the research results. If the development process is successful, then we have to decide whether to
market the new product.”
“Why wouldn’t we want to market it after successfully developing it?” asks Marc.
“That’s a good question. Basically what I mean is that we could decide not to sell the product
ourselves but instead give the right to sell it to somebody else, to GM, for example. They would pay us
$1 million for it.”
“I like those numbers!” remarks Julie.
“Once we decide to build the product and market it, we will face the market uncertainties and
I’m sure that Julie has those numbers ready for us. Thanks.”
At this point, Brian sits down and Julie comes forward to give her presentation. Immediately
some colorful slides are projected on the wall behind her as Max operates the computer.
“Thanks, Brian. Well, here’s the data we have been able to gather from some marketing
research. The acceptance of our new product in the market can be high, medium, or low,” Julie is
pointing to some figures projected on the wall behind her. “Our estimates indicate that high acceptance
would result in profits of $8.0 million, and that medium acceptance would give us $4.0 million. In the
unfortunate case of a poor reception by our customers, we still expect $2.2 million in profit. I should
mention that these profits do not include the additional costs of marketing or R&D expenses.”
“So, you are saying that in the worst case we’ll make barely more money than with the current
product?” asks Brian.
“Yes, that’s what I am saying.”
“What budget would you need for the marketing of our DSS with the road scanner?” asks
Marc.
“For that we would need an additional $200,000 on top of what has already been included in
the profit estimates,” Julie replies.
“What are the chances of ending up with a high, medium, or low acceptance of the new DSS?”
asks Brian.
“We can see those numbers at the bottom of the slide,” says Julie, while she is turning toward
the projection behind her. There is a 30 percent chance of high market acceptance and a 20 percent
chance of low market acceptance.
At this point, Marc moves in his seat and asks: “Given all these numbers and bits of
information, what are you suggesting that we do?”

(a) Organize the available data on cost and profit estimates in a table.

(b) Formulate the problem in a decision tree. Clearly distinguish between decision and event
nodes

Transcribed Image Text:we just want to sell the technology without developing a product. If we do decide to develop the product ourselves, there is a chance that the product development process might not be successful. In that case, we could still sell the technology. In the case of successful product development, we would have to decide whether to market the product. If we decide not to market the developed product, we could at least sell the product concept that was the result of our successful research and development efforts. Doing so would earn more than just selling the technology prematurely. If, on the other hand, we decide to market the driver support system, then we are faced with the uncertainty of how the product will be received by our customers." "You completely lost me." snipes Marc. Max, Julie's assistant, just shakes his head and murmurs, "those techno-nerds... Brian starts to explain: "Sorry for the confusion. Let's just go through it again, step by step." "Good idea and perhaps make smaller steps!" Julie obviously dislikes Brian's style of presentation. "OK, the first decision we are facing is whether to invest in research for the road scanning device." "How much would that cost us?" asks Marc. "Our estimated budget for this is $300,000. Once we invest that money, the outcome of the research effort is somewhat uncertain. Our engineers assess the probability of successful research at 80 percent." "That's a pretty optimistic success rate, don't you think?" Julie remarks sarcastically. She still remembers the disaster with Brian's last project, the fingerprint-based car security system. After spending half a million dollars, the development engineers concluded that it would be impossible to produce the security system at an attractive price. Brian senses Julie's hostility and shoots back: "In engineering we are quite accustomed to these success rates- something we can't say about marketing...." "What would be the next step?" intervenes Marc. "Hm, sorry. If the research is not successful, then we can only sell the DSS in its current form." "The profit estimate for that scenario is $2 million," Julie throws in. "If, however, the research effort is successful, then we will have to make another decision, namely, whether to go on to the development stage." "If we wouldn't want to develop a product at that point, would that mean that we would have to sell the DSS as it is now?" asks Max. "Yes, Max. Except that additionally we would earn some $200,000 from selling our research results to GM. Their research division is very interested in our work and they have offered me that money for our findings." "Ah, now that's good news," remarks Julie. Brian continues, "If, however, after successfully completing the research stage, we decide to develop a new product then we'll have to spend another $800,000 for that task, at a chance of 35 percent of not being successful." "So you are telling us we'll have to spend $800,000 for a ticket in a lottery where we have a 35 percent chance of not winning anything?" asks Julie. "Julie, don't focus on the losses, but on the potential gains! The chance of winning in this lottery, as you call it, is 65 percent. I believe that that's much more than with a normal lottery ticket," says Marc. "Thanks, Marc," says Brian. "Once we invest that money in development, we have two possible outcomes: either we will be successful in developing the road scanning device or we won't. If we fail, then once again we'll sell the DSS in its current form and cash in the $200,000 from GM for
Transcribed Image Text:Case 16.2 Smart Steering Support On a sunny May morning, Marc Binton, CEO of Bay Area Automobile Gadgets (BAAG), enters the conference room on the 40th floor of the Gates building in San Francisco, where BAAG's offices are located. The other executive officers of the company have already gathered. The meeting has only one item on its agenda: planning a research and development project to develop a new driver support system (DSS). Brian Huang, Manager of Research and Development, is walking around nervously. He has to inform the group about the R&D strategy he has developed for the DSS. Marc has identified DSS as the strategic new product for the company. Julie Aker, Vice President of Marketing, will speak after Brian. She will give detailed information about the target segment, expected sales, and marketing costs associated with the introduction of the DSS. BAAG builds electronic nonaudio equipment for luxury cars. Founded by a group of Stanford graduates, the company sold its first product a car routing system relying on a technology called global positioning satellites (GPS) a few years ago. Such routing systems help drivers to find directions to their desired destinations using satellites to determine the exact position of the car. To keep up with technology and to meet the wishes of their customers, the company has added a number of new features to its router during the last few years. The DSS will be a completely new product, incorporating recent developments in GPS as well as voice recognition and display technologies. Marc strongly supports this product, as it will give BAAG a competitive advantage over its Asian and European competitors. Driver support systems have been a field of intense research for more than a decade. These systems provide the driver with a wide range of information, such as directions, road conditions, traffic updates, etc. The information exchange can take place verbally or via projection of text onto the windscreen. Other features help the driver avoid obstacles that have been identified by cars ahead on the road (these cars transmit the information to the following vehicles). Marc wants to incorporate all these features and other technologies into one support system that would then be sold to BAAG's customers in the automobile industry. After all the attendees have taken their seats, Brian starts his presentation: "Marc asked me to inform you about our efforts with the driver support system, particularly the road scanning device. We have reached a stage where we basically have to make a go or no-go decision concerning the research for this device, which, as you all know by now, is a key feature in the DSS. We have already integrated the other devices, such as the PGS-based positioning and direction system. The question we have to deal with is whether to fund basic research into the road scanning device. If this research were successful, we then would have to decide if we want to develop a product based on these results or if

