Which of the following statements regarding market penetration as a pricing strategy is/are correct?
(1) It is useful if significant economies of scale can be achieved
(2) It is useful if demand for a product is highly elastic
A 1 only
B 2 only
C Neither 1 nor 2
D Both 1 and 2
Chair Co has in development several new products. One of them is a new type of luxury car seat. The estimated labour time for the first unit is 12 hours but a learning curve of 75% is expected to apply for the first eight units produced. The cost of labour is $15 per hour.
The cost of materials and other variable overheads is expected to total $230 per unit. Chair Co plans on pricing the seat by adding a 50% mark-up to the total variable cost per seat, with the labour cost being based on the incremental time taken to produce the 8th unit.
Chair Co uses cost-plus pricing.
Which of the following statements regarding cost-plus pricing strategies are correct?
(1) Marginal cost-plus pricing is easier where there is a readily identifiable variable cost
(2) Full cost-plus pricing requires the budgeted level of output to be determined at the outset
(3) Cost-plus pricing is a strategically focused approach as it accounts for external factors
(4) Cost-plus pricing requires that the profit mark-up applied by an organisation is fixed
A. (1), (2) and (4)
B. (1) and (2) only
C. (3) and (4)
D. (1) and (3)
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)
The following circumstances may arise in relation to the launch of a new product:
(i) Demand is relatively inelastic
(ii) There are significant economies of scale
(iii) The firm wishes to discourage new entrants to the market
(iv) The product life cycle is particularly short
Which of the above circumstances favour a penetration pricing policy?
A. (ii) and (iii) only
B. (ii) and (iv)
C. (i), (ii) and (iii)
D. (ii), (iii) and (iv) only
A company has entered two different new markets.
In market A, it is initially charging low prices so as to gain rapid market share while demand is relatively elastic.
In market B, it is initially charging high prices so as to earn maximum profits while demand is relatively inelastic.
Which price strategy is the company using in each market?
A. Penetration pricing in market A and price skimming in market B
B. Price discrimination in market A and penetration pricing in market B
C. Price skimming in market A and penetration pricing in market B
D. Price skimming in market A and price discrimination in market B
Brick by Brick (BBB) is a business which provides a range of building services to the public. Recently they have been asked to quote for garage conversions (GC) and extensions to properties (EX) and have found that they are winning fewer GC contracts than expected.
BBB has a policy to price all jobs at budgeted total cost plus 50%. Overheads are currently absorbed on a labour hour basis, resulting in a budgeted total cost of $11,000 for each GC and $20,500 for each EX. Consequently, the products are priced at $16,500 and $30,750 respectively.
The company is considering moving to an activity based cost approach. You are provided with the following data:
| Overhead category | Annual overheads | Activity driver | Total number of activities per year |
|---|---|---|---|
| $ | |||
| Supervisors | 90,000 | Site visits | 500 |
| Planners | 70,000 | Planning documents | 250 |
| Property related | 240,000 | Labour hours | 40,000 |
| Total | 400,000 |
A typical GC costs $3,500 in materials and takes 300 labour hours to complete. A GC requires only one site visit by a supervisor and needs only one planning document to be raised. The typical EX costs $8,000 in materials and takes 500 hours to complete. An EX requires six site visits and five planning documents. In all cases, labour is paid $15 per hour.
(b) Assume that the cost of a GC falls by approximately 7% and the cost of an EX rises by approximately 2% as a result of a change to ABC.
Required:
Suggest possible pricing strategies for the two products which BBB sells and suggest one reason other than high prices for the current poor sales of the GC. (5 marks)