Hw#1

Pricing (Electronic copy with your name on the top)

Homework #1 1. Pricing Practice A pizza parlor sells its large pizza at $15 each. At that price, the current sales are 1,000 units per week. The variable cost per unit is $5. The management is considering the proposal of running a 20% price promotion. Please answer the following questions: 1) How much do the sales of large pizza have to increase for the price promotion to be profitable, if the cost structure for the parlor does not change due to the promotion? 2) Suppose now that the management believes that it is necessary to spend $400 to advertise the price cut to its customers, how much do sales have to increase now for the price cut to be profitable? 3)To make the problem even more realistic, suppose now that 40% of the customers who buy a large pizza also buy a six-pack of coke (the rest of customers do not buy anything else), from which the pizza parlor makes a dollar net profit, how much do sales have to increase now for the price cut to be profitable? 2. EVC analysis Harbor East Auto Finish is the best car polish and paint protection available anywhere. It is a substitute for regular wax and sold in a bottle that is adequate for one application to one car. Regular wax, which is sold in a container that is enough for two applications, costs about $4.00/container. Harbor East protects and maintains the shine of a car's finish at least 20% longer than regular car wax. It needs 2 hours to apply Harbor East, the same as regular wax. The labor cost is $5.00 per hour. Some cars have oxidized paint (no shine) at the time wax is to be applied, requiring cleaning with an oxidation cleaner before one can apply regular car wax. Oxidation cleaner costs $2.50 per bottle (good for one application) and needs 2 hours to be applied. However, Harbor East removes the oxidation and shines the car's surface in one step. Harbor East can also be applied directly to a car's surface that is already highly oxidized. 1) Estimate the EVC of Harbor East Auto Finish for consumers whose cars require cleaning with an oxidation cleaner before applying regular car wax and consumers whose cars do not require an oxidation cleaner. 2) There are a number of factors that influence price sensitivity other than EVC. Consequently, it may the case the customers would not be willing to pay as much as this product is really worth. Please identify at least two other factors that could influence how much people would be willing to pay for this product and briefly state the marketing 1

effort you can make to influence their willingness to pay or price sensitivity. Please refer to the textbook on the 8 factors affecting price sensitivity. 3. Incremental Break-even analysis PQR manufactures and markets home video equipment. One of the most popular items in the company’s product line is a video tape player at $250 each. Sales have been growing rapidly and are expected to reach 4,800 units in the next year if the price remains unchanged. Variable costs are $112.50 per unit. Despite its projected growth in sales at the current price, PQR is considering a 5% price cut to remain competitive and retain its share in this rapidly growing market. Since the cut would be implemented in the next year, the initial sales level, or baseline is next year's projected sales (4,800 unites). Production capacity is currently limited to 5,000 units but can be increased by purchasing equipment which costs $15,000 for each additional 1,000 units of capacity. 1). Calculate the total contribution before the price cut and after the price cut assuming total sales volume stays the same (4,800 units). 2). Calculate the breakeven sales (units and percentage) for a 5% price cut assuming there is no change of relevant variable cost. 3). Suppose the variable cost is decreased by $12.5 (assume this is true for 4) and 5)). Given that PQR can manufacture home video equipment at a lower variable cost, the management is considering a 5% price cut. By how many units sales has to change to maintain the same profit (the baseline case is P1=250 and S1=4800)? 4). Given the decrease of variable cost by $12.5, the management is also considering various price changes in addition to a 5% price cut. Develop a Breakeven Sales Curve by varying the percentage of price change at -15% (price cut), +5%, +15% (price increase). 5). After studying the Break-even Sales Curve, the management decides to go with a 5% price cut. But there is still uncertainty about how market will actually respond to the 5% price cut. Develop an Actual Sales Change Sensitivity Table by varying the percentage of actual sales change at 0%, 5%, 12.5%, 20%, and 40% to evaluate the actual impact of a 5% price cut on profit. 4. Making profitable pricing decisions (consider cost, customer and competition simultaneously) Swing Manufacturing and Steady Manufacturing both operate in the widget industry, but with radically different cost structure. Swing is a capital-intensive, automated manufacturer, while Steady is a labor-intensive “job-shop.” Monthly operating data are as follows:

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Sales Price Variable cost Fixed cost Current profit

Swing Manufacturing 5,000 units $10 $2.50 $35,000/month $2,500/month

Steady Manufacturing 5,000 units $10 $5.50 $20,000/month $2,500/month

Swing and Steady both currently have equal (50%) shares of the market. Each is evaluating opportunities to enhance profits. One opportunity involves selling to a lowvalue, but potentially high volume market segment not currently served by either company. Unfortunately, reaching that market would require pricing at $8.5, 15% below current level. Neither Swing nor Steady can effectively segment this market (each can only charge one price to different segments). 1) Calculate the minimum required sales increase in order to break-even the profit for a 15% price decrease for both Swing and Steady. Which competitor is better positioned to take advantage of this opportunity? 2) In reality, the potential increase in sales for either company entering that market alone would be 40% (2000 units). If they both enter, the potential sales increase would be 20% for each of them. Calculate the profit change for both Swing and Steady when Swing alone takes this opportunity and both take this opportunity by filling up the following table. Strategy

Market Response

Swing cuts price Both cut price

2000 units increase for Swing 1000 units increase for both

Change of Profit for Swing

Change of Profit for Steady

What do you recommend for Steady? 3) Now suppose, after some marketing research, Steady’s management believes that it would have lost 60% of its current market if it failed to reduce its price. Under this condition, what do you recommend for Steady? Keep the price or follow Swing’s price cut? Strategy Swing cuts price

Both cut price

Market Response

Change of Profit for Swing

5000 units increase for Swing; 3000 units decrease for Steady 1000 units increase for both

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Change of Profit for Steady

4) Assume that if Steady were to ignore the new opportunity and serve the remaining 2000 customers, it could reduce its fixed costs by half by giving up its lease on the rental property. Would Steady be better off to withdraw from the market? (avoidable cost) 5) Fortunately, crisis has a way of focusing the mind. After studying Competitive Advantage, Steady’s management decided to give up producing generic widget and start to produce specialized widget because they learned that 3500 of the current market demand comes from companies that must modify the commodity widget to meet their specific needs. To achieve this, Steady would need to invest in additional fixed capital generating a fixed charge of $3000 monthly. They believe that Steady can charge prices at least $6 higher than the going commodity price ($16), but would incur additional variable cost of $0.5 per unit ($6). What are the minimum unit sales that Steady would require to break even (use original price $10 as the bench mark)? Given the market potential, is it profitable to switch to manufacturing specialty widget?

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