Sunny Phone Company
Sunny Phone Company is a small manufacturer of telephones for the consumer market with
annual sales of $400 million. The company was started in the early eighties by two entrepreneurs,
Martha Stalwart and Oprah Winfield, with the intent of creating stylish phones for the “Pottery Barn”
segment of the market. Recently the company has run into financial difficulties that have caused it to
evaluate its current marketing strategies for various market segments. One product that is particularly
important for the company is the T-3000 model (also known as the “Cape Cod”). Last year, the T-3000
captured 30% share of the total category sales of 3,000,000.
T-3000 STRATEGY
Historically, the consumer phone market has experienced stable prices despite the relative
maturity of the market. However, the advent of new digital technologies has sparked consumer interest
and attracted new competitors. The effect has been increased competitive pricing activity. In the past,
Sunny was regarded as a price leader in the market. Consumers perceived Sunny’s phones to have
above average quality even though the technical differences between most phones are minimal.
Consequently, Sunny maintained a slight price premium compared to other phones. This pricing
approach resulted in substantial profits as shown below in the pro-forma income statement for the coming
year.
Pro-Forma Income Statement for T-3000
Revenues
COGS
Net Sales
Expenses
Advertising
Promotions
Amort. Investment
G&A
Total expenses
EBIT
$159,804,000
110,016,000
49,788,000
$6,000,000
3,000,000
4,000,000
4,500,000
17,500,000
$32,288,000
The increased competition has led Sunny’s management to become concerned that the T-3000
will not maintain its current market position. The new competitors have shown a willingness to gain share
through price-cutting -- thereby upsetting the market equilibrium that had been established. In fact, the
brand manager for the T-3000, Ms. Trisha Yearwood, does not believe that the T-3000 will be able to “hit
its numbers” for next year. She thinks that a more realistic scenario is that increased competitive
pressure will erode market share by as much as two points (although the 30% figure is still the most likely
value) and force Sunny to cut price by as much as $2.50 (Trisha feels that all values for a price cut are
equally likely). In the event that the T-3000 does lose share, then Sunny would have to respond by
increasing sales promotions by as much as $1,250,000, although this extreme amount is deemed
unlikely. However, reducing purchasing costs by using slightly lower quality components might offset
some of the extra promotional expense. After speaking with the director of purchasing, Trisha believed
that this approach could reduce variable costs between $0.00 and $2.85 with a most likely value of $0.35.
After voicing her concerns to senior management, Trisha was instructed to develop an alternative
plan for the T-3000.
TRISHA’S PLAN
At the next executive meeting, Trisha presented her plan to reposition the T-3000 line upward in
an attempt to differentiate the product from the many similar phones on the market. To accomplish this
goal, Sunny would have to incorporate its new proprietary “clear tone” technology into the phone in order
to provide the best sound quality available in the market today. Using the “clear tone” technology would
require Sunny to negotiate the purchase of new production equipment. Purchasing estimated that the
price of the new equipment would range from $7,000,000 to $12,000,000 depending on the supplier
selected and production process chosen. The equipment would be depreciated over 5 years using
straight-line depreciation. The addition of “clear tone” technology would also increase the production cost
of the T-3000. When Trisha asked engineering for a cost estimate, they told her that they expected
production costs to increase by an average of $17.50 per phone. However, they could not be certain
about this figure until the new production equipment was installed and the final production process was
implemented. Thus, the engineers explained that variable costs might increase by as little as $15.50 or
as much as $21.00, although these extreme values were considered less likely than their “best guess” of
$17.50.
In order to communicate the new positioning of the T-3000, Trisha proposed a $4,000,000
increase in the advertising budget. The additional funds would be used primarily for print ads in select
markets. In addition, Trisha proposed offering a joint-advertising promotion for retailers where Sunny
would pay half the cost of any retailer ads featuring the New T-3000. She expected this promotion to cost
an additional $2,000,000 depending on retailer response to the program. However, if dealer response
was positive, the cost could rise to $3,000,000. Conversely, if dealer response was negative, then the
cost could be as low as $1,000,000. Trisha thought each possibility was equally likely.
A change in pricing strategy was also a part of Trisha’s plan. Trisha intended to adopt a premium
pricing strategy that would increase the selling price to Sunny’s distributors from $177.56 to $205.95.
