Arsi University

Case Studies for MBA students

Part I

Case study I: Introduction

What to do about global warming

A UN treaty now under discussion looks promising as long as it remains flexible. How should reasonable
people react to the hype and controversy over global warming? Judging by recent headlines, you might
think we are already doomed. Newspapers have been quick to link extreme weather events, ranging from
floods in Bangladesh and India to hurricanes in North and Central America, directly to global warming.
Greens say that worse will ensue if governments do not act. Many politicians have duly jumped on the
bandwagon, citing recent disasters as a reason for speeding up action on the Paris treaty on climate
change that commits rich countries to cut emissions of greenhouse gases. But what, exactly the Paris
treaty seems to offer a good way forward. It is a global treaty: it would be foolish to deal with this most
global of problems in any other way. It sets a long-term framework that requires frequent updating and
revision, rather like the post-war process of trade liberalization. That is sensible because climate change
will be at least a 100-year problem, and so will require a treaty with institutions and mechanisms that
endure. The big question over Paris remains its cost and the rejection of newly elected USA president.
How much insurance is worth buying now against an uncertain, but possibly devastating, future threat?
And the answer lies in a clear-headed assessment of benefits and costs and how to bring USA to the
agreements? The case for doing something has increased during the three years since Paris was signed.
Yet it also remains true that all answers will be easier if economic growth is meanwhile sustained:
stopping the world while the problem is dealt with is not a sensible option, given that resources to deal
with it would then become steadily scarcer. That points to two general conclusions about how to
implement Paris. The simplest is that countries should search out ‘‘no regrets’’ measures that are
beneficial in their own right as well as reducing emissions – such as scrapping coal subsidies, liberalizing
energy markets and cutting farm support. The second is that implementation should use market-friendly
measures that minimize the costs and risks of slowing economic growth.

This case study illustrates the variety of issues with which managerial economics is concerned. The
following questions arise:
 1. Is there a problem to be addressed?
2. Is there a solution or solutions to the problem, in terms of strategies or courses of action that can
be taken?
3. What objective or objectives can be defined for these strategies?
4. What constraints exist in terms of operating any strategies?
5. How can we identify strategies as solutions to the problem?
6. How can we evaluate these strategies in terms of costs and benefits, particularly when these
involve life and health?
7. What is the best way of measuring the relevant variables?
8. What assumptions should be made in our analysis?
9. How do we deal with the problem of risk and uncertainty regarding the future and the effects of
strategies in the future?
10. How can we approach the problems of conflicts of interest between different countries and
between different consumers and producers?

Case study II. Demand Elasticity

Part I: The Wii is a video game console made by Nintendo.

It seems that this is the one of the most successful consoles made by Nintendo to date, and it is the
successor to the GameCube. The Wii is Nintendo's fifth home video game console. The Wii is a very
interesting console, having Wi-Fi online capabilities, wireless controllers, and blue-tooth. The Wii is
different than other video game consoles launched by Nintendo in the past due to many reasons, but the
main one is the controller. The controller has revolutionized gaming. The controller uses a miniature
gyroscope inside of it to detect its orientation, and a sensor bar attached to the Wii console to detect where
it is in 3D space. The controller can be used much like a mouse, as things on the screen can be
manipulated simply by pointing and pressing a button, but instead of moving the controller on a flat
surface, a person can simply point the controller at the TV much like a TV remote. By this merit, the
controller has become simple, and it gives game developers something new to toy with. Nintendo
packaged a game with the system called Wii Sports, which features 5 different minigames: baseball,
boxing, bowling, tennis, and golf, each having the player using the controller as if they were playing the
actual game. For example, you would swing the remote as if it was a tennis racket in tennis.
Launch

On September 14, 2006, Nintendo released information for Japan, North and South America, Australia,
Asia and Europe, including dates, prices, and projected unit distribution numbers. It was announced that
the majority of the 2006 shipments would be allotted to the Americas. The media hype began
immediately. The Wii was launched in the United States at $249.99 on November 19, 2006, two days
after the PS3 was released in North America. It was later launched in the United Kingdom on December
8, 2006 at £179. The Wii was launched in South Korea on April 26, 2008 and in Taiwan on July 12, 2008.

