Washburn Guitars: Using Break-Even Points to Make Pricing Decisions Video 13-3 Washburn Guitars Video Case kerin.tv/13e/v13-3 We offer a guitar at every price point for every skill level, explains Kevin Lello, vice president of marketing at Washburn Guitars. Washburn is one of the most prestigious guitar manufacturers in the world, offering instruments that range from one-of-a-kind, custom-made acoustic and electric guitars and basses to less-expensive, mass-produced guitars. Lello has responsibility for marketing Washburn's products and ensuring that the price of each product matches the company's objectives related to sales, profit, and market share. We do pay attention to break-even points, adds Lello. We need to know exactly how much a guitar costs us, and how much the overhead is for each guitar. Paul Kane/Getty Images THE COMPANY The modern Washburn Guitars company started in 1977 when a small Chicago firm bought the century-old Washburn brand name and a small inventory of guitars, parts, and promotional supplies. At that time, annual company sales of about 2,500 guitars generated revenues of $300,000. Washburn's first catalog, appearing in 1978, told a frightening truth: Our designs are translated by Japan's most experienced craftsmen, assuring the consistent quality and craftsmanship for which they are known. At that time, the American guitar-making craft was at an all-time low. Guitars made by Japanese firms, such as Ibanez and Yamaha, were in use by an increasing number of professionals. Times have changed for Washburn. Today, the company sells about 50,000 guitars each year and annual revenues exceed $40 million. All this resulted from Washburn's aggressive marketing strategies to develop product lines with different price points targeted at musicians in distinctly different market segments. THE PRODUCTS AND MARKET SEGMENTS One of Washburn's early successes was the trendsetting Festival Series of cutaway, thin-bodied flattops, with built-in bridge pickups and controls. This guitar became the standard for live performances as its popularity with rock and country stars increased. Over the years, several generations of musicians have used Washburn guitars. Early artists included Bob Dylan, Dolly Parton, Greg Allman, and the late George Harrison of the Beatles. In recent years, Mike Kennerty of The All-American Rejects, Rick Savage of Def Leppard, and Hugh McDonald of Bon Jovi have been among the many musicians who use Washburn products. Until 1991, all Washburn guitars were manufactured in Asia. That year Washburn started building its high-end guitars in the United States. Today, Washburn marketing executives divide its product line into four categories to appeal to different market segments. From high-end guitars to low-end ones, these product groupings are: One-of-a-kind, custom instruments. Batch-custom instruments. Mass-customized instruments. Mass-produced instruments. The one-of-a-kind custom products appeal to the many stars who use Washburn instruments as well as collectors. The batch-custom products appeal to professional musicians. The mass-customized products appeal to musicians with intermediate skill levels who may not yet be professionals. Finally, the mass-produced units are targeted at first-time buyers and are still manufactured in Asian factories. PRICING ISSUES Setting prices for its various lines presents a continuing challenge for Washburn. Not only do the prices have to reflect the changing tastes of its various segments of musicians, but the prices must also be competitive with the prices of other guitars manufactured and marketed globally. The price elasticity of demand, or price sensitivity, for Washburn's products varies between its segments. To reduce the price sensitivity for some of its products, Washburn uses endorsements by internationally known musicians who play its instruments and lend their names to lines of Washburn signature guitars. Stars playing Washburn guitars, such as Nuno Bettencourt of Extreme, Paul Stanley of KISS, Scott Ian of Anthrax, and Dan Donegan of Disturbed, have their own lines of signature guitarsthe batch-custom units mentioned earlier. These guitars receive excellent reviews. Total Guitar magazine, for example, recently said, If you want a truly original axe that has been built with great attention to detail then the Washburn Maya Pro DD75 could be the one. Bill Abel, Washburn's vice president of sales, is responsible for reviewing and approving prices for the company's lines of guitars. Setting a sales target of 2,000 units for a new line of guitars, he is considering a suggested retail price of $349 per unit for customers at one of the hundreds of retail outlets carrying the Washburn line. For planning purposes, Abel estimates half of the final retail price will be the price Washburn nets when it sells its guitar to the wholesalers and dealers in its channel of distribution. Source: Washburn Guitars Looking at Washburn's financial data for its present plant, Abel estimates that this line of guitars must bear these fixed costs: In addition, he estimates the variable costs for each unit to be: Carefully kept production records at Washburn's plant make Abel believe that these are reasonable estimates. He explains, Before we begin a production run, we have a good feel for what our costs will be. The U.S.built N-4, for example, simply costs more than one of our foreign-produced electrics. Caught in the global competition for guitar sales, Washburn continually searches for ways to reduce and control costs. For example, Washburn recently purchased Parker Guitar, another guitar manufacturer that designed products for professionals and collectors and will combine the two production facilities in a new location. Washburn expects the acquisition to lower its fixed and variable costs. Specifically, Washburn projects that its new factory location will reduce its rent and taxes expense by 40 percent, and the new skilled employees will reduce the hours of work needed for each unit by 15 percent. By managing the prices of its products, Washburn also helps its dealers and retailers. In fact, Abel believes it is another reason for Washburn's success: We have excellent relationships with the independent retailers. They're our lifeblood, and our outlet to sell our product. We sell through chains and online dealers, but it's the independent dealer that sells the guitars. So we take a smaller margin from them because they have to do more work. They appreciate it, and they go the extra mile for us.20 Note for Questions: The retail price listed in the case and the questions below is the retail price for a retailer not for Washburn. Therefore, you have to look again to the wording in the case above to figure out what price Washburn will get when they sell to the retailers and use that price when figuring breakeven points and profitability. Answer all parts of the 2 questions below and show all your work. Here are the equations for BE and Profit Profit = Total Revenue Total Cost Profit = (Unit Price X Quantity Sold) Total Cost Questions 1. In Washburn's factory, what is the break-even point for the new line of guitars if the retail price is: (note: Washburn is a manufacturer, not a retailertherefore you must figure out from the case what Washburn will charge retailers in order to answer the questions below.) (a) $349, (b) $389, and (c) $309? Also, (d) if Washburn achieves the sales target of 2,000 units at the $349 retail price, what will its profit be? 2. Assume that the merger with Parker leads to the cost reductions projected in the case. What will be the (a) new break-even point at a $349 retail price for this line of guitars and (b) new profit if it sells 2,000 units