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To: Meathead who wrote (23585)	11/30/1997 1:30:00 PM
From: Chuzzlewit	Read Replies (2) \| Respond to of 176387

Good morning Meathead. Thanks for the kind words. Here is a little bit of additional analysis that might help some on this thread understand what the article was getting at. First, here are the assumptions (and I underscore the fact that they are assumptions -- there are no reliable data in the public domain to support the margin assumptions): 1. The average wholesale price of a bundled sub-zero is $1100. The gross margin is 14%. 2. The average wholesale price of a bundled higher-priced Presario is $1,750. The gross margin is 15%. Therefore, the gross profit generated per subzero is $1100 x 14% = $154.00, and the average gross margin per higher-priced Presario is $1,750 x 15%, or $262.50. This means that you would have to sell 1.705 sub-zeros to equal the same gross profit for one higher-priced Presario. Now, let's do the same calculation using my set of margin assumptions: the gross margin on a sub-zero is 10% and the gross margin on a higher-priced Presario is 16%. Now we have the gross profit of $280 vs. $110. This mean you would have to sell 2.545 sub-zeros to generate the same profit as one higher priced Presario. This clearly demonstrates how sensitive the analysis is to assumptions. Now, the author argues as follows: If we take the reciprocal of the equivalence figures above (1.705 and 2.545) we have the maximum allowable "cannibalization rate", or 1/1.705 = 58.7%. In effect, he is saying that 58.7% of the sales could have been substitutes for higher-priced Presarios. If we use 1000 sub-zeros as a base, they would generate a gross profit of $154,000, which compares to the gross profit generated by the sale of 587 higher-priced machines. So here are my basic problems with his analysis: 1. There are no data to support his margin assumptions; 2. Sensitivity analysis clearly demonstrates how small decrements in gross margin can have a major impact on permissable cannibalization; 3. The data from marketing research is suspect because the wrong categories were examined. All consumers are price-conscious, which leads to the use of economic substitutes (e.g., margarine for butter). As you lower the price of a substitute, demand increases and it acts as if there were an additional competitor in the arena. This results in the price of the original product dropping due to reduced demand. For example, when the price of heating oil drops, the price of natural gas drops. As I said in my previous post, the analysis presented by Wolf misses what I believe to be the major point behind sub-zeros: a fight for market-share which would push the weaker players out of the market. And as I think about it, one additional target that nobody discusses may actually be the mom and pop box shops. I have no data, but this may in fact be a tremendous source of potential fututre profits. Regards, Paul