Group Homework II

Course : Pricing Strategy Date : 2008. 04. 29

1. McDonald's offered their franchisees breakfast items (e.g., Chinese egg cake) that they could offer in the mornings when demand for hamburgers and fries was not very large. What costs should a franchisee have properly considered in deciding whether to offer a breakfast menu and in determining the most profitable prices to charge for breakfast items?

2. A sporting goods store purchases running shoes in the spring for $310 a pair and sells them during the spring and summer months for $500 a pair. In the autumn, the demand for running shoes dwindles. The store has two choices: it can sell out its remaining inventory of 50 pairs by having an end-of-summer sale of $299 a pair, or it can hold the shoes in inventory until next spring (eight months hence) and sell them for $399 a pair. (It could not get $500 because the manufacturer will introduce a new "improved" model next spring.) Should the store hold the inventory until next spring or sell it at a loss in the autumn?

3. For each type of business listed below: (1) What costs would you consider as incremental for pricing decisions and what costs would you deem irrelevant? (2) Might your answers differ for pricing decisions made under different circumstances? Explain. (3) Do all companies in the same line of business have the same cost structures? Explain. a. Grocery store b. Doctor's office c. University d. Automobile manufacturer e. Publisher f. Airline

- 1 - 4. Case of ACE Manufacturing: Identifying True Costs for Pricing

Ace Manufacturing earns revenues of $2,100,000 annually on 150,000 unit sales of an industrial part. The part is priced at $14 each. A potential customer, in an industry that the company has not previously served, asks ACE to submit a bid for a similar product that ACE could produce in the same facility using much of the same capital equipment. The new customer would purchase 30,000 units annually. After evaluating this customer's needs and identifying the substitute product, ACE's sales engineers conclude that a bid in the range of $10 per unit would be required to win this account. However, since the durability required by this customer was below ACE's usual standards, the engineers felt that cheaper materials could be used. ACE's engineers estimate that the variable cost of manufacturing this product, using the cheaper materials, will be $2.50 /unit. ACE will also require some additional production capacity that will increase fixed costs by $90,000. G&A costs to service this account will be approximately $60,000 annually.

(1)What is the relevant unit cost for making this pricing decision? (2)Is this business sufficiently profitable to make bidding worthwhile?

Total Dollars Dollars Per Unit 150,000 units 180,000 units 150,000 units +30,000 +30,000 Revenues $2,100,000 $14.0 Costs Direct Variable Costs 450,000 3 Direct Fixed Costs 750,000 5 General & Admin. Costs 675,000 4.5 Total Costs 1,875,000 12.5 Profits $225,000 $ 1.5