Sales

The UK suffered a widespread shortage of console units as many high-street and online stores were
unable to fulfill all pre-orders by March of the next year.The market lead is largest in the Japanese
market, where it currently leads in total sales, having outsold PlayStation 3 and Xbox 360 by factors of
2:1 to 6:1nearly every week from launch until November 2007. In 2008, the Wii was the best-selling
home console in Japan with 2,908,342 units sold. In Australia, the Wii exceeded the record set by the
Xbox 360 to become the fastest-selling game console in Australian history. In the North American market
lifetime-to-date sales for the Wii have reached 30 million in the North American market alone since the
console's launch in November 2006. Demand still outpaced supply in the United States as of June 2007.
In October 2008, Nintendo announced that between October and December 2008 the Wii would have its
North American supplies increased considerably from 2007’s levels, while producing 2.4 million Wii
units a month worldwide, compared to 1.6 million per month in 2007.Unfortunately for consumers, it
took until March 2009 (and 48 million units) to make Wii available to those who want to walk into a
retail store and pick one up

Profit

While Microsoft and Sony have experienced losses producing their consoles in the hopes of making a
long-term profit on software sales, Nintendo reportedly has optimized production costs to obtain a
significant profit margin with each Wii unit sold. Nintendo reported on May 7, 2009 increases in
operating profits for its fiscal year (April 1, 2008 – March 31, 2009), and a rise in sales—setting record
earnings compared to the previous year.
Price drop

On September 23, 2009, Nintendo announced its first price drops for the console. In Japan, the price
dropped from ¥25,000 to ¥20,000, effective October 1, 2009. In the United States, the price was reduced
to $199.99, effective September 27, 2009. In Europe (excepting non-Eurozone nations), the price of a Wii
console dropped to €199 from €249. Nintendo sold more than three million Wii consoles in the U.S. in
December 2009, setting a regional record for the month and ending 9 months of declining sales, as a
result of the price cut and software releases such as New Super Mario Bros. Wii. As of the end of that
month, the Wii was the best-selling home video game console produced by Nintendo with sales of over
67 million units, surpassing that of the original Nintendo Entertainment System. As of June 30, 2011,
Nintendo has sold 87.57 million Wii consoles.

Questions

1. Would the demand for the Wii console be relatively inelastic or relatively elastic? State why.
2. Would the supply for the Wii console be relatively inelastic or relatively elastic? State why.
3. Draw the demand and supply curves as you have described them.
4. Was the severe shortage for over two years an old marketing ploy called intentional scarcity, in
which a company purposely keeps its hot product in short supply to build buzz. Or was it simply
bad planning on Nintendo's part? What did this mean for households? What were the implications
for Nintendo?
5. Can you suggest a reason why Nintendo dropped the price of the Wii Console in late 2009? How
would you expect this to affect revenues?

