Marketing Research For Augustine Medical Essay, Research Paper
Executive summary
By early 1988, Augustine Medical executives were actively engaged in finalizing and marketing the program for the patient warming system named Bair Hugger Patient Warming System. The principal question yet to be resolved was how to price this system. Several considerations are required in terms of organizational objectives, demand for the product, customer value perception, buyer price sensitivity, the price of competitive offering, and direct variable costs. The company has two alternatives to price this system, either the skimming pricing strategy or the penetration pricing strategy.
The Bair Hugger system, which consist of a heater/blower unit and a separate inflatable plastic/paper blanket, is an air-circulation product and provides hypothermia patients surface warming. Although using the skimming pricing strategy has greater return in the short run, the danger is the company can not have a greater market share as well as a long run profit. Also, this market is price-sensitive to alternative methods. On the other hand, since the demand is known, the estimate of the total potential market for this system is about 2737 units, and 1000 units of blankets for each blower unit per year, and there are many substitutes existing, we strongly recommend that the company should employ penetration pricing strategy to market this system. In conclusion, the company can get into the market quickly and gain favorable market shares as soon as possible if it offers a low-priced blower unit. Also, the company could have long-term profits by selling lots of blankets only if they have greater market shares.
Problem Definition
In July 1987, Augustine Medical was incorporated as a Minnesota corporation to develop and market products for hospital operating rooms and postoperative recovery rooms. One of two products the company planned to produce and sell was the Bair Hugger Patient Warming System designed to treat postoperative hypothermia in the recovery room. Postoperative hypothermia (a condition defined as a body temperature of less than 36 degrees Centigrade or 96 degrees Fahrenheit) occurs in 60-80 percent of all postoperative patients.
Many competing technologies are available for the prevention and treatment of hypothermia. These technologies generally fall into one of two broad types of patient warming: surface warming or internal warming. The Bair Hugger system, which consist of a heater/blower unit and a separate inflatable plastic/paper blanket, is an air-circulation product and provides hypothermia patients surface warming. The warming time per patient is about two hours. The plastic cover was patented in 1986; there is no patent protection for the heater/blower unit.
The central issue at this time was the determination of the list price to hospitals for the heater/blower unit and the plastic blanket. The price set for the Bair Hugger Patient Warming System would influence the rate at which prospective buyers would purchase the system since the market was price-sensitive to alternative methods. Also, price and volume together would influence the cash flow position of the company. Before the company prices this system, several considerations are required in terms of organizational objectives, demand for the product, customer value perception and buyer price sensitivity, the price of competitive offering, and direct variable costs.
The estimate of total potential market for heater/blower unit is 2737 units and 2737000 units for blankets (see exhibit 1). The direct cost of the heater/blower unit would be $380 and $0.85 per blanket. The initial investment, $500,000, for this system would cover the fixed cost of the company during first year of operation. Based on this basic information and other considerations, the company has to determine its pricing strategy for both products. There are two alternatives for this company.
Statement of Alternatives
Alternative A: Skimming pricing strategy.
Alternative B: Penetration pricing strategy.
Analysis of Alternative
Alternative A: The company could employ skimming pricing strategy and price heater/blower unit and blanket by $4000 and $20 respectively.
Many competing technologies are available for the prevention and treatment of hypothermia. These technologies generally fall into one of two broad types of patient warming: surface warming or internal warming. A variety of competitive products includes warmed hospital blankets, water-circulating blankets, reflective thermal drapes, and air-circulating blankets and mattresses. Their comparison in terms of product value and annual cost show in exhibit 1.
There are three reasons to support the company to employ the skimming pricing strategy. First, the Bair Hugger system, an air-circulating product, consists of a heater/blower unit and a separate inflatable plastic blanket. The plastic cover was patented in 1986, which is the chief competitive advantage to prevent The Bair Hugger system from losing to competition. Even though there is no patent protection for the heater/blower unit, the heater/blower unit can not work without the blanket. In the other words, they are complementary products.
