might go after 4, even 5. The assumption is that the revenue and proLts in quarter 4 will generate enough
money to pay for the completion of the R&D in quarter 5. Unfortunately, quarter 4 could be a slow quarter and some Lrms
may not obtain the income they were predicting. If demand, revenue and proLts fall short of expectations, the Lrm may
not be allowed to complete one or more of these projects in subsequent quarters. Sometimes, none of the projects can
be completed.
The reason these projects cannot be completed is because the external auditors will not let the executives put the Lrm at
risk. The auditors will not allow the team to spend more than 90% of the net equity of the quarter that has just been
completed. If most of the equity has been used up in the prior quarter, then the R&D will be the Lrst casualty. Again, the
solution is to have su^cient equity to withstand a downturn in revenue and proLts.
As a side note, observe that the auditors focus on the results of the prior quarter rather than the pro forma projections of
the current one. This orientation is because the last quarter's results are a certainty and this quarter's results are
speculative, perhaps even wishful thinking. Some teams might consider this position to be unfair, but the auditors have
considerable experience that tells them to only count what is in the bank and not what is promised.
Another problem that teams have is that demand during quarters 4 and 5 fails to live up to expectations. The teams see
that demand has jumped substantially between quarter 2 and quarter 3. They assume that the growth will continue into
quarters 5 and 6. What they fail to take into account is 1) much smaller marginal improvement in their marketing
decisions, and 2) better decisions by some competitors.
The problem with the reduced marginal success of marketing is hard to grasp or anticipate. The primary reason demand
jumps so strongly from quarter 2 to quarter 3 is that all the teams make substantially better decisions in quarter 3. The
improvement is due to the better information that is available to the Lrm after the Lrst quarter of test marketing. Analysis
of the market data will help the marketers develop a better understanding of what the customers want and are willing to
pay for. All the teams make many skillful adjustments that result in substantial demand increases.
However, from quarter 3 to 4, the teams do not make as many improvements in their decisions. They tend to continue
what they did in quarter 3 because it was successful. Without a substantial improvement in brand designs, pricing,
advertising, sales force deployment, etc., demand will not improve by very much.
Finally, some teams fail to anticipate unusually strong actions by competitors. If even one competitor signiLcantly drops
price, expands brand selection, advertises aggressively, or hires lots of sales people, a team's demand may take a
nosedive. This drop in demand will probably result in signiLcant losses that, in turn, will reduce retained earnings that, in
turn, will reduce the amount that the auditors will allow the team to invest. The only antidote is su^cient equity capital to
survive the unexpected losses.
This is a common theme: teams run into problems because they tend to undercapitalize the Lrm. For one reason or
another, they do not take as much equity as they should, then something bad happens in the market and they are
constrained from fulLlling their dreams. If you are to make a mistake, it should be in taking too much equity rather than
not enough. There will always be something that can be done with the extra funding.
Debt Funding
The determination of the amount of debt to take should be made after the equity decision is made. As argued before,
debt cannot substitute for equity. If you start with the debt decision (usually because you want to avoid taking too much
equity), then you will almost certainly run into Lnancial di^culties later.
Here is the recommended procedure. First, determine the amount of equity required in the fashion outlined above. Do not
be too stingy in taking on equity; it will give you more freedom to deal with unexpected problems and opportunities.
Second, after the equity decisions have been entered into the tactical plan and imported into the cash low statement,
check the ending cash position. If it is negative, then you may want to consider borrowing money in order to turn it
positive.
The assumption here is that the Lrm sold enough common stock to cover any losses that may occur. Thus, the negative