Question

the research results. If the development process is successful, then we have to decide whether to
market the new product.”
“Why wouldn’t we want to market it after successfully developing it?” asks Marc.
“That’s a good question. Basically what I mean is that we could decide not to sell the product
ourselves but instead give the right to sell it to somebody else, to GM, for example. They would pay us
$1 million for it.”
“I like those numbers!” remarks Julie.
“Once we decide to build the product and market it, we will face the market uncertainties and
I’m sure that Julie has those numbers ready for us. Thanks.”
At this point, Brian sits down and Julie comes forward to give her presentation. Immediately
some colorful slides are projected on the wall behind her as Max operates the computer.
“Thanks, Brian. Well, here’s the data we have been able to gather from some marketing
research. The acceptance of our new product in the market can be high, medium, or low,” Julie is
pointing to some figures projected on the wall behind her. “Our estimates indicate that high acceptance
would result in profits of $8.0 million, and that medium acceptance would give us $4.0 million. In the
unfortunate case of a poor reception by our customers, we still expect $2.2 million in profit. I should
mention that these profits do not include the additional costs of marketing or R&D expenses.”
“So, you are saying that in the worst case we’ll make barely more money than with the current
product?” asks Brian.
“Yes, that’s what I am saying.”
“What budget would you need for the marketing of our DSS with the road scanner?” asks
Marc.
“For that we would need an additional $200,000 on top of what has already been included in
the profit estimates,” Julie replies.
“What are the chances of ending up with a high, medium, or low acceptance of the new DSS?”
asks Brian.
“We can see those numbers at the bottom of the slide,” says Julie, while she is turning toward
the projection behind her. There is a 30 percent chance of high market acceptance and a 20 percent
chance of low market acceptance.
At this point, Marc moves in his seat and asks: “Given all these numbers and bits of
information, what are you suggesting that we do?”

(a) Organize the available data on cost and profit estimates in a table.

