Of all the topics in this course, many students find Lesson 4 to be the most frustrating. I think this may be due in part to an apparent contradiction: there are lots of numbers and equations to work with, but surprisingly little certainty in our conclusions. I share your frustrations at times. Fortunately, these cases are the only “strictly financial” case studies … the only ones where number crunching is an end unto itself. However, basic financial analysis will always be an important part of our toolkit for making pricing decisions.
The document which follows contains the “answers” to these two case study assignments: Ace Manufacturing and Healthy Spring Water. Despite the …show more content…
The other, a loss of $1.25 per incremental unit. When you look at the total dollars columns, however … either scheme generates the same level of profitability – a net gain of $75,000.
Confused? The notion of the incremental units covering their “fair share” of fixed costs shows a net loss resulting from this additional business, but you can’t argue with the total dollars outcome. While the additional units don’t cover their “fair share” of costs, they contribute $75,000 toward these costs – costs that would not have been covered by the original 150,000 units. In this situation, the concepts of fairness and conventional practice could obscure a profitable opportunity.
Based on the financial analysis alone, the company should definitely take the new business. What other considerations are relevant? Well … is there a potential downside in terms of “indirect” cannibalization and price erosion? There’s always the Walmart effect to worry about … that if you sell an “incremental volume” of goods at a discount through an alternative channel, buyers may switch channels – and 10,000 units sold at discount will cannibalize 10,000 units in sales at higher margins.