1.a) Using the domestic price PolyPrin receives and the normal mark-ups, distribution costs and duties, calculate a possible retail price in the Australian market.
PolyPrin sells their products at roughly 30$ per item. This is found by dividing the annual revenue by the amount of units it produces and sells domestically; the total amount of dollars charged per item. In this case, 90 million in revenue divided by 3 million in production. (90M/3M=$30/unit)
With the addition of import duties (5%) and shipping insurance ($5 per item) we see the $30 rise to 36.75 ((30+5) x 1.05). An additional 10% markup is added from the manufacturer to retailer raising the price again to 40.43 (36.75×1.1) before finally being marked up 25% for the customer, a final retail price of $50.53 USD (40.43×1.25).
b.) Determine the cost to produce one dress, and using this plus the normal mark-ups and distribution costs and duties, calculate the potential retail price in the Australian market.
To determine the cost of producing one dress we will need to identify all the factors contributing to cost, that is, fixed and variable cost. Our total variable costs for the dresses are materials ($22M) and energy ($6M), which amounts to $28M, divided by the amount of units, (3M) giving us to $9.3 per dress. Now we have fixed costs, which are labour ($12M), plant overhead ($3M) and SG&A Costs ($14M), equaling $29M, divided by the total number of units (3M) for a total of $9.6 per dress. The full cost of the dress is $18.9 per dress. (See calculations below)
Total variable(22)+(6)28/3= 9.3
Items produced (3)
Total fixed cost(12) + (14) +(3)29/3= 9.6
Items produced (3)
($9.3) + ($9.6) = $18.9
Now we add the additional cost of insurance per item, ($5), import duties (5%), manufacturer to retail markup (10%) and retailer to customer markup (25%) for a final retail price of $34.5 per dress. (See calculations below)
18.9 + 5 = 23.9
23.9 x 1.05 (5%)
25.1 x 1.10 (10%)
27.6 x 1.25 (25%)
2) Which pricing scenario is better for the company? Explain your answer, considering key factors beyond costing that influence pricing decisions.
Before concluding that one pricing strategy is superior to the other, it is first crucial to consider the market, analyze it’s characteristics and understand how each pricing strategy might fit before ultimately deciding which strategy is most fostering towards Polyprin’s long term strategy.
First let us break down the potential that the Australian market offers. Perhaps most comforting to the decision makers at Polyprin is the similarity between the Australian culture to the American west coast surfer culture of California. Not only the climate, but the style and seemingly easy-going way of life, reflects almost identically what Australians are known for on the sandy shores around it’s nearly 50,000km of coastline. This alleviates much
of the stress in marketing as consumers will be able to identify immediately with the product and will not need to have it explained to them. More to support the enthusiasm for the Australian market is their promising economic future. As a result of the increase in demand for Australian commodities, the Aussie government has been pleased to see a rise in the value of it’s dollar – which currently brings in 3 cents on every American dollar – as a significant contributor to its strengthening purchasing power.
When speaking specifically of the casual type wear market in Australia, Polyprin has identified that it is an industry worth a total of $5 billion, and although some local competitors are present, it seems that imported products from neighboring countries are seizing the majority of the business. These items are sold within an average range of $A30-35 and sometimes as much as $A45 for styles, which Polyprin believes to be of inferior quality.
Now let us consider pricing options. A cost escalation strategy consists of identifying the amount it costs to produce each item, and using that number as the baseline upon which shipping costs, duties and markups are added for a final retail price. This strategy guarantees that the company does not loose out on the venture by covering their fundamental costs of operation. This allows them to keep the price low enough to entice consumers while simultaneously hedging themselves from the risk of losing money on each item sold. This is basis for a market penetration strategy.
A price escalation strategy consists of using the price has been determined for the domestic market and then adding the costs of shipping, duties and markups to come up with a final retail price. This strategy ensures that the company not only recovers the cost of the export venture, but also includes a built in profit per item. Because they begin with charging the amount that they would otherwise sell for in the United States – one that brings with it a profit – they are promising themselves returns at least equal to that which they would receive if they continued to sell domestically. The price is ultimately higher than that which is derived from a cost escalation strategy, but with a higher end product – like those produced by Polyprin –
a higher price is not at all detrimental to the likelihood of its success.
So which strategy is better? If we assume efficient plant operation allows Polyprin to produce 1 million items more per year, a price escalation strategy brings in $16 million more in revenue than a cost escalation strategy. ($50.5M-$34.5) It is clear that a price escalation strategy would allow Polyprin to maximize earning potential to its utmost, therefore being the more lucrative option. By starting with the domestic price as the base for its export price, Polyprin can price itself as the niche product it is so clearly capable of being. For one thing it will help Polyprin stand out from the existing price average and its superior quality will support its higher price against the $45 imported items from Southeast Asia. 3) Given this information, what price would you ultimately charge, and why? How would you enter the Australian market and distribute the product?
If I were among the decision makers responsible setting the price of Polyprin’s casual type wears for the Australian market, I would be a strong advocate for retailing the clothing at $49.95, and there are a number of reasons why.
True, the price of $49.95 is approximately 10% higher than the more expensive imported clothes, however this is well justified when consumers recognize the significant superiority in the quality of fabric as well as sophistication and elegance it its design. Moreover, due to the simple psychological trigger of the “left digit-effect” (where a consumers judgment on price is associated with the leftmost digit) 49.95 feels more like an item priced at $40 than at $50, therefore perhaps less likely to be deemed “too pricy”.
Second, pricing the items at 49.95 means there is a potential for an additional 55% in total revenue simply by exporting 25% of the total goods to Australia (where Polyprin exports all of the additional 1 million goods it is capable of producing as a result of efficient production). This ties in with the market entry strategy.
To enter the Australian market I would begin with exporting. No sense in diving into the market headfirst when you aren’t sure how deep the water is. By this I mean, make sure the returns from the export venture are close to what was projected and can sustain over a certain length of time, after which point, establishment of a wholly owned subsidiary should be considered.
If sales of the 1 million items at $49.95 persist and factoring in the cost per item ($34.5; see question 1.b) total profit from exports should amount to close to $15.45 million per year. If these numbers were met for two consecutive years, the profits from these exports alone would fund the expansion of a wholly owned subsidiary in Australia, which was estimated at $30 million.
Once established in Australia, Polyprin could sell through it’s subsidiary thereby collecting the 35% in markups that it used to forfeit to local retailers. This would more than make up for the 10% in retail tax for wholly owned subsidiaries. Furthermore, this increased exposure to the market could entice Polyprin to distribute a larger portion of its 4 million in production to the Australian market. Then in the 4th year (after one year of running 1 million items through its newly acquired subsidiary) Polyprin may choose to distribute a larger portion – perhaps 35 to 45 percent – of it’s goods to the higher priced Australian market.