Question

Consider the problem facing two businesses in the care market, Starbucks and Waves. Each company has just come up with an idea for a new coffee, which it would sell for $4. Assume that the marginal cost to produce a new coffee is a constant $2 and the only fixed cost is advertising. Each company knows that if it spends $6 million on advertising, it will get 2 million consumers to try its new product. Starbucks market research suggests that its coffee does not have any staying power in the market. Even though it could get 2 million consumers to buy their coffee once, it is unlikely that they will continue to buy the coffee in the future. Wave's research suggests that its coffee is very good, and consumers who try it will continue to be consumers over the ensuing year. On the basis of its market research, Crunch Time estimates that its initial 2 million customers will buy one unit of the product each month in the coming year, for a total of 24 million units. Given this information we should expect ____________ to advertise and to earn total profit of ________ from this new product.

Answer 1

We should expect Waves to advertise, as its coffee is likely to generate repeat purchases leading to a potential total profit of $18 million. Starbucks, expecting no repeat purchases, may not advertise to avoid losses.

Step-by-step explanation:

Given the information provided, we can analyze the expected behavior of Starbucks and Waves in the context of advertising and potential profits from their new coffee products. Waves, whose market research indicates that its coffee has staying power and will generate repeat purchases, should expect to earn substantial profits. With initial customers projected to buy one unit of the product each month for a year, Waves would expect to sell 24 million units in total. Assuming a sell price of $4 per unit and a marginal cost of $2 per unit, the total variable profit (excluding fixed costs) is $2 per unit sold. With $6 million in advertising being the only fixed cost, Waves' total variable profits would be $24 million (2 million customers times $2 times 12 months), and after subtracting the fixed cost for advertising, Waves' total profit would be $18 million ($24 million - $6 million).

On the other hand, Starbucks expects that its customers will not make repeat purchases. Thus, Starbucks might not choose to advertise at all because the single purchase by the initial customers would not be sufficient to recover the advertising costs, leading to a loss. Therefore, based on the available information, we should expect Waves to advertise and to earn a total profit of $18 million from the new product.