cash is probably not due to lost income. It is probably due to an increase in assets. The most likely cause is an increase
in Lxed production capacity.
To illustrate, if your Lrm decides to spend 2,000,000 to increase Lxed production capacity, it is not treated as a current
period expense. Rather, it is considered a long-term asset and is expensed over several quarters via a charge for
depreciation. As a result, your cash position is drawn down by 2,000,000 but this outlay does not show up in the retained
earnings Lgure. Thus, it would not trigger an equity decision.
However, you have converted 2,000,000 from cash to an asset. Thus, the 2,000,000 disbursement does show up as a
reduction in cash. So, if you have a cash shortage after you have taken all the equity, you need to pay for any losses
incurred, then you probably need a loan equal to or greater than the negative cash amount. Actually, you will want to take
out a loan that is greater than the negative cash Lgure because you should build in a safety margin of several hundred
thousand.
There is one other potential user of cash that would not trigger an equity investment but could require a loan. This is
increasing inventories. If the Lrm's ending inventories are large or growing, they will draw down on the Lrm's cash
reserves. Essentially, you are converting cash to inventory. Unusually large inventories result from either large safety
stocks or overestimating demand. In any case, they will show up as a drain on cash and a negative cash position.
Fortunately, large inventories can usually be sold off quickly and so the need is for short-term debt.
Typical Problems Stemming from Debt Decisions
The most frequent problem has already been discussed. That is, the assumption that debt can be used to cover losses.
Many participants feel that as long as they have cash (even if it is from a lending agency), they are in good Lnancial
shape. This is not true.
The next most frequent problem is that a team will take out a short-term loan and then experience an unexpected decline
in revenue and proLts. A Lrm's debt capacity in any quarter is determined by its net equity in the prior quarter. If a Lrm
experienced a loss in the prior quarter, the loss will have reduced retained earnings, which, in turn, will have reduced debt
capacity. This, in turn, will cause the bank to call in part of the loan. And, this in turn, will worsen an already bad situation
(unexpected losses, cash shortfalls).
Unexpected losses are the largest cause of Lnancial trouble for any Lrm. Thus, it is prudent to do some worst-case
planning. It is recommended that you reduce the projected demand but keep all other expenses the same. Consider
reductions of 20% to 40%. This scenario will almost certainly result in large losses and large increases in inventory, both
of which will result in substantial reductions in available cash. Check your ending cash position and your retained
earnings under this worst-case scenario. Will you have positive equity and positive cash? If not, think seriously about
tempering you plans.
Finally, there are guidelines in the tactical plan to help make your debt decisions. Click on the "?" next to the loan options.
In conclusion, good strategy requires time and effort. You must consider all the possibilities, think every decision through
to its logical conclusion, and be willing to make many adjustments to "get it right." It is not easy to formulate a strategy
that will achieve the desired goals and be within the resource capabilities of the Lrm. Use the tactical plan and pro forma
Lnancial statements to help you plan for the future and anticipate potential problems from the outset.
M. Balanced Scorecard
The balanced scorecard is the most important measure of your total performance. It provides a single number that can
be compared between companies. As such, it is the main indicator for evaluating your performance in the market. It
becomes available after the Lrst quarter of sales.
The cumulative balanced scorecard provides the average of your performance over the past 4 quarters at most. It
smooths out any spikes or dips in your performance and therefore relects your ability to perform, not in one particular
quarter, but over time.
Total Performance
The Total Business Performance indicator is a quantitative measure of the executive team's ability to effectively manage
the resources of the Lrm. It considers both the historical performance of the Lrm as well as how well the Lrm is
positioned to compete in the future. As such, it measures the action potential of the Lrm.
