Question

Suppose Toyota and Honda must decide whether to make a new breed of side-impact airbags standard equipment on all models. Side-impact airbags raise the price of each automobile by $1,000. If both firms make side-impact airbags standard equipment, each company will earn profits of $1 billion. If neither company adopts the side-impact airbag technology, each company will earn $1.8 billion. If one company adopts the technology as standard equipment and the other does not, the adopting company will earn a profit of $2.6 billion and the other company will earn $-1 billion. If you were a decision maker at Honda, would you make side-impact airbags standard equipment? Explain.

Answer 1

The option 1 and 2 are highly risky, so I will choose option 3 if the CEO of Toyota doesn't agree.

Step-by-step explanation:

I have four options here, which are listed as under:

1. Make Side-Impact Airbags Standard Equipment.
2. Don't Make Side-Impact Airbags Standard Equipment.
3. Wait till Toyota starts selling its product with side-impact airbags standard equipment.
4. Negotiate with Toyota Chief Executive

Option 1. Make Side-Impact Airbags Standard Equipment.

If I take the decision to make the airbags then I have opportunity to increase the earnings by $1.6 billion dollars required that Toyota doesn't provides the same feature in its product.

So here is uncertainty whether or not Toyota will offer the same feature, which risks the future earnings is between $0 - $1.6 billions.

Key Extracts:

Earnings Opportunity $1.6 Billions

Risk of future earnings loss $1.6 Billions

Option 2. Don't make Side-Impact Airbags Standard Equipment.

If I don't make the side-impact airbags standard equipment then there is opportunity to earn $1.8 billion which is above $1 billion if Toyota also doesn't offers the side-impact airbags standard equipment in its product.

Key Extracts

Earnings Opportunity $0.8 Billions

Risk of future earnings loss $0.8 Billions

Option 3. Wait till Toyota starts selling its product with side-impact airbags standard equipment.

If I manufacture 1000 units with side-impact airbags and place all of these in the showrooms but don't sell until the announcement of my competitor then I and my competitor are earning $1.8 billion each which is higher than $1 billion option (Option 2). So the opportunity to earn is between $1 billion and $1.8 billion and risk is between $0.8 to $1.6

Key Extracts

Earnings Opportunity $1 - $1.8 Billions

Risk of future earnings loss $0.8 - $1.6 Billions

Option 4. Negotiate with Toyota Chief Executive

If I negotiate with Toyota's CEO that neither of the company will offer the side-side-impact airbags standard equipment unless anyother company starts offering this product which would effect our product offerings. So this will increase the chances of earning $1.8 billion to each company which means that together we can control the market.

Key Extracts

Earnings Opportunity $1.8 Billions

Risk of future earnings loss $0.8 Billions

Decision

My decision would be to negotiate with the CEO of Toyota to not offer the side-impact airbags standard equipment as the risk at lowest level and the opportunity to earn is at $1.8 billion which is below $2.6 billions.

The second priority would be to wait untill Toyota announces its offering of the side-impact airbags which is the second best option with opportunity to earn between $1 - $1.8 billion and the risk was between $0.8 - $1.6.

The option 1 and 2 are highly risky, so I will choose option 3 if the CEO of Toyota doesn't agree.