You are a Product Manager for your company. Your VP of Sales requested that you
ID: 3324790 • Letter: Y
Question
You are a Product Manager for your company. Your VP of Sales requested that you drop the price for your product by 20%. This is necessary, according to your VP, to combat a new competitor entering your market.
The long standing policy of your firm is that any price reductions have to be Gross Profit neutral. In other words, they cannot affect the $ value of the Gross Profit.
The most recent market research shows that your company has 70% market share. The remaining share is equally divided between two other established competitors.
It also estimates that the market for your products grows at the rate of 20% per year.
Currently, your manufacturing plant works at 90% of capacity. That is, it produces 100,000 units per year.
The revenues are $500,000 per year and the Cost of Goods Sold is $300,000.
Calculate the following:
a) the required change in unit sales that will keep the $ level of
Gross Sales unchanged at the end of first year.
b) Should the proposed price change be approved (Y/N)
Explain your answer.
Explanation / Answer
(a) Current Gross Profit Value = $500,000 - $300,000 = $200,000
Current production = 100,000 units
Cost per unit = $3, Price per unit = $5
If prices are dropped by 20%, then new Selling Price = 80% of $5 = $4
New gross profit = $4-$3 = $1
If N units are sold, then gross sales = $4N
If this value remains unchanged, then $4N = $500,000 => N = 125,000
(b) With 20% increase in demand per year, capacity to sell = 120,000 units. But above calculations suggest we need to sell an extra 5,000 units. That is possible only if the market share is increased above 70%
But since production is already running at 90%, so max. capacity to produce = 100,000 units/0.9 = 111,111 units
So, we are also constrained with production capacity. Setting up more capacity would require additional capital expenditure in terms of machines, manpower and other resources.
Moreover, Gross Profit at 125,000 units = $125,000 which is way below the current value of $200,000
So in all respects, the 20% price reduction will harm the business more than bring any positive growth. Hence the proposed change should be rejected.
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