The index employs what is called a balanced scorecard to measure the executive team's performance. The most
important measure is the team's Lnancial performance, and thus its ability to sustain and grow the business and create
wealth for the investors. However, the focus on current proLts has caused many executives to stress the present at the
expense of the future and to ignore all of its other stakeholders.
The long-term viability of the Lrm requires that the executive team be good at managing not only the Lrm's proLtability,
but also its marketing activities, production operations, human resources, cash, and Lnancial resources. The
management team must also invest in the future. And, it must satisfy the needs of the customers, provide rewarding
employment for its workers, develop a strong supply chain, take care of the environment, and contribute to the
community. These expenses might depress the current Lnancial performance, but are vital to creating new products,
markets, and manufacturing capabilities and building a strong reputation.
In short, top managers must be good at managing all aspects of the Lrm. The balanced scorecard puts this perspective
into practice. It focuses attention on multiple performance measures, and thus multiple decision areas. None can be
ignored or downplayed. The best managers will be strong in all areas measured.
The Total Business Performance measure is computed by multiplying several indicators of business performance. This
model underscores the importance of all measures. This is because any strength or weakness will have multiple effects
on the Lnal outcome, the Action Potential of the Firm.
The following is a summary of the measure of the Lrm's Total Business Performance and its key performance indicators.
The computational details follow. Note that a negative score in any of these indicators will result in a Total Performance
of "0".
Total Performance = Financial Performance * Market Performance * Marketing Effectiveness * Investment in Future *
Wealth * Human Resource Management * Asset Management * Manufacturing Productivity * Financial Risk *
Reputation
Financial Performance
measures how well the executive team has been able to create proLts for its shareholders. A positive number is always
desired and the larger the better. It is computed in three steps.
First, a measure of the company's proLtability is computed by taking the average of your gross proLt and your net proLt
from operations.
The gross proLt is the company's revenue minus the costs of making your products. It is computed by subtracting
rebates and the cost of the goods sold from total revenues. Gross proLt measures how e^ciently you produce revenue.
The net proLt from operations is computed by taking the operating proLt shown in the income statement and adding
back investments in the future that are expensed in the current quarter. It measures how well the managers are able to
create revenue from the current quarter's marketing, sales and manufacturing activities.
Note that the income statement also includes investments that will beneLt your Lrm's future (referred to as 'Investment in
Future' in the balanced scorecard). Because these expenses will help you to create new business opportunities, they are
added back to the operating proLt so that the Lnancial performance measure is entirely focused on current quarter
revenues and expenses.
Second, the total number of shares of stock is computed by adding all forms of equity investment. If an emergency loan
has been taken out, shares of stock will automatically be issued to the loan shark and they become a permanent part of
the equity Lnancing.
Third, the average of your gross proLt and your net proLt from current operations is divided by the number of shares of
stock issued to determine the proLtability per share of stock.
Financial Performance = (Net ProLt from Current Operations + Gross ProLt ) / 2 / Total Shares Issued
Net ProLt from Current Operations = Operating ProLt + Investments in Firm's Future
Operating ProLt = Gross ProLt - Total Expenses
Investments in Firm's Future = Cost to Open New Sales O^ces + R&D Investment in New Brand Features and New
Brands + R&D Licenses + System Improvements + Depreciation
System Improvements = rd_quality_cost - rd_warranty_cost
Total Shares Issued = Number of Shares Issued to Executive Team + Number of Shares Issued to Venture Capitalists
+ Number of Shares Issued to Loan Shark
Market Performance
is a measure of how well the managers are able to create demand in their primary and secondary segments. The Lrm's
