Question 4c
ALG Co is launching a new, innovative product onto the market and is trying to decide on the right launch price for the product. The product’s expected life is three years. Given the high level of costs which have been incurred in developing the product, ALG Co wants to ensure that it sets its price at the right level and has therefore consulted a market research company to help it do this. The research, which relates to similar but not identical products launched by other companies, has revealed that at a price of $60, annual demand would be expected to be 250,000 units.
However, for every $2 increase in selling price, demand would be expected to fall by 2,000 units and for every $2 decrease in selling price, demand would be expected to increase by 2,000 units.
A forecast of the annual production costs which would be incurred by ALG Co in relation to the new product are as follows:
| Annual production (units) | 200,000 | 250,000 | 300,000 | 350,000 |
|---|---|---|---|---|
| $ | $ | $ | $ | |
| Direct material | 2,400,000 | 3,000,000 | 3,600,000 | 4,200,000 |
| Direct labour | 1,200,000 | 1,500,000 | 1,800,000 | 2,100,000 |
| Overheads | 1,400,000 | 1,550,000 | 1,700,000 | 1,850,000 |
(c) The sales director is unconvinced that the sales price calculated in (b) above is the right one to charge on the initial launch of the product. He believes that a high price should be charged at launch so that those customers prepared to pay a higher price for the product can be ‘skimmed off’ first.
Required:
Discuss the conditions which would make market skimming a more suitable pricing strategy for ALG, and recommend whether ALG should adopt this approach instead. (5 marks)