I would say we should sell existing valves than develop an improved model and sell it at increased price if you simply look at the decision tree I made based on the assumption and information the case provides. The Expected Monetary Value (EMV) of building new model is $105,500, whereas we can earn $100,000 payoffs by selling current model (see Figure 1). When considering the situation the Orion Controls faces, however, I should reconsider my decision. Orion has established its reputation in leading-edge technology, product reliability, customer relations and willingness to design customized products.
For such reputation, Avion Chemicals approached to Orion and asked them to develop a new valve with the offer of paying higher premium. To meet Avion’s expectation as well as to leverage Orion’s brand equity, building new “supersmart” valve seems inevitable.
There are two factors we need to reconsider and evaluate if we go for building new valve: percentage of premium and the possibility for successful shortcut software development.
One of Orion’s biggest risks involves the software development. Using a short-cut approach and developing the software within three months, the software development phase of the project has a 75% chance of being completed at a cost of $120,000. However, if they are unsuccessful, it will cost Orion three times as much, i.e., $360,000 and take eight months to complete. If the possibility for success will increase from 75% to 80%, the EMV of building new valve will go up from $105,500 to $117,500.
In addition, if both Gide and Armstrong agree to pay a 110% premium for a dramatically improved valve and 10% premium for a modestly improved one instead of the original proposal, the EMV will significantly go up to $144,500 (See Figure 2).
In conclusion, if these two can be changed, I will support Armstrong’s decision. This may possibly result in a competitor developing the product before Orion. The benefit of taking the risk and trying the short-cut approach of developing the software for the valve includes building a brand name as the innovator of the valve and making substantial profits.
Armstrong may be upset about Harrington because she estimated that there was only an 80 percent chance the improvements would be dramatic enough to warrant the full 100 percent price premium. Again, Orion is the leading designer and manufacturer of industrial valve systems. For such leading and innovative company, her assumption seems to be quite low. It is obvious that her low expectation for dramatic improvement doesn’t make significant difference in the EMVs. In other words, if she proactively dedicates her effort to redesigning and increases the possibility for dramatic improvement to 90%, the EMV will go up to $141,500 so that Armstrong can positively go ahead with the development efforts (see Figure 3)