Warner Lambert Case Study

Warner-Lambert Canada Limited (X) In April 1968, Warner-Lambert Canada Limited was considering introducing throat lozenges to the Canadian pharmaceutical market. Lozenges distributed under the company brand name had sold well in the U.S. and had become a profitable venture. Consequently, the Canadian subsidiary was contemplating launching a throat lozenge on the Canadian market. Warner-Lambert Canada Limited was wholly owned subsidiary of the U.S. parent. The company had two factories in Canada, both in Toronto, one making candy and chewing gun and the other producing pharmaceuticals and health and beauty aids. One of the products sold throughout the world by the parent company and its subsidiaries was the Listerine Antiseptic, a well-known mouthwash. It had been on the market for many years and was highly regarded both by dealers and consumers. Distributed through both food and drug stores, Listerine mouthwash held nearly 40% of the Canadian mouthwash market. In the fall of 1965 the U.S. parent decided to test market a throat lozenge under Listerine brand name. The lozenges were designed to provide temporary relief from sore throats caused by coughs and colds. As the test market was successful, national distribution in the U.S. was undertaken the following year and 9.5% of the total throat lozenge market was achieved. In the fall of 1967 two additional flavors, orange and lemon-mint were added. By February 1968, Listerine was second in throat lozenge sales with 16.5% of the total U.S. market. In April 1968, Mr. R. T. DeMarco, Product Manager in the Consumer Products Division of Warner-Lambert Canada Limited, decided to investigate the possibilities of manufacturing and distributing Listerine Throat Lozenges in Canada. He assigned Chris Seymour, an Assistant Brand Manager in the Consumer Products Division, the task of recommending to the company an action plan for the proposed product.

The Market Mr. Seymour’s first step was to investigate the Canadian throat lozenge market. At that time there were about 40 brands of the product being sold in Canada at prices ranging from 35¢ (35 cents) to $1.49 per package. There were no unique product claims since all brands offered the same benefit (i.e. temporary relief from sore throat pain). Mr. Seymour was surprised to find out that there was virtually no media advertising in this product field. About 85% of the throat lozenges sold in Canada was sold through drug stores while the remainder was distributed through food stores and other mass merchandisers. In the U.S. only 70% were sold by drug stores. Mr. Seymour collected the growth data in the Canadian and U.S. markets for the previous few years as shown in Table 1. 1

Table 1 ($ in millions) 1963

1964

1965

1966

1967

Estimated 1968

$ 27.8

$ 29.4

$ 33.6

$ 33.6

$ 32.1

$ 34.3

11%

7%

15%

1%

 4%

7%

Canada Food/Drug**

-

$ 2.9

$ 3.5

$ 3.4

$ 3.3

$ 3.5

% Change

-

-

12%

 3%

 3%

6%

U.S. Food/Drug* % Change

* U.S. (A.C. Neilsen) * Estimated on Canadian D.K. & K. (retail sales) Pharmaceutical products which were available to Canadian consumers without prescription could be classified into two categories. 1. Antibacterial/Antibiotic Throat Lozenges (Sometimes called OTC products)1 These contained active ingredients which were either antibiotic in nature or which worked against specific kinds of bacteria. Canadian sales of lozenges in this category had declined 13% in the years 1964-67. 2. Proprietary Throat Lozenges These did not contain this kind of active ingredient; rather they contained ingredients which relieved throat irritation temporarily without specifically acting on the cause of the irritation. Canadian sales of lozenges in this category had increased 55% in the years 1964-67. The Canadian sales volumes for each category were as shown in Table 2. Table 2 Share of Lozenge Market by Product* (000’s) 1964 Anti/Anti % vs 1964 Base Proprietary % vs 1964 Base Total

1965

$ 862

58%

$ 975

100% $ 620

42%

$ 809

100%

$ 1,784

Davee, Koohnleln and Koallng Company OTC – Over the Counter

2

1967

$ 817

47%

$ 746

95% 45%

130%

*Based on D.K. & K drug wholesale figures. 1

55%

110%

100% $ 1,482

1966

100%

87%

$ 940

54%

150% $ 1,757

45%

100%

$ 958

55%

155% $ 1,704

100%

In analyzing the sales drop in Canada of the antibiotic lozenges Mr. Seymour learned that in March, 1966, the U.S. Federal Drug Administration had banned the sale of all antibiotic throat lozenges in the U.S. As far as he could determine there was no such legislation being contemplated in Canada at that time. Mr. Seymour also gathered information on the distribution of sales across Canada. In 1967 the Maritimes accounted for 7% of the total throat lozenge market, Quebec for 26%, Ontario for 42%, the Prairies for 15% and British Columbia (B.C.) for 10%. Mr. Seymour obtained data on the 10 leading brands which accounted for more than 50% of the market (Exhibit 1). Exhibit 1 Competitive Share of Canadian Market 1964-1967** % Share of Market Product

