Over the past three years Minnesota Micromotors’ strategic focus has included:
– Concentrate sales on large current customers (70% vs. small/65% focus on customer retention) – Customer segment prioritization:
• A&C: 30-35% • D: 20-25% • B: 11-13%

– Pricing Strategy
• Maximize margins to segments A, B, &C recognizing we are price limited because our motors do not fully meet their demanding specifications
– R&D strategy has led us to slowly lose Power-Size advantage against Segment A requirements

• Maximize discounts for Segment D and Small customers—sacrifice margin for volume

– R&D Strategy
• Focused on manufacturing efficiency to decrease manufacturing cost to allow lower pricing to segment D and small customers • Balanced between power-to-size and thermal components

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Total revenue grew 18%; but saw declines in gross (-0.5%) and net revenue (-2.5%)

Sales Across all large segments increased while small customer sales decreased Market Share Segment A B C D Small 2012 19% 4% 4% 7% 11% 2015 17% 4% 6% 11% 5%
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Trend

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Large Segment Sales Growth a function of customer retention; new sales remained flat

Gains in segment C good for margins while gains in segment D hurt margins; losing market share in segment A very problematic

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Our products to high margin customers are not good enough in terms of Power-to-Size and/or Thermal Resistance to allow us to charge them truly premium pricing
A P-t-S Requirement TR Requirement Pricing Comparison (Desired/Actual) 20.48 129.32 $135/129 B 15.09 172.43 $141/134 C 21.55 161.65 $176/140 MM Capability 16.44 129.88

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Meanwhile our products cost either more or almost as much to produce as the lower margin customers desire to pay because they do not have high performance requirements
D & Small P-t-S Requirement TR Requirement Desired Price $83 13 115 $92 $82.61
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MM COGS

How should Minnesota Micromotors invest in research and development to improve its brushless direct current motors (BDCM) to maximize net margins on each unit sold thereby increasing corporate profitability?

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Baseline Strategy—Increase sales force while continuing to balance R&D expenses year-over-year • Increase sales force by two ($400,000 additional annual expense) • Continue to focus on core strength of large customer retention for repeat sales • React to customer requirements by focusing annual R&D expenses to best target and balance segment needs
– Initial focus on Power-to-Size to regain Segment A satisfaction

This strategy will as a comparison to the other R&D investment strategies
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Single Characteristic Improvement
• MM will continue to produce one BLDC device • Will embark on a one-year R&D effort to improve one characteristic • When improving P-t-S or TR, effort is to keep PC constant
Target Segment A&C B&C D & Small Required Investment $3.3M $4.1M $2.0M Borrowing Requirement $0 2 yr./$200k $0 Sales Force change None None -1

Characteristic Power-to-Size (P-t-S) Thermal Resistance (TR) Production Cost (PC)

Goal P-t-S: 21.95 TR: 175.74 PC $67.00

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Multiple Device Development
• MM will produce two BLDC devices each targeted to different segments
– High performance device targeted at high margin customers (A, B, and/or C) – Lower performance device with lower production costs (D and small)

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One-year R&D effort
Characteristic Target Segment All A, C, D, & Small B, C, D, & Small A, B, & C Goal P-t-S: 21.95 TR: 175.74 PC*: $67.00 P-t-S: 21.95 PC:: $67.00 TR: 175.74 PC:$67.00 P-t-S: 21.95 TR: 175.74 Required Investment $13M Borrowing Requirement $10M Sales Force change +4

All Power-to-Size & Production Cost Thermal Resistance & Production Cost Power-to-Size & Thermal

$8.3M

5.2M

+1

$10.1M

$7M

+1

$10.4M

$7.5M

0

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Increase sales force while continuing to balance R&D expenses year-over-year Advantages:
• • • • • Leverages effective sales force proven at getting repeat purchases from existing customers Requires no up-front costs Sacrifices lower margin customers for higher margin customers Trend is not MM’s friend—as product capability declines against requirements either prices or demand must fall Unclear if additional sales force and normal R&D investments in power-to-size ratio will reverse segment A sales declines; this strategy becomes a money loser if Segment A demand growth above 3%/year is not restored Product remains undifferentiated Broad market approach dilutes efforts Reactive R&D strategy—we will never be ahead of the requirements
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Disadvantages:

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Single Characteristic Improvement Advantages:
• • • • • • • • • Allows specific differentiation Focuses targeting effort on specific segments Can be achieved with little to no borrowing Requires no additional investment in plant, property, & equipment or working capital Guaranteed to eliminate MM’s competitiveness in at least one segment Never grants competitive advantage in highest margin segment (segment C) Anticipates segments A or B (depending on characteristic targeted) will not need increased capability in the other characteristic in the future Assumes characteristic improvement is achievable without increase in production costs Adoption of the production cost R&D track removes MM from the high margin segments

Disadvantages:

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Multiple Device Development Advantages:
• • Allows MM to compete across multiple segments simultaneously with multiple products Allows high margin segments to choose (and pay for) features they want while allowing low margin segments an alternative (except in the ‘P-t-S & TR’ plan)

Disadvantages:
• Expensive, requires not only R&D expenses but increase in property, plant, and equipment and working capital to accommodate additional production capacity for second line Requires assumption of debt Highest risk—if sales and margin projections do not materialize firm may not have adequate resources to pay off debt

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A
Sales Growth Gross Margins $36 Sales Growth 2%

