Question

Jessica Alba, a famous actress, starts the baby and family products business, The Honest Company, with Christopher Gavigan. Alba and Gavigan set up their site so families can choose what kinds of non-toxic, all-natural products they'd like to use and get them in a bundle. Families can choose all kinds of products from food to hygiene necessities and cleaning supplies. Suppose they are thinking of expanding their business into five domestic markets: Phoenix, Dallas, Chicago, New York, and Atlanta. Assume their primary goal of business is to maximize economic profits, although they want to do business honestly.

Show all your calculations and process. Describe your answer for each question in three- to five-complete sentences.

B. ) Are they likely to make economic profits initially? Can they continue to make economic profits in the long term? Why or why not? Discuss.

Answer 1

Solution(s):

Alba and Gavigan are new in the market, so they would be facing high competition at first. If they keep their prices high initially then they will not be able to sell any of their products and so would be making huge loss and run out of business.

They should go for market capturing at first in order to outrun their competitors. In this process they might be incurring some loss in the initial situation as the prices of their products will be low, but after they capture the market share they can go for increase in the prices of their products to compensate their initial loss.

This is a very popular strategy in market, where big companies artificially lowers the prices or new companies with improved technology lowers the prices of their products in order to outrun their competitors from the market to capture the market share. And in this way monopoly would establish to make the company a price maker, who sets their prices at a high rate to compensate their initial loss.

So, as an advisor I would advise going for the penetration pricing policy, where the price starts at a low level and then increases over time as the competition reduces. This policy is better than the skimming pricing policy, where price starts at a high rate and then falls over time.

If we adapt skimming pricing policy then none of our products will sold as the competitors would be selling those same products at a low price. So, we will make huge loss and go out of business.

On the other hand if we adapt penetration pricing strategy, then initially we may be incurring some loss as the price we would be charging might not be enough to compensate the cost of production, but with the lowering of competition the price would be increasing to compensate the cost and to left us with high profit.

If the company adapt penetration pricing, then they might or might not be making economic profit initially that is in the short run, depending on the fact that the marginal cost of production is less or more than the price charged respectively.

But whatever may be the profit in the short run, they certainly will be making economic profit in the long run as the competition will be less and the price will be greater than the marginal cost of production.

The advice I would give to the company to make more profit in the long run would be to go for profit maximization in the long run, in order to produce profit maximizing output and charging the profit maximizing price level. And along with that as the profit being accumulated over the recent past, I would also recommend to expand their business to capture more market, as this would increase their profitability even more.