The Silk Purse Cosmetics Company operates in close competition with several other major sup¬ pliers of cosmetics and toiletries. In this market, consumers do not seem to be very price con¬ scious: If they believe a product will help them, they tend to buy that product as long as its price lies below a limit that the consumer considers intolerable. Consequently, Silk Purse and its rivals tend to compete through their advertising and promotional expenditures, which are typi¬ cally aimed at informing consumers of the virtues of their new and established products. Silk Purse’s advertising and promotion budget is $25 million for this year, and it estimates that its rivals will collectively spend about $100 million this year. Silk Purse’s net profits are projected to be $2.8 million this year.

The vice-president of finance is worried that the expected profits this year will not be high enough to support the continuation of Silk Purse’s research and development program, given that dividends, taxes, and managerial bonuses must be paid out of profits. He suggests that a reduction of advertising to around $20 million would cause the profit situation to improve.

The vice-president of marketing argues that a reduction in the advertising budget to $20 million would cause sales to drop by $10 million, meaning a $1.7 million dollar reduction in net profits. On the contrary, she says, Silk Purse should increase advertising and promotional ex¬ penditures to $30 million. This action will increase sales by $8.5 million and net profits by $1.2 million.
The president of Silk Purse, M. C. Hogg, fears that an increase in advertising and promo¬ tional expenditures of this magnitude will very likely cause a competitive reaction from the ma¬ jor rivals. You are called in to advise Mr. Hogg.

(a) With the aid of a payoff matrix, explain the vice-president of marketing’s argument to Mr. Hogg.

(b) How does Mr. Hogg’s assessment of the situation differ from that of the marketing vice- president?

(c) What information would you encourage Mr. Hogg to obtain before making his decision?