When introducing new products, some manufacturers set a high initial price and then reduce price later. However, reducing price also reduces contribution margins, which in turn impacts profitability. To be profitable, the reduced price must sufficiently increase sales. For example, a company with a contribution margin of 30 percent on sales of $60,000,000 realizes a total contribution to fixed costs and profits of $18 million ($60 million x 0.30 = $18 million). If this company decreases price, the contribution margin will also decrease. So to maintain or increase profitability, the price reduction must increase sales considerably.
1. Refer to Appendix 2, Marketing by the Numbers, and calculate the new contribution margin for the company discussed above if it reduces price by 10 percent. Assume that unit variable costs are $70 and the original price was $100.
2. What level of total sales must a company capture at the new price to maintain the same level of total contribution as before the price reduction (that is, total contribution = $18 million) ?