Projection of Costs and Revenues for a Startup Bed and Breakfast Establishment

The Case of Luxury Vibes Bed & Breakfast

1. What are your two to three pricing objectives for the new product?

Pricing objectives are the goals that guide a producer in determining the selling price of their product or service (Dransfield, 2005). According to Dransfield (2005), pricing objectives often reflect the company’s strategic, financial, and marketing goals, as well as customer expectations. Each pricing objective attracts a specific pricing strategy. With the background information provided about Luxury Vibes Bed and Breakfast, the managers could focus on realizing three objectives. The two objectives to be realized in the short run, the first year of operation, are: a) to build or gain market share, and b) to survive by at least breaking even. In the long-run, when the establishment has built a sizeable market share, the pricing objective will be to maximize profits.

To realize the objective of gaining market share, Luxury Vibes will use a combination of penetration pricing and skimming (Rao, 2009). Penetration pricing involves offering a low initial price (usually lower than the competition) as a means to attract price-sensitive customers and get a foothold in the market (Dransfield, 2005). It is preferred in cases where a company is launching a new product in a competitive market (Dransfield, 2005). The rationale is that the low price helps to attract new customers and as more people interact with the product, the company starts to build a reputation, on which it can then ride to charge more (Rao, 2009). Given that San Diego already has a large number of bed and breakfast establishments; it may be plausible for Luxury Vibes to use penetration pricing to win customers who already have a wide array to choose from. The initial price offered will be one that allows the B&B to at least break even so as to survive in the short run (Rekettye & Liu, 2018). The company could use penetration pricing for first-time customers and skimming for return customers in the short run (Rekettye & Liu, 2018).

Skimming involves charging a high initial price as a means to yield high returns from customers willing to pay the premium (Dransfield, 2005). The establishment is committed to providing a superior, family-feel experience with the extravagance of a five-star hotel. The key features include a one-of-a-kind spa, exquisite rooms, magnificent buffets, an infinity-edge swimming pool, and jeeps and jet skis for rent. Return customers who experience the establishment’s exquisite family-feel five-star experience unavailable in other B&Bs will be comfortable paying a higher price in their subsequent visits. The establishment could apply penetration pricing for all first-time visitors in the first year of operation, then fully adopt skimming in the second year because then, it will have established a niche in the market and built brand loyalty and customers will be more willing to pay a price higher than that offered by the competition. Skimming in the long-run will help in realizing the long-term objective of profit maximization.

2. What is your expected final price for this new product? Show how you arrived at this

Breakeven analysis provides a valuable framework for determining a product’s sales price. The break-even point in sales ($) is the point at which a company’s sales revenues equal its total costs, hence the company does not generate any profits (Shim & Siegel, 2008). As mentioned in the preceding section, Luxury Vibes will be seeking to just break even in year 1, which means generating sales revenues that are just enough to cover the cost of production. To use breakeven analysis, however, the establishments managers would need to project the number of visitors served in the first year of operation.

One would expect higher sales and more vacationers during spring and summer than during winter. Spring in California begins in March and runs through September (7 months). We project maximum occupancy (20 visitors) during these months, and an average of 5 guests daily during winter. Assuming a 30-day month, the projected number of visitors:

During spring and summer = 20 guests daily x 30 days x 7 months = 4,200 guests

During winter = 3 guests daily x 30 days x 5 months = 450 guests

Projected number of guests in year 1 = 4,650

To obtain the selling price per unit, we obtain the contribution margin per unit and add it to the variable cost per unit.

Contribution margin = net sales - variable costs

At the break even point, total cost = total sales revenue

But net sales = total sales – discounts and allowances

Net sales = 1,591,300 – 1,000 = 1, 590,300

Contribution Margin = 1,590,300 - 1,285,000 = 305,300

Contribution margin per unit = 305,300/4650 = 1,590

We can obtain the selling price per unit by adding the contribution margin per unit to the variable cost per unit (Indeed Editorial Team, 2021)

3. Project your costs and profits for getting this product to market

The managers of Luxury Vibes project that the establishment will incur fixed costs amounting to $306,300 in the first year of operation. Variable costs are projected at $1,285,000, leading to total costs of $ 1,591,300. The greatest components of the projected fixed costs in year 1 are capital expenditure and personnel costs, mainly the salaries and monetary benefits of at least five full-time employees including an aesthetician, culinary expert, establishment manager, marketer, and an inn-keeper. Capital expenditure, which involves purchase of fixed assets, including computers, beds, spa equipment, skin care equipment, jet skis, and cooking equipment, is projected at $80,000. As AKJM Inc. does not own any suitable establishments in San Diego, the company will take out a 15-year mortgage to finance the purchase of a house. The mortgage will be repaid in annual installments of $4,500. The rest of the fixed costs will be incurred in payment of utility bills, including water, electricity, sewerage, and gas cylinder; annual deprecation costs for fixed assets, web hosting, telephone and mail, and property maintenance. The company will take a general insurance cover against its fixed assets to cushion itself from losses resulting from hazards such as fire, theft, and terrorism (Park Hotels and Resorts, 2020). Annual license fees are the costs incurred in obtaining annual accreditation for compliance with environmental regulations and other requirements such as the Americans with Diasbilities Act (ADA) (Park Hotels and Resorts, 2020).

Cleaning materials, food and beverage supplies, and office supplies (all referred to as supplies), account for the chunk of variable costs at a projected annual cost of $1.2 million. The wages of hourly workers are projected at an annual cost of $72,000, commissions at $3,600, and transport costs at $8,400. Allowances and discounts offered to customers are projected at $1,000 in year 1. Generally, Luxury Vibes will need to generate sales revenues of at least $1.591 million to break even. In the first year of operation, the projected costs are relatively high due to the initial capital expenditure. The company may not generate sufficient revenues to cover this cost based on the projected selling price. For this reason, this text recommends that the establishment combines penetration pricing with skimming to increase yields generated from quality-sensitive return customers (Weil & Maher, 2005). The fixed costs are expected to reduce by $80,000 in year 2 as the variable costs increase due to increases in market share.

4. Using a spreadsheet, project your expected revenue for 1 year – 1st year by month, 2nd and 3rd years by quarter

Luxury Vibes projects that its market share will increase by 20 percent annually beginning from year 2 of operations. The projected increase in market share is represented by the 20 percent increment in the projected number of vacationers visiting the establishment every quarter in the spreadsheet. In addition to the projected increase in market share, the managers expect a further increase in quarterly sales revenues resulting from the replacement of penetration pricing with skimming at the start of year 2. The managers thus project that the number of vacationers visiting Luxury Vibes will increase from 4,650 in year 1 to 5,580 in year 2, and 6.696 in year 3. In year 1, the managers project that the establishment will receive a minimum of 90 visitors in each of the 5 months of winter, and 600 visitors in each of the 5 months of spring and summer, at the initial penetration price of $1,866. Quarter 1 sales revenues are projected to increase by 54 percent from $1.5 million in year 1 to $2.246 million in year 3, and quarter 2 and 3 revenues from $3.4 million to $5.2 million in year 3. Quarter 4 revenues are expected to increase from $500,000 in year 1 to $777,600 in year 3. Generally, Luxury Vibes’ annual sales revenues are projected to grow by 54 percent, from $8.68 million in year 1 to $13.4 million in year 3.