# Replacement after a product harm crisis.

Replacement After A Product Harm Crisis

Recent research has shown that in a product harm crisis denial of responsibility and involuntary product recall are detrimental to both high- and low-reputation companies (Jolly & Mowen, Mowen & Ellis, Siomkos). Specifically, it has been concluded that consumer attitudes deteriorate and consumers are not willing to buy the new product that is developed to replace the defective one (Siomkos). There was, however, a call for future research work in the area of enhancing its generalization and external validity of these findings.

While consumer interest in a new product to replace the recalled defective product can be measured, managers of companies-in-crisis still have to make an important decision. They must decide on whether they should initiate a new product development process. Given that sufficient consumer interest in a new product to replace the defective one exists, several important factors must be considered: new product development costs; estimated time that will take the company to come up with a new, safer product; and money and people resources allocated to the new product development process.

This study presents managers with a first attempt to determine analytically the number of new product development experiments or trials the company has to devote its resources to, in order to come up with a new, safer replacement. That number of trials would consequently determine the cost of the whole new product development process.

Consumer interest in a product replacement after a crisis

In Siomkos' study, a variable was introduced describing the degree of consumers' interest in buying a new model of a hair dryer, which the company was about to produce to replace the defective model (variable name: NEW). The study examined, among others, the influence of three fundamental factors in a product harm crisis on NEW. The factors and their levels were: company reputation (high - low), external effects that the company faced during the crisis (positive - negative), and organizational response (denial of responsibility - involuntary product recall - voluntary product recall - super effort). NEW lay closer to an action-orientation on the part of the consumer reaction to a crisis than any other variable presented in the same study. Consumers were directly asked to respond to the question, "How interested would you be in buying the new model to replace the defective?" on a 7-point scale (1 = very much interested; 7 = not at all interested). A 2x2x4 experimental design was used; subjects were presented with 16 treatments (combinations of the different factors' levels).

The same study was replicated later by Siomkos for a different product, i.e., apple juice. Subjects were presented with a real case of product adulteration: the apple concentrate used in making the juice was a blend of synthetic ingredients, some of which could be poisonous.

Ranking of the means of variable NEW for the two products offer similar results as in the Siomkos study (Table 1). Analysis of variance yielded similar results as well. Results suggest that main effects were significant in both product cases (Table 2). The replication of the study offers higher external validity to the results by combining findings from the original study and its extension, specific conclusions can be drawn.

Consumers are more likely to be interested in buying the new product from the same company when the company: is well-known; rates high in reputation; faced positive external effects during the crisis; and voluntarily recalls the harmful product.

New product development

It is strongly recommended to companies in product harm crises that they voluntarily recall the product. For those that do, another problem arises that demands an immediate solution. The company has to decide whether to introduce a new (safer) model of the product to replace the defective one, or to simply kill the product after its recall. Consumers' interest in a new model is not enough to base making a go/no go judgment on. Cost considerations are involved and should be seriously taken into account.

Therefore, it seems logical for a manager of a company-in-crisis to ask:

* given that consumers express a strong interest in the new model

(which is to replace the defective), how many additional

experiments will be necessary to develop a better, safer, new

product? * given the new product development efforts, i.e., number of

trials required to develop a safer product, what would be the

total cost to the company if it is to decide that it will go ahead

with the new product introduction? * what are some of the fundamental considerations before

deciding to continue with the new product development process

after the harmful product is recalled?

With these questions in mind, they were two central objectives in developing a model:

* to determine the number of trials it would take the company to

develop a new, safer product, and * to incorporate new product development costs, so that

managers would use the model in deciding whether they should

proceed with new product development after the defective

product is recalled.

The new product development decision

Having recalled a harmful product, a company is faced with making a decision. Should it forget about the product altogether, or should it attempt to develop a new, safer model of the product and introduce it in the market. The company is then concerned with finding the optimal number of experiments (n*) to be performed in order to develop the replacement product, when the costs of experimentation (C for each run) are accounted for. In order to ensure consistent dimensions in the objective function, we must incorporate total market sales volume. Also, letting n be the total number of experiments; T be the total sales volume of the product market in which the recalled model belonged; S be the maximum market share obtainable by the replacement; and, k be a discounting factor, the objective function becomes:

V(n) = TkSn/(n+1) - nC and its solution is

n* = (TkS/C)1/2 - 1 It should be noted that k, the discounting factor, represents the present value coefficient of expected future cash flows. Thus if the time to introduce the replacement product to the market is one year and the discount rate is 10 percent, k = 1/(1 + .10) = .90.

As an example, consider a case of new product development experiments. It is recognized that the maximum market share obtainable is S = 30 percent. The cost of each experiment run is C=$20,000. The discounting factor is k = .90. The present value of the total volume of market sales is T = $7.4 million at the end of the experimentation period. The magnitude of k indicates that this period is approximately one year. The approximate solution is:

n* = (1,998,000/20,000)1/2 - 1 = 9 Evaluating V(n*) from above,

V(n*) = $1,618,200

Thus it is apparent that management should proceed with the new product development using nine trials which will result in an expected value of an overall profit of $1,618,200. It can be noted that cost (n*C) to achieve the V(n*) equaled $180,000. If V(n*) proved to be negative, then the company would forsake a new product development.

