Case Study II:Ski Right
After retiring as a physician, Bob Guthrie became an avid downhillskier on the steep slopes of the Utah Rocky Mountains. As anamateur inventor, Bob was always looking for something new. Withthe recent deaths of several celebrity skiers, Bob knew he coulduse his creative mind to make skiing safer and his bank accountlarger. He knew that many deaths on the slopes were caused by headinjuries. Although ski helmets have been on the market for sometime, most skiers considered them boring and basically ugly. As aphysician, Bob knew that some type of new ski helmet was theanswer.
Bob’s biggest challenge was to invent a helmet that was attractive,safe, and fun to wear. Multiple colors, using the latest fashiondesigns, would be a must. After years of skiing, Bob knew that manyskiers believed that how you looked on the slopes was moreimportant than how you skied. His helmets would have to look goodand fit in with current fashion trends. But attractive helmets werenot enough. Bob had to make the helmets fun and useful. The name ofthe new ski helmet, Ski Right, was sure to be a winner. If Bobcould come up with a good idea, he believed that there was a 20%chance that the market for the Ski Right helmet would be excellent.The chance of a good market should be 40%. Bob also knew that themarket for his helmet could be only average (30% chance) or evenpoor (10% chance).
The idea of how to make ski helmets fun and useful came to Bob on agondola ride to the top of a mountain. A busy executive on thegondola ride was on his cell phone, trying to complete acomplicated merger. When the executive got off the gondola, hedropped the phone, and it was crushed by the gondola mechanism. Bobdecided that his new ski helmet would have a built-in cell phoneand an AM/FM stereo radio. All the electronics could be operated bya control pad worn on a skier’s arm or leg.
Bob decided to try a small pilot project for Ski Right. He enjoyedbeing retired and didn’t want a failure to cause him to go back towork. After some research, Bob found Progressive Products (PP). Thecompany was willing to be a partner in developing the Ski Right andsharing any profits. If the market was excellent, Bob would net$5,000. With a good market, Bob would net $2,000. An average marketwould result in a loss of $2,000, and a poor market would mean Bobwould be out $5,000.
Another option for Bob was to have Leadville Barts (LB) make thehelmet. The company had extensive experience in making bicyclehelmets. PP would then take the helmets made by LB and do the rest.Bob had a greater risk. He estimated that he could lose $10,000 ina poor market or $4,000 in an average market. A good market for SkiRight would result in a $6,000 profit for Bob, and an excellentmarket would mean a $12,000 profit.
A third option for Bob was to use TalRad (TR), a radio company inTallahassee, Florida. TR had extensive experience in makingmilitary radios. LB could make the helmets, and PP could do therest. Again, Bob would be taking on greater risk. A poor marketwould mean a $15,000 loss, and an average market would mean a$10,000 loss. A good market would result in a net profit of $7,000for Bob. An excellent market would return $13,000.
Bob could also have Celestial Cellular (CC) develop the cellphones. Thus, another option was to have CC make the phones andhave PP do the rest of the production and distribution. Because thecell phone was the most expensive component of the helmet, Bobcould lose $30,000 in a poor market. He could lose $20,000 in anaverage market. If the market was good or excellent, Bob would seea net profit of $10,000 or $30,000, respectively.
Bob’s final option was to forget about PP entirely. He could use LBto make the helmets, CC to make the phones, and TR to make theAM/FM stereo radios. Bob could then hire some friends to assembleeverything and market the finished Ski Right helmets. With thisfinal alternative, Bob could realize a net profit of $55,000 in anexcellent market. Even if the market were just good, Bob would net$20,000. An average market, however, would mean a loss of $35,000.If the market was poor, Bob would lose $60,000.
Discussion Questions
1. What do you recommend??
2. What is the opportunity loss for this problem??
3. Compute the expected value of perfect information.?
