Cumberland Metal Industries
- Pages: 7
- Word count: 1675
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Cumberland Metal Industries (CMI) is one of the largest manufacturers of curled metal products in the U.S. The company started the business by making highly technical applications, but soon changed from selling the finished products to selling the products that were considered as raw materials for other products. By doing so, the company experienced a dramatic growth in the 1970’s and occupied 80% of the market share. However, the managers were not sanguine about the future since there was a slightly decrease in sales and net income in 1979. Therefore, the company developed a new cushion pad to boost company’s revenue. The performance of the new product was really impressive in the test and the test company Colerick was eager to make the purchase. The only problem left is to decide what price should the company charge for the new product, and it is a decision case.
The cushion pad is used in the driving piles. It is used to prevent damages caused to the hammer and the piles when the machine is working, while also transform the energy from the hammer to the pile. Normally, people use hardwood as cushion pads, and then changed to asbestos pads. However, the new cushion pad is better than these two because it can stretch in both length and width to provide more resilience, and also effectively transmit the force power without changing the power to heat or other mechanics.
Based on a report by Construction Engineering magazine, the manager Simpson estimated that there were 19500 to 26000 hammers operating about 25 weeks per year, and for each week, the hammers would be used for 30 hours. Then he made further assumption that the average actual driving figure for most jobs was 20 feet per hour. After calculation, the total amount of piles driven per year is between 290000000 and 390000000, which I assumed to be 340000000 for easy calculation. Another factor is that a set of curled metal pad contains 6 pad and can be used to drive 10000 feet. Therefore, the total number of sets that are needed annually for the entire market is 340000000/10000=34000 sets.
There are three ways to determine the price of the product, the first one is the cost approach. It sums up the total cost of the entire production process and then adds a portion of it as profit. Based on the Exhibit 6, there are two ways to manufacture the cushion pad. One is using the existing equipment, another is adding a $50000 worth of permanent tooling to lower the variable cost. Also, since the 11 1/2-inch size is the most popular one, it is used as the example. For the existing equipment method, the total manufacturing cost per pad is $148.12, which include $15.64 material cost, $28.8 labor cost and $103.68 fixed factory overhead. For the permanent tooling method, the total manufacturing cost is reduced to $69.18, which create a gap of $78.94 per unit. Since there is a fixed cost of $50000 for using this method, the breakeven point is $50000/$78.94=633.39 unit. It means that it will take the company less than 3 month to cover the fix cost of purchasing the permanent tooling.
Therefore, if the price is the same for both method, the company should use the permanent tooling method. As mentioned in the case, the corporate management expected a contribution margin after all manufacturing costs of 40% to 50% of selling price (pg 8, 5th paragraph). For the purpose of easy calculation, 50% of the selling price is $148.12, so the price for the 11 1/2-inch size should be $296.12. Since the volume was 250 cushion pads per month, the annually production is 250*12=3000, and the total revenue will be 3000*$296.12=$888360. If we use the tooling method for pricing, the price should be $138.36 and the total revenue will be $138.36*3000=$415080. In conclusion, both of the method will provide profit for the company, and the annual production of 3000 pads is only about 10% of the total market share. It implies that there will be a huge potential profit in the market as a whole. The second price method is the value based approach. It means that the price of the product should base on the value it produced to the customers.
In other word, it evaluated how much the customers would like to pay for this product. The data from the Colerick test has shown the unique quality of the product and also implied the value of the cushion pad. Based on the Colerick test result table that showed on page 3 of the case and Table A on the next page, we can easily calculate the value of the cushion pad. Since the job required 300 piles drive 50 feet into the ground, the total feet is 300*50=15000 feet. The asbestos cushion pad can only drive 150 feet per hour while the CMI cushion pad can drive 200 feet per hour. Therefore, the job took 100 hours to finish using asbestos but only 75 hours using CMI. The 25 hours gap with the $138 per hour operating cost (from table A, the average cost per real hour for the sum of the diesel hammer, crane, leads, labor is 34+52+8+21+10+13=$138 per hour, the overhead cost is based on the working hours so it does not included) gives us the savings of 25*$138=$3450. Meanwhile, the CMI also save time by reduce the time required for change of the set. It took 20 minutes to change an asbestos pad but only 4 minutes to change a CMI pad.
With the number of set needed is 20 and 1 respectively, the gap of hours needed to change the pad set is 20*20-4*1=396 minutes/60 minute/hour=6.6 hours. Therefore, the cost saving is $138*6.6=$910.8. Another cost is the price of the asbestos pad set, which is $50. With 20 sets of pad needed to complete the job, the total cost of the asbestos pad set is $50*20=$1000. Finally, add up all the value together, $1000+$3450+$910.8=$5360.8 per pad set, and for single pad its value is $5360.8/6=$893.47. This price indicate the value that the Colerick Company can gain from using the CMI cushion pad. Using one test result to set the price is not enough, there is another test that done by the Fazio Construction.
By using the same calculation method and the table that shown on the 6th page of the case, the total feet needed to drive is 300*40=12000 feet and the gap between the hours needed to finish the job is 15 hours, it leads to the savings of $2070. The time needed to change the pad set is the same as the previous test, therefore the total time needed is 50*20-4*1=996 minutes=16.6 hours and the cost saving is 16.6*$138=$2290.8. The cost of asbestos pad set in total is $2000. Add the value all together the value of the CMI pad set is $2000+$2290.8+$2070=$6360.8, and the value for each pad is $1272, which is even higher than the previous test result. It means that the new cushion pad performs much better than the managers’ expectation. In summary, the cost based approach shows that the price should be set between $138 and $296, compare with the approximately $1000 price using the value based approach.
Other influences on pricing:
Although pricing strategy is the most urgent problem that the company is facing, there are still a few other important factors that affect the price of the product and the sales. One of the factors is the problem recognition. Although in the case the CMI pad have significant performance increase compare with normal pad, but most of the driving piles don’t know about it. In fact, the contractors or the companies only pay little attention to the pad and purchase whichever is on the market. It implies that the customers pay low effort on making the decision so the main concern they have will be only the price. Therefore if CMI set the price too high, it will scare away many customers at the first place. (Compare with the extremely low price of the pad in the current market, about $2-$10 each.) The other factor is the purchase influences among different entities that affect the purchase decision.
There are six entities that involve in the business, which are pile hammer manufacturers, architectural/consulting engineers, soil consultants, pile hammer distributing/renting companies, engineering/construction contractors and independent pile-driving contractors. These entities have different influence on the market and the price. The most influential group is the architectural engineers because they have the ultimate authority on the process. The pile hammer manufacturers have influence over the market, but since they don’t actually purchase pads, they can only make recommendations. The engineering contractors can be very helpful unless the product has already proved its performance. However, the renting companies will have negative influence on the market because they want to make their customers rent as long as they can, but the CMI pad reduced the time needed. Finally, the independent pile-driving contractors are the main purchasers and they will do whatever they can to increase their profit.
The CMI Company should set the price lower when they first introduce the product to the market. Using the cost based approach and the permanent tooling method to set the price at around $200 as a discounted price. This market penetration strategy will attract some of the independent contractors to test its performance. Meanwhile, the company should use all the accessible resources to make advertisements of the new cushion pad and its unique performance based on the Professor R. Stephen McCormack’s test result. Since the professor has a huge impact on the engineering firms and architectural consultants, the product recognition will increase on a sophisticated level, especially for the large construction contractors segment of the market. And also independent contractors can prove its performance as well. After the recognition increases, the company can increase the price of the product using the value based approach and set the price at about $800.