Question

You have just taken over the job of senior product manager for a line of Consumer Home Routers at Cisco. On your first day at work (March 15…the Ides of March) your new boss walks into your office and informs you that your product line will be discontinued and replaced by a (revolutionary) new product line on October 1 of the same year. She also tells you that she wants you to raise prices on your existing product line by 20% in order to protect profitability during the transition. After a moment of (stunned) reflection, you tell her that you need 24-hours to gather some information and will respond to her at that time. You go to a number of sources including field sales VPs, market research, other product managers, and an external consulting firm (McKinsey & Co.) and ask them how responsive customers have been to changes in prices in the past. They tell you that a 10% increase in price always leads to a 20% decrease in sales volume. The next day you walk into your boss’s office.

What is your decison rule? What is your recommendation and what is your reasoning?

Answer 1

As per the gathered information,

Price elasticity of demand = % change in sales / % change in P

Price elasticity of demand = -20/10

Price elasticity of demand = -2

This means the demand for the good is highly elastic in nature.

In order to maximize sales or revenues in this case, the best strategy would be to lower prices. This is because raising prices would lead to lower sales and thus lower profits.

So, the decission rule is to cut down prices (in order to maximize sales and profits) since the product has highly elastic demand.