Question

AIP 2.4 Differential Costs of a New Product LO 1 pany manufactures Syndex, a popular drug for headaches. Recently, Indurin has hiert to increased competitive pressure as other pharmaceutical firms have developed sted new products. The president of Indurin is considering the introduction of Syndex Plus Syndex Plus will be a new drug targeted to consumers who prefer extra-strength medications. The president wants a prediction of the additional profit that this new drug will generate. In his management accounting course, he learned that he should compare incremental revenues with incremental costs. He has determined that the total expected sales of Syndex Plus equals incremental revenues, as there were no previous sales of Syndex Plus. The incremental costs are the additional costs necessary to make Syndex Plus. Extra space and labor are available; therefore these costs are expected to be very low. When asked to compute the expected costs, the controller asked, "What about the effect of introducing Syndex Plus on the sales of Syndex?" The president replied, "Irrelevant! The decision to introduce a new product should only be based on a comparison of incremental costs and revenues." Evaluate the decision rule of the president.

Answer 1

While taking the decision to introduce a new product, we have to include incremental revenue and incremental costs associated with that product. However, the introduction may have some negative impact on the sales of other products, i.e. it may cannibalize some of the sales of other products. In this case, we have to also account for the cannibalization.

Here, the revenue will be

Incremental Revenue = Revenue (post introduction of the new product) - Revenue (prior to the introduction)

This includes the impact of the cannibalization.

So the decision that cannibalization will not impact the incremental revenue is wrong.