High Tech Video Inc. is a small electronics company that produces hand-held video game systems. The company was started 5 years ago by university friends Justin Medakiewicz and Gregg Eisner.Justin's business background combined with Gregg's expertise in software development gave the company a strong start in developing and marketing their first product, the CV3. Justin is now the general manager of HTV and Gregg is the software operations manager. Despite the initial success of CV3, the company faced some tough challenges. The electronics industry is competitive and successful companies must produce a top quality product that is fully debugged, and extremely user-friendly. After the introduction of CV3, Justin and Gregg realized the importance of bringing their product to market before their competition. A major competitor introduced a similar product just before CV3 was released and HTV lost a lot of potential customers.
HTV is about to release a new version of its product, the CV4. Justin scheduled a meeting on June 2 with his management team to discuss various aspects of this project. In addition to Justin and Gregg, the management team consists of Lesley Braschel, sales manager, Adam Payne, accountant. At the meeting, Lesley could hardly control her enthusiasm for the new product. ‘This product is exactly what we've been waiting for", she said. "We shouldn't wait another day to introduce this product. Let's make July 1 the release date". Gregg had some concerns. "I don't disagree with the market potential for this product, but there are some other things we need to consider. The threatened strike by our printers caused us to purchase large quantities of instruction booklets for CV3. We don't like to store the instruction booklets separately, so we produced extra CV3's. The booklets and CV3's were then packaged and shrink-wrapped. We are holding 60,000 completed packages, which equals the expected sales for July, August, and September of CV3. I think we should make October 1 the release date of CV4. This would allow us to sell all our inventory of CV3."
Justin realized that this was an important decision for HTV. The inventory of CV3 was too large to ignore. He was concerned about the implications of delaying the introduction of the new product on employee morale, especially the software developers who were eager to see their
product sold. The software developers were key employees at HTV since their creativity and hard work was critical to the company's success. He asked Lesley what they would do with CV3 inventory if the new product was introduced on July 1.
"We currently sell CV3 to our distributors for $150 each. The additional features of CV4 mean that we should be able to sell it for $185. We may be able to sell it for 10% more than the $185 estimate without hurting sales. I should warn you though that pricing decisions on this product are not yet finalized. We could just as easily see a price 10% lower than $185, say around $165. But we shouldn't ignore the higher potential profit margins from CV4. Each time we sell one unit of CV4, we forgo the sale of one unit of CV3. Since the expected demand for CV4 is at least as large as the demand for CV3, we may have to throw away the existing inventory of CV3 once we introduce CV4.
The end of the meeting focused on the financials. Adam Payne, the accountant, provided the group with unit costs for the two products. In addition, he mentioned another complication. "Disposing of the extra CV3s may not be as easy as it sounds. Because the instruction booklets are shrink wrapped with the CV3s, the regular recycling is not an option, and we don't want to just dump it in the garbage because of the potential environmental implications. I'm not sure what this will cost, but I estimate we will incur disposal fees of $120,000 ($2 per unit) to properly dispose of the CV3s. Before the end of the meeting, Adam noted a final consideration, "HTV's performance evaluation system is set up to pay bonuses based on operating income calculated as revenue less fully allocated costs. As members of the management team, we all know that our bonus is dependent on the decision we make here."
Justin asked the BUSI2083 Yorkville Accounting Consultants to prepare a detailed analysis of the alternatives facing HTV, and report back to the management team.