AT&T Magicphone PFC1
Introduction
The American Telephone and Telegraph Company (AT&T) was incorporated in 1885. For nearly
a century, AT&T provided universal phone service throughout the United States. AT&T would
describe its primary business as the moving and managing of information: providing quality
products, systems, and services in the United States and internationally. AT&T’s Bell
Laboratories (Bell Labs), dedicated to basic research, had been the source of many quality
products throughout AT&T’s history.
The Bell System was dissolved at the end of 1983 with AT&T’s divestiture of the Bell Telephone
Companies. At that time, the Federal Communications Commission chairman, Charles D. Ferris,
stated, “Today we have removed the barricades from the door to the information age.
Government will no longer be a barrier that prevents or delays the introduction of innovations in
technology.” Today, AT&T operates worldwide in competitive, high-technology markets with,
principally, only its long distance operation remaining under government regulation.
This case examines the development and launch of a new product, the AT&T Magicphone PFC,
aimed at the industrial market, and also investigates AT&T’s defensive behavior in the face of an
attack by a competitor with a comparable product. In the first part of the case (development of
the Magicphone), AT&T must carry out several forms of analysis: early, judgment-based demand
forecasting; positioning analysis relative to competing products; selection of advertising,
promotion, and distribution levels; and profit analysis. Each of these forms of analysis is
supported by spreadsheets in the Toolbox. The last part of the case explores the effects of
competitive attack on the Magicphone and assesses AT&T’s defense options.
The Magicphone PFC
In 1995, AT&T announced the Magicphone PFC (Phone-Fax-Copier) as a complement to its
Magicphone Plus and System 25 communications systems. The Magicphone PFC is the first
fully integrated business phone system with built-in fax and copier. The Magicphone Plus
communications system is designed for businesses with a need for up to eight lines and twenty
phones, and the larger System 25 serves businesses requiring up to 150 phones. These systems
can be configured as a stand-alone office network, and the addition of the Magicphone PFC
facilitates the use of either of these systems as an office automation hub incorporating fax and
copier capabilities.
The Magicphone PFC provides business users with the following features:
1. Built-in facsimile system.
2. Built-in photocopier.
1 The name of the product is disguised, and some of the positioning and financial data are for illustrative purposes
only.
3. Built-in speakerphone.
4. Conferencing.
5. Personalized ring.
6. Exclusive hold.
7. Call pickup.
8. Simultaneous phone and fax capability.
The Magicphone PFC has a projected retail price of $1175, while variable costs per unit are
estimated to be $500. There will be a production setup charge of only $19,562 the first year and
$1964 in Year Two. Furthermore, the only other new investment foreseen by AT&T for the
Magicphone is a one-time $20,000 charge in 1994 (Year 0).
Market Demand Estimation
As a first step in assessing the total industry market potential for integrated business
communications systems, AT&T secured the cooperation of ten of the communications industry’s
leading futurists and technology experts in a Delphi probe. Each agreed to fill out a short mail
questionnaire on long-run industry demand for products such as the Magicphone. Among other
questions the experts were asked to provide their estimate of most likely industry demand by
1996, as well as optimistic and pessimistic (best-case and worst-case) scenarios. Initial results
were tabulated and released to each expert, who was provided with the opportunity to make
changes to his or her estimates after having looked at the opinions of the other experts. After two
rounds of the probe, none of the experts wanted to make any more changes to their projections.
The experts’ projections are summarized in the following table.
Industry Sales (in Thousands of Units)
Respondent Pessimistic Most Likely Optimistic
1 150 200 300
2 130 150 240
3 140 175 230
4 180 240 270
5 160 180 225
6 140 200 260
7 220 260 320
8 140 180 225
9 130 220 240
10 125 165 230
Target Market
The primary targets for the Magicphone PFC are the aftermarket and new system customers who
can benefit from the personal desk-top phone, fax, and quick copy capability. AT&T considers
aftermarket customers to be those who purchased richer systems such as the Magicphone Mail
and Magicphone Cordless. The new system customers are those who have had a Magicphone
system proposed to them but have not yet purchased one. It was found in preliminary market
research that the new market comprises 60% of the market potential for the Magicphone, and the
aftermarket comprises the remainder.
