1. Pricing Strategy & Elasticity (15 points) Best Buy stoc...

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1. Pricing Strategy & Elasticity (15 points) Best Buy stocks two types of merchandise: a private-label portable DVD player and DVD disks as a complementary good for the DVD player. Originally, Best Buy priced the DVD player at $99, and then sold 1,200 units per week. After raising the price to $120, sales dropped to 1,000 units per week. Similarly, Best Buy priced one box of DVD disks at $25, and then sold 1,500 boxes per week. After lowering the price to $21, sales increased to 2,000 boxes per week. (1) Please calculate the price elasticity for i) DVD player and; ii) DVD disk sold by Best Buy (2) Marketers usually use price elasticity to examine how customers would respond to the change of the product prices. When the absolute value of price elasticity is greater than 1, it means that customers are price sensitive. When the absolute value of price elasticity is smaller than 1, it means that customer are price insensitive. Based upon the results from the previous question, price elasticity for 1) DVD player and 2) DVD disk, which product is price sensitive)? Which is price-insensitive? (*Hint: if we get a price elasticity equals to -0.4, the absolute value of price elasticity is 0.4. Since it is smaller than 1, therefore it is price inelastic). (3) Suppose the cost of a box of DVD disks is $12, what would be the profit-maximizing price of one box of DVD disks? (The equation for calculating profit-maximizing price is given as bellow) Price elasticity x Cost Prolit-maximizing price - Price elasticity + 1 2. Customer Life-Time Value (35 points) A retail store is thinking about whether or not it should create a frequent shopper program for its customers. To make the decision, it starts keeping track of some customers shopping behaviors (see table below) to get some rough idea about customer's purchase behaviors within certain period of time. Customer Feb. March April May June July A $10 $20 $30 $30 $20 $10 B $20 $20 $20 $20 $20 $20 C $60 $60 D $120 E $40 $35 $40 $35 1/2 (1) (5 points) Based upon the following customer purchase data, which customer would have a higher life-time value to the retail store? And why? (2) (30 points) The retail store recognized that the table above can only give it rough estimation about customer life-time value. So, it decides to use more advanced methodologies to estimate customer life-time value in a more precise way. Here are some assumptions that the retail store has for calculating each customer's life-time value. Assumption: 1. The acquisition cost for each new customer is $15. 2. Each customer will purchase three times a year. For each purchase, the profit value is $5. 3. Retention rate (r) is 75% and Interest rate (i) is 15%. Questions: Note: Please round up all answers to two digits after the decimal points. (1) Please fill out the empty cells in the table below. And write down all the detailed calculation steps. (Note: each cell is 2 points including the detailed calculation and the results) (2) In order to make profit from this program, how many years do you think that the customers should stay in this program? And why? (3) Assuming that the retail store can recruit 1,000 customers once it launches the frequent shopper program, and would like to reach a profit goal of $3,000 in Year 4. Do you think the store could accomplish this goal? If not, how many more customers it should recruit at the beginning? Frequent Buyer Year I Year 2 Year 3 Year 4 A. Margin on each purchase $5 $5 $5 $5 B. Survival Rate 100% 75% C. Cost of Mailing $6 $6 $6 $6 D. Total Expected Profit per $9 Customer 3*5-6=9 $7.83 E. Net Present Value 9/(1+0.15)=7.83 F. Cumulative Profit per 7.83-15=-7.17 Customer 2/2

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