In late spring 1991, as Sig. Cesare Preve was wrestling with the issue of how what strategic moves should form the basis for Gallo's future in Argentina, he decided that an analysis of whether to cut prices to meet local competition would be useful.
Market Situation.
Preve knew that annual retail sales of rice in Argentina were about 140,000 tons, of which 85,000 were branded product. Gallo's planning department had estimated that retail market was well-represented by the following demand formula:
Q = 95,000 +65 I - 100,000 P
where
I = (average income in $ per household) = $3,000
and
P = (average market price per kg for parboiled rice) = $1.50
They did not estimate the standard error of this estimate, but believed it would be rather small. This formula also described the behavior of the specialty and parboiled segment of the market, adjusted for their segment volume levels.
Specialty rice products accounted for about 20 % -- and rising -- of the 140,000 ton total market and the majority of Gallo's sales were in this segment, particularly in the supermarket portion of this segment and in the area close to Buenos Ares. Gallo's overall share of the 140,000 tons was 17.5% by volume and 23.7% by value.
Competitive Situation.
Gallo's leading competitor, Molinas, held 10.1% of this market -- up from 8.8% a year earlier. To gain share, it priced its parboiled Maximo brand product (with 7.5% volume share and 10.3% dollar share) 12% below Gallo's parboiled Oro product which was the market leader (with 9.8% volume share and 12.5% dollar share).
Oro Cost Structure.
Gallo's existing cost structure (based on Oro) was as follows (average unit costs per kg):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proposed Action.
Sig. Preve had heard proposals from the Gallo sales department that in addition to maintaining it's "fighting brand" Noblesa Gaucho", Gallo should cut the price of Oro and its other specialty products by about 12% or 20 cents per kg to meet Molinas. This would have the immediate effect of lowering the average unit price in the market by about 10 cents -- if Molinas did not respond by reducing its prices. The sales group stated that this would "significantly increase the size of the market" and that Gallo share would increase by "at least 2% of the total market". Preve had met with the sales group to discuss these estimates. Based on these meetings he had summarized their "best estimates" of Gallo's overall market share gain as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
When Sig. Preve raised the question of whether Molinas would retaliate, the consensus was that there was a 50-50 chance of retaliation. All agreed that if Molinas did retaliate, it was highly likely -- more than 90% chance -- that Molinas will in turn cut their prices for Maximo by 1/2 as much as Gallo (10 cents per kg). If this happens, they agreed that ORO would not retaliate and the overall market price will decline an additional 5 cents per kg and again expand to reflect this lower price. But Oro will keep just 1/2 the gain in share set out above -- about 1% market share gain.
Next Steps.
Preve believed that he had effectively challenged these estimates and that the sales group had done as good a job as possible defending them. They had studied previous pricing conflicts and produced extensive analyses to back their views. He felt these were the best estimates he could get. Now he believed he should move ahead to recommend action on the proposed price cut. To help him do so, he intends to calculate sales, costs and prrofits at each step in the above process.
__________
This case was prepared by Professors Isaacson and Polutnik as the basis of class discussion. So far as we know, none of the events alluded to in this case ever actually happened.
Copyright © 1997, Professors Larry Isaacson and Lidija Polutnik