Lille Tissages is located in Lille, France and it is the largest textile company in the region. The department whose financial management is under scrutiny in this case study sells only Item 345. The price for Item 345 was raised from FF15 to FF20 in 2002, which resulted in decrease in market share of Lille Tissages for item 345.
The company is facing stiff competition and the management of the department is forced to rethink its pricing strategy for Item345. The sales director proposed that if the department decides to reduce the price of Item345 to 15 French francs, the company would be able to increase the market share to 25% from the current 20%. The market volume is expected to grow from 625,000 units to 700,000 units; this would mean the sales for 2004 would be 175,000 units.
If the company was to keep the price at 20 French francs, which is the current price, the sales would only be able to touch 75,000 units.
The effort in the paper will be to analyze the impact of the following factors on the pricing strategy for Item345: a)
Lowering of costs for Item 345
Impact on profit if price is lowered for Item 345
Effect of the pricing strategy on competition and market share d)
Calculation of contribution margins for the pricing options
Should Lille Tissages lower the price to FF15? (Assume no intermediate prices are being considered.)
Answer: In order to understand the pricing decision we need to understand the contribution margin of Item345 at FF20 and at a lower price FF15. Please refer to Exhibit-2, which shows the per unit contribution margin at the price FF20 as 13.2 (volume is 75,000 units), whereas if the price is FF15 then the contribution margin is equal to 8.51 (volume at 175,000 units).
The above per unit information shows that keeping the price at FF20 will result in a higher contribution margin per unit. But if you see the total contribution figure at 75,000 units for FF20 and at 175,000 units for FF20, you will see that the total contribution at price FF20 is 990,000 compared to a contribution margin of 1,489,250 if lower the price to FF15.
Clearly this indicates that decreasing the price would increase the selling volume which in turn would contribute higher towards the fixed cost. Decreasing the price would also increase demand, knock out competition and eventually translate into higher total contributions towards the company’s fixed costs.
If the department that produces Item 345 was a profit center and if you were the manager of that department, would it be to your financial advantage to lower the price?
Answer: The definition of a profit center, the idea is to maximize revenue and minimize expenses resulting in a higher net profit. Referring to Exhibit 2 at selling price of FF20 and sales volume 75,000 the total revenue is estimated to be FF1.5 million and total expense to be FF0.996 million resulting in a net profit of FF0.503 million. Similarly, for the selling price of FF15 and sales volume of 175,000 the total revenue is estimated to be FF2.625 million with total expense of FF1.622 million resulting in a net profit of FF1 million.
Since the goal of a profit center manager is to maximize profit, it would be to our financial advantage to lower the price to FF15, if it guarantees higher sales volumes eventually resulting in a higher net profit.
Is there any possibility that competition might raise their prices if Lille Tissages maintains its price of FF20? If so, how do you take this factor in your analysis?
Answer: If the competition raises their price they will risk losing the market share, because the general public believes that Lille Tissages produce better products. Loss in competition’s market share would mean increase in Lille Tissages market share. If the competition...
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