Company

Product Category

1964

1965

1966

1967

Bradosol

Ciba

Proprietary

11.8%

11.7%

15.5%

16.3%

Cepacol

Merrill

Proprietary

7.0

7.6

8.5

7.7

Formalid

Wampole

OTC

7.0

6.7

7.2

6.7

Dequadin

Glaxo

OTC

5.2

4.8

5.7

6.3

Bionets

Horner

OTC

5.5

3.8

6.0

5.5

Strepsils

W-C

Proprietary

-

-

1.1

5.3

Sucrets

M.S.&D

Proprietary

4.2

5.0

4.0

5.2

Spectrocin - T

Squibb

OTC

2.2

3.6

7.7

4.9

Meggazones

Meggasson

Proprietary

3.5

4.1

4.3

4.7

Spectrocin - C

Squibb

Proprietary

1.0

2.9

3.6

2.9

% Total Above Products

47.4%

50.2%

63.6%

65.5%

% All Others

52.6%

49.8%

36.4%

34.5%

% Total Market

100%

100%

100%

100%

* Not on Market * D.K. & K.

Mr. Seymour noted that the first two months of 1968 Listerine throat lozenges in the U.S. had achieved second position with 16.5% of lozenge sales while market leading Sucrets held 35%. Both brands were proprietary products.

3

One difference between the Canadian and the U.S. markets was the amount of media advertising. While there was virtually no advertising in Canada, Warner-Lambert in the U.S. spent $1.25 million on throat lozenges, Sucrets spend $1.92 million and the total industry expenditures on advertising reached $5.8 million. Mr. Seymour believed that if a new product were to be introduced it should be supported by a strong marketing campaign. Mr. Seymour believed the prairie provinces would be an easily isolated geographical region with a minimum of advertising spillover from media in other areas. Management chose to price the product in direct competition with market leading Bradosol’s price of 91¢ and accordingly set the price of Listerine lozenges at 89¢ per package of 18. Retailers would purchase the lozenges from Warner-Lambert for 55¢ a box. Mr. Seymour originally estimated that the test market sales would be $60,500 (net factory value) which would represent 12.8% of the prairie market for lozenges. Because they could not have the necessary equipment for test period between September 16, 1968 and August 15, 1969 the blister packaged lozenges would have to be imported from the U.S. and would be boxed in Canada in bilingual boxes. The costof test was estimated to be: Advertising $ 43,900 Promotion $ 20,000 Research $ 10,000 Direct Selling $ 5,000 Direct Operating $ 4,600 Lozenge Cost (Including Packaging) $ 30,800 __________________ $114,300 The lozenge cost was fixed since none of the imported product could be salvaged if it was not sold. Mr. Seymour used three volume estimates to represent the possible sales outcomes. He defined a successful test market as sales of 110,000 boxes ($60,500) of lozenges and he assessed the chance of achieving this level at 70%. He realized that even if they did not sell 110,000 boxes during the test year, they might sell a sufficient amount to be able to label the test as inconclusive. He believed that there was a 20% chance that an inconclusive test having sales of about 90,000 boxes ($49.500) would occur. He would label the test a failure if sales were as low as 60,000 boxes ($33,000). In order to give the product an adequate test and to be operating efficiently during the cold season it would be necessary to have the product on the store shelves by the end of October 1968. This would require shipments from the factory to start by September 16th. Mr. L. J. O’Keefe, Sales Manager, informed Mr. Seymour that the very latest his salesmen could begin to take orders for September delivery was August 12th. This meant that July 15 would have to be the deadline for a decision to test market the product. If the order for the bunch wrapped and carded lozenges was sent to the U.S. before that date, however, there would be a sufficient time to have them placed in billingual boxes in Canada and delivered to the stores for the fall cough/cold season.