If the cost structure of the experimentation consisted of a fixed component in addition to the unit cost (C), the optimal number n* would remain the same since the additional fixed component is constant. The overall value of V(n*) would be reduced by this fixed component. For example, if the fixed component was $100,000, then V(n*) would equal $1,518,200.

Future research

We have presented a model for determining the optimal number of new product development experiments for replacing a product that has been withdrawn from the market. The optimal number of experiments is based upon costs of experimentation, the time value of money, and an estimate of the potential market share.

Future research should deal with the specifics of implementation of the model by incorporating such items as promotional costs.

Table 1

Source of variation Hair Dryer Apple Juice

Main Effects:

Interaction Effects:

Further reading

Jolly, D.W. and Mowen, J.C., 1984. "Product recall communications: the effects of source, media and social responsibility information." Advances in Consumer Research, Vol. 12. Kabak, Irwin W. and Bertram S. Kabak, 1985. "On breaking records and some applications." Industrial Engineering News-Operations Research Division, Vol. 19, No. 4 (Spring). Mowen, J.C. and Ellis, H.W., 1981. "The product defect: management and consumer implications." Review of Marketing. American Marketing Association, Chicago, Ill. Siomkos, George J., 1989. "Managing product-harm crises." Industrial Crisis Quarterly, Vol. 3, No.I.

Irwin W. Kabak, Ph.D., is professor of operations research, statistics and operations research department, Stern School of Business, New York University, New York, NY. George J. Siomkos, Ph.D., is adjunct assistant professor of marketing, Stern School of Business, New York University, New York, NY.

Recent research has shown that in a product harm crisis denial of responsibility and involuntary product recall are detrimental to both high- and low-reputation companies (Jolly & Mowen, Mowen & Ellis, Siomkos). Specifically, it has been concluded that consumer attitudes deteriorate and consumers are not willing to buy the new product that is developed to replace the defective one (Siomkos). There was, however, a call for future research work in the area of enhancing its generalization and external validity of these findings.

While consumer interest in a new product to replace the recalled defective product can be measured, managers of companies-in-crisis still have to make an important decision. They must decide on whether they should initiate a new product development process. Given that sufficient consumer interest in a new product to replace the defective one exists, several important factors must be considered: new product development costs; estimated time that will take the company to come up with a new, safer product; and money and people resources allocated to the new product development process.

This study presents managers with a first attempt to determine analytically the number of new product development experiments or trials the company has to devote its resources to, in order to come up with a new, safer replacement. That number of trials would consequently determine the cost of the whole new product development process.

Consumer interest in a product replacement after a crisis

In Siomkos' study, a variable was introduced describing the degree of consumers' interest in buying a new model of a hair dryer, which the company was about to produce to replace the defective model (variable name: NEW). The study examined, among others, the influence of three fundamental factors in a product harm crisis on NEW. The factors and their levels were: company reputation (high - low), external effects that the company faced during the crisis (positive - negative), and organizational response (denial of responsibility - involuntary product recall - voluntary product recall - super effort). NEW lay closer to an action-orientation on the part of the consumer reaction to a crisis than any other variable presented in the same study. Consumers were directly asked to respond to the question, "How interested would you be in buying the new model to replace the defective?" on a 7-point scale (1 = very much interested; 7 = not at all interested). A 2x2x4 experimental design was used; subjects were presented with 16 treatments (combinations of the different factors' levels).

The same study was replicated later by Siomkos for a different product, i.e., apple juice. Subjects were presented with a real case of product adulteration: the apple concentrate used in making the juice was a blend of synthetic ingredients, some of which could be poisonous.

Ranking of the means of variable NEW for the two products offer similar results as in the Siomkos study (Table 1). Analysis of variance yielded similar results as well. Results suggest that main effects were significant in both product cases (Table 2). The replication of the study offers higher external validity to the results by combining findings from the original study and its extension, specific conclusions can be drawn.

Consumers are more likely to be interested in buying the new product from the same company when the company: is well-known; rates high in reputation; faced positive external effects during the crisis; and voluntarily recalls the harmful product.

New product development

It is strongly recommended to companies in product harm crises that they voluntarily recall the product. For those that do, another problem arises that demands an immediate solution. The company has to decide whether to introduce a new (safer) model of the product to replace the defective one, or to simply kill the product after its recall. Consumers' interest in a new model is not enough to base making a go/no go judgment on. Cost considerations are involved and should be seriously taken into account.

Therefore, it seems logical for a manager of a company-in-crisis to ask:

* given that consumers express a strong interest in the new model

(which is to replace the defective), how many additional

experiments will be necessary to develop a better, safer, new

product? * given the new product development efforts, i.e., number of

trials required to develop a safer product, what would be the

total cost to the company if it is to decide that it will go ahead

with the new product introduction? * what are some of the fundamental considerations before

deciding to continue with the new product development process

after the harmful product is recalled?