Preliminary research indicated that Sunny’s distributors deemed this new price appropriate, although
there was some uncertainty about the ultimate pocket price that would be realized. Best estimates
suggested that the realized price could range between $199.65 and $206.95 with all values deemed
equally likely. When analyzing the new pricing strategy, Trisha considered three possible scenarios for
how the market would respond. The first scenario, considered the most likely by Trisha, suggested the T3000 would lose between 0 - 2 points of market share (she felt all possible values were equally likely) as
price sensitive consumers responded to the higher price point by switching to lower priced phones.
Trisha estimated that there was a 50% chance of this scenario occurring.
The second scenario recognized that consumers might perceive the new “clear tone” technology
to be a good value at the new price point. If this occurred, the T-3000 might actually increase its share
from 0 to 1.5 points (with all values being equally likely). Trisha estimated there was a 25% chance that
this scenario would occur. The third scenario recognized the threat of competitive response. If the
current price-cutting environment intensified, Trisha estimated that the market share of the T-3000 would
drop to 26-28% (all values equally likely) of the entire market despite the improved quality. She
suspected that many competitors wanted to avoid the risk of a price war, however. Thus, she estimated
that there was only a 25% chance of this scenario occurring.
THE DECISION
After hearing Trisha’s proposal the management team was faced with a dilemma. They could
stick with a proven approach for the T-3000 or tamper with a currently successful product in hopes of
improving its future performance. The decision was made more complicated by the fact that the T-3000
accounted for a significant portion of Sunny’s total sales. Thus, its sales were followed closely by Wall
Street analysts. The management was very sensitive to the issue that any decline in T-3000 sales or
profitability would adversely affect Sunny’s stock price.
ASSIGNMENT
1. a) Develop a pro-forma income statement for both of Trisha’s scenarios (realistic base case and
repositioning). Use the “most likely” or average value for each variable.
b) Based on the pro-forma income statement, would you recommend that Sunny implement the
plan? Why or why not?
2. Develop an influence diagram for Trisha’s repositioning strategy. Be sure to include all of the variables
that you think are relevant to the decision even if they are not mentioned explicitly in the case.
3. Develop a simulation model to compare the risk of Sunny’s repositioning strategy for the coming period
relative to the risk of maintaining the status quo (using Trisha’s expectations). Do not extend the model
into additional years. Use only uniform, triangular, or custom distributions for the uncertainties. Assume
that all uncertainties are independent of one another. Run 5,000 trials of the simulation. Turn in a copy
of the spreadsheet (with formulas and numbers) and the Crystal Ball report.
4. Based on your analysis, would you recommend that Sunny proceed with the repositioning strategy?
Why or why not? Be sure to provide a thorough discussion of relevant issues such as:




Relative merits of each outcome probability distribution. (Note: You may find the “Overlay Chart”
feature in Crystal Ball helpful).
Specific insights into how Sunny might be able to improve upon the probability distribution for each
option.
Long-term implications for the T-3000
Risk profile of firm.
5. Upon further reflection, Tricia realized that the model was a bit unrealistic because it assumed that
there was no relationship between price, promotions, and sales. She did some analysis and estimated
that in the current scenario the correlation between price and sales is approximately -0.65 while the
correlation between promotional spending and sales is + 0.6. These relatively high correlations reflect the
importance of price in the consumer purchase decision. In contrast, with the repositioned product, she
expects the correlation between price and sales to be lower due to an increased role of quality in the
consumer purchase decision. With a repositioned product, she expects the correlation between price and
sales to be only -0.35 while the correlation between promotional spending and sales is + 0.35.
Incorporate this new information into the model. How does the result change? Explain why the mean
and variance of the forecast distributions changed as they did. Does this information alter your
recommendation in any way? If so, how?
6. Tricia is the contemplative type, so upon still further reflection she suspects that the model could still
be substantially improved. Provide your recommendations on how the model should be altered in order
to improve the quality of the decision.
Extra Credit:
In her spare time, Tricia has been known to pen and sing a few country music songs. Write a short
country music ditty to describe your experience of working through this problem. A small amount of extra
credit will be provided to anyone willing to sing their song to the rest of the class.