Energy gel case:
Overview
HPC is a company in the energy foods industry. Currently, the company has three arms, food, drinks, and international operations. The company sells energy drinks as well as the quick-pro energy bar. The head of business development Harry Wickler has come up with a comprehensive business plan for the introduction of energy bars in the market. However, there have been problems because not everyone agrees with his reasoning. In particular, Mark Leiter the head of the quick-pro energy bar product disagrees with Wickler’s cost calculation for the introduction of the new product as well as the cost of cannibalizing the existing energy bar business.
This case study analyzes the difference in ideas between the two men and comes out with a position that is best for the whole company. The market growth for the whole industry as well as the growth rate for the individual products requires consideration. The main factors to consider will be the cost of introducing the new product into the market versus the costs of waiting before introduction of the product. Current projections show that the energy gels segment is the fastest growing segment in the energy foods industry. The company will therefore have to introduce the product into the market eventually.
Analysis
Wickler needs to consider the costs for overhead and mixing machine usage. The mixing machines already in use for the energy bars can find use in the mixing of energy gel. Currently, the mixing machine usage is at sixty percent. Because of the similar manufacturing methods for energy bars and energy gels, the same machines can be used for mixing energy gels. The remaining forty percent of capacity can find use in the manufacture the energy gels. Utilizing the same machines for mixing both the products will result in a reduction of initial investments for the energy gel product. Alternatively, investment in new machinery from the start for the energy gel would require at least a $2 million investment and the machinery would only be used at a twenty-five percent capacity in the first year of full time production. However, the energy gel will need its own machinery.
Packaging machinery for the energy gel would be different from the machinery used in packaging energy bars. This would require an investment of $2 million as well as an additional $1.5 million for modification of existing buildings to accommodate the new production lines. Currently, the mixing machines are used at sixty percent capacity. The idle capacity is sufficient to launch the new product without incurring additional costs. However, currently, there are only minor players in the energy gel industry. HPC will be the largest player in the business to start its own energy gel product. It is therefore likely that its product will gain traction in the market fast. This might result in the capacity currently available being unavailable. The increased usage of the machinery is also likely to lead to more wear and tear. This will increase the depreciation on the available machines and it is important to include this in the costs for the mixing machine usage in energy gel production.
Increased usage of the machines is also likely to increase the overhead costs of operating the machinery. Some costs will remain constant. Administration costs will remain constant whether the machinery is operating at 10% or 100%. However, some costs are likely to increase. Maintenance costs will likely go up because of increased usage of the mixing machinery. Similarly, the cost of energy used by the machinery is also likely to go up with increased usage. For example, if the mixing machinery was operating at 60%, they might run for fourteen hours a day. At 100%, the same machines would need to run for an additional ten hours a day. The cost of energy or the additional ten hours a day needs consideration when making calculations for energy gel production using the same machines. However, idle capacity is capacity that the company already paid for but is of no economic use. Using the idle capacity for production of the new product will result in net efficiency for the use of company resources (Liozu and Hinterhuber, 2014).
Wickler needs to include potential cannibalization in his estimates. Energy bars and energy gels target at the same type of clients. However, there is one major advantage for HPC. It is going to be the first big company to manufacture energy gels. This is advantageous to the company. When HPC introduces its own energy gels to the market, it will enter into a market with a few major players the dominant position of the company initially is likely to help its initiative. The energy bar is the company’s fastest growing product. It has experienced double-digit growth since its introduction. However, the company needs to look at its history to get the answer. The energy was introduced when the company is already selling energy drinks. These products target the same market. Despite the introduction, both products have continued to show high rates of growth concurrently over the years.
Energy bars and energy gels are similar products. It is therefore likely that some customers will prefer one or the other (Boone, and Kurtz, 2013). Other present customers are likely to consume both products in less quantity of each but the total will be similar to current consumption rates. Cannibalization of energy bars however is not likely to affect the overall position of the company. The estimated cost of cannibalization of the existing product is likely to remain lower than the overall growth in the energy bar segment of the market. The company should therefore just experience slightly lower growth rates for the energy bars. The alternative is worse. If the company does not introduce energy gels into the market, potential customers will opt from the offerings of competitors. If the energy gel proves to be more popular than energy bars, existing customers of the energy bar will shift to offerings from competitors.
HPC is also at an advantage if it introduces energy gels currently. The initial costs can be added incrementally. This means that the initial cost for the business will be lower (Png, 2013). If this happens at present when major players in the energy food industry still have not delved into energy gels, HPC will likely get a market advantage and attract customers from smaller players already offering energy gels. The cost of cannibalization will be present but the overall benefits to the business will be higher. Energy bars are a relatively new product in the market and are growing very fast. It is therefore important for HPC to introduce the new product despite the threat of cannibalization of energy bar sales. The cost of cannibalization requires estimation by taking the difference in revenues from product sales as a direct result of the use of its equipment in the manufacturing process (Rajagopal, 2015).
