Question

You are hired as a product manager at a camnie nroduct company that has developed a new lightweight, collapsible drinking cup for backpackers. You are considering two alternative prices for the product - $7.50 or $4.50. Research has estimated that at the $7.50 price the first year market will be 200,000 units, plus or minus 20%. At the $4.50 price the first year market is estimated at 600,000 units, plus or minus 30%. In either case, manufacturing costs (variable costs) will be $2.80 per unit and fixed costs for plant and equipment will be $50 thousand. Since the product will simply be added to the company's line, other expenses, such as advertising costs, will be minimal. You estimate $15 thousand at either volume level. You are trying to decide whether to use a price skimming or penetration strategy. Because you have heard that a major competitor is working on a similar unit, you are afraid that you will have very little lead time - a month or two at the most. You have filed for a patent on the product but are not sure that it is patentable. At the same time, you have to introduce the product immediately to be in the market in time for the backpacking season. Questions: 1. What are your projected sales and profits at the skimming and penetration prices? 2. What are your breakeven points for the skimming and penetration prices? 3. What decision do you make, skimming or penetration? Why? 4. What are your assumptions and considerations that led you to this decision? 5. What additional information would you like to know to make a more informed decision? Notes: Break-even = Fixed Cost/Contribution Margin Contribution Margin = Selling Price - Variable Unit Cost

Answer 1

Answer :

(1). The price under the price skimming strategy would be $7.5.

Hence, the projected Sales and profits are:

Skimming	Normal	Best	Worst
Sales units	200000	240000	160000
Sales price	$7.5	$7.5	$7.5
Sales revenue	$15,00,000	$18,00,000	$12,00,000
variable cost	$5,60,000	$6,72,000	$4,48,000
Fixed cost	$50,000	$50,000	$50,000
Marketing costs	$15,000	$15,000	$15,000
Net profit	$8,75,000	$10,63,000	$6,87,000

The projected sales and profits under the penetration strategy

Penetration	Normal	Best	Worst
Sales units	600000	780000	420000
Sales price	$4.5	$4.5	$4.5
Sales revenue	$27,00,000	$35,10,000	$18,90,000
variable cost	$16,80,000	$21,84,000	$11,76,000
Fixed cost	$50,000	$50,000	$50,000
Marketing costs	$15,000	$15,000	$15,000
Net profit	$9,55,000	$12,61,000	$6,49,000

(2). Break even point = Fixed cost / contribution margin

Break even point for Skimming = 65000 / (7.5-2.8)

= 13830 units

Break even point for Penetration = 65000 / (4.5-2.8)

= 38235 units

(3). The penetration has higher potential of maximizing profit. Also the minimum profit in both cases doesn't have too much difference although it is lower for penetration. Also, penetration strategy will help to capture market first and then skimming can be done as there is threat from competitor initially. Also at 600,000 units profit is higher compared to 200,000.

(4). The major consideration is the profits earned under each strategy. we assume that the sales units will remain in the range mentioned above.