PWSA Problem

RTEM Nutraceuticals is a consumer food products firm in Middle Earth. It has recently invested heavily into nutraceuticals. Nutraceuticals are food products with proven medical benefits. These benefits include weight reduction, reducing prediabetes, improved skin condition among other benefits. Proven means nutraceutical products must pass rigorous protocol tests before receiving certification from the Food & Drug Administration. RTEM is re-considering its focus on the nutraceutical market sector, and its nutraceutical research and development investment strategy. Since Nutraceuticals are a new food product category there is not a lot of information about which R&D investment strategies are most profitable. Up to this point RTEM has been treating its nutraceuticals as normal new food products; effectively investing in them as they would any new line of cookies, bread products, or breakfast replacement bars. Recent developments are enticing top management to concentrate more resources and manpower, and money on the market.

They have been encouraged by the price premiums and returns organic food producers have been earning. They have paid attention to the price premiums and margins earned when certification is received. As a result the top management at RTEM is considering making major investments in R&D and manufacturing capabilities for potential new nutraceutical products. Up to this point RTEM's food scientists have been re-engineering the recipes of existing products by substituting current ingredients with ingredients known to have proven health benefits. This has included replacing sugar with natural sweeteners like stevia or honey, reducing salt and fat content. But the top management team wants to go even further. They would like to investigate the possibility of incorporating health improving pharmaceutical ingredients into food products. They are also considering investing manufacturing capabilities. Investing early can sometimes create a positive interactive exchange between the R&D food scientists and the manufacturing engineers where both groups inform each other on better more effective processes.

RTEMs internal consultants have identified a number of factors that will potentially impact the long-term profitability (NPVs) of RTEM's nutraceutical initiative. They include:

• Expected Demand. While overall demand for nutraceuticals has been increasing in the 3-5 percent range, industry experts differ as to stable long-term levels. Some are exceptionally pessimistic expecting consumer demand for nutraceuticals to decline (if not completely disappear). They predict that consumer will not want to pay premium prices for modified food products and revert back to buying more natural version of the same products; and purchase pharmaceuticals (vitamins, etc.) separately. Others are exceptionally optimistic, seeing the nutraceutical category as being much more important than organic foods. They predict double-digit growth rates for the next 5-8 years. Others see much more moderate levels of growth much more similar to the demand for organic foods. These industry observers see nutraceuticals as being a product category primarily for the affluent consumer.
• Global CPG Competitors. A powerful and concerning development that has begun in the nutraceutical market is the behavior of global CPG firms like Unilever, Nestle, and P&G. They have started to watch the product introductions of smaller firms, like RTEM, very closely. Often they allow these smaller firms to prove the product concept and bear all the pioneering costs, only to swoop in with me-too products supported by larger marketing and distribution budgets and their immense shelf-space bargaining power with retailers. Where nutraceutical products can easily be reverse-engineered and where certification is easily obtained, global CPG firms almost always quickly capture the largest market share. Where nutraceuticals are protected by complex formulations, IP, and complicated production processes, smaller firms have been able to capture profitable leading market share positions.
• R&D and Manufacturing Process Investments. As noted above, investments in unique product formulations and proprietary manufacturing processes can, in some cases, give RTEM sustainable first mover advantages. When the larger more powerful global CPGs cannot easily replicate the nutraceuticals, RTEM can expect higher NPVs. However, the internal consultants anticipate that RTEM would need to invest an additional $35 million into its nutraceutical business unit.

The internal consultants have generated five scenarios that they think are highly plausible. Their data is present in Table 1. This is where you come in. (and all the fabricated story telling above is unimportant.) They want you to offer them analyses and recommendations that they can present to their top management team.

Question A: What is the highest expected value of RTEM proposed focus on nutraceuticals? What is the lowest expected value? Show your calculations

Question B: What would be the best possible outcome for RTEM? The worst?

Question C: The internal consultant want to know what the expected NPVs would be, if RTEM were to make the additional $35 million investment discussed above. They suggest that with the added investment the probabilities and payoffs for Scenarios 2 and 4 would change as below:

• Scenario 2: probability min 0.40, max 0.60; payoffs min 35, max 70
• Scenario 4: probability min 0.05, max 0.15; payoffs min -25, max -50

The added investment would, however, also negatively impact Scenarios 3 and 5 where a weak competitive response was projected. Given that the increased investment limits competitive imitation the added investment would reduce the NPVS directly by reducing the payoffs in Scenario 1 and 3 by at least $25 million. It would also negatively impact Scenario 5 by $30 million because declining demand would make it difficult to recover the $35 investment.

Would you recommend RTEM invest the additional $35 Show your calculations.

Range of NPVs for Scenario Probability of Scenario 10% to 30% $75m to $110m Table 1. Data for RTEM's Nutraceutical Business Unit Demand Outlook for Global CPG Nutraceutical Products Competitive Response Weak competitive Scenario 1 Strong demand growth response Aggressive Scenario 2 Strong demand growth competitive response Weak competitive Scenario 3 Flat to moderate growth response Aggressive Scenario 4 Flat to moderate growth competitive response Aggressive Scenario 5 Decline in demand competitive response 35% to 50% $25m to $55m 10% to 20% $18m to $43m 10% to 25% $35m to $60m 5% to 25% $42m to $75m