4

Equipment Decision The machinery necessary for Canadian production would cost $88,000 with an additional $8,000 for installation expenses. If the order was placed in October 1968 the equipment would be ready to produce the lozenges for the introduction of the national campaign in the fall of 1969. Equipment ordered in October would require a deposit of $25,000 that would be forfeited if the order was concelled during or before February 1969. After February the order could not be cancelled. Mr. Seymour felt that by the end of February the company would know whether the test market was going to be succesful, inconclusive, or a failure. An alternative choice to ordering in October was to hold the original order until the end of February 1969 when the test market outcome could be determined. Under this alternative the equipment would not be ready for the start of the 1969 campaign and if Warner-Lambert decided to national 85% of the first year sales would have to be imported. The total variable cost to the Canadian division for lozenges imported from U.S. was 28¢ per box whereas this would be reduced to 14¢ if the product was made entirely in Canada. Since Warner-Lambert Canada based their decisions on the profit contribution to the Canadian division only, and since the U.S. division would only guarantee to supply 85% of the fist year demand, it was decided that the equipment should be ordered no later than February 28, 1969 if a national campaign was to be launched.

Profit Potential Mr. Seymour estimated before the test market that there was a 50% chance of achieving high sales of 800,000 boxes from the national campaign. He believed medium sales of 650,000 and low sales of 400,000 boxes had a 30% and 20% chance of occurrence respectively. National introduction would increase fixed costs due to advertising, research, and direct operating and selling expenses. Initial forecasts suggested these costs would be approximately 255,000 a year. This does not include equipment or test marketing costs. The product would be dropped after one year if national sales were medium or low. If the product reached the high sales forecast in the first year, Mr. Seymour felt it was conservative to assume that that level would be maintained for the expected ten year life of the equipment. The test market results would allow Mr. Seymour to make more accurate estimates for the sales outcome of the national campaign. He did not think there was any chance of achieving medium or high sales nationally if the test market sales volume was considered a failure. On the other hand, a successful test would suggest a 90% chance for high sales and a 10% chance for medium sales. Although an inconclusive test result was the most difficult to evaluate, Mr. Seymour estimated it would suggest a 65% chance of low national sales and a 35% chance of high sales. Mr. Seymour learned that the new equipment had no other use and would have negligible value if the new product was dropped. He decided to make his initial projections on a before tax basis since all the revenues and expenses with the exception of

5

the equipment purchase3 were period flows and were subject to the same tax rate. If this analysis did not make the optimum course of action obvious he planned to recalculate considering the tax effects. At the same time he realized that a dollar received in the future was of less value than a dollar received immediately. Since the company looked for new projects that returned 10 to 15% after taxes he decided to discount the before tax income figures for the national campaign at 22%. With these assumptions he felt he could determine the best strategy for the new product.

Exhibit 2 Profit Contribution From National Sales I. Equipment ordered October 1968

Sales (boxes) Contribution Margin Per box (55¢ - 14¢) Contribution Margin Fixed Costs Profit Years Present Value Discount Factor at 22% Present Value of Expected Profit

High 800,000

Sales Medium 650,000

Low 400,000

41¢ ------------------$328,000 $255,000 ------------------$73,000 10 3.923

41¢ ------------------$266,500 $255,000 ------------------$11,000 1 0.82

41¢ ------------------$164,000 $255,000 -------------------$91,000 1 0.82

$286,379

$9,430

-$74,620

6

Exhibit 2 (cont) II. Equipment ordered February 1969 A. Year 1 Sales (boxes) Contribution margin / box year 1 = 55¢ (0.85×0.28) + (0.15×0.14) Year 1 Contribution Fixed Costs Profit from Year 1 Present Value of Year 1 Profit (Profit ×.82)

800,000

650,000

400,000

29.1¢

29.1¢

29.1¢

---------------$189,150 $255,000 --------------$-65,850

------------$116,400 $255,000 ------------$-138,600

$-53,997

$-113,652

$-53,997

$-113,652

--------------$232,800 $255,000 --------------$-22,200

$-18,204

B. Years 2 to 10 Contribution Margin per box years 2-10 Contribution Margin per year Fixed Cost Profit per year Discount Annuity from Years 2 to 10 to time zero 3.786 ×0.82

41¢ $328,000 $255,000 --------------$73,000 3.104 ---------------

Present value Profit Years 2 to 10 Present Value of Expected Proft

$226,592

$208,388

7