market share in two target segments is used to measure this demand creation ability. The market share score is adjusted
downwards if there were any stock-outs. This penalty for stock-outs is to underscore two points. First, unnecessary
resources have been spent to generate more demand than can be satisLed. Second, ill will has been created by having
potential customers become frustrated when they do not Lnd the products that they have been persuaded to buy. The
score ranges from 0 to 1.0 and will depend upon the number of competitors. If there are 3 Lrms, a good score would be
greater than 0.5. If there are 8 teams, a good score would be greater than 0.35.
Market Performance = Average Market Share in Targeted Segments / 100 * Percent of Demand Actually Served / 100
Average Market Share in Targeted Segments = ( Market Share in First Segment + Market Share in Second Segment )
/2
Percent of Demand Actually Served = ( ( Total Net Demand - Number of Stock-outs ) / Total Net Demand ) * 100
Marketing Effectiveness
is a measure of how well the managers have been able to satisfy the needs of the customers as measured by the quality
of their brands and ads. Customer perceptions of the Lrm's brands and ads in its primary and secondary segments are
used to measure customer satisfaction. The two scores are then averaged to obtain the indicator for marketing
effectiveness. The score ranges from 0 to 1.0. A good score would be greater than 0.8.
Marketing Effectiveness = ( Average Brand Judgment / 100 + Average Ad Judgment / 100 ) / 2
Average Brand Judgment = ( Highest Brand Judgment in First Segment + Highest Brand Judgment in Second
Segment ) / 2
Average Ad Judgment = ( Highest Ad Judgment in First Segment + Highest Ad Judgment in Second Segment ) / 2
Investment in Future
relects the willingness of the executive team to spend current revenues on future business opportunities and goodwill.
These investments are also the most tangible way to measure the executive team's allegiance to Conscious Capitalism.
Investments in the future are necessary for the long-term viability of the Lrm, but risky. In the short-term, these
expenditures can cause large negative proLts on the income statement. As a result, the retained earnings may become
highly negative, thus indicating that a substantial portion of the stockholder's investment has disappeared into the
operations of the Lrm. In the long-term, these investments are absolutely necessary if the Lrm is to thrive and be
competitive. Thus, there is a need to balance the loss of stockholder's equity against investments that could create even
greater returns for the investors in the future. The score is always greater or equal to 1.0 and a good score would be
greater than 3.0.
Investment in Future = ( Cumulative Expenses that BeneLt Firm's Future / Cumulative Net Revenues ) * 10 + 1
Cumulative Expenses that BeneLt Firm's Future = Cumulative Cost to Open New Sales O^ces + Cumulative R&D
Investment in New Brand Features and New Brands + Cumulative R&D Licenses + Cumulative System Improvements
+ Cumulative Depreciation
Cumulative System Improvements = cum_rd_quality_cost - cum_rd_warranty_cost
Cumulative Net Revenues = Cumulative Sales Revenue - Cumulative Rebates
Wealth
is a measure of how well the executive team has been able to add wealth to the initial investments of the stockholders.
During the start-up phase of the company, it is expected that expenses can exceed revenues leading to losses and
retained earnings Lgures that are negative.
To compute the creation of wealth measure, the net equity of the Lrm is Lrst computed by adding the retained earnings
to the total of the investments from all of the stockholders. The retained earnings Lgure is the sum of all proLts from the
inception of the Lrm. As noted above, the retained earnings will be negative in the early quarters as the Lrm invests
money to start up and grow the business.
Next, the net equity is divided by the total of all equity investments to obtain a ratio of wealth creation. A value of zero or
less indicates bankruptcy. A value greater than zero and less than one indicates the executive team is relying upon the
initial stockholder's investments to pay day-to-day expenses plus invest in the future. A value greater than one indicates
the Lrm is adding wealth to the stockholders.
Wealth = Net Equity / Total Stockholders Equity
Net Equity = Retained Earnings + Common Stock
Total Stockholders Equity = Common Stock
Human Resource Management

