Side Effects

Remember that the incremental cash flows for a project include all the resulting changes in the firm's future cash flows. It would not be unusual for a project to have side, or spillover, effects, both good and bad. For example, in 2002, Japanese automaker Nissan introduced an all new version of its Altima sedan. The new model was larger all around and, in fact, looked a lot like a freshened-up version of its big brother, the Maxima. Many observers predicted that some portion of the Altima's sales would simply come at the expense of the Maxima. A negative impact on the cash flows of an existing product from the introduction of a new product is called erosion, and the same general problem anticipated by Nissan could occur for any multiline consumer product producer or seller.3 In this case, the cash flows from the new line should be adjusted downwards to reflect lost profits on other lines.

In accounting for erosion, it is important to recognize that any sales lost as a result of launching a new product might be lost anyway because of future competition. Erosion is only relevant when the sales would not otherwise be lost.

Side effects show up in a lot of different ways. For example, one of Walt Disney's concerns when it built Euro Disney was that the new park would drain visitors from the Florida park, a popular vacation destination for Europeans. To give an example from the world of professional sports, when the L.A. Lakers signed Shaquille O'Neal, Coca-Cola Co. decided not to renew a marketing agreement with the Lakers worth an estimated $1 million a year because Shaq was a high-profile endorser of Pepsi.

There are beneficial spillover effects, of course. For example, you might think that Hewlett-Packard would have been concerned when the price of a printer that sold for $500 to $600 in 1994 declined to below $100 by 2001, but they weren't. What HP realized was that the big money is in the consumables that printer owners buy to keep their printers going, such as ink-jet cartridges, laser toner cartridges, and special paper. The profit margins for these products are substantial, reaching as high as 70 percent in some cases.

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