Schindler, Pricing Strategies – Instructor Resources

Chapter 4: Answers to the End-of-Chapter Questions

Exercises

1. A new product has per-unit variable costs of $15 and an estimated value to the customer
of $45 per unit. Products in this category have been selling at around $35 per unit.
Describe the three basic initial-pricing strategies, and give the approximate price for this
product that would be suggested by each of these three strategies. For each price, explain
your reasoning.

2. In 1999, Sony introduced a new product into the U.S. market. It was Aibo, the first
interactive robot dog. It was able to learn its name, respond to commands, dance, and be
programmed to perform a variety of actions.
Assume Sony’s variable costs for producing this product were around $700, and market
research indicated that the VTC of this product was around $1,400. Recommend a price
that consumers should be charged for this product, and explain how you considered the
factors determining initial-pricing strategy in making your recommendation.

3. A manufacturer is considering incurring $60,000 in research and development costs in order

to produce a more sensitive electronic thermostat. The materials and labor costs for the
production and sale of this product are $1.60 per unit.
(a) Calculate the breakeven sales level for this product if it is priced at $2.20 per unit.

(b) Calculate the product’s breakeven sales level if it is priced at $4 per unit.

(c) Explain the implications of the difference between these two breakeven sales levels.

4. Optical Distortion, Inc. (ODI) is about to introduce its new product: contact lenses for
chickens.i Unlike contact lenses for humans, which are designed to improve sight, these
contact lenses for chickens are designed to distort images so that the chickens become half-
blind. This is desirable to poultry farmers because chickens whose vision is impaired will
exhibit significantly less fighting (i.e., establishing of a pecking order). This will reduce flock
mortality from 25% to 4.5% (each chicken killed through this fighting costs the farmer
$2.40).
The typical poultry farm consists of 10,000 to 50,000 birds. Currently, poultry farmers deal
with deaths due to fighting by debeaking the chickens. Debeaking reduces flock mortality
from 25% to 9% but is so traumatic to the chickens that they stop laying eggs for a week
after the operation (a chicken lays an average of five eggs per week and the farmer sells eggs
for an average price of $0.53/dozen). Moreover, debeaked chickens have difficulty eating
feed from a trough. The resulting spillage causes increased feed costs to the farmer that
 amount to $0.084 per chicken per year (the normal life span of a chicken is approximately
one year).
The ODI lenses do not cause the chickens to become traumatized, and since it enables them
to keep their beaks, it does not cause any eating difficulties. A three-person crew, which is
able to debeak 250 chickens per hour could, after training, install contact lenses in 225
chickens per hour. The average labor costs for this crew is $36 per hour. ODI’s materials and
manufacturing costs are $0.035 per pair of lenses.
ODI is aware that promoting their new product will not be easy. Many poultry farmers
consider the idea of contact lenses for chickens to be ridiculous and complain that their
workers are unfamiliar with the lens insertion procedure. However, ODI’s immediate
question is what price to charge for a pair of lenses.
(a) What is the low end of the price range that ODI should be considering?
(b) What is the high end of the price range that ODI should be considering?
(c) What price within this range should ODI use for its new contact lens product? Justify
your answer, making use of what you know about the basic initial-pricing strategies.
(d) Assume the contact lens price that you recommended in Part (c). If first-year fixed costs
are $68,000, how many pairs of contacts lenses would ODI have to sell during the first
year to breakeven? How does this number affect your confidence in the price you
recommended in Part (c)?

. Adapted from Darrel G. Clarke and Randall E. Wise, “Optical Distortion, Inc. (A),” Harvard Business School Case
i

9-575-072, Boston: Harvard Business School Publishing. [AU: Please provide an author if available.] [MM:
Done.]

Review and Discussion Questions

1. Describe the difference between fixed costs and variable costs.

2. What makes it difficult to allocate a portion of fixed costs to individual products? Why is it
useful to consider only variable costs when making price-setting decisions?

3. What is meant by a price ceiling? Describe the logic of considering a product’s VTC to be its
price ceiling.

4. What is meant by a price floor? Describe the logic of considering a product’s variable costs
to be its price floor.
5. If there is little space between a product’s price ceiling and price floor, what, then, should be
its price? If there is substantial space between these two quantities, then what pricing-related
factors should be considered next?

6. Describe the skimming strategy. Where within the bounds of a typical price is a skim price
likely to fall?

7. Describe the penetration strategy. Where within the bounds of a typical price is a penetration
price likely to fall?

8. Describe the in-line strategy, and indicate where within the bounds of a typical price an in-
line price is likely to fall. Explain how an in-line price for an item could be different than the
price of competing items.

9. Explain how a brand of a commonly purchased consumer packaged good, such as toilet
tissue, could be skim-priced.

10. How does a search characteristic differ from an experience or credence characteristic? Why
might product benefits based on search characteristics be particularly useful for in-line
pricing?

11. Which initial-pricing strategy would be most appropriate for a risky innovative product?
Explain your reasoning.

12. Explain how protection against lower-priced competition supports a skimming strategy. Give
examples of factors that might offer such protection.

13. Give an example of a situation where a price that is low with respect to the product’s VTC
would not serve as an incentive to buy. What would be the implications of this for the use of
a penetration strategy for pricing this product?

14. Explain how protection against low-price matching could support a penetration strategy.
Give examples of factors that might offer such protection.

15. What is a pioneer advantage? Describe some examples of market conditions that would make
a pioneer advantage possible. Why does a pioneer advantage support a penetration strategy?

16. Explain the concept of contribution margin. How is a contribution margin calculated?

17. If offering a new product would involve $10,000 in incremental fixed costs and variable
costs of $3 per unit, what would be the breakeven sales level if the product were priced at
 $5? How can knowing this breakeven sales level facilitate the evaluation of this possible
price?

18. Given that a breakeven sales level is not a sales prediction, explain why it is so widely used
in business situations where accurate sales predictions would be helpful.