is a measure of how well the executive team is able to recruit the best employees, satisfy their needs and motivate them
to excel. The measure is based upon employee satisfaction with compensation, employee turnover, and employee
morale. The three values are averaged together to obtain a single score. The score ranges from zero to 1.00 and a good
score would be greater than 0.80.
Employee satisfaction with the Lrm's compensation packages is measured by computing the average satisfaction for
production supervisors, production workers, and sales force people. High performance is only possible if the Lrm's
compensation packages are competitive and in tune with what is important to employees over time.
Employee turnover is a measure of the percent of production workers who quit or are Lred. When workers leave for any
reason, production productivity goes down and costs go up. The effect of employee turnover on human resources is
computed by subtracting employee turnover from 100. The difference is a measure of employee retention, a number that
should improve over time.
Employee morale is driven by how good the employees feel about the things they produce and the company for which
they work. Morale will increase to the extent that the Lrm produces good quality products, has genuine concern for the
employees, has integrity, and is a good corporate citizen.
Human Resource Management = ( Employee Compensation Satisfaction / 100 + ( 100 - Employee Turnover ) / 100 +
Employee Morale / 100 ) / 3
Employee Compensation Satisfaction = ( Production Supervisor Compensation Satisfaction + Production Worker

Compensation Satisfaction + Sales Force Compensation Satisfaction ) / 3
Asset Management
is a measure of the executive team's ability to use the Lrm's assets to create sales revenue. The Lrst step in measuring
asset management is to compute the asset turnover of the Lrm. Effective managers are able to use the assets to create
sales which are two or three times the value of the assets. Thus, a very good score would be 3.0.
In addition to asset turnover, ending inventories are also measured and included. To avoid stock-outs, and their
associated penalties, managers might be inclined to acquire excessive inventory. To discourage large ending inventories,
there is a penalty for purchasing more inventory than is needed to meet demand. The penalty increases as the proportion
of ending inventory to purchased inventory increases.
Note that a negative penalty for excess inventory will result in an Asset Management of "0".
Asset Management = Asset Turnover * Penalty for Excess Inventory
Asset Turnover = Net Revenues / Total Assets
Net Revenues = Sales Revenue - Rebates + Interest Income
Penalty for Excess Inventory = 1 - Ending Inventory / Production
Manufacturing Productivity
measures the executive team's ability to e^ciently create reliable products.
Reliable products are a high priority of all customers and thus it is the Lrst measure of manufacturing productivity. To
achieve a reliable manufacturing process, the managers will have to invest money to study and then improve upon the
production processes. It is a multi-step process that takes time and considerable resources as part of a system
improvement program.
The second measure of productivity focuses the e^ciency of production scheduling. SpeciLcally, how much of the
operating capacity is actually used in production versus that portion lost due to excess capacity.
Excess capacity costs occur when the production facility is scheduled to produce more units than is needed to meet
demand or stock the warehouse. Good forecasting and production scheduling will reduce penalties for excess capacity.
The score ranges from 0.0 to 1.0. A very good score would be 0.80.
Manufacturing Productivity = ( Reliability Judgment / 100 ) * ( Percent of Operating Capacity Used in Production / 100 )
Percent of Operating Capacity Used in Production = ( Total Effective Operating Capacity / Operating Capacity
Scheduled ) * 100
Financial Risk
measures the executive team's ability to manage debt as a Lnancial resource. The Lnancial risk indicator is based upon
the degree to which debt is part of the capital of the Lrm. As debt increases relative to the total capital, then the Lnancial
risk associated with the company increases. Conversely, as the proportion of equity in the total capital increases, then
the perceived Lnancial risk in the Lrm decreases.
To compute Lnancial risk, the proportion of equity is obtained by computing the amount of equity in the Lrm and dividing
it by the amount of capital invested in the Lrm from all sources. SpeciLcally, the amount of equity is equal to the sum of
common stock plus retained earnings. The amount of capital is equal to the sum of debt plus common stock plus
retained earnings. As the ratio of equity to capital decreases (meaning more debt), then Lnancial risk increases.
A value of 1.00 would indicate there is no debt and, therefore, no perceived Lnancial risk.
It is important to realize that Lnancial managers do not want to totally discourage debt. The optimum capital structure
will vary by Lrm depending on its tax situation, overall risk, asset base, and Lnancial slack. Some debt may be desirable in
order to help the Lrm take advantage of value enhancing business opportunities (i.e., opportunities that earn more than
the company's weighted average cost of capital).
In order to mitigate or downplay the effect of low amounts of debt in the capital structure, the value for the share of
equity in the company is raised to a power of 0.5 (square root). Thus, if debt represented 20% of the capital structure,
then the Financial risk indicator would be 0.89 (0.80 ^ 0.5). If debt were 50% of the capital structure, the Financial Risk
indicator would be 0.71.
A Financial Risk indicator below 0.80 (more than 36% debt) would be considered unfavorable.
Financial Risk = ( Total Equity / Total Capital ) ^ 0.5
Total Equity = Common Stock + Retained Earnings
Total Capital = Common Stock + Retained Earnings + Debt
Reputation
relects the amount of esteem that your Lrm has earned in the eyes of its stakeholders - that is its customers, employees,
suppliers, investors, competitors and community. To be held in high esteem, your executive team must be reliable,
credible, trustworthy and responsible. Being aware of how your company is perceived is important to generating goodwill
and increasing sales. Stakeholder impressions can be colored by your Lrm's prominent brands and advertising; employee
experiences; corporate success, productivity, and responsiveness; and a willingness to improve outdated systems and
processes.
Your marketing research Lrm conducts a quarterly survey of your company's stakeholders to score your reputation. This
is a subjectively determined measure ranging from 0 to 100. It takes time to develop a good reputation. Starting out in
the 60s, a good score would be in the high 70s by the end of 6 quarters of business.
Reputation = Reputation Score from the Stakeholder Survey / 100