B
Gross Margins $40 Sales Growth 5%

C
Gross Margins $43 Sales Growth -5%

D
Gross Margins $24

Small
Sales Growth -5% Gross Margins $23

Baseline
(Strategy 1)

5%

Strategy 2 P-t-S TR PC
10% -10% -10% $50 $36 $50 -10% 10% -15% $40 $56 $50 5% 5% -15% $43 $60 $50 -5% -5% 20% $24 $24 $16 -5% -5% 15% $23 $23 $25

Strategy 3 All P-t-S&PC TR&PC P-t-S&TR
10% 10% -10% 10% $33 $50 $36 $33 10% -10% 10% 10% $44 $44 $56 $44 10% 5% 5% 10% $80 $54 $60 $80 20% 20% 20% -10% $16 $16 $16 $9 15% 15% 15% -10% $25 $25 $25 $16

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Strategy 3 2 2 2 3 3 3

R&D Plan Power-to-Size & Production Cost Power-to-Size Production Costs Thermal Resistance All Plan Thermal Resistence & Production Costs Power-to-Size & Thermal Resistence

NPV $6,838,864 $5,721,581 $5,048,777 ($1,147,420) ($1,439,132) ($2,969,607) ($8,013,592)

Superior to Strategy 1 Inferior to Strategy 1

Observations • Pursuing segment A; D & Small Customers; or A, D, & Small Customers will yield highest value going forward • Pursuing Power-to-Size also yields tangential benefit of attracting Segment C (highest margin) customers • Despite low margins, Segment D’s market size precludes ignoring it in favor of high margin segments • Narrow spread of NPVs across superior plans requires additional analysis
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Gross Profit Projections
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Observations
Dual product strategy yields fastest growth in marginal gross profit differential from baseline—if all assumptions hold Thanks to its smallest initial investment and reliance on retained earnings to fund (no debt), P-t-S and PC strategies becomes profitable soonest P-t-S plan focusing on Segment A provides greatest buffer against poor sales forecasts Although the ‘P-t-S & PC’ R&D plan has the greatest gross margin opportunity, it carries the greatest risk if forecasts are overly optimistic

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Breakeven Point
Strategy R&D Plan 2 Power-to-Size 2 Production Costs 3 Power-to-Size & Production Cost Break Even Point 3 Years 3 Years 6 Years

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Reduce sales growth assumptions by 50%
Strategy R&D Plan 2 Power-to-Size 2 Production Costs 3 Power-to-Size & Production Cost NPV $1,131,537 ($2,394,281) ($2,758,716)

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Minnesota Micromotors will engage in a one-year, $3.3M research and development effort to maximize the power-to-size ratio of its brushless direct current motors
Implementation
• • • • • • During 2016, sales force will increase focus on Segment A and shift focus from Segment B to Segments C&D Once product is improved, sales force will continue to focus on large customer retention Pricing will capture maximum margin from Segment A and an equivalent margin from Segment C; Segment D pricing will be set to achieve $2-4 net profit/unit Annual R&D investments will focus on maintaining P-t-S competitive advantage while controlling production costs Will revisit question of a second major R&D investment in 2018 Although the dual device strategy (P-t-S and inexpensive models) has greatest profit potential, there is too much variability in the sales forecasts to declare that the clearly best strategy This research project remains profitable even if sales forecasts are overly optimistic The lack of debt makes this strategy more profitable than the dual development strategy
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Justification

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Errors I made in the simulation:
– – Reduced prices to Segment D too much, I was actually selling at a loss because I failed to consider operating costs along with COGS I should have focused R&D more on power to size while maintaining manufacturing efficiency investments Pricing to Segments A-C Sales force focus on large customer retention

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Good decisions
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Companies are rarely successful at being all things to all customers. The costs associated with providing each segment exactly what it wants are prohibitive. For an established company, retaining current customers is more profitable over time than luring new ones. Retaining customers is inherently cheaper. Companies need to establish early their targeted customer segments and then make all marketing decisions based on their needs. Management cannot get lured to try to compete for other segments despite potential higher margins. While a decision to shift may need to be made at some point—it has to be seen as a strategic shift and executed as such—not as a ‘let’s give this a try’ effort. If the company has the production capacity, it should consider multiple product lines that target specific segments. Had MM pursued this strategy early in development, it could have had two motors (base model and high end model) available.
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Final Project—D. Wagner

If a company is going to go ‘discount’ go early. It saves money up front and allows the company to focus on controlling costs as opposed to product development. Knowing contribution margin is critical to accurate pricing—not having that data (the simulation only provided aggregate cost of goods sold) made pricing decisions more of a guessing game than an informed decision making process Sales force feedback as to why customers make certain purchasing decisions is critical. It is unclear why my strategy increased Segment B’s purchases by 19% and Segment C’s purchases by 62% despite not meeting their product requirements. Maybe thermal resistance isn’t as important to them as originally let on or perhaps they have a specific market segment that needs power-to-size. Also, why did Segment D’s purchases double despite our prices being higher than the competitors and well over their price point. Knowing that drove these outcomes would go a long way to developing a more rational strategy. Understanding your customers’ customers is important for a component producer. Anticipating their needs will help the company position itself better. Knowing the customers’ marketing forecasts is incredibly important to a component producer—for instance if demand for devices with high power-to-size ratio motors is expected to drop—I would have chosen a different strategy. Although not an option in the simulation—a ‘Intel’ strategy of marketing the motors directly to the surgeons (‘Minnesota Motors Inside’) could provide some additional demand—especially for Segment D.

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