HPC should proceed with the manufacture of energy gels. Currently, energy gels are a new product in the market that has shown a huge potential for growth. Furthermore, there are only a handful of manufacturers selling energy gels. If HPC gets into this segment, it will be the biggest manufacturer. It is important to note that because of the company’s big status and experience in the industry, it is likely to gain a large market share quickly. This would be ideal before its existing customers start opting for energy gel offerings from other manufacturers. The present would also be the best time for HPC to enter into the segment before larger manufacturers get into the segment. When a company gets into a new segment and quickly gains market share, it is easier to protect its market share than when entering a market already dominated by larger companies (Megginson, Scott, and Brian, 2008).
HPC is therefore under pressure to enter the energy gel segment of the market. This is because there are already offerings from competing companies. The energy gel segment of the industry is looking very promising. Currently, the energy food industry as a whole is expected to continue growing at an average of 12% for the next five years. New products like the energy gel are projected to experience even higher growth. Currently, the competitors in this segment are comparatively smaller compared to HPC. On their own, these competitors are unlikely to meet demand. If HPC gets into the industry currently, they will be in a good position to meet the market deficit. However, if there are major delays, bigger companies in the industry are likely to get in the market. HPC will have to work extremely hard to gain any market share from these manufacturers. Therefore, it would be in the best interest of the company as a whole to get into the segment when it is still experiencing very fast growth rates and before it becomes saturated. If the company delays its entry into the segment and energy gels become favored by people over energy bars, the company will still lose its customers to offerings from competitors.
When deciding whether to get into the segment, HPC should consider a number of factors. The first cost is the cost of introducing the product to the market (Samuelson and Marks, 2011). This cost is going to be significantly lower as compared to a new entrant into the industry. The initial investment in energy gel production will be lower because HPC can use some of its machinery already in use for energy bar production. As the market for energy gels grow, the revenues are also expected to increase and these revenues can be used to offset any investment costs. This will require incremental investments (Stengel, 2011). Revenues gained from energy bars can be re-invested into the business in order to get its own independent equipment.
HPC already has a Research and Development arm that works on its other products. The role of the R&D department is to work to improve the products on offer by the company and look into new products that the company can offer. Already, the R&D department has been working on a prototype for an energy gel that the company can complete in a matter of weeks. The company using the R&D department has already handled the cost of developing the energy gel from scratch. This makes it easy to introduce the new product, as a prototype already exists within the company whose costs have already been covered. HPC already has distribution channels for its other products. Since the energy gel is a similar product to its other offerings, the same distribution channels can find use in the sales and marketing of the energy gels. This will reduce the costs needed for setting up distribution channels for the energy gel. This lower cost of introduction into the market for the new product should act as an incentive for the company to introduce the product to the market. Estimated costs for the company in terms of marketing for the new product have been estimated at an additional $250,000 over the current $2 million for the other products.
The company should also consider the costs of not entering the market. The biggest fear for the company is cannibalization of its existing products. However, if the current growth in the energy gel segment continues to grow as predicted, the company is likely to lose its existing customers to offerings from competitors. This situation will be worse if larger companies enter the market before HPC. These companies have distribution channels and financial might that rivals that of HPC. If it turns out that energy gels are the product of choice in the industry, the company will end up losing more than it will gain.
The costs that should enter into the profit analysis for the best benefit to the entire company should be the cost of additional marketing, new machinery, and modification of the buildings for the new production lines. If the costs of cannibalization and use of existing equipment are considered, it will only benefit the energy bar side of the business. However, energy products market is dynamic and the product offerings are changing. If the company concentrates on preserving its market share in the energy bar segment and ignores the energy gel segment, the whole company will likely suffer. The cost of cannibalization will most likely be compensated for by the growing market in both segments. Even if the energy bar side of the business loses a proportion of its market to the energy gel side, the company should easily experience gains overall. This is because the whole industry is growing at a rate of 12% per annum and new products like the energy gel are actually experiencing above industry average growth.
Conclusions
HPC should consider entering the energy gel segment in the short term. This is because current conditions favor the company’s entry into the segment. There is spare capacity in the company’s existing production line that can be used to introduce the new product. This will significantly lower the initial investments needed to enter the market. Use of the idle capacity at the company will also reduce the costs for the company. Another factor in favor of the company’s entry into the segment is that its research and development department already has a product prototype that can be finalized into the final products in a matter of weeks. This essentially means that the product has already been developed and research and development costs, which contribute to the initial high cost of introduction, have already been covered. The company already has distribution channels for its existing products. Introducing the new product will take advantage of the existing distribution channels. This means that the costs of developing distribution channels for the new product will be minimized (Allen, Weigelt, Doherty, and Mansfield, 2012).
The alternative for waiting before introduction of the new product is not very attractive. This is because there are already competitors who have introduced the product to the market. If the company waits because of fear of cannibalizing its existing products, customers will opt for the competitor offerings, which will result in sales moving away from the company (Boyes, 2011). The company would therefore rather cannibalize its existing product rather than losing sales to competitors. Market entry in the short term will also be advantageous for the company. They will be able to enter the market segment before the entry of larger competitors. This will give the company a time advantage during which it should be able to gain a foothold in the market before competition grows. Entry when the competition is less is better than entering a highly competitive market. The company will be in a position to recoup some of its investments before increased competition which will likely result in lower margins per item. Early entry into the segment will also give the company time to refine its processes in order to ensure that the product will remain competitive in a more saturated market.
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