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

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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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 Swing Manufacturing Steady Manufacturing
Sales 5,000 units 5,000 units
Price $10 $10
Variable cost $2.50 $5.50
Fixed cost $35,000/month $20,000/month
Current profit $2,500/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 low-
value, 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 Change of Profit for Change of Profit

Swing for Steady
Swing cuts 2000 units
price increase for Swing
Both cut 1000 units
price increase for both

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 Market Response Change of Profit for Change of Profit

Swing for Steady
Swing cuts 5000 units increase
price for Swing;
3000 units decrease
for Steady
Both cut 1000 units increase
price for both

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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?