Imagine that you are the product manager of a camping products 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?
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