CASE STUDY

Crates for Critters Co. manufactures a line of pet cages, kennels, and carriers for variety of pet-care purposes. The market for pet cages, kennels, and carriers is quite competitive, so Crates for Critters continuously explores evolving customer requirements and endeavors to develop new product offerings to maintain and/or increase market share in different categories. Crates for Critters' prices are somewhat higher than those of its competitors, so the company's market share and profitability are based on the company's ability to develop new products, maintain a quality image (resulting in greater perceived value on the part of its customers and consequently, the ability to sustain higher prices), and the company's ability to effectively manage product costs.

Over the last ten years, Crates for Critters' market research has revealed changing customer demands due to the rising popularity of non-mainstream household pets (i.e., pets other than cats and dogs) often referred to as "exotic pets" or "interactive pets" (e.g. birds, chinchillas, ferrets, rabbits, etc). Crates for Critters' market research suggests that ferrets have rapidly evolved into one of the most popular pets in the U.S. and that these energetic, fun-loving, trainable members of the family rank just behind cats and dogs as the third most popular pet in the U.S. In response to this revelation, Crates for Critters began developing a new ferret product line, for which the flagship product is a new cage designed specifically for pet ferrets. Crates for Critters' initial market research indicated that ferrets have unique housing needs and suggested that ferret owners often keep multiple ferrets. As a consequence, Crates for Critters concluded that the new ferret cage would have to be carefully designed and be large enough to house two or more ferrets.

Further research consisted of customer focus groups and surveys and indicated that the key features and functionality valued by customers (in order of perceived importance) include quality(durable materials and sturdy construction), safety (well-tested construction and no small parts, sharp edges, pinching points, or dangerous openings), flexible design (movable shelves, ramps between shelves, fasteners with which to hang tubes and hammocks, ability to secure a potty box), size (large size sufficient to house an average of two or more ferrets), convenience (setup, mobility, storage), accessibility (large front and top doors, ease of opening, ability to close securely), layout (space saving vertical layout with multiple levels as opposed to space-hogging horizontal layout), economical pricing (although quality and safety justify a higher price), fanciful styling (colors, tooling), and personalization (name plate). Focus groups and customers surveyed indicated they would be willing to pay up to 20-22% more for the new ferret cage if the cage addressed quality, safety, flexibility, size, convenience, and accessibility considerations. The initial market for Crates for Critters' new ferret cage was estimated to be 40,000 cages over a five-year period with a proposed selling price of $240.00.1The board of directors keenly approved the new product concept based on a market feasibility assessment conducted by the marketing department with the expectation that the new ferret cage would generate a 25% profit margin. The target profit margin was a result of the design team's estimate of total product cost.

1The proposed selling price was developed based on comparative analysis of the pricing of competing products, the perceived value of proposed product enhancements, and the price differential customers indicated that they would be willing to accept. Research indicated that the average selling price for comparable competing products was $200.00 so Crates for Critters calculated the proposed selling price to be $240.00 (120% of the average price).

Crates for Critters created a cross-functional product development team consisting of representatives from several areas such as product development, engineering and production logistics, materials purchasing, marketing, and distribution to develop the new ferret cage. The development team utilized the customer focus group and survey research to develop an initial concept design. The development team then compared competing products with their initial concept design and identified several opportunities for improving customer value particularly with respect to quality, safety, flexibility, size, and convenience, accessibility, and layout dimensions. The resulting revised concept design consisted of a roomy, easily collapsible, two-level ferret cage with durable materials and construction, enhanced safety features, flexible design (movable shelves, ramps, and fasteners which also allow the cage to be collapsed for shipping or storage), front and top accessibility, a rolling base, a stylish design with a choice of colors and decorative tooling on the base, and an engraved brass personalization plate on the front (so customers engrave ferret names on the cage). The exterior, shelves, and base are machine manufactured but the final product is assembled by hand so quality and safety inspections can be conducted during assembly. The product is then collapsed so it may be boxed and shipped conveniently and cost efficiently. The cost estimate for the new ferret cage was $180.00 per unit which includes standard estimates for production costs (e.g., materials, labor, and overhead), marketing costs, and support costs.