N. Glossary
1. Brand Components
2. Fatal Errors
Brand Components
Essentials
Base components are hardware components to which all other hardware features are connected. Includes main
circuit board, video and sound adapters, memory chips, internal wiring, external ports, speaker and other features.
Case
Standard desktop encasement is a basic rectangular shaped tower case for a desktop model computer.
Stylish desktop encasement is a stylishly shaped and contoured tower case for a desktop model computer.
Casing is coated in a lead-free paint.
Standard laptop encasement is a lat, rectangular shaped laptop case for a portable model computer.
Ultra slim laptop encasement is a lat, rectangular shaped laptop case for a portable model computer with lower
height proLle than a standard case. Casing is coated in a lead-free paint.
Stylish laptop encasement is a slim, stylishly shaped and contoured laptop case for a portable model computer
with lower height proLle than a standard case. Casing is coated in a lead-free paint.
Hard drive
Standard hard drive is a hardware component that allows the computer to store digital data.
High capacity hard drive is a hardware component with greater storage capacity compared to a standard hard
drive. Usually describes a set of two disk drives.
Ultra capacity hard drive is a hardware component with greater storage capacity compared to a high capacity hard
drive. Usually represents three disk drives for maximum storage capacity.
Fail-proof ultra capacity hard drive has the same storage capacity as the ultra capacity hard drive and it offers
better protection against the loss of data.
OBce software
O^ce software allows computer to manipulate text and spreadsheet documents for reading and editing, including
formatting, arithmetic and graphing functions and other features.
O^ce software upgrade contains all the functionality of the previous version in an updated format, plus adds
several new features.
Other software
Business graphics software allows computer to create advanced graphical demonstrations and animations.
Includes functions for importing data from other o^ce applications and for publishing for the web.
Presentation software allows computer to create stylized slide shows and reports. Includes functions for creating
charts and graphs from scratch or by importing the data from a spreadsheet application.
Database software allows computer to store, modify and organize large sets of data, extract information and
present it in a variety of formats.
Bookkeeping software allows computer to manage business accounting and Lnance information.
Engineering software allows computer to create, edit, and navigate three dimensional models and surfaces as
visual images in the design process, and translate them into scientiLc documents.
Manufacturing control software allows users to monitor, direct and adjust manufacturing and inventory
processes.
Security suite helps protect computer from malicious programs such as viruses and spyware or Internet threats
which can destroy user's data or compromise personal information.
Power management software reduces the environmental footprint of a computer by managing its energy
consumption.
Game programs allow computer to run electronic versions of several board and arcade games.
Monitor
17 inch standard monitor for desktop computer is an output device that allows the operator to interface with the
computer through a visual display of data.
19 inch standard monitor for desktop is an output device that allows the operator to interface with the computer
through a visual display of data.
21 inch high resolution monitor for desktop is an output device that allows the operator to interface with the
computer through a visual display of data with Lner visual quality.
32 inch wide screen monitor for desktop provides a large display area which allows the operator to view many
different applications on the screen at the same time.
14 inch standard monitor for laptop is an output device that allows the operator to interface with the computer
through a visual display of data.
17 inch advanced monitor for laptop is an output device that allows the operator to interface with the computer
through a visual display of data with Lner level of visual quality.
Computing power
Budget computing power describes a central processing unit with a single microprocessor managing and
performing data processing operations.
Mid-range computing power describes a central processing unit with two microprocessors that manage data as
needed. Provides faster processing response than a budget computing power component.
High speed computing power describes a central processing unit with three microprocessors that manage data
as needed. Provides faster processing response than a mid-range computing power component.
Ultra fast computing power describes a central processing unit with advanced architecture which allows much
faster processing than a high speed computing power component.
Keyboard & mouse
Standard keyboard is an input device that allows the operator to enter data in the computer through a set of
typewriter-like keys.
Expanded keyboard is an input device that contains standard key set plus 15 additional special-function keys and
10 programmable hot keys.
High comfort keyboard is an input device that contains standard key set with ergonomic design and padded wrist
rest to reduce physical stress on the user.
Special features
Auto backup system is an external component that wirelessly connects to a computer and automatically backs up
data. Used to restore data in case of hard drive failure or operator error.
Touch screen allows user to control the computer via tapping directly on the monitor screen. It serves as an
alternative to keyboard and mouse input devices.
Networking
Standard networking describes a device that enables a computer to connect to a network and/or the Internet.
High speed networking describes a device that enables a computer to connect to a network and/or the Internet
allowing a faster data transfer than a standard networking component.
Battery
Standard battery allows portable computers to run for 2 to 3 hours without access to the electrical source.
Long-life lithium battery allows portable computers to run for 6 to 8 hours without access to the electrical source.
Packaging
Standard cardboard box with foam molded to Lt the computer.