The six types of businesses that AT&T believes would benefit from the Magicphone PFC are:
1. Project professionals.
2. Information managers.
3. Care providers.
4. Walk-in merchants.
5. Producers and distributors.
6. Hotels and motels.
The first group, project professionals, includes individuals such as attorneys and accountants, as
well as companies like public relations firms. All of these professionals have clients that demand
fast, competent, and confidential service. With a Magicphone, professionals can reassure their
clients that faxed information will remain strictly confidential, because the clients can fax it
directly as they communicate by phone. This simultaneous voice/fax capability also allows
conferencing with several people and faxing of documents to all participants simultaneously.
Information managers include stockbrokers, real estate brokers, employment and travel agencies,
telemarketers, and banks. As many among these draw their income from fees and commissions,
customer service is extremely important. Time and convenience for their customers are also
important considerations. The Magicphone would permit these users to do business with several
clients at the same time. For example, an employment agent could fax a resume to a prospective
employer while talking about the applicant’s qualifications. These users will also appreciate the
small amount of desk space required, as compared to a separate phone and fax.
The third group, care providers, includes hospitals, intermediate care facilities, outpatient clinics,
nursing homes, physicians, dentists, veterinarians, and psychologists. This user group is
particularly interested in seeking ways to control rising health care costs. The Magicphone can
help health care providers become more productive. For example, when consulting with a
specialist by phone, a physician can fax a patient’s records simultaneously. This otherwise
lengthy process is greatly simplified, the patient’s medical history remains confidential, and the
experts can work together on the diagnosis. As another example, the physician could call a
patient to discuss a test result and fax a prescription to the pharmacy simultaneously.
Walk-in merchants are retail stores and businesses: department stores, pharmacies, restaurants,
auto dealerships, and so on. These merchants all have very obvious and extensive telephone
needs (with potential and existing customers and with suppliers) and could improve their
business activity with the capabilities provided by the Magicphone.
The producers and distributors group includes manufacturers, subcontractors, restaurant
suppliers, commercial printers, wholesalers, and others. All of these companies have significant
internal communication needs. The Magicphone can make it possible for employees to spend
more time at their desks, faxing important information to other offices rather than delivering it by
hand. This improves worker productivity and also keeps all employees accessible to all other
employees in the company. The Magicphone can also work 24 hours a day, taking orders from
customers after hours. Overnight orders will be sitting on the salesperson’s desk in the morning.
Hotels and motels can also benefit from the Magicphone. Business travelers have come to
depend on a variety of communications tools on their business trips. If a hotel provides
Magicphone service, its business guests would be more effective while on the road and may be
encouraged to patronize that hotel again. The Magicphone can also offer cost saving features to
the hotel user, such as routing calls over the lowest cost lines available. Along with its
convenience, the Magicphone can improve employee efficiency and customer service.
Concept Testing and Test Marketing
AT&T relies on the marketing concept in order to remain the leader in the telecommunications
industry: it consistently seeks to discover its customers’ needs. It was from this pro-marketing
attitude that the Magicphone was developed. AT&T surveyed all its complex product customers
to find out their likes and dislikes about the system they currently had and to list possible
changes they would like to make. These surveys indicated that customers were not entirely
satisfied with their current phone systems. They wanted something that was more convenient,
less expensive, and more compact. This information was passed on to engineers who quickly
developed the Magicphone PFC concept. In its original design, the Magicphone was intended to
be an AT&T technology with a difference: a personal, desktop tool for enhancing the user’s
privacy and productivity. It was designed to have many if not most of the characteristics the
customers had requested in the surveys.
Concept testing using focus groups provided a very positive response to the Magicphone product
concept. AT&T proceeded to the next step of selling the Magicphone PFC to test markets. The
limited quantities of the Magicphone PFC sold extremely well in these areas and AT&T knew it
had a successful product. Customers expressed very encouraging thoughts to AT&T about the
Magicphone PFC. Over 90% of those surveyed felt the phone system was excellent or good,
85% felt it offered good to excellent value for the price, and 80% said they would be extremely
willing to buy another. The Magicphone exceeded AT&T’s “willingness to pay” goals, even
given that 20% of sales were priced above $1400 during the test.
The customers in the test markets also ranked the benefits of the Magicphone in order of
importance:
1. Convenience.
2. Productivity.
3. Improves sending and receiving messages.
4. Saves space.
5. Controls cost and saves money.
6. Improves customer service.
The test markets allowed AT&T to adjust any problems with the Magicphone PFC that were not
discovered in the focus groups, concerning price, physical characteristics, reliability, and
servicing.