The design proposal was then forwarded to Crates for Critters' board of directors for final approval. The board was very pleased in particular with the quality, safety, flexibility, size, and convenience features of the product and emphasized the significance of these features to the company's product differentiation strategy. The board approved the final design of the product based on the development team's cost figures, design, and profitability expectations. Subsequently, upon reviewing the projected figures, the head of the development team, Dave Fairit, was extremely alarmed to find that expected profit margin would not be met, due in part to a $2.00 per unit cost assignment error when computing the estimated unit cost and in part because the development team's cost estimates had neglected to included $320,000 worth of preproduction costs related to product research and development. Dave immediately contacted the three other members of the development team, Brian Furet from the marketing department, Willie Frettchen from the accounting department, and Calvin Mustelid, from engineering and production, to verify his findings. The following is a partial transcript of the emergency meeting of the development team:

Dave: What are we going to do? The board of directors approved the new product design based on our figures.

Brian: I suggest that we reduce the selling price in an attempt to increase the number of cages sold. If we lower the price by $10.00 per unit we can probably expand our market share and sell another 10,000 cages over the first five years. This sales increase should make up the difference in total profit.

Dave: But the board approved the $240.00 selling price and I don't think they will approve a lower selling price.

Willie: They are only concerned with the bottom line. Besides, the 25% profit margin is what we proposed to the board based on our cost estimates. We can just play around with the numbers a bit so the revised proposal focuses on an increase in totalprofit. Do you really want to go back to the board and tell them we screwed up? I think we should handle the problem without going back to the board.

Dave: No, I don't think I am comfortable misleading the board. In any case, I don't want to sacrifice profit margin per unit. I am also concerned that customers might perceive a lower price as indicating lower quality and as such, negatively impact Crates for Critters' ability to differentiate its product based on perceived value compared to competing products in the market. Calvin, any suggestions?

Calvin: I was afraid the product cost was going to be a problem because the board insisted on all the quality, safety, flexibility, and convenience features. These are nice features, but they run up the unit cost of the cage significantly. Cost reductions could be made in several areas by redesigning the product to reduce the durability of the cage materials (cost reduction of $6 per cage), reduce safety features (resulting in cost reduction of $4 per cage), eliminate the movable shelves and collapsibility of the cage (cost reduction $4 per cage), reduce the size of the cage (resulting in cost reduction of $5 per cage), eliminate the top opening (cost reduction of $2 per cage), eliminating the wheels in the base (cost reduction of $4 per cage), eliminate the decorative tooling on the base (cost reduction of $2 per cage), eliminate the choice of color (cost reduction from $3 to $5 per cage as a consequence of eliminating set up changes), or even eliminate the engraved brass personalization plate (cost reduction of $4 per cage). Just eliminating the durability and safety features of the cage alone will allow us to make the expected profit margin per cage. Unfortunately, this would result in some additional preproduction costs to redesign the cage but if we remove the top opening as well, we can make up the additional preproduction costs with no problem.

Willie: I would like to review both the original cost estimates as well as Calvin's cost savings estimates closely to verify cost accuracy before we commit to redesigning the cage to achieve such cost reductions.

Dave: I just don't know if the board will accept eliminating key features to reduce the cost of the cage even if the cost estimates are reliable.

Calvin: Does the board need to be informed of these cuts because we are simply attempting to meet the profit margin they stipulated? If we go back to the board now, it will delay production and as a consequence, most likely delay the planned holiday season release date of the product. Delaying the product release could negatively impact the first year sales and profitability of the product.

Brian: Wait a minute, wait a minute ... are you are suggesting we eliminate key features, features that both our market research and the board identified as critical? Withoutnotifying the board?

Calvin: If you want to make the stipulated profit margin, we have to make cuts. The suggested changes are the most obvious areas to cut costs. The board doesn't need to know the details. Customers will still buy the product and the board will still get its 25% profit margin. What's the problem?

Willie: I agree. We need to make some cuts to make the stipulated profit margin. We have a lot riding on this new product as it represents the initial product offering in our new ferret product line.

Brian: Well I disagree. Calvin's suggested cuts could result in a shoddy, unsafe, and undesirable product and increase postproduction costs to customers for using, maintaining, and disposing of the product. In addition, all the pet food contamination issues a few years back showed us that people have no tolerance for products that jeopardize the safety of their beloved pets. An unsafe product could result in injury to caged ferrets and ultimately, damage the image of the company in the long run.

Dave: I am going to schedule a meeting of the development team to discuss this problem further. What a nightmare!