Second, there is a realistic perceived value in this system by comparing with other competitive products (see exhibit 2). The advantages of warmed-air technology are that it is safe, lightweight, and theoretically more effective than warmed hospital blankets or water-circulating blankets. Also, based on interviews with physicians and nurses, respondents felt that the Bair Hugger Patient Warming System would speed recovery for postoperative patients. Since this technology is not in common use in the Unite States and no product is available in the current market, the target markets are not familiar with these kind of products. Therefore, the company can position and price this system as a premium quality product.
Third, skimming pricing strategy can help the company to generate funds quickly to recover its investment or finance other development efforts. From exhibit 1, we know the total potential market demand for the heater/blower unit is 2737 units. Since the heater/blower unit is a durable product and the total demand for heater/blower units is known, the future development of this market has been constrained. Under this situation, the company may plan an early withdrawal from the market by employing the skimming price strategy. This involves setting a high price and engaging in only limited introductory advertising and promotion to maximize per unit profits and recover the product s development costs as soon as possible. At the same time, the company also works to develop new applications for its technology or the next generation of more advanced technology. Then when competitors enter the market and margins fall, the company is ready to move into new segments of the market.
In the short run, skimming pricing strategy could help the company gain funds quickly, but high price may also cause the company to get out of the market quickly. In this case, since the demand is known and substitutes are numerous, the company may fail to gain favorable market shares because of high price for both products. If Augustine Medical adopts the skimming pricing strategy, the company only needs to sell 37 units to reach the break-even point and sell 48 units to gain 30% ROI (see exhibit 4) in first year. Let us assume that the sales volume is held constant, 48 units in the second year, the company can have $2,112,000 revenue, in which blanket sales contribute $1,920,000. Also, from the table contribution by combination of blower prices and blanket prices, the price of a blanket is more sensitive than the price of a heater/blower unit because a blanket is a disposable product and sales of each heater/blower unit will create 1000 units of blankets per year. If the blower price is held constant, per dollar change in blanket price will have a $600 difference in contribution margin. In other words, the blower price can influence the rate at which prospective buyers would purchase the system since the market was price-sensitive to alternative methods, whereas the blanket price dominates margins because of its volume. Therefore, in the long run, a company can maximize its profits by selling lots of blankets, which requires selling large volume of blower units in the early marketing stage. Besides, there is no patent protection for the blower unit. The competitor can enter this market easily by offering low-priced products as well as blanket market since they are complementary. In short, it is risky to employ skimming pricing strategy for this company in the current market.
II Alternative B: The company could employ penetration-pricing strategy and price the heater/blower unit and blanket by $380 and $16 respectively.
A penetration strategy is one in which the seller charges a relatively low price on a new product. Generally, this policy is appropriate for the Bair Hugger Patient Warming System because of the following conditions.
1. Demand for the product is price elastic. The more substitutes a product has, the greater its price elasticity. Obviously, it is valid in this market because there is a variety of competitive products existing. Also, through an interview with physicians and nurses, respondents felt that the product was price-sensitive. Moreover, in the hospital, expenditures for equipment over $1500 were typically subject to a formal review and decision process.
2. Competitors are expected move in rapidly. The Hosworth-Climator is an English-made product that provides a controlled temperature microclimate by means of airflow from a mattress. The Climator comes in a variety of models for use in recovery rooms. This product could be distributed in the United States sometime in 1988.
3. The offering is not unique or protected by patents. Since many competing technologies are available for the prevention and treatment of hypothermia and there is no patent protection for the heater/blower unit, we price blower unit by its various cost in order to protect this system from low-priced or patented products.
4. A low price and profit margin may also discourage competition. The product of Bair Hugger Patient Warming System has a very flexible room on its price range. The selling price of the heater/blower could be from $380 to $5,295 per unit and the blanket is from $0.85 to $26 at each. The company can price their new product on low price in order to make the profit larger.