Competition and Positioning Analysis
AT&T wants to be the company that gains market share and loyalty by creating more innovative
products than its competitors. AT&T management believes that, with the company’s high quality
products, it would be hard for competitors to duplicate these products and position themselves
head to head against them. AT&T anticipates that its main competition in terms of comparable
products will come from ROLM, TIE, and Executone. In addition, many personal in-home fax
machines offer copier capability along with a built-in phone. These are considered substitute
products but not direct competitors. In 1995, the Magicphone PFC was the only business phone
with built-in fax and copier. It was expected that it would be one or more of these three
competitors that could produce a product similar to the Magicphone PFC.
Based on the understanding of the target market, test market results, and competition, a
positioning map for Magicphone PFC and its competitors can be constructed.
Attribute 1
(Convenience)
Attribute 2
(Productivity)
Segment Ideals Aftermarket Customers 3.50 2.00
New Customers 1.75 3.75
Brand Positions Magicphone PFC 4.25 3.25
ROLM 2.50 3.00
TIE 3.75 1.75
Executone 2.00 3.50
Marketing Mix Decisions
AT&T was reasonably certain about an initial selling price of $1175, but it could still investigate
whether a slightly lower or higher price would be advisable. The company also had to make
decisions on other aspects of the marketing mix for the Magicphone, namely distribution
expenditure, advertising expenditure, and expenditures on sales promotions to the industrial
customer. The level of distribution achieved affects the availability of the Magicphone to
prospective adopters. Increasing advertising level increases the awareness of a prospective buyer
of the existence of the Magicphone. Finally, sales promotions to prospective customers (such as
limited-time trial offers for the small businessperson operating out of a home office) can
encourage trial and adoption. The ASSESSOR model can be used to support the decision of how
much to spend on each of these marketing mix elements.
Distribution and Availability
After AT&T got the encouraging test market results, it set a general availability date for February
1, 1995. On this date, all sales agents, account executives, and aftermarket representatives could
begin selling and leasing the Magicphone to customers. The time from initial research to general
availability was actually quite short for the Magicphone, compared to other products in its line,
mostly because the technologies incorporated in its design were already available – they were
just rearranged and combined in new ways for the convenience of customers.
AT&T knew that it would have a minimum of six months from the general availability date
before competition could enter the market with a product similar to the Magicphone. AT&T
believes that it should continually be the leader in technology. For example, when a recent
cordless telephone product was launched, AT&T expected competition to enter after about six
months. However, by the time of introduction of the Magicphone, two years had passed and
competition had not yet produced a similar product.
AT&T management was able to provide the following judgmental estimates as inputs into the
distribution section of the ASSESSOR model:
Reference distribution expenditure: $2,000,000.
Minimum market share: 5%.
Maximum market share: 90%.
Exponent: 0.9.
Advertising and Sales Promotion
AT&T plans to undertake advertising campaigns in appropriate business-oriented publications as
well as sales promotion activities such as free, limited time in-office trials. The product benefits
(identified earlier in the test market) are to be mentioned prominently in all advertising copy as
well as in the “pitch” used by the AT&T sales force in calling on prospective customers. Each of
the customer benefits was further developed and refined by the advertising agency handling the
Magicphone account. AT&T plans to promote the Magicphone along the following concepts:
1. Saves Time. The Magicphone saves the user time because of the AT&T technology used to
handle both voice and fax calls. Users can send and receive faxes as easily as voice calls,
even while they make voice calls. The user can also make copies while using the phone.
The built-in speakerphone and hands-free answering feature permit the user to talk on the
phone without picking up the handset. Faxes can be sent and received and copies made
while discussing business with clients or responding to workers on the intercom.
2. Saves Space. The Magicphone requires only a very small space on the user’s desk. It takes
up about a square foot, substantially less than the space needed for a separate multi-line
phone, fax machine and copier. This frees up space for other important business items on the
user’s desk.
3. Confidentiality/Privacy. The Magicphone ensures document confidentiality and privacy by
allowing the user to receive personal or confidential information directly at his or her desk.
No other individuals could gain access to these documents.
4. Cost Control. The Magicphone takes advantage of system features for managing and
controlling costs. It is equipped with features such as dial restrictions that prevent
unauthorized voice and fax calls and call accounting to track client bill-back. The
Magicphone also has automatic route selection that finds and uses the lowest cost
long-distance service available on the user’s communications system when the user places a
long-distance or fax call.
