Outline a Plan for Managers
The frozen food market in the US is undergoing a deceleration since 2014, especially for the ready-to-eat segment, which was one of the most lucrative segments even in 2014 (Frozen Food Industry, 2015). As the market forecast predicts a deceleration in business, managers are eager to present a pricing strategy in anticipation with the rising prices in the long run. The pricing strategy, as suggested by World Health Organization, should promote healthy eating habit (Eyles, Mhurchu, Nghiem, & Blakely, 2012).
When the food prices are altered, it directly affects the purchase volume of the product that can be estimated using price elasticities. It may vary due to own price elasticity or cross price elasticity. The higher is the price elasticity, the greater will be the change in the purchase volume change due to an increase in price. Further, the cross elastic may also vary due to the change in government policy, in form of tax or subsidy, towards a non-competing food item, which due to the policy change may become a direct competition.
Thus, government regulation and policy towards consumer health objective may change the cross price elasticity, thereby, influencing the pricing strategy of a company. Government policies directed towards dietary change influence consumer choices of food items and thereby changes the demand for a particular food (Traill, Mazzocchi, Shankar, & Hallam, 2014).
When prices are increased by the managers compensating the increase in cost, the decline in volume of the product will be higher as many consumers may shift their preference for frozen ready to eat meal to wards frozen fresh, and raw vegetables or meat. This is due to the change in the cross elasticity induced by a change in government policy. In such as case, managers should try to device a pricing strategy that would increase the prices only marginally in order to optimize their profit in the long run, given that there can be a shift in demand towards substitute products.
Mathematically, we can compute price variations based on the above scenario. The information provided, cost of production (total cost) = 160,000,000 + 100Q + 0.11Q
- The firm’s variable cost (VC) = 100Q + 0.1111Q^2
- Please note that marginal cost (MC) = 100 + 0.02222Q
Assuming an increase in the cost of an ingredient, there will be an increase in the variable cost. Thus, we assume an increase of variable cost from 100 to 150. This will change the equation of variable cost:
- VC = 150Q + 0.1111Q^2.
Therefore changing the marginal cost:
- MC = 150 + 0.2222Q.
In the long run, all costs are variable. Therefore, Long run Average Total Cost (ATC) = 150 + 0.1111Q
Now considering the demand side equation we assume
- P = 2100 – 0.10Q
- Please note that total revenue (TR) = P x Q = 21,000Q – 0.1Q^2
- However, marginal revenue (MR) – (dTR/dQ) = 21,100 – 0.2Q.
Thus, to maximize performance and profit in the short run, the organization must estimate equate MR to MC. However, to maximize performance in the long-term, product demand must align with ATC (average total cost). By implication, fast foods investment could superimpose profit and breakeven. From the above analysis, the organization will lose customers if the price increases.
Therefore, for long term maximization of profit,
- ATC = P
- 150 + 0.1111Q = 2100 – 0.10Q
Solving the equation for Q, we find the long run equilibrium quantity is 9237. Substituting Q for P we get 1176. Therefore, the long run equilibrium Q is 9237 and P is 1176.
Now we will consider how an increase in the cost of an ingredient will increase the price of the product. We know that
- P = [1/(1+1/e)]MC
Where P is the price of the product, e is the own price elasticity, and MC is the marginal cost. As we have seen in the long run a change in the VC is actually a change in the Total cost as there is no fixed cost. Therefore, we may compute marginal cost as:
- MC = 150 + 0.02222Q
- Therefore, P = [1/(1+1/e)]*[150 + 0.02222Q].
According to inverse elasticity rule, in a monopolistic competition scenario, price varies inversely to own price elasticity of the product (Fjell, 2003). Thus, products with less elasticity, will receive greater markup (Fjell, 2003). In this case, if the elasticity is high for low-calorie microwavable frozen products, there will be a higher increase in price if there is a low fall in the demand.
Fjell (2003) points out that the marginal cost markup rule will not be effective just by equating MC and MR or in the long run, ATC and MR. therefore, elasticity based pricing is a superior method of pricing mechanism that should be adopted by managers when pricing the products in long run. Thus, given that the equilibrium quantity is 9237 and the elasticity is assumed to 0.6 then the long run price can be substituting Q and e in the above equation:
- P = 1243
Thus, the price is 1243 when e is assumed to be 0.4. Therefore, if price elasticity is higher, i.e. e is assumed to 0.8 then price will become 799. Thus, higher the elasticity, lower should be the price, even when there is an increase in cost.