With these questions in mind, they were two central objectives in developing a model:

* to determine the number of trials it would take the company to

develop a new, safer product, and * to incorporate new product development costs, so that

managers would use the model in deciding whether they should

proceed with new product development after the defective

product is recalled.

The new product development decision

Having recalled a harmful product, a company is faced with making a decision. Should it forget about the product altogether, or should it attempt to develop a new, safer model of the product and introduce it in the market. The company is then concerned with finding the optimal number of experiments (n*) to be performed in order to develop the replacement product, when the costs of experimentation (C for each run) are accounted for. In order to ensure consistent dimensions in the objective function, we must incorporate total market sales volume. Also, letting n be the total number of experiments; T be the total sales volume of the product market in which the recalled model belonged; S be the maximum market share obtainable by the replacement; and, k be a discounting factor, the objective function becomes:

V(n) = TkSn/(n+1) - nC and its solution is

n* = (TkS/C)1/2 - 1 It should be noted that k, the discounting factor, represents the present value coefficient of expected future cash flows. Thus if the time to introduce the replacement product to the market is one year and the discount rate is 10 percent, k = 1/(1 + .10) = .90.

As an example, consider a case of new product development experiments. It is recognized that the maximum market share obtainable is S = 30 percent. The cost of each experiment run is C=$20,000. The discounting factor is k = .90. The present value of the total volume of market sales is T = $7.4 million at the end of the experimentation period. The magnitude of k indicates that this period is approximately one year. The approximate solution is:

n* = (1,998,000/20,000)1/2 - 1 = 9 Evaluating V(n*) from above,

V(n*) = $1,618,200

Thus it is apparent that management should proceed with the new product development using nine trials which will result in an expected value of an overall profit of $1,618,200. It can be noted that cost (n*C) to achieve the V(n*) equaled $180,000. If V(n*) proved to be negative, then the company would forsake a new product development.

If the cost structure of the experimentation consisted of a fixed component in addition to the unit cost (C), the optimal number n* would remain the same since the additional fixed component is constant. The overall value of V(n*) would be reduced by this fixed component. For example, if the fixed component was $100,000, then V(n*) would equal $1,518,200.

Future research

We have presented a model for determining the optimal number of new product development experiments for replacing a product that has been withdrawn from the market. The optimal number of experiments is based upon costs of experimentation, the time value of money, and an estimate of the potential market share.

Future research should deal with the specifics of implementation of the model by incorporating such items as promotional costs.

HAIR DRYER APPLE JUICE RANK A B C NEW A B C NEW 1 H 4 + 3.58 H 3 + 3.42 2 H 3 + 3.50 H 4 + 3.08 3 H 2 + 2.92 H 1 + 2.42 4 L 3 + 2.42 H 3 - 2.00 5 H 1 - 2.42 H 4 - 1.83 6 L 1 + 2.33 L 3 + 1.75 7 H 4 - 2.00 L 1 + 1.67 8 L 4 + 1.92 H 1 - 1.50 9 H 3 - 1.92 H 2 + 1.33 10 L 2 + 1.75 L 4 + 1.33 11 L 3 - 1.58 H 2 - 1.25 12 H 2 - 1.58 L 4 - 1.17 13 H 1 + 1.17 L 1 - 1.17 14 L 4 - .92 L 3 - 1.00 15 L 2 - .83 L 2 - .75 16 L 1 - .75 L 2 + .67

Table 1

Source of variation Hair Dryer Apple Juice

Main Effects:

Reputation (A) 12.4(a) 23.0(a) Response (B) 2.7(b) 5.6(b) External (C) 21.7(a) 10.7(a)

Interaction Effects:

A x B 1.4 1.2 A x C .7 2.3 B x C 1.8 1.4 A x B x C 3.5(b) .3 a:p<.005 b:p<.05 c:p<.10

Further reading

Jolly, D.W. and Mowen, J.C., 1984. "Product recall communications: the effects of source, media and social responsibility information." Advances in Consumer Research, Vol. 12. Kabak, Irwin W. and Bertram S. Kabak, 1985. "On breaking records and some applications." Industrial Engineering News-Operations Research Division, Vol. 19, No. 4 (Spring). Mowen, J.C. and Ellis, H.W., 1981. "The product defect: management and consumer implications." Review of Marketing. American Marketing Association, Chicago, Ill. Siomkos, George J., 1989. "Managing product-harm crises." Industrial Crisis Quarterly, Vol. 3, No.I.

Irwin W. Kabak, Ph.D., is professor of operations research, statistics and operations research department, Stern School of Business, New York University, New York, NY. George J. Siomkos, Ph.D., is adjunct assistant professor of marketing, Stern School of Business, New York University, New York, NY.

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Title Annotation: | ensuring consumer satisfaction after recalling a defective product |
---|---|

Author: | Kabak, Irwin W.; Siomkos, George J. |

Publication: | Industrial Management |

Date: | Sep 1, 1991 |

Words: | 1680 |

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