Energy Gel A New Product Introduction A Case Solution

1. Analysis

Energy Gel’s market’s overall outlook for the next ten years is very favorable with a projected stronger growth than the average 10% growth rate for the energy bars market. However, there are two questions that need to be addressed before HPC could undertake the launch of the new product line. Firstly, there is an issue of potential cannibalization of the existing energy bars business of HPC. Energy Gels could potentially eat into its sister product for up to a projected 10% on an annual basis. Secondly, the different costing and capital budgeting methods used by the company are under heated debate and Wickler and Leiter are stuck in a debate of which one is better than the other. HPC works on two different capital budgeting models for gauging the financial feasibility of any potential investment i.e. ‘Payback Period’ and ‘Return on Invested Capital’ (ROIC model). The minimum payback period for all investments of HPC is at seven years at most and the hurdle rate set for any investment is 15%; thus, ideally a higher demand of ROIC is done from all investments of HPC.

Having these two capital budgeting models in place for the organization, the main problem now is an indecisiveness prevailing on the matter of selection of the appropriate project costing/evaluation technique. Wickler is of the view that the new project should be charged with only the direct costs involved with the launch, thus excluding the costs of the idle capacity usage of energy bars line. However, Leiter is completely uncomfortable with this model of costing and is a strong advocate of an alternative model namely ‘full costing model’. Leiter suggests that Wickler should not be allowed to ‘free ride’ on the idle capacity of the already existing energy bars line. He should be considering the cost of implementing a new mixing machine facility plus a potential cost of cannibalization of energy bars business must also be taken into account. This could be done by making a pay-out to Leiter’s team as compensation money for loss of margin share of energy bars business towards total business due to cannibalization. And finally, Wickler should take into account the standalone overhead costs of energy gels business. The financial controller, with the purpose to break this rift between the two gentlemen, jumps in with his ‘equipment based’ costing methodology which suggests a pro-rating of costs of idle capacity usage and of other costs as well. Only then, according to this approach, could the attractiveness of this new product line be decided by recalculating the CAPEX parameters.

CFO of HPC Florence Vivar is very concerned about which approach would be better and what possible alteration needs to be done to the whole capital budgeting process in order for this and all the future projects to be valued appropriately. Based on these facts and figures, certain strategic options could be suggested and in order to reach the best possible solution which could form the basis of a sane business decision.

2. Strategic Alternatives / Options

Evaluating the project on the ‘Equipment-based’ approach

The ‘Energy Gels’ project could be justifiably evaluated using this method as suggested by Frank Nanzen, the financial controller of HPC. This method of evaluation could be critically analysed by studying its various pros and lesser cons. The major advantage of using this method is that it takes into account the exact costs associated with the running of the energy gels product line. For instance, this approach takes into account the costs to as much as the project will be required to cost. This is a pro-rata approach and this could easily manage the issue of charging of the initial investment of energy bars product line as well. Thus, it will not hurt Leiter’s business line’s results. Moreover, it will also ensure that the product is properly priced in the market, neither too high nor low. In the end, it could yield a realistic indication of financial evaluation parameters of payback period and ROIC. One disadvantage attached to this approach is that it does not take into account the projected cannibalization cost. A potential cannibalization of 10% is projected to take place which could badly impact the margin contributions of energy bars business towards the whole business. This needs to be somehow quantified and accounted for.