A company has invented a lightbulb that lasts 50 times longer than ordinary light bulbs but only costs 50 percent more to make. What should there tail price be if regular bulbs sell for $1?
This is a brainteaser with a little bit of a strategy and economics twist. Although there are a number of reasonable answers to this problem, the interviewer is likely looking for both creativity and a sense of business. This question is good because it can be answered in varying levels of detail, depending on the candidates background and inclinations.
Candidate: If I were the company, I would charge a fortune! Maybe $50 or $100 for a bulb that lasted that long. Lets face it, soon enough someone will market a bulb that never burns out, and then theyll make the big money, so in the meantime, this company should milk customers for as much as possible.
This applicant actually isnt totally off base. Indeed, he reveals one or two small insights.Heseems to understand that an early mover can usually charge a premium for innovative products, but that subsequent producers will eventually drive the price down. However, he commits several fatal flaws. He starts spouting without really knowing; he gives an answer without any backup or analysis, and he seems to have a bad attitude. Together, or even separately, these mean that he wont be asked back for another round of interviews.
Candidate: This isnt quite as straightforward as it might seem at first. There are three different pieces Id want to consider in developing my pricing strategy.First, Id want to look at the economics of the pricing decision from the companys internal perspective. Second, Id want to consider the customers reaction to different pricing strategies. Finally, Id want to think about the likely competitive response to the product and the pricing.
The candidate is off to a good start. He has clearly set forth a framework for his answer.
Although he didnt use the C-word, his answer is taking shape as a 3C analysis (customer,
company, competition). By listing the three areas he will be analyzing, he has given himself a roadmap for the answer. Also, if the interviewer wants to jump right in on a particular angle, she can easily do so (e.g., Lets go straight to the competition. What do you think might happen?).
Candidate: Lets look at the economics of the pricing decision. Although the current market prices of the old bulb and other bulbs in the market are important reference points, they dont really tell us much about the economics for the new product. For one thing, we dont even know if the current bulb is actually priced correctly. From the companys internal perspective, its important that we know the price at which the new product is a break-even proposition. From a purely microeconomic perspective, this will happen when the product sells at a price greater than its cost of production. (Actually, the marginal revenue should be greater than the marginal cost of production.) As long as this holds true, the company is making money on each bulb sold. Knowledge of these numbers will be especially important as we start to consider the impact of competition. However, it wont tell the company how to maximize its earnings from the new product.
The candidate begins with the first point in his framework: the companys internal perspective.He chooses to talk about microeconomics (other angles are also possible). This also helps him identify and discard the information about the current bulbs pricing because its irrelevant to the point he is making here. One note of caution: in a real interview setting, its entirely possible that the interviewer will choose to pursue the angle about marginal cost/marginal revenue and really test out the candidates microeconomic knowledge. Therefore, if you do sprinkle a little theory on your answer, be prepared for the consequences!
Candidate: Fortunately for consultants, the world never quite works like it does in the textbooks. Therefore, beyond the cost structure, the company will need to understand how the consumer will react to different pricing strategies.
The company can look at pricing the lightbulb in at least two ways. First, it can price according to how much value the product gives to the consumeraptlycalled value pricing. If the new bulb lasts 50 times longer than the original bulb, it can be said that the new bulb gives 50 times more value to the consumer, with value defined in this case as light bulb longevity. If the original bulb sells for $1, then in the spirit of value pricing, the new bulb can sell for 50 times $1, or $50.This is good. The candidate continues to draw on his framework as he moves through the
This is good. The candidate continues to draw on his framework as he moves through the
answer. He explains value pricing and then goes on to state specifically what the product price would be under this strategy.
Candidate: Alternately, the company can simply look to maintain the margins it earns on the regular lightbulb, and price accordingly. In other words, if it costs 50percent more to make the new bulb, to earn the same gross margins as on the original bulb, the company would have to charge 50 percent more, or $1.50. In this way, the company could preserve a decent, if not exorbitant profit margin.
Its always a good idea to use specific examples when answering a question. In this case, the candidate mentions specific figures to give the interviewer a more visual understanding of the proposed solution and confidence in his grasp of the simple math involved.
Candidate: Now, the different pricing strategies could have very different revenue implications, depending on the price and unit sales for the product. If the company opted for the first approach, the value pricing approach, unit sales would likely decline (because of the longer lasting life of the new bulb), but overall revenues might increase (because the price per unit is so much higher). If current customers merely switched over to the new bulb, there would soon be something close to a50:1 drop in sales. (It would be slightly less than 50:1 because not all purchases are replacing bulbs that died of old age.) However, the new technology would all soundoubtedly attract new customers. As purchasers of competing old bulb technology came over, the companys market share would likely increase.
The candidate chooses to analyze the implications of one of his recommended pricing strategies.As he does here, its important to draw implications from his recommended strategies. He also demonstrates several other good things here: an understanding of a basic business relationship (price ¨ units = revenues), the importance of other factors on customer behavior (replacement and substitution), and an ability to draw some quick common-sense implications of the proposed value pricing approach. He might also have discussed customers purchasing behavior when faced with different pricing scenarios.
Candidate: I could talk about the implications of the other pricing strategy, but I want to touch briefly on the third area of analysis: competitor reactions.The appropriate pricing strategy will be greatly affected by the companysposition vis-à-vis competitors. If the new bulb is a proprietary technology and it is the first one on the market, the company will likely be able to charge a premium for its technology. There is certainly a lot of value in a bulb that will last 50 times longer. Whether customers would be willing to pay 50 times the price of the old bulb is another question. However, they would almost certainly
be willing to pay more than $1.50 for the bulb. The company would be able to continue charging a premium until its competitors came in with a response: as a ubstitute long-life product, a different pricing strategy on the old bulbs, or something of the sort.
Although the candidate chose to explain the logic behind his answer, he might also have used a few standard microeconomics graphs or charts demonstrating monopoly profits and consumer surplus. This might impress the interviewer, but more important, it might help clarify his answer. One other possible line of inquiry here would be for the interviewer to ask the candidate how he would research these questions. Good answers might involve doing customer research through surveys or focus groups. Note here that the interviewee did all the talking.This isnt likely to happenthe case is supposed to be a dialogue. But if you get a silent interviewer, dont worry. Youll be interrupted if youre way off course.