IB Business Management HL 4.5.4 HL pricing methods

[Maximum number: 6]

Creative Toys (CT)

Creative Toys (CT) manufactures toys and markets them business-to-customers (B2C) online only. The business operates in a leased industrial site and relies on word-of-mouth promotion only. To make customers believe that CTs toys are better than its competitors, CT sets prices slightly higher than the competition. Production and sales are mostly between 1 October and 24 December. Most of the employees work on temporary contracts during this busy period. For the remainder of the year, CT operates well below capacity utilization.
Table 1 contains selected data for CT, for 2014:

Table 1

In 2014, the management of CT considered a change of the marketing mix to include above the line promotion, lower prices, and an additional sales method called "toy parties". Toy parties would be hosted by newly recruited CT sales representatives and attended by parents and their children. At the parties parents could see the toys and children could play with them. Sales would be made at the parties by the new sales representatives, who would be paid on a commission-only basis.

Toy parties could be held throughout the year and make CTs total sales less seasonal. Based on market research, management has estimated that the parents' demand for toys is price elastic and is planning to set lower prices for all toys sold online and at toy parties. The management has prepared forecasted financial data for CT, for 2015, based upon the proposed change to the marketing mix, shown in Table 2 below.

Table 2

The Finance Manager will carry out a variance analysis in order to determine whether the proposed change to the marketing mix has been successful.

Analyse CTs management plan to reduce the price of CTs toys.

Analyse CT's management plan to reduce the price of CT's toys.

The management of C T "has estimated that the parent's demand for toys is price elastic", which means that for every percentage change in price the quantity demanded for toys will increase by a larger percentage. If this assessment of demand is accurate, CT's plan to lower prices will increase sales volume and total revenue (TR) quite significantly to make up for the fall in price per toy / unit. Presumably management believes that the increase in volume will make up for the lower gross margin.

Profit should increase as TR will be higher and the sales representatives in the toy parties are to be paid on a commission-only basis anyway.

The discovery of the market research that the customers are price elastic indicates that CT's current pricing decision is inappropriate as customers do not really see the toys as highly differentiated / better than the competitors. Otherwise, one would expect the price elasticity of demand to be lower. Therefore, the decision to reduce the price from a marketing point of view is also correct.

However, one negative impact of lowering prices is that it could change market perception about C T. Right now, C T charges more than its competitors with the intention of creating the perception that CT's toys are better. Lowering prices could alter that quality perception of some of the customers who might see the toys as differentiated with a USP of being creative and CT could lose some of its existing customers.

A lower price might mitigate the brand name of C T.
By increasing volume, CT will have to find a new location / extra storage space, the former requiring more finance and the latter requiring extra costs. For much of the year, capacity utilization at C T is low.

CT may have the capacity to produce and hold enough toys for the new, higher-sales-volume holiday months, but CT will either have to make the toys earlier in the year and/or have to increase capacity - requiring more space and possibly more manufacturing equipment, which will increase costs.

Of course, with an increase in the scale of production, C T may be able to gain economies of scale, increase profit and this could possibly allow prices of its toys to fall further.

Accept any other relevant analysis.

It is not expected that the candidates covers all of the above issues.
For one relevant issue that is one-sided, award up to [3]. For more than one relevant issue that is one-sided, award up to a maximum of [4].

For one relevant argument for and one relevant argument against award up to [4].

For [5] it is expected that the analysis is relevant and detailed, but it may lack some balance. For example, it includes only two detailed arguments for and one detailed argument against.

For [6] it is expected that the analysis will contain at least two detailed arguments for and at least two detailed arguments against the notion of CT reducing the price of its toys.

Marks should be allocated according to the markbands on page 3.

IB Business Management HL 4.5.4 HL pricing methods Question Bank

Exam points

4.5.4 (HL)—HL pricing methods question 1