Case study II: OPEC’s oil shock32

OPEC has surprised the markets with an output cut of 900,000 barrels per day, to take effect at the
beginning of November, 2005. Observers had expected the oil producers’ cartel to hold its quotas steady
because production in Iraq has been hit by sabotage. Before the regular meeting of the Organization of
Petroleum Exporting Countries (OPEC) in Vienna on Wednesday September 24th, 2005, most of the
drama was provided by Hugo Cha´ vez, the Venezuelan president, who opined that the Iraq representative
should not have been at the get-together because he was an illegitimate stooge of American occupiers. If
that is so, Ibrahim Bahr al-Uloum behaved very oddly. His bullish predictions that Iraq could produce at
least 3.5m barrels per day (bpd) by 2005 seem to have been among the factors that persuaded the ten
members of OPEC’s quota system to approve a surprise production cut of 900,000 bpd, to 24.5m bpd.
The effect of the cut was to send oil prices sharply higher. Equities in America retreated on fears that a
higher oil price could stymie the incipient economic recovery: the Dow Jones Industrial Average of 30
leading shares fell by 1.57% that day. In their official communication, OPEC’s oil ministers pointed to
their expectation of a ‘contra-seasonal stock build-up’ at the end of this year and the beginning of next
year. Normally, oil stocks decline over the winter in the northern hemisphere, thanks to heavy use of
heating oil. But this year, demand for oil, according to OPEC, will grow merely at its ‘normal, seasonal’
level, despite an improving world economy. OPEC expects supply to grow faster than demand, thanks to
continued increases in production from Iraq and non-OPEC countries (of which Russia, the world’s
second-biggest oil exporter, is the most important).OPEC expects this supply–demand mismatch to
translate into a stock increase of 600,000 bpd in the final quarter of this year. This contrasts with an
estimated stock reduction of 500,000 bpd in the final quarter of 2001, and 1m bpd in the last quarter of
2002. Larry Goldstein, president of the Petroleum Industry Research Foundation, believes OPEC has got
its sums wrong. In remarks to the Wall Street Journal, he said he thought stocks would be flat over the
coming three months.

Although the communiqué´ did not explicitly say so, OPEC members are keen to keep worldwide oil
stocks below their ten-year average. That would give the cartel more power to determine the price.
American oil stocks have been creeping up again after hitting 26-year lows earlier this year. America’s
energy secretary, Spencer Abraham, was clearly disappointed by OPEC’s move, saying: ‘Sustained global
economic growth requires abundant supplies of energy. The US believes oil prices should be set by
market forces in order to ensure adequate supplies.’ America’s opposition Democrats have been even
more outspoken. Last month, they publicly rebuked Saudi Arabia, OPEC’s (and the world’s) leading
producer, for reducing exports in August, thus causing an unpopular rise in American petrol prices. Some
observers are also speculating that OPEC may be sneakily trying to shift its price target above the current
$22–28 range (per barrel, for a basket of Middle Eastern crudes, which tend to trade a couple of dollars
below West Texas crude). After all, the oil price has been well within that range for the past few months.
Why cut production when current supply levels are achieving their aim? In fact, the oil price has stayed
higher than many expected: it was widely expected to fall well below$20 per barrel after the end of the
Iraq war. However, unrest in Nigeria, a big producer, and the continuing attacks on Iraq’s oil facilities put
paid to that.

OPEC’s fears about non-OPEC production may be well-founded. After decades of communism, the
industry in Russia is ramping up output: so far this year, it has been pumping an average of 800,000 bpd
more than last year. Oil and gas are the country’s biggest exports, earning hard currency that is seen as a
key ingredient of economic revival. Moreover, the oil industry is in private hands, so even if the
government in Moscow wanted to put a lid on production, it has less influence over its oil companies than
OPEC governments have over theirs. The president of OPEC, Abdullah bin Hamad al-Attiyah, told the
Wall Street Journal that the cartel would not cut production below 24m bpd unless big oil exporters
outside OPEC, including Mexico and Norway as well as Russia, were prepared to cut production too.
OPEC’s stance on Iraq is very different. Here, the cartel seems to be taking an overly rosy view. Iraq says
it is currently producing around 1.8m bpd, well below the 2.5m bpd that it was pumping before the
country was invaded in the spring (and even that was well below its potential, owing to years of
sanctions). Moreover, exports, which are a crucial source of revenue for reconstruction, are still running
at only about 500,000 bpd, compared with 2m bpd before the war. These have been seriously disrupted,
and continue to be threatened by sabotage. Currently, oil is being exported mainly through the north: the
southern ports on the Gulf coast are operating far below capacity.

For those who take OPEC’s optimistic view of Iraqi production at face value, the cartel’s move should not
have come as a surprise. But the sharp reaction from oil markets and stock markets suggests it did. Many
speculators had sold oil in the futures market, or ‘shorted’ it, expecting the price to fall in the short term –
they clearly weren’t expecting a big cut in output quotas any time soon. According to the Commodity
Futures Trading Commission, the American regulator for commodity futures markets, the increase in
short positions over September was equivalent to 470,000 barrels of oil. OPEC’s decision led to a
scramble to ‘cover’ such positions by buying oil. Whether prices stay higher will depend on two key
factors. Will OPEC members stick to their new quotas? (They have a history of cheating.) And will Iraqi
militants continue to destroy their own country’s wells and pipelines?

