Price Formulation for an Electric Adjustable Speed Drive

...

AVDC drives were used, for example, to power the rolls in a steel rolling mill. In making steel sheet, the speeds of all rolls in the line had to be closely coordinated to avoid having the sheet either buckle or stretch.

More efficient than electric adjustable speed drives, the AVDC drive did not have the disadvantage of high power losses and overheating at low speed operation. In addition, the AVDC drive could be installed so that only the DC motor was at the work location. This component by itself was much smaller than an EAS drive unit. Even with its improvements over existing EAS drives, the new Avon unit still fell short of AVDC drives in performance.

Avon Corporation was one of several manufacturers of AVDC drives. The company's sales of this product in the past year had amounted to $6 million.

[pic 5]

2

This document is authorized for use by Wasim Azhar, from 8/1/2015 to 12/18/2015, in the course: MBA 269: Pricing - Azhar (Fall 2015), University of California, Berkeley.

Any unauthorized use or reproduction of this document is strictly prohibited.

---------------------------------------------------------------

Avon Company

590-022

Reasons for Adding an Electric Adjustable Speed Drive to the Avon Line

The Avon management had originally authorized research and development work on a new type EAS drive because they believed attractive profits were available. In addition they recognized a need to include a product of this type in the line. Avon sales reps and distributors had reported, not infrequently, that they had lost sales of AVDC drives when prospective customers had been persuaded to purchase an EAS drive. The competition from EAS drives, it was believed, would be even greater if manufacturers of this equipment had wider distribution than they had. Recognizing that the EAS drive was not completely efficient, salespeople nevertheless believed it to be an effective and worthwhile product for many applications. They were reluctant to sell an AVDC drive when EAS equipment was quite adequate for the application. Thus one salesperson reported as follows:

While the efficiencies of our drives are equal to or better than the efficiency of electric adjustable speed drives at the normal operating speed (two-thirds of full speed), we still cannot show it to be economically sound on single-motored conveyors to purchase our equipment over the EAS drive because it would take something in the order of 10 to 15 years' worth of savings in power to make up the difference in price.

Another Avon sales rep made the following comment in a call report:

While we never did admit to [Customer XJ that we did not have as good a proposition from an overall engineering aspect as they could obtain from [Competitor A] using an EAS drive, we did feel deep in our hearts that we do not have any equipment developed which could truly match up to the EAS drive for this particular application. Certainly we could match this performance if we were given the-sky-as-the-limit for price, and providing we were allowed to furnish as much equipment as necessary to do the job. Nevertheless, we must be realistic and admit that if simplicity is combined with relatively low price it is a good buy for the customer. We are proud of these factors when they are in our favor.

Manufacturing Cost Analysis

Because of the way it was designed, Avon's new drive could be manufactured at lower costs than existing EAS drives of equivalent capacity. In calculating what it would actually cost to make the new product, Avon engineers had worked from drawings of a 5 hp model. This size was known to be a very popular one in the case of existing EAS drives.

Engineering analysis indicated that if the rate of production (of all sizes) was over 200 units per week, the 5 hp units could be made for a unit cost of $2,995 exclusive of selling and administrative overhead. (Selling and administrative overhead was regarded as fixed, and in calculating costs, Avon accountants estimated this overhead at 10% of net sales.)

Unit costs, it was further estimated, would increase by 20% if the rate of production was 100 units a week instead of 200 or more and by 40% if the rate of production was 50 units a week. If production was as low as 30 units a week, unit costs of production would be 50% greater (or $4,500 for the 5 hp model).

[pic 6]

3

This document is authorized for use by Wasim Azhar, from 8/1/2015 to 12/18/2015, in the course: MBA 269: Pricing - Azhar (Fall 2015), University of California, Berkeley.

Any unauthorized use or reproduction of this document is strictly prohibited.

---------------------------------------------------------------

590-022 Avon Company

Estimates of Required Investment

Engineering estimates indicated that to produce at the rate of 200-400 units per week would require an additional investment in plant of $12.5 million and an investment in equipment of $7.5 million.1 An additional investment of $2.3 million in inventory would be needed if 400 units a week were produced. At lower levels of production correspondingly lower investments in inventory would be needed. Inventory investment was calculated on the assumption that a 10-times-inventory turnover could be achieved.

Finally, it would be necessary to include in the total investment figure an amount to cover receivables. On the basis of previous experience this amount could be roughly calculated at 8% of sales. The investment in receivables, however, would be partially offset by Avon's accounts payable, an amount that was estimated at 4% of sales.

If the rate of production was 100–150 units a week, the investment in plant and in equipment would be $10 million and $5 million respectively. To manufacture between 25 and 50 units a week Avon would need to construct a plant which would cost $8,250,000 and which would be equipped with machinery costing $4 million.

When asked how long it would take to build plant capacity for the new electric adjustable speed drive and to get into production, executives in the engineering department stated that more than a year