(b) Formulate the problem in a decision tree. Clearly distinguish between decision and event
nodes

we just want to sell the technology without developing a product. If we do decide to develop the
product ourselves, there is a chance that the product development process might not be successful. In
that case, we could still sell the technology. In the case of successful product development, we would
have to decide whether to market the product. If we decide not to market the developed product, we
could at least sell the product concept that was the result of our successful research and development
efforts. Doing so would earn more than just selling the technology prematurely. If, on the other hand,
we decide to market the driver support system, then we are faced with the uncertainty of how the
product will be received by our customers."
"You completely lost me." snipes Marc.
Max, Julie's assistant, just shakes his head and murmurs, "those techno-nerds...
Brian starts to explain: "Sorry for the confusion. Let's just go through it again, step by step."
"Good idea and perhaps make smaller steps!" Julie obviously dislikes Brian's style of
presentation.
"OK, the first decision we are facing is whether to invest in research for the road scanning
device."
"How much would that cost us?" asks Marc.
"Our estimated budget for this is $300,000. Once we invest that money, the outcome of the
research effort is somewhat uncertain. Our engineers assess the probability of successful research at 80
percent."
"That's a pretty optimistic success rate, don't you think?" Julie remarks sarcastically. She still
remembers the disaster with Brian's last project, the fingerprint-based car security system. After
spending half a million dollars, the development engineers concluded that it would be impossible to
produce the security system at an attractive price.
Brian senses Julie's hostility and shoots back: "In engineering we are quite accustomed to
these success rates- something we can't say about marketing...."
"What would be the next step?" intervenes Marc.
"Hm, sorry. If the research is not successful, then we can only sell the DSS in its current form."
"The profit estimate for that scenario is $2 million," Julie throws in.
"If, however, the research effort is successful, then we will have to make another decision,
namely, whether to go on to the development stage."
"If we wouldn't want to develop a product at that point, would that mean that we would have
to sell the DSS as it is now?" asks Max.
"Yes, Max. Except that additionally we would earn some $200,000 from selling our research
results to GM. Their research division is very interested in our work and they have offered me that
money for our findings."
"Ah, now that's good news," remarks Julie.
Brian continues, "If, however, after successfully completing the research stage, we decide to
develop a new product then we'll have to spend another $800,000 for that task, at a chance of 35
percent of not being successful."
"So you are telling us we'll have to spend $800,000 for a ticket in a lottery where we have a 35
percent chance of not winning anything?" asks Julie.
"Julie, don't focus on the losses, but on the potential gains! The chance of winning in this
lottery, as you call it, is 65 percent. I believe that that's much more than with a normal lottery ticket,"
says Marc.
"Thanks, Marc," says Brian. "Once we invest that money in development, we have two
possible outcomes: either we will be successful in developing the road scanning device or we won't. If
we fail, then once again we'll sell the DSS in its current form and cash in the $200,000 from GM for

Case 16.2 Smart Steering Support
On a sunny May morning, Marc Binton, CEO of Bay Area Automobile Gadgets (BAAG), enters the
conference room on the 40th floor of the Gates building in San Francisco, where BAAG's offices are
located. The other executive officers of the company have already gathered. The meeting has only one
item on its agenda: planning a research and development project to develop a new driver support
system (DSS). Brian Huang, Manager of Research and Development, is walking around nervously. He
has to inform the group about the R&D strategy he has developed for the DSS. Marc has identified
DSS as the strategic new product for the company. Julie Aker, Vice President of Marketing, will speak
after Brian. She will give detailed information about the target segment, expected sales, and marketing
costs associated with the introduction of the DSS.
BAAG builds electronic nonaudio equipment for luxury cars. Founded by a group of Stanford
graduates, the company sold its first product a car routing system relying on a technology called
global positioning satellites (GPS) a few years ago. Such routing systems help drivers to find
directions to their desired destinations using satellites to determine the exact position of the car. To
keep up with technology and to meet the wishes of their customers, the company has added a number
of new features to its router during the last few years. The DSS will be a completely new product,
incorporating recent developments in GPS as well as voice recognition and display technologies. Marc
strongly supports this product, as it will give BAAG a competitive advantage over its Asian and
European competitors.
Driver support systems have been a field of intense research for more than a decade. These
systems provide the driver with a wide range of information, such as directions, road conditions,
traffic updates, etc. The information exchange can take place verbally or via projection of text onto the
windscreen. Other features help the driver avoid obstacles that have been identified by cars ahead on
the road (these cars transmit the information to the following vehicles). Marc wants to incorporate all
these features and other technologies into one support system that would then be sold to BAAG's
customers in the automobile industry.
After all the attendees have taken their seats, Brian starts his presentation: "Marc asked me to
inform you about our efforts with the driver support system, particularly the road scanning device. We
have reached a stage where we basically have to make a go or no-go decision concerning the research
for this device, which, as you all know by now, is a key feature in the DSS. We have already
integrated the other devices, such as the PGS-based positioning and direction system. The question we
have to deal with is whether to fund basic research into the road scanning device. If this research were
successful, we then would have to decide if we want to develop a product based on these results or if

Accepted Answer

A decision tree is a flowchart-like structure in which each internal node represents a "test" on an…