Questions

1. OPEC currently produces about 38 per cent of the world output of oil. Assuming the short-term
price elasticity of demand is -0.28, estimate the effect of the output cut on the current price,
stating any assumptions in your calculations.
2. Describe the factors currently driving the world demand for oil; why has the price not fallen
below the $20 level as many expected?
3. Explain the effect of other non-OPEC producers on the cartel’s output decisions.
Part III: Production and Cost r

Case study I: Microsoft – increasing or diminishing returns?

In some industries, securing the adoption of an industry standard that is favorable to one’s own product is
an enormous advantage. It can involve marketing efforts that grow more productive the larger the
product’s market share. Microsoft’s Windows is an excellent example. The more customers adopt
Windows, the more applications are introduced by independent software developers, and the more
applications that are introduced the greater the chance for further adoptions. With other products the
market can quickly exhibit diminishing returns to promotional expenditure, as it becomes saturated.
However, with the adoption of new industry standards, or a new technology, increasing returns can
persist. Microsoft is therefore willing to spend huge amounts on promotion and marketing to gain this
advantage and dominate the industry. Many would claim that this is a restrictive practice, and that this has
justified the recent anti-trust suit against the company.

Microsoft introduced Office 2000, a program that includes Word, Excel, PowerPoint and Access, to
general retail customers in December 1999. It represented a considerable advance over the previous
package, Office 97, by allowing much more interaction with the Internet. It also allows easier
collaborative work for firms using an intranet. Thus many larger firms have been willing to buy upgrades
and pay the price of around $230. However, there is limited scope for users to take advantage of these
improvements. Office 97 was already so full of features that most customers could not begin to exhaust its
possibilities. It has been estimated that with Word 97 even adventurous users were unlikely to use more
than a quarter of all its capabilities. In this respect Microsoft is a victim of the law of diminishing returns.
Smaller businesses and home users may not be too impressed with the further capabilities of Office 2000.

Given the enormous costs of developing upgrades to the package, the question is where Microsoft goes
from here. It is speculated that the next version, Office 2003, may incorporate a speech-recognition
program, making keyboard and mouse redundant. At the moment such programs require a considerable
investment in time and effort from the user to train the computer to interpret their commands accurately,
as well as the considerable investment by the software producer in developing the package.

Questions
1. Is it possible for a firm to experience both increasing and diminishing returns at the same time?
2. What other firms, in other industries, might be in similar situations to Microsoft, and in what
respects?
 3. What is the nature of the fixed factor that is causing the law of diminishing returns in Microsoft’s
case?
4. Are there any ways in which Microsoft can reduce the undesirable effects of the law of
diminishing returns?

Case study II: Brewster Roofing

Mr Brewster operates a roofing company in London and has been asked by the local government
authority of Merton to repair the roofs of several of their properties damaged in a recent storm. The job
must be completed during the next four weeks (twenty working days), and Merton has offered £16,000
for the job. Mr Brewster has estimated that the job requires seventy-five work days, but he can only use
his regular three workers for the job because it is a very busy period for the industry as a whole.
Fortunately, Mr Brewster’s son, Will, can take time off from his regular job (paying £80 per day) to help
complete the work. Mr Brewster has estimated that, for his regular employees, the cost per work day is
£150. This consists of a wage of £100 (which is only paid if the employee is working) and £50 in
contributions to the government (which are paid annually regardless of how many days the employees
work). Brewster Roofing has all the equipment necessary for the job and has some of the materials
available in inventory. The materials cost £5,000 originally, but these costs have since increased by an
average of 5 per cent. Additional materials costing £3,000 are also required. Mr Brewster has costed the
job as follows:

Revenue 16000$
Costs
Labor 9000$
Materials 8000$
Total cost 17000$
Profit 1000$

On the basis of the above analysis Mr Brewster rejects the job.

