Energizer is one of the leading producers of lithium batteries used in electric cars, and has…
Energizer is one of the leading producers of lithium batteries used in electric cars, and has been supplying batteries to Tesla vehicles for about a decade.
Currently Energizer is receiving a steady stream of profits from the battery business amounting to $10 million a year and expects to continue receiving it indefinitely.
The research department at Energizer has recently had a breakthrough in their exploration of batteries based on a modified chemical compound named LFP, or lithium-ferrum-phosphate, which may allow them to develop and build a superior battery. Energizer is now debating whether to commercialize the new technology.
Development would entail a one-time fixed cost but would at the same time alter its future profit stream. More specifically, if Energizer develops and markets the new batteries, and remains the sole owner of the new technology, then its annual profit is expected to increase to $20 million in perpetuity.
The problem lies in the fact that, once the information about the promise offered by LFP becomes publicly known, it is reasonable to expect that Energizer’s competitors will attempt to enter the market with their own version of the same battery. In that case, Energizer’s stream of future earnings will be reduced to $12 million per annum.
For tractability, let’s discuss a situation where Energizer has only one serious competitor, BYD. Both companies can be assumed to be risk-neutral.
Because in this fast-changing industry companies are constantly starved for cash needed for various development projects, both companies discount future profits at the fairly high rate of 20% per year.
Energizer can implement the new technology in two distinctly different ways.
Option 1. Energizer can produce a ‘plain’ battery that is estimated to cost them $30 million in one-time fixed development expenses. BYD can copy the idea and spend $10 million on developing their own analog, after which there is a 60% chance that BYD’s effort is successful, allowing them to earn a stream of $4 million per year in addition to their existing profit, and a 40% chance that their project fails and is scrapped.
1) If Energizer develops and markets the ‘plain’ version of the battery, do you expect BYD to attempt copying it? Explain the reason for your prediction.
2) Taking into account your answer to part a, what is Energizer’s expected payoff from developing and marketing the ‘plain’ version of the new battery? Show and explain your work.
Option 2. Alternatively, Energizer can market a ‘sophisticated’ version of the battery which is estimated to cost them $45 million to develop but is expected to reduce the probability of successful copying. BYD is once again willing to spend $10 million on analog development, and earn $4 million per year in additional profits if their effort is successful, but this time their probability of success is only 25%.
3) If Energizer develops and markets the ‘sophisticated’ version of the battery, do you expect BYD to attempt copying it? Explain the reason for your prediction.
4) Taking into account your answer to part c, what is Energizer’s expected payoff from developing and marketing the ‘sophisticated’ version of the new battery? Show your work.
5) Present this ENTIRE game in the form of a tree. Make sure all the strategies available to each firm are presented, all the payoffs are listed, and all the nodes and branches are properly labeled.
6) All things considered, would you recommend Panasonic to develop the plain version of the LFP battery, the sophisticated version, or scrap the idea completely? Please reference your work above.