Managerial Economics - Pricing Strategy - Assignment Example

? Pricing Strategy ChurroZ Type here Type here 5/22 Pricing The product is meant for an average and high end customer of the market. Moreover, since the ingredients used are expensive, the ChurroZ cannot be priced at the same level as others, otherwise the notion of a high quality tasty product wouldn’t be displayed. We can also not price it too high otherwise it would go out of the reach of the local market. Pricing a product too high or too low is always a disaster; we need find a balance between the two. The main objective of pricing is to cover the total costs while earning profits. Cost includes the cost of goods manufactured, which includes raw materials, processing, labor, etc. and the cost of goods sold that includes the operating expenses. The operating expenses and initial investment would be covered under the assigned budget. Mostly, businesses that are entering into a market try to set a price that covers their cost while helping them earn a reasonable amount of profit. Hence, the pricing methodology is pretty simple, they add a markup to the total cost of the product. There are several pricing options available based on which we can decide the price of an item of ChurroZ Pricing Strategies A product can be priced according to several strategies. A business should decide on a pricing strategy based on its marketing strategy, as well as the market it is moving into. We are discussing the following two pricing strategies here: Price Skimming – Using this strategy, a business charges a relatively high price for a short period of time exploiting newness of the product. The main target of the strategy is to ‘skim off’ customers who are willing to pay a high price for getting the product sooner. The prices are reduced as the demand goes down. This strategy is effective for extremely innovative products or for products being introduced to a market so that they can take advantage of customer involvement and attraction towards the product. ChurroZ are Spanish donuts and they are being introduced in New Zealand on a cart for customers on the go. As the product is being introduced in the market, the business could think about utilizing Price Skimming as a strategy because it is a relatively new product for the New Zealand market and customers would be interested in trying it. Later, they bring the prices down if the demand falls or the competition increases. Penetration Pricing – In this pricing strategy, a business sets a relatively low price to enter a market to attract maximum customers and induce trials. The objective of the strategy is to make the customers switch from their existing brands due to the lower pricing. The target is to increase market share, sales volume. This strategy is not suitable for ChurroZ as it is a new product and there is very little or no competition currently in the market. Various Price Allocation Techniques Cost plus pricing – this technique is the most commonly used and popular with manufacturers. It involved adding up all the costs associated with the manufacturing of a single item and then adding up a desired profit to find the price. This is a fairly simple and transparent technique and it involved minimum complexity. It is most suitable for business startups or if entering a new market. Competitive Pricing – Another strategy of pricing is to price your product based on the prices of the competitors. However, this strategy is a risky one as it can back fire if it induces a price competition among businesses. Hence, business should only compete with others of their own size and strength. This strategy is not suitable for startups as they would looking to stabilize themselves and understand the market and their customers and blend in accordingly. Demand Based Pricing – Demand based pricing is the method in which an analysis of consumer response to a range of prices reveals the highest acceptable price. This is a relatively new method that relies on research and time. A company before deciding on a price and launch the product must allocate time and money for research. However, it is pretty accurate and reduces the risk to a large extent. (Gale Encyclopedia of Small Business, n.d.). Cost-Plus Pricing – We are going to go with Cost-Plus pricing. It is the oldest and most commonly used methodology that most businesses adopt specifically new businesses. Cost plus pricing is the method in which we add a markup percentage to the overall cost of manufacturing and selling the product. Pricing a product with this method is simple, we need to calculate the cost of manufacturing one donut and then multiply it with a profit margin percentage and add the result to the manufacturing cost to get the price. The profit margin percentage should be such that it covers the operating expenses while providing a certain profit as well. The profit margin is initially kept low in the beginning to prevent the price going too high (Alexis, 2003). However, in our case we need to keep just a little higher than or equal to the competitors as we are using a superior product in the ingredients and this should depict on the price. We can decide on the profit margin percentage once we have an exact cost of goods manufactured as well as the operating expenses. We can use breakeven units to calculate the profit margin percentage (Pricing your products, n.d.). The current allocated budget for the setup and machinery is $ 250,000. The following are cost assumptions and the actual costs may differ. Moreover, the calculations have been made assuming that the business would distribution is as follows: Setup Costs (including cart, machinery,etc. )………………………..$ 160,000 Labor costs (2 persons)……………………………………………....$ 2,400 Marketing Costs……………………………………………………..$ 10,000 Raw material costs…………………………………………………..$ 2,250 Variable Production Overhead…………………………………$ 1,650 Variable selling costs…………………………………………..$ 900 Direct Fixed Costs……………………………………………..$ 3,000 Assuming that the business produces 300,000 donuts per year totaling to 500 donuts in a day, the price at which the donuts would be profitable and still remain competitive would be calculated as follows: Calculation for a year Total initial investment – $ 180,200 Total units produced – 300,000 Cost of one donut - $ 0.6 Markup Percentage – 40% Selling Price – $ 0.84 If the business is able to sell all the units produced during the year, it would be able to not only break-even during the year but also earn a profit of $2, 280. Net Earnings = 0.84 * 300,000 = $ 252, 280 Profit = 252,280 – 250,000 = $ 2,280 Justification One of the major advantage of the method is the minimum complexity it brings with itself along with the fact that it is fairly reflective of the overall process. Moreover, since ChurroZ is starting off in New Zealand, the method would help the business in satisfying its consumers with their pricing. The business can also afford to give discounts to its consumers in case the costs of the ingredients used declines while keeping the same profit percentage. The implementation of the method is also easy and it can be carried out separately for each of the different lines of products so that each product brings in its own profit margin. The following are the more significant reasons behind the decision of using Cost plus pricing: Assured profit – a startup business means that a significant amount of investment has been made and the business needs to start making profit to ensure payback, cost plus pricing ensures that the business would definitely be making profit Reduced Risk – pricing above costs means that the business has ensured that it would be able to cover its expenses and sustain itself in the long run from the profit it makes Consistency and stability – a business can continue to run successfully as long as it covers costs and keeps on making profit. Besides sustainability, a business would be consistent in front of its customers as it would not have to take major price ups or downs, which it might have to if it gets into a price war with competition due to usage of other techniques. References US Small Business Administration, (n.d). Pricing your products – financial management series. Retrieved on May 22, 2012 from < http://archive.sba.gov/idc/groups/public/documents/sba_homepage/pub_fm13.pdf > Alexis, W. (2003). How Do I Choose the Best Markup Percentage? wiseGeek.com. Retrieved on May 22, 2012 from < http://www.wisegeek.com/how-do-i-choose-the-best-markup-percentage.htm > Gale Encyclopedia of Small business, (n.d). Pricing. Retrieved on May 22, 2012 from < http://www.answers.com/topic/pricing-2 > Jain, Sudhir (2009). Managerial Economics. Pearson Education. ISBN 978-81-7758-386-1. Steve W., James D., Stice, Earl, Monte, R. (2008). Accounting Concepts and Application. 10th edition; Pp. 1173. Thomas Higher Education. Retrieved on May 24, 2012 from Read More