This paper develops a comprehensive pricing plan for Luxury Vibes Bed & Breakfast, a new five-star boutique lodging concept launching in San Diego, California. It identifies three pricing objectives — gaining market share, breaking even in year one, and maximizing profits in the long run — and proposes a combined penetration-pricing and skimming strategy to achieve them. Using break-even analysis, the paper calculates an initial selling price of $1,866 per guest and projects fixed and variable costs totaling approximately $1.59 million for year one. A three-year revenue forecast then models quarterly and monthly sales, showing projected annual revenues growing from roughly $8.68 million in year one to $13.4 million by year three.
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 a company's strategic, financial, and marketing goals, as well as customer expectations. Each pricing objective calls for a specific pricing strategy. Given the background of Luxury Vibes Bed and Breakfast, management could focus on three objectives. The two short-run objectives, targeting 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, once 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 gain a foothold in the market (Dransfield, 2005). It is preferred when a company is launching a new product in a competitive market (Dransfield, 2005). The rationale is that the low price attracts new customers, and as more people interact with the product, the company begins to build a reputation on which it can later rely to charge more (Rao, 2009). Given that San Diego already has a large number of bed and breakfast establishments, it may be prudent for Luxury Vibes to use penetration pricing to win customers who already have a wide array of options. The initial price offered will be set to allow the B&B to at least break even, ensuring short-run survival (Rekettye & Liu, 2018). The company could apply 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 to yield high returns from customers willing to pay a premium (Dransfield, 2005). Luxury Vibes is committed to providing a superior, family-feel experience with the extravagance of a five-star hotel. Key features include a one-of-a-kind spa, exquisite rooms, magnificent buffets, an infinity-edge swimming pool, and jeeps and jet skis available for rent. Return customers who experience this unique family-feel, five-star offering — unavailable at other B&Bs — will be comfortable paying a higher price on subsequent visits. The establishment could apply penetration pricing for all first-time visitors during year one, then fully adopt skimming in year two, by which point it will have established a niche, built brand loyalty, and positioned customers to accept a price above that of the competition. Skimming in the long run will support the objective of profit maximization.
Break-even analysis provides a valuable framework for determining a product's selling price. The break-even point in sales dollars is the point at which a company's sales revenues equal its total costs, meaning the company generates no profit (Shim & Siegel, 2008). As noted above, Luxury Vibes will seek to break even in year one, generating revenues just sufficient to cover costs of production. Applying break-even analysis requires management to project the number of visitors served in the first year of operation.
Higher sales and more vacationers are expected during spring and summer than during winter. Spring in California begins in March and runs through September (seven months). Maximum occupancy of 20 visitors per day is projected for those months, and an average of 5 guests per day during winter. Assuming a 30-day month, the projected visitor counts are:
During spring and summer: 20 guests/day × 30 days × 7 months = 4,200 guests
During winter: 3 guests/day × 30 days × 5 months = 450 guests
Projected total guests in year one: 4,650
To obtain the selling price per unit, the contribution margin per unit is calculated and added to the variable cost per unit.
Contribution margin = Net sales − Variable costs
At the break-even point, total costs equal total sales revenue. Net sales equal total sales less 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 ÷ 4,650 = $65.66 per guest
The selling price per unit is obtained by adding the contribution margin per unit to the variable cost per unit (Indeed Editorial Team, 2021):
"Fixed, variable, and total year-one cost breakdown"
"Revenue grows from $8.68M to $13.4M by year three"
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