Questions
1. Prepare a revised cost estimate for the job, taking into account opportunity costs, replacement
costs and incremental costs. Assume that Mr Brewster considers the job from the viewpoint of a
family business, including himself and his son together.
 2. Advice Mr Brewster regarding whether he should accept the job, stating any assumptions
involved in your analysis.

Part III: Market Structure

Case study I: Revenue relationships

KA Products has just carried out a survey of the demand for their guidebooks to spoken English. They
have found the following results over the last six months. a. Estimate an appropriate demand relationship.

Sales Revenue(Birr, 000) 356 398 372 360 365 350

A. Draw a graph of the data and the above relationship.

Case study II: Price cuts for medicines

Big price cuts on a wide range of medicines and vitamins were promised by the supermarket chains
yesterday as 30 years of price-fixing were swept aside. Many popular products, including painkillers,
cough medicines, indigestion tablets and nutritional supplements are being halved in price from last night,
with reductions of between 20 and 40 per cent on many others. The Office of Fair Trading called it
excellent news for consumers but the body representing small pharmacies said that many would close,
threatening community services. The big supermarkets trumpeted ‘millions of pounds-worth of savings’
as they competed to offer the biggest reductions. At Asda, a packet of 16 regular Anadin will be 87p,
instead of £1.75, and Nurofen tablets will cost £1.14 for 16, rather than £2.29. Reductions at Tesco
included a 40 per cent cut in Anadin Extra, to £1.29 for 16, while Sainsbury’s matched the Asda price for
Nurofen, and reduced Seven Seas Evening Primrose Oil from £5.59 for a 60-pack to £2.79. The cuts came
after the Community Pharmacy Action Group, representing small retailers, withdrew its opposition to a
High Court action brought by the Office of Fair Trading. The OFT had sought the abolition of resale price
maintenance in the industry, exempted 30 years ago from general price-fixing rules to try to ensure the
survival of small pharmacies. There are 13,500 pharmacies in Britain, of which 9,000 are small shops
serving local high streets and rural communities.

The action group backed out after Mr Justice Buckley said that he believed there was insufficient proof
that a large number of independent pharmacies would close, or that the range of products would be
reduced. But the group’s chairman, David Sharpe, said that the outcome would be a devastating blow.
‘Many pharmacists will simply not be able to survive given the buying power and aggressive pricing of
the supermarkets’ he said. ‘It’s a sad day for Britain. Th potential losers are the elderly, disabled and
young mothers who rely on the free advice and range of services offered by the local pharmacist. We’ll
fight on and hope the public will remain loyal.’ The changes will cover about 2,500 products sold without
requiring a doctor’s prescription, and will have no effect on prescription drugs or on cosmetics sold by
pharmacists. Prices are likely to fall even lower as competition grows. In the United States, where prices
are unregulated, comparable products are markedly cheaper.

Richard Hyman, chairman of the Verdict retail research consultancy, said: ‘This is a market made for
supermarkets. Medicines are small, they fit on shelves and supermarkets are going to make a lot of noise
about the great prices that they will be offering. Soon medicines will become like any other product and
be part of the weekly shop.’ John Vickers, Director-General of Fair Trading, said: ‘This is excellent news
for consumers, who will now benefit from lower and more competitive prices for common household
medicines. Consumers will save many millions of pounds a year.’ The Proprietary Association of Great
Britain, which represents medicine and food supplement manufacturers, said it was disappointed.

Questions

1. What kind of market structure is involved for the sale of medicines and vitamins?
2. What can be said about barriers to entry in this market?
3. Might there be a change in market structure after the change in the law?
4. Explain the disadvantages of the abolition of resale price maintenance (RPM) for this market.
5. When RPM was abolished for book sales in 1995, the same concerns as those expressed in the above
case were voiced. Since then, 10 per cent of bookshops have gone out of business. What conclusions
might this help you to draw regarding the future of small pharmacies?
6. How does the rise of the Internet affect this situation?