In: Operations Management
Frankie Frommagio’s Pizza Palace
The competition for pizza consumers in the Bloomington Indiana market is fierce. Indiana University has 38,000 undergraduate students. On average, undergraduate students eat 1.2 pizzas per person per week throughout the August 31 – May 1 academic year
Frankie Frommagio’s Pizza Palace is a new competitor in the Bloomington pizza market, which includes national pizza chains such as Papa John’s, Pizza Hut and Little Caesar’s, local chains such as Avers, and Pizza X, and independent restaurants such as Mother Bears.
The price of a basic 14” cheese and 1 topping pizza at Frankie Frommagio’s is $12.95 compared to $14.85 at Mother Bears, and $11.49 at Papa John’s. Frankie’s standard contribution margin on that pizza is $7.00.
Knowing that undergraduate students have limited budgets, Frankie is considering a reduction in the price of the basic pizza to $11.00 beginning on the weekend the first home Hoosier basketball game. He believes that if he reduces his price for the basic 14” pizza to $11.00 he will generate a lot of new business.
How much of an increase in pizzas will Frankie have to sell at $11.00 to generate the same total contribution dollars as he currently generates?
Frankie’s partner, Melanzana Frommagio, was not sure about Frankie’s idea. In fact, he wanted to increase the price of the basic pizza the company sold to $16.00, making the Frommagio’s basic pizza by far the most expensive in the Bloomington area. Mellanzana argued that his idea would allow Fromagio’s to focus on the more sophisticated pizza consumer who would appreciate his “old world” secret sauce recipe. Mellanzana believed the sauce made pizza much better than any other pizza available, and that most people would be willing to pay the extra amount for his “buongustaio” (gourmet) recipe. Frankie, however, worried about the size of the “sophisticated pizza consumer” segment in Bloomington. Would it be large enough to be profitable?
If he adopts Mellanzana’s recommendation, how many customers could Frankie afford to lose and still generate the same total contribution as he currently generates?
10 Bonus points: Which pricing action should Frankie take? Provide a rationale for your decision based on the class discussion, and not just an opinion.
Current contribution margin = $7
Difference in Selling price = 12.95 - 11 = 1.95
New contribution margin = 7- 1.95 = $5.05
Ratio of Contribution margin = 7/5/95 = 1.386
Frankie will have to increase the pizzas sales by 1.386 times to generate the same contribution dollars as he currently generates.
Suppose Frankie sold 1000 pizas earlier, now he will have to sell 1386 pizzas
(1000 * 7 = 1386 *.5.05)
Mellanzana's recommendation
Increase in selling price = 16 - 12.95 = $3.05
Increase in contribution margin = 7 + 3.05 = 10.05
Ratio of contribution margins, current to new = 7 / 10.05 = 0.6965
Hence, Frankie needs to sell to 69.65% of customers and can afford to lose 1 - 0.6965 = 30.35% of customers.
Suppose Frankie sold 1000 pizas earlier, now he will have to sell 696.5 pizzas
(1000 * 7 = 696.5 *.10.05)
Frainkie should go with reducing the price instead of increasing the price. The bigger target market here is University students who more than a gourmet recipe would prefer pocket-friendly pizzas. As Frankie is apprehensive about the size of sophisticated pizza consumer, it is possible that it is a small segment of the market. Increasing the price would definitely mean losing a bigger chunk of market of 38000 students. Further, the competition is fierce with 6-7 vendors in the market. Pricing it at the highest price point would mean Frankie would need to justify the premimum and pizzas is a fast food (on the go product) and it is difficult to justify the premimum just on the basis of taste.