The measurement of cannibalization and capital budgeting decisions.
Product cannibalization is when an investment in a new product will eat away at the cash flows earned by an existing product.
Capital budgeting decisions need to be taken in aholistic way.It is important to consider the impact of a business decision on the overall profitability of the business.It is important to measure the impact of a new product.The cannibalization rate is calculated when this is done.
The ratio of revenue lost to total revenue added by the product is called cannibalism rate.
The gross cash flows of the new project must be reduced by the cannibalization rate in order to calculate the NPV and IRR.
An analysis which considers the strategic position of a business and the potential actions of its competitors should not be a mechanical exercise.If a business expects its competitors to introduce a new product anyway, it should not stop introducing new products.Self-cannibalization is important to maintain competitive advantage in many industries.
Potato chips and other potato products are manufactured by Crispy Potatoes.It makes and sells two versions of chips: French cheese and salty.It expects to make $8 million from the new product.According to market surveys, 20% and 5% of customers would substitute Spicy for French Cheese.
The total loss of revenue is $4.5 million if the price is the same.The cannibalization rate would be 56 percent.