Cannibalization—description and example When your company sells more than one product, and when some or all of your products are similar, increasing sales from one product can cause a decrease in sales for another. In other words, you can steal share from yourself by convincing customers to buy your Product A instead of your Product B. This is called “cannibalization” because revenues from one of your own products eat into revenues from another of your own products. Cannibalization is a fact of life for many companies. It’s difficult to launch several products in a category without competing with yourself. So the question is not whether cannibalization can be avoided but rather whether the inevitable cannibalization losses are offset by other benefits. How do companies incorporate cannibalization into their strategic thinking? Based on past experience, consumer research, and/or educated guessing, managers estimate a “cannibalization rate.” A cannibalization rate represents the percent of the new business unit volume which is expected to be sourced (or stolen) from the old business. A cannibalization rate answers the following question: What percent of unit sales of the new product would otherwise have been sales of the old product? This provides a sense of how many existing customers switched from one product to another as a result of the new product launch. For example, imagine that Coca-Cola sells 1 million cans of Diet Coke per year, and is thinking of launching a diet cola with extra caffeine called Diet Coke Buzz. If the company expects a cannibalization rate of 25 percent, this means they expect that 25 percent of unit sales of Diet Coke Buzz will be stolen from the Diet Coke business. In other words, if Diet Coke Buzz sells 400,000 units in the first year, Diet Coke will sell 0.25 x 400,000 = 100,000 fewer units in that same year, resulting in total unit sales of 900,000 instead of 1 million. This is because 100,000 of Diet Coke’s current customers decided to buy Diet Coke Buzz instead. Note that cannibalization rate is not the percent of the old business unit volume that is stolen by the new product. If you incorrectly calculate cannibalization rates in this way, you would predict that 25 percent of unit sales of Diet Coke will be stolen by Diet Coke Buzz. In other words, you would incorrectly estimate that 0.25 x 1,000,000 = 250,000 units of Diet Coke Buzz will be purchased by those who would otherwise have purchased a Diet Coke. You would therefore incorrectly conclude that Diet Coke’s sales would be 750,000 instead of 1 million. But what if it were true that 250,000 units of Diet Coke Buzz were purchased by those who otherwise would have purchased Diet Coke? Then the correct cannibalization rate calculation would be 250,000/400,000 = 62.5%. This correctly calculates the percent of the new business unit volume that was stolen from the old business. Note also that cannibalization rate focuses on units lost from the existing business, not profits lost. But we can calculate lost profit if we know the number of units likely to be lost and

Marketing 430 1 Cannibalization Assignment

the average unit contribution. Let’s say the average unit contribution of Diet Coke is $0.40 per unit. If Diet Coke sells 100,000 fewer units in the coming year due to the launch of Diet Coke Buzz, Diet Coke’s operating profit would go down by 100,000 x $0.40 = $40,000. This $40,000 loss is not due to poor marketing decisions by the Diet Coke brand manager or because of a competitor’s actions, but is instead due to the company’s decision to launch a new (and somewhat similar) product. So this expected loss should be incorporated into the company’s strategic decision-making about whether to launch the new product. One way that Coke might do this is to count the $40,000 as a cost for Diet Coke Buzz. This is reasonable because $40,000 is indeed a price the company will pay if it launches the product. With this thinking in mind, the manager proposing to launch Diet Coke Buzz might produce the following financials in support of his or her plan:

A Predicted unit sales, Diet Coke Buzz* 400,000 B Proposed unit price to retailers, Diet Coke Buzz $0.60 C Predicted revenue $240,000 = A x B D Predicted unit contribution, Diet Coke Buzz $0.40 E Predicted cost of sales (total variable costs) $80,000 = A x (B – D) F Proposed advertising expense Diet Coke Buzz $90,000 G Proposed consumer promotions Diet Coke Buzz $20,000 H Proposed trade promotions Diet Coke Buzz $10,000 I Expected operating profit before cannibalization $40,000 = C – (E+F+G+H) J Expected cannibalization rate 25% K Expected sales of Diet Coke without launch (units) 1,000,000 L Expected sales of Diet Coke Buzz (units) 400,000 M Expected sales of Diet Coke Buzz stolen from Diet Coke (units) 100,000 = J x L N Expected sales of Diet Coke with launch (units) 900,000 = K – M O Average unit contribution, Diet Coke $0.40 P Loss of Profit Due To Cannibalization $40,000 = M x O Q Operating Profit After Cannibalization $0 = I – P

* estimated based on segment attractiveness analysis and expected conversion likelihood Note that the cost of cannibalization is units stolen (line M) times the unit contribution of the cannibalized product. Consult the Kerrin and Patterson chapter to be sure you understand the calculation of unit contribution, which is the margin that remains after accounting for variable (not fixed) costs. After incorporating the cost of cannibalization, we can see that the new product does not earn any incremental profit for the company. It merely breaks even after cannibalization. So the financial argument in favor of the new product is weak. To justify launching the product, the manager must do one or more of the following:

Marketing 430 2 Cannibalization Assignment

1. Develop a strategy where the predicted sales for Diet Coke Buzz are higher. For example, identify a larger target segment or an insight that would increase conversion. Higher Diet Coke Buzz sales would cause even more cannibalization but, because the cannibalization rate is 25%, Diet Coke Buzz profit increases would offset Diet Coke profit losses

2. Develop a strategy where the price per unit for Diet Coke Buzz is higher. Currently, the unit contribution for both products is the same, but if the unit contribution for Diet Coke Buzz were higher, then even cannibalized customers would contribute more to the company’s profit than when they were buying Diet Coke. So, for example, the company might reduce the package size by 30% (comparable in size to many energy drinks) and reduce the price by only 10%.

3. Provide a competitive rationale for launching the product. For example, if the company

managers were aware that a competitor was also planning to launch a high-caffeine diet soda (for example, Diet Pepsi Jolt), the Diet Coke Buzz manager might effectively argue that it is better to cannibalize your own sales than to allow a competitor to steal them. To persuasively make this argument, the manager would need defensible data on the extent to which Diet Pepsi Jolt will steal share from Diet Coke.

Marketing 430 3 Cannibalization Assignment