Pricing strategy and demand probability analysis for Pringly's new product
A meeting of senior managers at the Pringly Division has been called to discuss the pricing strategy for a new product. Part of the discussion will focus on estimating sales for the new product. Over the past years, a number of new products have failed to meet their sales targets. It appears that the company's profit for the year will be lower than budget and the main reason for this is the disappointing sales of new products. A new technique for estimating the probability of achieving target sales and profits will be discussed. This requires managers to estimate demand for the new product and assign probabilities. A range, rather than only one goal will be established.
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Pringly
A meeting of senior managers at the Pringly Division has been called to discuss the pricing strategy for a new product. Part of the discussion will focus on estimating sales for the new product. Over the past years, a number of new products have failed to meet their sales targets. It appears that the company's profit for the year will be lower than budget and the main reason for this is the disappointing sales of new products. A new technique for estimating the probability of achieving target sales and profits will be discussed. This requires managers to estimate demand for the new product and assign probabilities. A range, rather than only one goal will be established.
Proposed Scenario - One
Selling price of $170
Annual fixed costs at $20,000,000
Variable costs are $30 per unit
Target Profit is $4,000,000
A number of managers are in favor of this strategy, as they believe it is important to reduce costs.
Table 1 - Scenario One Calculations
Price
$170.00
Fixed Costs
$20,000,000.00
Variable Costs
$30.00
Break Even (Units)
142,857.14
Target Profit
$4,000,000.00
Target Units for Expected Profit
171,428.57
Proposed Scenario -- Two
The second strategy is to increase spending on advertising and promotions and set a selling price of $200. With the higher selling price the annual fixed costs would increase to $25,000,000. The marketing department is adamant that increased emphasis on advertising and promotions is essential.
Selling price of $200
Annual fixed costs at $25,000,000
Variable costs are $30 per unit
Target Profit is $4,000,000
Table 2 - Scenario Two Calculations
Price
Fixed Costs
25
Variable Costs
30
Break Even (Units)
147,058.82
Target Profit
4
Target Units for Expected Profit
170,588.24
Product Demand
The following probability distributions have been agreed, with the managers after consultation with all departments, and are the same for both selling prices.
Table 3 - Expected Demand
Estimated demand (units)
Estimated probability (units)
150,000
0.25
180,000
0.5
200,000
0.25
Table 4 - Profits for Unit Probabilities
Estimated demand (units)
Estimated probability (units)
Scenario 1 Profits
Scenario 2 Profits
150,000
0.25
$1,000,000.00
$500,000.00
180,000
0.5
$25,199,970.00
$30,599,970.00
200,000
0.25
$27,857,142.86
$33,852,941.18
Figure 1 - Revenue Streams for Both Scenarios
Discussion
The second scenario has been deemed to be the most beneficial route for the organization to take. The two revenue streams are equal at roughly 166,667 units. This means that if that is the actual sales amount of units than each strategy will produce the exact same amount of total profits. However, since the most likely demand will be at the 180,000 units mark, the second scenario will most likely produce the greatest profits. Under the second scenario, the company also has to sell 170,589 units to break even with the included expected $4,000,000 profit; which is also far less than the expected demand. Therefore the company should go ahead with the new product.
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