BUSS 517 Managerial Economics

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Nov 17, 2013 (3 years and 6 months ago)

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BUSS 517 Managerial Economics

Problem
-
based Learning

Problem No. 1

Prepared by Group C

Susanna Kong, Susan Cheung, Fergus Ko, Michelle Kan

Florence Yip, Wendy Ting, Vincie Lee, Nicky Ng

Nov 4, 2002

Question A

Evaluates the three recommendations

Cost
-
plus Pricing by Accountant

Benchmarking by Marketing Director

Return on Capital by Company Owner

3 Price Setting Methods

Recommended Price : $105

Average Direct cost + Margin for Overhead +
Margin for Profit


$5+$100 = $105

Evaluation:


Without considering the competitor’s price and
customer demand


Without considering the external factors


Economical/sociological/technological


Price set cannot help achieving maximum profit

Cost
-
plus Pricing Method

Recommended Price : $200


Price of similar software without the grammar checking feature

Evaluation:


The method is more applicable under a perfect competition
market with identical products and same price


Not applicable under a monopolistic competition market with
new product, new feature


Benchmarking can only serve as a reference


Should evaluate how valuable the new feature is and the extra
amount consumer willing to pay for


Benchmarking Pricing Method

Recommended Price : $150


A target return pricing method based on return on capital

Evaluation:


The method is more applicable only for long run pricing
estimation


Return on capital includes fixed cost which do not comply
with the company’s objective to achieve maximum profit in
the short run


In short run, only marginal cost and marginal revenue is
being considered

Return on Capital Pricing Method

Question B

Suggests a price

Steps for Price Setting

Step 1
-

Evaluate the Market Situation


Voice Recognition


Software Market

Cantonese

Other Languages

Brands:

Penpower Voice Writer

Brands:

IBM

SpeechWorks

Philips

Nuance ……

Step 1
-

Evaluate the Market Situation (Cont’d)

Market Structure


Monopolistic Competition


Many firms in the market


Free entry


Differentiated product (voice recognition
software with a new feature able to perform
Chinese grammar checking)

Steps for Price Setting

Step 2


Assessment of Company Objective

Company Objective

Profit Maximization


The company aims at achieving as much profit as
possible in the next year (Short Run)


Steps for Price Setting

Steps for Price Setting

Step 3


Evaluate the Product Nature


This is an IT software product


The market contains a group of “trendsetters” or
“first
-
adopters” who must have, or like to have, a
product first and are willing to pay a higher price for it


The market also contains a significant group of
buyers prepared to pay high prices because of this
new feature


Inelasticity of Demand


Price insensitive


Steps for Price Setting

Step 4


Evaluate the Product Life Cycle


This new product is at introductory stage


It has new feature with grammar checking of the
Chinese input


No other company is able to offer this new feature
and no substitute in short run


The high price will not induce entry in a short run
because it takes a long time and huge cost for
product development and imitation

Steps for Price Setting

Step 5


Set Pricing Strategy


Suggest to use Skimming Pricing Strategy


Price = Benchmark the similar product + Max. value
of new feature which buyers are willing to pay



Price = $200 + $?


The value $? can be found by conducting a focus
group


Focus group told us that the max. value they are
willing to pay for this new feature is $100


Steps for Price Setting

Step 6


Set The Price


We propose to set the price at
$299


Pricing tactics: psychological pricing below $300


If experience shows it is the wrong strategy, the price
can be cut without much customer resistance

Question C


Outlines any factors that would lead to
the adjustment of the recommended
price, after its launch



Change of Pricing Objectives


Change of Market Structure


Change in Product Life Cycle


Change in 5
-
Forces


Change of Pricing Objectives

If company objective change from profit
-
maximizing to :

1.
Target Rate of Return



Conflict between long run profit and short run profit



Recommended price decrease

2.
Target Market Share



Preference on market share than profit



Recommended price decreases

3.

Meeting or matching competition



Set by market forces



Recommended price decreases

Change of Market Structure

When time goes on, there may have changes in
market structure :


1.
When profit of this market goes up, many competitors
enter into this market



Perfect Competition



P=MR=M C



Recommended price decreases


2.
When profit of this market goes down because of
vigorous competition and only few firms survive



Oligopoly



Recommended price increases to collusion price


Change in Product Life Cycle

Products have limited lives and they will pass
through a series of distinct stages

Relatively simple relationship between
different stages of PLC and optimal level of
price


the two being linked by gradually
increasing elasticity of demand over time

Change in Product Life Cycle

.


Introduction

Growth

Maturity

Decline

Time

Sales

Volume

Price Elasticity and Product
Life Cycle

Introductory Period


Buyers hardly aware of the product


Low sales volume and price inelastic of demand


Large investment in promotion of new product


Substantial margin aim to profit maximizing


Recommended price increases

Price Elasticity and Product
Life Cycle

Growth Phase


Buyers more aware of the product


Sales grow rapidly and more price elastic of
demand


Competitors start to enter


Smaller margin


Recommended price decreases

Price Elasticity and Product
Life Cycle

Maturity or Saturation


Sales slows down, eventually to zero


Buyers well informed


Competitors produce substitutes


Price elasticity of demand continue to increase


Further reduction of margin


Further decrease in recommended price

Price Elasticity and Product
Life Cycle

Decline


Changes in buyers’ requirement


Increase in competition


Changes in technological progress


Sales decline


Very high price elasticity


Narrow margins


Recommended price continues to decrease

Change in 5
-
Forces

Power of

Suppliers

Power of

Buyers

Threat of

Entry

Threat of

Substitutes

Intensity of

Rivalry Amongst

Incumbents

Intensity of Rivalry Amongst
Incumbents


No competitor in short run


Competitor will develop similar software in
long run




Increase in intensity of rivalry leads to
decrease in recommended price

Threat of Entry


Low capital investment


Product differentiation can be copied by
other competitors very quickly




Increase in threat of entry leads to
decrease in recommended price

Threat of Substitutes


No exact substitutes


However, close substitutes exist



Other

brands voice writer without grammar
checking


Hand writer




Increase in no. of
substitute leads to
decrease in recommended rice

Power of Buyers


Power of wholesalers is relatively high




Recommended price decreases



Power of retailer is relatively low



Recommended price increases

Power of Suppliers


Availability and no. of suppliers is high


Switching cost of transferring to alternative suppliers
is low



Power of suppliers is low


However, bargaining power of supplier does not
have impact on our recommended pricing in this case
because


Our Recommended Price = Benchmark the similar product +
Max. value of new feature which buyers are willing to pay

we
use bench mark



No change in recommended price

The End


Thank You