Pricing is a key component of every organization’s decisions and is one of the most difficult decisions to make. Price affects the most important aspects of any organization such as the number of customers an organization has, the revenue generated from the sales, the market share, and the profit among other things. Prices are determined by a variety of factors, some of which are beyond the organizational ability, for example, the prices being charged by the competitors, government regulations, and the financial ability of the targeted customers. Organizations need to have strategic decisions on how to set favorable prices and how various price changes affect the organization’s profit. The following study illustrates how a change of sales volume can make an organization profitable or lose in profits. This will advice an organization on what market segments to concentrate and how much to spend on it.
For a case where the sales volume increases by 20% and the new selling price comes to €8.50 for the extra volume. Total sales for Swing manufacturing and for Steady manufacturing, the new contribution margin will be as follows.
If the sales increase by 40% for the two companies, with different selling prices
Additional profitability for Swing manufacturing is €14500-€2200=€12300, by increasing sales by 40% and €8,500-€2,200=€6,300 when there is a 20% increase in sales. For Steady manufacturing, increase of 20% in sales brings €3,300 income, while that of 40% brings €6,300 increments in operating profit.
From the structures of the companies, Swing is capital intensive and Steady is labor intensive. Swing manufacturing has high fixed cost, while Steady manufacturing has high variable cost. For any increment in sales above €5,000 units, Swing manufacture has better cost structure because its contribution margin (CM) ratio is higher and its profit will increase faster as the sales increase.
(b) Both companies charge the same price of €8.5 and explore the same market. (Assumption is that all the companies will charge the lowest price)
Calculation of break even points.
Fixed cost = €35,000
Contribution margin = 70%
Break even in total sales dollars = €3500/70%= €50,000
Fixed cost = €20,000
Contribution margin = 35%
Break even in total sales = €20,000/35% = €57,143
Steady manufacturing has a lower breakeven point, due to its lower fixed expenses and a higher margin of safety. This makes Steady manufacturing company less vulnerable to Financial crisis than swing manufacturing.
In this case there is a 40% increase in sales.
The answer in (b) is different from the answer in (a) because there is no market segmentation of the two products and the two companies are charging equal prices.
(c) Swing manufacturing is better positioned to take an advantage of venturing into other markets because it has less operating variable expenses.
Advice - Swing should expand more to make use of its high operating fixed cost, whereas Steady should try to minimize the variable expenses.
(d) Steady decision to cut price was not justified because of its high variable cost and hence any cut would lead to a decrease in sales and in profit. This is illustrated in calculations on question (b) above.