Sustainable packaging which reduces the environmental impact and ecological footprint of the shipping
container.
Fatal Errors
As you begin to compete in the Marketplace, you will Lnd that your auditor will impose a number of limitations on your
decisions. These constraints will be listed in the Final Check link at the end of your decisions. Unless you correct all fatal
errors, you will not be able to wrap up your decisions.
The following table indicates the limitations that you can expect in each quarter of play. These constraints will keep you
in a safe zone until you get more experience. As you will note, in later quarters, the constraints imposed by the auditor
will gradually be released.
Fatal errors overview over all game quarters
Quarter Quarter Quarter Quarter Quarter Quarter

FINAL CHECK FATAL ERRORS
1 2 3 4 5 6
Limit on number of new sales oBces

x x x
(maximum of 1 sales oBce per quarter)
Limit on number of sales people per oBce

x x
(7 or less)
Limit to 3 brand features R&D projects x
Brand price minus rebate must be greater

x x x x x
than 1,300
Brand price must be less than 8,500 x x x x x
Limit on advertising expenditures

Q2: 150,000 x x
Q3: 300,000
Limit on spending for brand feature R&D

and new sales outlets must be less than
x x x
90% of net equity (common stock +
retained earnings)
Limit on debt capacity (based on previous

quarter's balance sheet + new equity in x x x
current quarter)
Limit on amount of money that can be

spent on Pxed capacity, new sales outlets,
x
etc. (there should be at least 1 in the
ending cash balance)
Limit on how much Pxed capacity can be

added (maximum of 50 units/day in the x x x
indicated quarters)
Limit to 200 on maximum ending

x
inventory per brand
Other limitations (valid for the entire game):

- You cannot have more than 40 brands.
- You cannot have more than 25 differently designed advertisements.
- The minimum compensation you set cannot be less than 70% of the previous quarter's industry compensation.
- The maximum compensation you set cannot be more than 130%of the previous quarter's industry compensation.
- In any quarter, you cannot increase your operating capacity by more than 400 units/day (even if you have su^cient Lxed
capacity).

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G. Human Resource Management

Each segment has different needs and wants and requires a

The Workhorse segment is the largest group of customers. They

The Traveler segment wants a practical computer to use on the

The formula for success in business and marketing is very simple.

Here are the rules:

Find out what people want.

Sounds easy, right?

How will they do this?

Fourth, customers will always gravitate towards the better offer.

Decisions to be Made by Quarter

Quarter 1: Organize the Prm and setup shop.

Determine desired image of company

Quarter 2: Go to test market.

Sell 1 million in stock to executive team (done automatically)

Quarter 3: Skillful adjustment and market expansion.

Evaluate Lnancial performance

Quarter 4: Invest in the future.

Evaluate Lnancial performance

Quarter 6: RePne the business strategy.

Evaluate performance - Lnancial, marketing, team and competitive

Quarter 7: Report to the board.

Organization: Division and assignment of tasks.

1. Consider other viewpoints.

Functional Organization of the Executive Team

Goals and Strategic Direction

During these executive brieLngs, the team will review its:

Theme: Introduction and initial goals

All Team Members should:

Name and describe each market segment (provide customer proLles).

Describe expected sales strategies and tactics.

Describe and justify your production capacity decisions.

Describe your current Lnancial status.

Theme: Let's go to market!

How are you beginning to accomplish your corporate goals?

Estimate market demand by segment for each brand. Explain process.

DeLne speciLc, quantiLable goals for the test market.

Explain and justify your compensation decisions.

Describe and justify your production facility decisions, Lxed capacity.

DeLne speciLc, quantiLable, Lnancial goals for the test market.

Theme: The results are in! What now?

How did your performance compare to your corporate goals?

How did your performance compare to your business goals?

How did your performance compare to your market goals?

All Team Members should:

Prepare Tactical Plan for following quarters.

Theme: Departures from the business plan.

What is your position in the market?

Are you on target with your marketing goals?

Review your production facility operation in the previous quarter.

Theme: Preparing for the big push.

What is your position in the market?

How does your market performance compare to your market goals?

Review your production facility operation in the previous quarter.

Theme: Rating your performance.

All Team Members should:

Review Balanced Scorecard.

Initially, your company should conduct marketing research to determine:

1. The structure of the market.