Transcript final: healthy spring water company defining the price

FINAL: HEALTHY SPRING WATER COMPANY
DEFINING THE PRICE-VOLUME TRADEOFF FOR A PRICE INCREASE
1. What is the maximum % sales loss that Healthy Spring could tolerate before a 10% price
increase would fail to make a positive contribution to its profitability? And what is the unit
break-even sales volume?
- %DP
Sales D % -10%/(60%+10%) = -10%/70% = -14.3%
~ 1714-1720
%CM’ + %DP
B/E Sales Volume
2. Repositioning as a premium water will require upgrading the packaging, changing from
plastic bottles to glass bottles that are "safety sealed" to insure cleanliness until the covering is
removed in the customer's home. These changes will add $1.00 per bottle to the variable cost
of sales. What is the new breakeven volume with the 10% price increase?
- $DCM
Sales D % -1/13 = -7.7%
New $CM
B/E Sales Volume
~ 1846
3. Repositioning the water as a premium product will require an advertising and promotion
budget increase of $900 daily. What is the maximum sales loss that Healthy Spring could
tolerate before a 10% price increase would fail to increase net profit? That is, what is the
break-even sales change including the incremental fixed cost of advertising?
-4.2%
- $DCM
+
$D in FC
Sales D %
New $CM
NEW $CM × initial unit sales
B/E Sales Volume ~ 1915
-1/13 + 900/(13*2000) = -4.2%
Profit Implications of Competitive (Re)Actions
Healthy’s Profit if Competitor Matches Price Change (Use Primary Elasticity ≈ -1)
New
Expected Expected Exp Var Costs
Total
Expected
Price D
Price
Demand Revenue
($9 VC/U)
Fixed Costs
Profit
$45,540
$18,630
$20,900
$6,010
10%
$22.00
2,070
$46,000
$20,700
$20,900
$4,400
0%
$20.00
2,300
Healthy’s Profit if Competitor Does Not Match Price Change (Increase Elasticity ≈ -2)
New
Expected Expected Exp Var Costs
Total
Expected
Price D
Price
Demand Revenue
($9 VC/U)
Fixed Costs
Profit
1,840
$40,480
$16,560
$20,900
$3,020
10%
$22.00
2,300
$46,000
$20,700
$20,900
$4,400
0%
$20.00
Cheapie’s Profit if Cheapie maintains/increases price (Healthy’s Increase Elasticity ≈ -2)
Healthy Cheapie’s Expected Expected Exp Var Costs
Total
Expected
Price D
Price
Demand Revenue
($8 VC/U)
Fixed Costs
Profit
10%
$20.00
2,660
$53,200
$21,280
$24,000
$7,920
0%
$20.00
2,200
$44,000
$17,600
$24,000
$2,400
10%
$22.00
1,980
$43,560
$15,840
$24,000
$3,720
Cheapie’s Profit if Cheapie decreases price (Healthy’s Increase Elasticity ≈ -2; Cheapie’s Decrease Elasticity ≈ -3)
Healthy Cheapie’s Expected Expected Exp Var Costs
Total
Expected
Price D
Price
Demand Revenue
($8 VC/U)
Fixed Costs
Profit
3,232
$58,176
$25,856
$25,000
$7,320
10%
$18.00
2,860
$51,480
$22,880
$24,000
$4,600
0%
$18.00
6. Construct a payoff matrix that summarizes unit volumes and profit for Cheapie with prices at $18
and $20 and for Healthy with prices at $20 and $22. What are the take-aways?
Exhibit 1: Payoff Matrix under Different Pricing Scenarios1
Healthy
Cheapie
Total
Healthy
Cheapie
Total
3232
4720
1840
2660
4500
$7,320
$5,764
$3,020
$7,920
$10,940
1860
2860
4720
2300
2200
4500
($440)
$4,600
$4,160
$4,400
$2,400
$6,800
Units 1488
$22.00
Profit ($1,556)
Healthy price
Units
$20.00
Profit
$18.00
$20.00
Cheapie price
Strictly according to the payoff matrix…
1. If Healthy sets its price at $20, Cheapie maximizes profit with a:
$
price
2. If Healthy sets its price at $22, Cheapie maximizes profit with a:
$
price
3. Given that Cheapie will try to maximize profit, what price should Healthy set?
$
price
4. What is the major concern facing Healthy if it keeps its price at $20.00?