5. Improves Customer Service. Users can receive important voice and fax calls right at their
own desk, which improves the service they can provide to customers. With the Magicphone,
the user can talk on the phone or conference with up to two parties and fax at the same time.
The fax-on-intercom system, used for intra-office fax calls, keeps outside lines open for
clients to reach the user, further enhancing customer service. Also, personal fax capability
reduces user errors by allowing the user to receive or send copies during the same call.
AT&T management was able to provide the following judgmental estimates as inputs into the
advertising and sales promotion sections of the ASSESSOR model:
Advertising Sales Promotion
Reference Expenditure $2,000,000 $1,500,000
Minimum Market Share 0% 0%
Maximum Market Share 90% 80%
Exponent 1.3 0.9
On the basis of preliminary target market analysis, long-run trial probability was estimated at
90%. Probability of a non-AT&T customer switching to the AT&T Magicphone was estimated to
be 70%, while the probability of a current AT&T customer upgrading to the Magicphone
(“repurchase”) was set at 80%. (Note: The estimate “Probability of Trying a Received Sample”
required by ASSESSOR is meaningless in this context. To eliminate the effect of this estimate,
please set it to a value of 1.) Fixed costs other than advertising, distribution, and sales promotion
incurred by the Magicphone have been estimated at $2,800,000 annually.
Pricing
In setting the initial selling price for the Magicphone, AT&T management was particularly
concerned about the total effect on the overall fax product line. Currently AT&T sells two other
cheaper phone/fax machines that do not have all the features of the Magicphone. It is reasonable
to assume that the Magicphone might draw some sales away from these other fax machines.
Thus, to assess the effect of increasing or decreasing the initial price from the originally planned
$1175, the sensitivity of demand for the Magicphone as well as the cheaper fax machines to
changes in Magicphone’s price must be assessed. This can be done by getting estimates of price
elasticity of demand. Price elasticity of demand can be expressed as:
e = % change in quantity demanded / % change in price.
The “own” price elasticity of demand for Magicphone represents the change in number of
Magicphone units demanded as price is adjusted. Normally, this would be expected to be a
negative number: as price goes down, quantity demanded increases, other things being equal.
The “cross” price elasticity of demand refers to the change in demand for the other fax machines
as the price of Magicphone is adjusted. For substitute products such as these fax machines, one
would expect cross elasticity to be positive: cutting price on the Magicphone makes Magicphone
more attractive to purchasers, who would then be more likely to trade up and less likely to buy
the cheaper fax machine. A small-scale tradeoff analysis was conducted with a group of
potential customers to assess price elasticities. In this analysis, each was asked what the price of
the Magicphone would have to fall to in order for them to want to trade up from either of the
cheaper fax machines to the Magicphone. Based on the results of the analysis and previous work
done on Magicphone pricing, price elasticity of the Magicphone was estimated at –2 and
cross-elasticities of the two substitute fax machines were 1.1 and 1.3 respectively.
Additional relevant financial information is as follows:
Old Fax Machine A Old Fax Machine B
AT&T’s Selling Price $800 $700
Quantity sold (000s) 25 25
Variable Costs $400 $350
Fixed Costs (000s) $6,000 $6,400
Indirect Overhead for Fax Product Line: $10,000,000.
(Note: Use your estimates of first-year Magicphone sales and fixed costs derived in earlier stages
of this analysis as input in this stage. Don’t forget to include advertising, distribution, sales
promotion, and other fixed costs in your estimate of total fixed costs.)
Profit Analysis
By examining internal financial records, AT&T was able to develop the following financial
estimates that can be used as inputs to the FINANCIAL model.
Division overhead charged to Magicphone: $10,000,000 yearly.
Corporate overhead charged to Magicphone: $100,000 yearly.
Production investments all are depreciated over five years using straight-line method.
Project abandonment: negligible.
Tax rate: 34%, with no applicable tax credits.
Cost of capital: 15%.
Working capital:
Cash as percent of sales: 10%.
Inventory as percent of sales: 10%.
Accounts Receivable as percent of sales: 15%.
Working capital recovery in Year 5:
Percent of cash: 100%.
Percent of inventory: 80%.
Percent of accounts receivable: 100%.
To account for cannibalization, assume that the two old fax machines are nearing the end of their
market life. In Year 1, it is expected that the Magicphone will reduce sales of both old fax
machine products by 12,000 units. Since these two older products will be essentially obsolete by
Year 2, cannibalization effects for Year 2 and further out are considered to be negligible.