Libby Flannery, the regional
manager of Ecsy-Cola, the international soft drinks empire, was reviewing her
investment plans for Central Asia. She had contemplated launching Ecsy-Cola
in the ex-Soviet republic of Inglistan in 2013. This would involve a capital
outlay of $20 million in 2012 to build a bottling plant and set up a
distribution system there. Fixed costs (for manufacturing, distribution, and
marketing) would then be $3 million per year from 2012 onward. This would be
sufficient to make and sell 200 million liters per year—enough for every man,
woman, and child in Inglistan to drink four bottles per week! But there would
be few savings from building a smaller plant, and import tariffs and
transport costs in the region would keep all production within national
The variable costs of production and
distribution would be 12 cents per liter. Company policy requires a rate of
return of 25% in nominal dollar terms, after local taxes but before deducting
any costs of financing. The sales revenue is forecasted to be 35 cents per
Bottling plants last almost forever, and
all unit costs and revenues were expected to remain constant in nominal
terms. Tax would be payable at a rate of 30%, and under the Inglistan
corporate tax code, capital expenditures can be written off on a
straight-line basis over four years.
All these inputs were reasonably clear.
But Ms. Flannery racked her brain trying to forecast sales. Ecsy-Cola found
that the “1–2–4” rule works in most new markets. Sales typically double in
the second year, double again in the third year, and after that remain roughly
constant. Libby’s best guess was that, if she went ahead immediately, initial
sales in Inglistan would be 12.5 million liters in 2014, ramping up to 50
million in 2016 and onward.
Ms. Flannery also worried whether it
would be better to wait a year. The soft drink market was developing rapidly
in neighboring countries, and in a year’s time she should have a much better
idea whether Ecsy-Cola would be likely to catch on in Inglistan. If it didn’t
catch on and sales stalled below 20 million liters, a large investment
probably would not be justified.
Ms. Flannery had assumed that
Ecsy-Cola’s keen rival, Sparky-Cola, would not also enter the market. But
last week she received a shock when in the lobby of the Kapitaliste Hotel she
bumped into her opposite number at Sparky-Cola. Sparky-Cola would face costs
similar to Ecsy-Cola. How would Sparky-Cola respond if Ecsy-Cola entered the
market? Would it decide to enter also? If so, how would that affect the
profitability of Ecsy-Cola’s project?
Ms. Flannery thought again about
postponing investment for a year. Suppose Sparky-Cola were interested in the
Inglistan market. Would that favor delay or immediate action?
Maybe Ecsy-Cola should announce its
plans before Sparky-Cola had a chance to develop its own proposals. It seemed
that the Inglistan project was becoming more complicated by the day.