The Market for ‘Lemons’, Case Study Example

Given what is known about IPL, the business objective that the company is most likely to focus on is a competitive analysis. Currently, the business owners are concerned as to whether Oceanic Printers will release a magazine that will compete with ZEST. As a consequence, the company must determine whether it will be profitable to release the magazine in light of the existence of competitors. However, it is important for the company to determine the profit it would be able to make if more competitors were to appear, and how to specifically brand the magazine so that competition would be less of a concern. It is necessary to run figures related to all of these scenarios to determine whether the money made from the magazine in sales will be more than the amount needed to both produce and market the magazine.

Furthermore, it is necessary for the company to consider competition in light of the offer that was made to them by Megamag. It is possible that providing the rights to Megamag will reduce the overall costs of magazine production, which will enhance its profitability. In this case, it would be necessary for the company to determine whether this deal will increase their ability to compete and whether the agreement would cost less than it would for the company to hire new personnel. In addition, it would be necessary for the company to consider whether it would be able to eliminate the redundancy that this partnership would create and if this would be a cost effective move.

Ultimately, the competition scenario that the company is considering is currently too small, and it is essential for them to consider competition in relation to many different variables. Furthermore, it would be more ideal for the company to assume that there will be competition of some sort in order to determine whether it would be truly beneficial to go ahead with magazine production. Failure to do so will create a risky situation in which the company is likely to suffer great financial loss.

The decision tree demonstrates that there is no certainty that launching Zest magazine for $3 per issue will be a beneficial decision on the behalf of the company because the profitability of this endeavor is dependent upon Oceanic Printers releasing its magazine first. Furthermore, this decision is not dependent upon whether the company decides to print the magazine on its own or whether it will partner with Megamag. It is important foremost to consider that the initial investment that the company owners placed in this business was $40,000. Additional funds for research and development will be needed to this, which totals $310,000 of funds necessary to begin the development of the magazine. The cost the company will have to pay to produce each magazine is $1.70, including the cost for the raw materials and the iTunes gift voucher. The labor costs will be $40,000 per year for the two basic workers and $24,000 for the specialized basic labor, which is a total of $64,000. The base funds needed for this project, without considering the costs of the magazine production due to its variability is $374,000. Given that Megamag is willing to do this all for $600,000 is likely not worthwhile because the company is projected to sell only approximately 25,000 magazines, which will increase the cost of the production to only $416,000, including the costs of the raw materials for this number of magazines. Thus, the Megamag deal may be worthwhile if more than this number of magazine are printed, which does not seem to be the case independently of the consideration of the competitor.

To determine whether it would be worthwhile to launch the magazine at $3, it would first be necessary to take into consideration the probability that the magazines will be sold both with and without competition. To do so, the lowest number of magazines that will reasonably bought was considered for each purchasing probability to determine whether releasing the magazine would be reasonable even if sales are low, because this is a necessary concern for a new publication. It was found that the initial investment into this magazine could be paid back only if the competitor’s magazine is not released and the highest probability for sales is achieved, as this will generate $40,500 worth of revenue. Over a years’ time, this would only generate $486,000 ($40,500 x 12 months) worth of profit. However, this is an ideal scenario. If the competitor’s magazine is not released and the lowest probability for sales is achieved, only $171,600 ($13,200 x 12 months) will be made in a year, while pales in comparison to the original investment. If the competitor’s magazine is released at all, it would have been a better business decision for Zest to have avoided releasing the magazine in the first place in order to save the initial investment funds, as these figures are significantly worse than those just proposed.

Based on the previous analysis, the company should only release the magazine if they can be certain that the competition magazine is not released. This may involve participating in discussions with the company and possibly offering them financial compensation if they agree to not release a competitive magazine. However, if such terms cannot be reached, it would be best for the company to seek other business ventures, as this is one that is likely to fail. Even though the projected earnings of the company are not significant, it is important to emphasize that calculated probabilities are simply predictions and not projections of reality. It would therefore be beneficial for the company to release a small number of magazines for a six month period to determine how the sales will be if operations are extended. The numbers generated during this preview period can be utilized to determine the extent of operations for the company, and will help them gain a greater understanding if the deal with Megamag is worthwhile. Ultimately, this type of deal should not be made until the company has a concrete understanding of what its sales will be and if the venture is profitable.

It may also be helpful for the company to adjust the price of the magazine to increase profitability. It is possible that if it is sold at a lower price, more copies will be sold. It is also possible that selling the magazine at a higher price will allow the same amount of copies to be sold but for a higher profit. Before the company releases the magazine, it would be necessary for them to consider these projections as well, because it would work against their goals to work with the concept of a single price for their product.

References

Akerlof, George A. (1970). The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism. Quarterly Journal of Economics, 84(3): 488–500.

Jordan, J.S. (1982). The Competitive Allocation Process Is Informationally Efficient Uniquely. Journal of Economic Theory, 28(1): 1–18.