Problem 1:
Jessica Alba, a famous actress, starts the baby and family products business, The Honest Company, with Christopher Gavigan. Alba and Gavigan set up their site so families can choose what kinds of non-toxic, all-natural products they would like to use and get them in a bundle. Families can choose all kinds of products from food to hygiene necessities and cleaning supplies. They are thinking of expanding their business into five domestic markets: Phoenix, Dallas, Chicago, New York, and Atlanta. Their primary goal of business is to maximize economic profits, although they want to do business honestly.
The pricing strategy for a new product should be developed so that the desired impact on the market is achieved while the emergence of competition is discouraged. Two basic strategies that may be used in pricing a new product are skimming pricing and penetration pricing. As the business adviser for Alba and Gavigan, I recommend a price skimming strategy for pricing merchandise. Penetration pricing occurs when a company launches a low-priced product with the goal of securing market share. Penetration pricing requires extensive planning to properly execute a penetration-pricing strategy, the company first must gear up for mass production and then launch a sizable advertising campaign to publicize its new low-priced product (Monger, 2012). Both steps are expensive, so penetration-pricing strategies might not work well for small businesses. In addition, if your company’s forecasts for consumer demand are off, you could end up with a large stockpile of unwanted products. Penetration pricing also do not allow you to take advantage of an eager market of customers with money to spend and a willingness to do so. Skimming pricing is the strategy of establishing a high initial price for a product with a view to “skimming the cream off the market” at the upper end of the demand curve (Monger, 2012).
As the business adviser for Alba and Gavigan, I recommend a price skimming strategy for pricing merchandise. Skimming pricing is accompanied by heavy expenditure on promotion. Only non-price-conscious customers will buy a new product during its initial stage. Later on, the mass market can be tapped by lowering the price. If there are doubts about the shape of the demand curve for a given product and the initial price is found to be too high, price may be slashed. Some products carry premium prices (high prices) permanently and build an image of superiority for themselves. When a mass market cannot be developed and upper-end demand seems adequate, manufacturers will not risk tarnishing the prestigious image of their products by lowering prices, thereby offering the product to everybody (Monger, 2012). Price skimming offers some major advantages. Price skimming can offer insight into what consumers are willing to pay. Skimming can create an aura of prestige around your product and if the initial price is too high, you can lower it easily. Finally, late adopters to the market might be pleased to get your prestigious product at a bargain price, which creates goodwill for your company. A major disadvantage, however, is that large profits attract competitors (Monger, 2012).
The Honest Company should emphasize sustainability over profit maximization within everything they create. This does not mean they should ignore profit. Profits are essential, and they are the essence of survivability. However, long-term viability should be your highest priority. As leaders of a business, both Jessica Alba and Christopher Gavigan must balance the need for profit with the need to create a business that can survive for the long term. Sustainability should be treated like any business priority, with actual, realistic metrics that can be measured and considered in terms of a company’s overall return on investment (ROI). Users of price skimming hope to pocket significant profit from initial customers and maintain high enough prices over time to maintain steady long-term profit from value-oriented buyers. The Honest Company are likely to be profitable and continue economic profits in the long term if they make viability and sustainability a priority.
The advice I would give to Alba and Gavigan to help them make more profit in the long term would be to keep customer service a priority, train sales staff on product knowledge, communication, and upselling. Making the customer aware of other product in line with what customers are purchasing will increase revenues. Monitor products that are moving slowly to determine if they are not presented correctly or if they are wrong for the demographic. Introduce new products only after researching the needs of their consumers. In line with marketing parlance, the Honest Company should considered price skimming to start and gradually reduce the pricing to draw on a larger market which effectively corresponds with long term profit maximization.
Problem 2:
You operate your own small building company and have decided to bid on a government contract to build a pedestrian walkway in a national park during the coming winter. The walkway is to be of standard government design and should involve no unexpected costs. Your present capacity utilization rate is moderate and allows sufficient scope to understand this contract, if you win it. You calculate your incremental costs to be $268,000 and your fully allocated costs to be $440,000. Your usual practice is to add between 60% and 80% to your incremental costs, depending on capacity utilization rate and other factors. You expect three other firms to also bid on this contract, and you have assembled the following competitor intelligence about those companies.
- “The incremental costs of the contract are all those costs, expressed in present value terms, that are incurred as a result of winning and completing the contract.” (Douglas, 2012). The price that I would bid if I must have the project is 428,800. Incremental cost 268,000.00 * (1+.60) = 428,800.00
- “If the firm’s objective is to maximize its net present worth, the optimal bid price will be the price that maximizes the expected present value of contribution (EPVC) to overheads and profits” (Douglas, 2012). To calculate the (EPVC) you have to multiply the present value of the contribution at each price by the probability of winning the contract at that price. The price I would bid if I wanted to maximize the expected value of the contribution from this contract would be 468,000. Net EPV at an incremental cost $ 0000s
- The price that I would bid if I must have the project is $428,800 this is based n the research gathered for all rival bidders, Rival A does not like winter jobs or dirty jobs, is at full capacity utilization and based on those factors will probably bid higher than what previous bidding history suggests. So offering a bid at 60% of the incremental cost is lower than Rival B and C and follows my usual practice. The price I would bid if I wanted to maximize the expected value of the contribution from this contract would be $468,000. The company may win some contract bids, “but it should expect to maximize its net present worth over an extended period of time. Indeed the firm will need to bid on many contracts if the success probability of this project (about 45%) is typical” (Douglas, 2012).
References
- Douglas, E. (2012). Managerial Economics (1st ed.). San Diego, CA: Bridgepoint Education. Monger, B. (2012). Pricing Strategies and Policies. Retrieved 1/9/2014 from http://smartamarketing.wordpress.com/2012/04/05/pricing-strategies-and-policies/ Narver, J. & Slater, S. (1990). The effect of a market orientation on business profitability. Journal of Marketing, 54, 4. 20-35