Effect of major government policies has on production and employment
Assuming there is a change in government policy that increases the tax on low calorie microwavable frozen food products. This will shift the demand for the product towards substitutes of the product where the government may have increased subsidy in order to change the dietary habit of the nation. (Mojduszka, Caswell, & Harris, 2001). Government regulation and policy intervention has changed the food habit and demand in the frozen food market even in the past (Traill et al., 2014).
The change in government regulation towards healthier food options in both frozen and fresh food market in order to increase the nutritional intake and calorie content of food has resulted in a shift in consumer demand for low-calorie healthier food options. This has resulted increased the cross elasticity of the products.
Predict potential effects that government policies could have on your company
When the government increases the subsidy of low calorie frozen food and increases taxes on high calorie frozen food, this will automatically increase the cost of the latter, this increasing the prices and reducing the demand for high calorie frozen food. When there is a reduction in demand, which actually shifts the demand curve to the left, there will be a rise in prices. When the cross elasticity between high calorie and low calorie frozen food is high, this will shift the quantity demanded by consumer to low calorie frozen food.
Thus, due to a change in government regulation in favor of low-calorie frozen food, there will be a shift in the demand and pricing can be done accordingly. However, if the government decides to increase the subsidy for fresh food and increase the demand for frozen food, due to perceived low nutritional value of the latter, this will make fresh food a direct competitor of the low calorie microwavable frozen food.
Is government intervention required to ensure fairness in low-calories microwavable food industry?
Government intervention is necessary to ensure fairness in the low-calorie microwavable food industry as the regulations ensure the public health and nutrition intake through various institutions life the FDA. Quality of these products must be checked and regulated to ensure fair deal provided to the consumers. However, from the business point of view a high degree of regulation acts as a barrier to the competitive environment of the industry, but it is necessary for ensuring safety and quality standard of the food products.
Example of Government Involvement
Two examples of government involvement in food industry and frozen food industry are provided in this section. The first example is the case when in the seventies and eighties the government made it compulsory for the frozen food companies to provide nutritional value index in their label in order to keep the consumers informed. This regulatory change was to make the consumers aware of what they were buying and what nutritional value the frozen food had or did not have.
The second example is the nutritional regulations, which enforces how the meat and raw fish is to be processed in order to make it more viable for preservation. This regulation increases the cost of operations.
Major complexities of expansion via capital projects
A major complexity a company faces is due to government intervention and high cross elasticity. Government regulations can change according the government’s policy towards food consumption. For instance, the government can regulate and increase the taxes on alcohol thereby forcing the manufacturers to increase the price of the product (DeCicca & Kenkel, 2015 ). This creates a complex situation for the management to expand as the government policy in the food sector is always changing. Further, due to high cross elasticity, the consumers have an option to move to the substitutes if the prices are increased too high. Thus, expansion becomes difficult in this industry.
Key actions that the company could take
The companies in the low calories microwavable food industry can try to price their products based on the elasticity of their products and expand in various areas in order to gain access to the vast and diverse consumer demand.
Create a convergence between the interests of stockholders and managers
The stockholder’s interest is to ensure greatest profitability of the company. The managers aim to expand as well as create profits. Devising a strategy that would align the product sales and production in such as a way that the company can price its products optimally by holding onto its sales, will help the company to attain convergence between the two.
Impact to profitability of such a convergence
Two examples for the impact of such convergence will be –
- optimum prices will ensure optimum level of price and quantity even when the price elasticity is high, retaining the number of customers for the product,
- this will help to adopt a pricing strategy that would look into the change cross elasticity due to the changes in government regulation and other external factors.
DeCicca, P., & Kenkel, D. (2015 ). Synthesizing Econometric Evidence: The Case of Demand Elasticity Estimates. Risk Analysis, 35(6) , 1073-1085. Web.
Eyles, H., Mhurchu, C. N., Nghiem, N., & Blakely, T. (2012). Food Pricing Strategies, Population Diets, and Non- Communicable Disease: A Systematic Review of Simulation Studies. PLoS Med, 9(12) , 1-23. Web.
Fjell, K. (2003). Elasticity based pricing rules: a cautionary note. Applied Economics Letters, 10 , 787–791. Web.
Frozen Food Industry Profile: United States. (2015). Frozen Food Industry Profile: United States, 1-41.
Mojduszka, E. M., Caswell, J., & Harris, J. M. (2001). Consumer Choice of Food Products and the Implications for Price Competition and Government Policy. Agribusiness, 17(1) , 81-104.
Traill, W. B., Mazzocchi, M., Shankar, B., & Hallam, D. (2014). Importance of government policies and other influences in transforming global diets. Nutrition Reviews, 72(9) , 591–604. Web.