5. Bair Hugger s major objective is to gain a large market share. The objective of pricing the warming system is to focus on buying market shares quickly, offering more benefits to customer, and accomplishing the objective of return on investment.
In short, Augustine could dominate this market by offering a low-priced blower unit; also, it will be easier for the company to achieve adequate rate of return and profit maximization in the long run. We consider the major profit should come from the disposable blanket because the blower unit is a durable product but the blanket is a disposable product. More the heater/blower sold the more blanket volume will sold because per machine consumes 1,000 units of blanket per year. In the other words, there will be no disposable blanket market if the company does not sell heater/blower. From Exhibit 2, we can evaluate that the potential markets for heater/blower were only 2,737 units per year which is limited. So, the company must apply low price strategy to seize the market quickly.
Since the blanket has patented protection, we charge this product with higher price. Therefore, there is only $4 different between alternative A and B. Also, once the company can successful gain the market share by low-priced blower units, they can also have greater market position in the blanket market. Physicians and nurses were very receptive to the notion of using the blower unit free of charge and only paying for the disposable blankets. Thus, the Bair Hugger System will be the lowest product if the hospitals do not need to pay for blankets.
The heater/blower will be sold same as its variable cost at $380 per unit, and the disposable blanket will be sold at $16 each for retail price. The company needs only gain 2.76% (76 machines/ 2,746 total machine) market share by selling 76 units of heater/blower and 75,267 blankets to achieve 30 percent ROI in 1988 (Exhibit 5). The volume at the break-even point is around 57,900 blankets and 58 heaters/blowers. Let us also assume the same sales volume, 76 units in the second year, the company can have 2,460,880 revenue, which is greater than alternative A although we charge the blower unit by its variable cost. From this situation, we know the profit can be most easily earned from disposable blanket. Therefore, the Augustine Medical, Inc. still has good opportunity to gain profit if it can sell more heaters/blowers in order to increase its volume of disposable blanket.
Planning and Development
For the purpose of this case, the most important pricing objectives are pricing to achieve a target return on investment, pricing to achieve a target market share, and pricing to prevent competition. Augustine Medical Inc. should apply the penetration-pricing strategy to increase heaters/blowers market share.
1. Keeping the market share in the heater/blower market is an important factor because the hospitals have to purchase its patented blankets once hospitals accept the company s heaters/blowers.
2. Even if Augustine Medical Inc. is selling the heaters/blowers under its variable cost, it is possible for the company to gain enough profit from selling blankets. If the market is very competitive, it is necessary to promote free charge for heaters/blowers.
3. Promotion is another important factor for the company s development in the future. Customers want to test the warming system before they purchase it. The company should satisfy the consumer s needs in a way to show them the operation of the system, and explain the benefits they will receive from the product. The company may provide guarantees such as maintaining the system frequently.
4. After the company dominates the market, it is possible to increase the blanket s price for only $.50 or $1 per unit that will increase lots of profits.
5. Do more research and develop on the different products for different kinds of patients.
Conclusion
In this case, it is more complex to price a product line, which consists of two products. Basically, they are complementary products, and their price should go together. But based on our analysis, we decided to price the blower unit at a low price, whereas the blanket has a high price. The reason is not only does the blanket have patented protection but also the blanket can continue to create profits. Also, the price of the blower unit will influence the market share because this is a price-sensitive market. Indeed, pricing decisions determine the type of customers and competitors an organization will attract.
We are wondering why this market did not become dominated by technology, whereas the warmed hospital blankets are the most commonly used because of low cost. If this market prefers technological products, the skimming pricing strategy may have more advantages for this company. Unfortunately, the factor of price sensitivity still dominates our price decision.
In conclusion, when a company introduces a new product into the price-sensitive market, the competitors are expected to move in the market quickly. It is better for the company to apply penetration-pricing strategy, in order to obtain a large market share in a short period and also discourage competitors who plan on entering the market.