Pricing case

Times have been rough at ShtinkerToy, Inc. Yesterday was the first anniversary
of its launch of its newest toy, "Thing-a-ma-bobber." It has been selling well,
as predicted, but at a net loss, which was not predicted. As the newly hired
vp of sales for ShtinkerToy, you were just emailed that you need to have a brief
report (no more than three typed pages) on the desk of Jack Schlemiel, the
ceo, in two hours. Jack asked you to prepare an emergency detailed report on
current and future pricing strategies, and whether last year's loss implies that
the Thing-a-ma-bobber line should be shut down.

Thing-a-ma-bobber is a set of blocks and connectors from which kids can
build all sorts of fun stuff. It is a unique building toy that combines engineering
skills and a sense of aesthetics. Currently, the Thing-a-ma-bobber is sold in a
kit, where a kit consists of one block and one connector. Children often want
to buy multiple kits as the pieces from the various kits can be combined. Each
kit is sold at a price of $3.13.

Bartholomew J. Simpson, your Thing-a-ma-bobber sales manager, collected
all the relevant data as follows: Last year, the company sold nearly 180,000 kits
at the $3.13 price. The children who buy the kits are typically in first grade.
Research suggests that boys and girls have different individual demands: The
demand of each potential boy buyer is given by xb = 20−4p and the demand of
each potential girl buyer is given by xg = 12−3p. There are an estimated 10,000
boys who are potentially interested in the Thing-a-ma-bobber and 40,000 girls
who are potentially interested. Research also suggests that this demand will
be stable on a yearly basis (new cohorts of first-graders), and that the patent
ShtinkerToy has on Thing-a-ma-bobber will prevent entry into this special niche.
The costs of producing 1,000 units of Thing-a-ma-bobber were calculated only
yesterday by the cost-accounting division and are summarized in Table 1. The
cost data indeed indicate that, at $3.13 per kit, there is considerable loss from
continuing operations.

An additional fact about ShtinkerToy is that has a 5% cost of capital.
In conversations with Mr. Simpson, a long-time veteran of ShtinkerToy, you
hear a number of pieces of gossip. For instance, the previous vp of Sales was
Jim Schlemiel, Jack's son (Jim has since been kicked upstairs). Consequently,
the current pricing of $3.13 per kit is a sensitive matter as it was Jim who set
it.

Table 1: Estimated Costs for 1000 units of Thing-a-ma-bobber (using last years
rounded to 180,000 units)
Item Cost
Direct Labor(a) $800
Administrative Labor(b) $880
General Administrative(c) $150
Raw Materials $700
Direct Utilities $500
Depreciation of Equipment(d) $100
Periodic Maintenancee $160
Total Costs $3,290
Unit Costs $3.29

(a)Direct labor: 5 people working together to produce 100 kits
per hour at an hourly wage (including benefits) of $16/hr.
(b)The annual total of salaries paid non-production labor (management
and administration, including benefits) involved in the
oversight of production and sales of Thing-a-ma-bob is $158,400.
This is divided by 180 because yearly sales were 180,000.
(c)$27,000 of the general administrative costs (e.g., the ceo's
salary) of ShtinkerToys has been allocated to the Thing-a-ma-bob
toy line.
(d)Calculated using a 30-year straight-line depreciation method.
Because of periodic maintenance, the equipment has retained its
original value of $540,000 and can be sold for that amount should
the Thing-a-ma-bob toy line be discontinued.
(e)The machinery needs inspection, cleaning and preventive care
every 6 months. Each of these inspections employs 8 technicians
for 60 hours each at $30 and hour (including benefits).

Questions---

A) Mr. Simpson suggests that you would be wise to include a discussion in
your report about what is the right price to charge if Thing-a-ma-bobber is sold
solely in kits. "It would help your career here if you could show that the boss's [125 points]
son wasn't a total screw-up," remarks Mr. Simpson. Include a discussion in about what is the right price to charge if Thing-a-ma-bobber is sold solely in kits. "

B) Mr. Simpson also tells you that Hermione Granger, the vp of Marketing, has
been arguing for selling pink kits and blue kits, arguing that these can be priced

separately because no boy will buy pink and no girl will buy blue. "Hermione
is a real witch, plus which she's the boss's niece, so you better analyze her
suggestion in your report," notes Mr. Simpson. "Both she and Jack will expect [180 points]
to see projections based on such a pricing scheme."
In conversations with others, you learn that there is strong evidence that the
markets for boys and girls cannot be segmented because today's kids no longer
exhibit stereotypical color preferences. After reviewing the evidence yourself,
you are convinced of its validity. Question - Can the pink kits and blue kits can be sold separately, (i.e. be priced separately because no boy will buy pink and no girl will buy blue?

C) In the email from Jack Schlemiel, he notes that Mr. Dufour, the vp of Engineering,
is pushing the idea of no longer selling individual kits, but selling
only pre-packaged boxes with six connectors and six blocks in each box (i.e.,
the equivalent of six kits) and price the boxes at $18 each. Mr. Simpson tells
you, "the boss thinks the world of Dufour, so he's not going to buy any recommendation
you make if you haven't compared it to Dufour's." Please compare your recommendations to Dufor's.

D) Write a report for the ceo that is responsive to Mr. Simpson's advice and is responsive to Mr. Schlemiel's request. Mr. Schlemiel's email says there's a $90,000 bonus if you come up with a pricing scheme better than those of his son and Mr. Dufour.

E) There's an additional $60,000 bonus if you can find the optimal scheme (recalling that modern children do not have stereotypical color preferences).