Question

Case 1: Pricing (SMAC)

Canadian Product Corporation Limited (CPCL) is a manufacturer of small household

appliances. The company has only one manufacturing facility which services

all of Canada. CPCL is well established and sells its products directly to department

stores.

CPCL wishes to begin manufacturing and marketing its newly developed

cordless steam iron. In order to properly evaluate the performance of this new

product, management has decided to have a new division for its production and

distribution.

Two of CPCL's competitors have recently introduced their own brands of

cordless steam irons at a price of $28 each. CPCL's usual pricing strategy for new

products is full absorption cost plus a 100% markup. For the new iron, at a production

and sales volume of 350,000 units per year, this strategy would imply a

price of $31.50. CPCL's president, Mr. T. C. Leopard, is not sure whether this

pricing strategy would be appropriate for the new iron and is considering other

proposals as follows:

1. Variable product cost plus a 200% markup

2. A price of $27 to undercut the competition

Mr. Leopard hired a market research firm to study the likely demand for

CPCL's cordless steam iron at the three proposed prices. The research firm conducted

an extensive market test resulting in projected annual sales volumes over the

next five years at these prices. These sales projections are summarized in Exhibit

A1-1. The research firm, however, made it clear that there were no guarantees that

the market would respond according to the projections.

Mr. Leopard was not happy with the probabilities that the market research

firm assigned to the various price/volume levels. He therefore used his own knowledge

and past experience to assign different probabilities (see Exhibit A1-2). Mr.

Leopard then called Joan Helm, the chief financial officer, to analyze the situation

and recommend a five-year pricing strategy for the new cordless steam iron. As a

first step, Joan assembled some relevant data which is presented in Exhibit A1-3.

As Joan Helm, comply with Mr. Leopard's request. Include in your analysis consideration

of both quantitative and qualitative factors in determining a five-year pricing strategy

for the new iron.

Exhibit 1-1 CPCL Market Research Data for Cordless Steam Iron

Selling Price Volume Probability

$24.00 500000 20% 400000 50% 300000 30% $27.00 400000 25% 350000 45% 250000 30% $31.50 300000 30% 250000 50% 200000 20%

Exhibit 1-2 CPCL Market Research Data for Cordless Steam Iron

Selling Price Volume Probability

$24.00 500000 10% 400000 50% 300000 40% $27.00 400000 20% 350000 40% 250000 40% $31.50 300000 40% 250000 50% 200000 10%

Exhibit 1-3 CPCL Other Relevant Data for Cordless Steam Iron Expected costs based on annual production of 350,000 units:

Total variable costs $2,800,000

Total fixed overheads $2,712,500

Plants and equipment: No additional machinery or plant space will be required to produce the cordless steam iron.

The plant has capacity available to produce 500,000 units per year

Inventory levels: Just-in-time inventory management will result in virtually no inventory being stored at any particular time.