# final: healthy spring water company defining the price

```FINAL: HEALTHY SPRING WATER COMPANY
DEFINING THE PRICE-VOLUME TRADEOFF FOR A PRICE INCREASE
1. What is the maximum % sales loss that Healthy Spring could tolerate before a 10% price
increase would fail to make a positive contribution to its profitability? And what is the unit
break-even sales volume?
- %DP
Sales D % -10%/(60%+10%) = -10%/70% = -14.3%
~ 1714-1720
%CM’ + %DP
B/E Sales Volume
2. Repositioning as a premium water will require upgrading the packaging, changing from
plastic bottles to glass bottles that are &quot;safety sealed&quot; to insure cleanliness until the covering is
removed in the customer's home. These changes will add \$1.00 per bottle to the variable cost
of sales. What is the new breakeven volume with the 10% price increase?
- \$DCM
Sales D % -1/13 = -7.7%
New \$CM
B/E Sales Volume
~ 1846
3. Repositioning the water as a premium product will require an advertising and promotion
budget increase of \$900 daily. What is the maximum sales loss that Healthy Spring could
tolerate before a 10% price increase would fail to increase net profit? That is, what is the
break-even sales change including the incremental fixed cost of advertising?
-4.2%
- \$DCM
+
\$D in FC
Sales D %
New \$CM
NEW \$CM &times; initial unit sales
B/E Sales Volume ~ 1915
-1/13 + 900/(13*2000) = -4.2%
Profit Implications of Competitive (Re)Actions
Healthy’s Profit if Competitor Matches Price Change (Use Primary Elasticity ≈ -1)
New
Expected Expected Exp Var Costs
Total
Expected
Price D
Price
Demand Revenue
(\$9 VC/U)
Fixed Costs
Profit
\$45,540
\$18,630
\$20,900
\$6,010
10%
\$22.00
2,070
\$46,000
\$20,700
\$20,900
\$4,400
0%
\$20.00
2,300
Healthy’s Profit if Competitor Does Not Match Price Change (Increase Elasticity ≈ -2)
New
Expected Expected Exp Var Costs
Total
Expected
Price D
Price
Demand Revenue
(\$9 VC/U)
Fixed Costs
Profit
1,840
\$40,480
\$16,560
\$20,900
\$3,020
10%
\$22.00
2,300
\$46,000
\$20,700
\$20,900
\$4,400
0%
\$20.00
Cheapie’s Profit if Cheapie maintains/increases price (Healthy’s Increase Elasticity ≈ -2)
Healthy Cheapie’s Expected Expected Exp Var Costs
Total
Expected
Price D
Price
Demand Revenue
(\$8 VC/U)
Fixed Costs
Profit
10%
\$20.00
2,660
\$53,200
\$21,280
\$24,000
\$7,920
0%
\$20.00
2,200
\$44,000
\$17,600
\$24,000
\$2,400
10%
\$22.00
1,980
\$43,560
\$15,840
\$24,000
\$3,720
Cheapie’s Profit if Cheapie decreases price (Healthy’s Increase Elasticity ≈ -2; Cheapie’s Decrease Elasticity ≈ -3)
Healthy Cheapie’s Expected Expected Exp Var Costs
Total
Expected
Price D
Price
Demand Revenue
(\$8 VC/U)
Fixed Costs
Profit
3,232
\$58,176
\$25,856
\$25,000
\$7,320
10%
\$18.00
2,860
\$51,480
\$22,880
\$24,000
\$4,600
0%
\$18.00
6. Construct a payoff matrix that summarizes unit volumes and profit for Cheapie with prices at \$18
and \$20 and for Healthy with prices at \$20 and \$22. What are the take-aways?
Exhibit 1: Payoff Matrix under Different Pricing Scenarios1
Healthy
Cheapie
Total
Healthy
Cheapie
Total
3232
4720
1840
2660
4500
\$7,320
\$5,764
\$3,020
\$7,920
\$10,940
1860
2860
4720
2300
2200
4500
(\$440)
\$4,600
\$4,160
\$4,400
\$2,400
\$6,800
Units 1488
\$22.00
Profit (\$1,556)
Healthy price
Units
\$20.00
Profit
\$18.00
\$20.00
Cheapie price
Strictly according to the payoff matrix…
1. If Healthy sets its price at \$20, Cheapie maximizes profit with a:
\$
price
2. If Healthy sets its price at \$22, Cheapie maximizes profit with a:
\$
price
3. Given that Cheapie will try to maximize profit, what price should Healthy set?
\$
price
4. What is the major concern facing Healthy if it keeps its price at \$20.00?
```