Chisomo Bakery: Matching a Supermarket Price
Chisomo Bakery operates from a rented shop in Mzuzu and sells 120 loaves a day at MK1,800 each. Its ovens can produce 200 loaves a day. Fixed costs - rent, wages and licence - are MK90,000 a day, and variable cost is MK1,000 a loaf. A supermarket chain has just opened two kilometres away and sells bread at MK1,500. Chisomo's customers are mostly low-income households who walk in for one loaf, plus twelve grocery kiosks that resell. The kiosks now say they will switch to the supermarket unless Chisomo gives them a trade discount. Chisomo has no delivery vehicle and does no advertising, but its bread is known for being baked fresh twice a day. The owner is weighing three options: cutting the price to MK1,500, giving kiosks 10 per cent off, or hiring a motorcycle for home delivery at MK15,000 a day.
1. Calculate Chisomo's current daily profit and break-even output, then evaluate whether matching the supermarket's MK1,500 price is a sound move.
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Current position. Contribution per loaf = 1,800 − 1,000 = MK800. Total contribution = 120 × 800 = MK96,000. Less fixed costs of MK90,000 leaves a profit of MK6,000 a day. Break-even = 90,000 ÷ 800 = 112.5, so 113 loaves. The bakery is operating with a cushion of only seven loaves.
At MK1,500. Contribution falls to MK500. Break-even rises to 90,000 ÷ 500 = 180 loaves. To keep the present profit of MK6,000 it would need (90,000 + 6,000) ÷ 500 = 192 loaves, a 60 per cent increase on 120. The ovens can physically make 200, so the target sits just inside capacity with no allowance for waste, a slow day or a demand shortfall.
Judgement. Matching the price turns a thin profit into a knife-edge. Demand would have to rise immediately by 60 per cent for the owner to be no worse off, and the households who buy one loaf on foot are not especially price-sensitive at that level. The supermarket buys centrally, has its own distribution and can absorb a price war far longer than a single rented shop. Cutting the price also tells the market the product is ordinary, which erodes the one real advantage Chisomo has - bread baked twice daily. The supermarket competes on convenience and range, so a price response attacks the wrong flank.
2. Recommend, with justification, how Chisomo should respond to the kiosks and to the delivery option, using the figures to support your answer.
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Kiosks. Ten per cent off is MK180 a loaf, leaving a contribution of MK620. If the twelve kiosks together take 60 loaves a day, the discount costs 60 × 180 = MK10,800 a day in lost contribution - more than the entire current daily profit - so it is only defensible if it genuinely stops them defecting. A volume discount tied to a written commitment is better: for example 5 per cent off for a standing order of eight loaves a day, reviewed monthly. Kiosks are resellers and respond to margin and reliability, not to Chisomo's freshness story, so the offer should buy loyalty cheaply and be withdrawn if volume does not appear. The owner should also ask why they are tempted: if the real issue is credit terms or delivery timing, a discount is the wrong instrument.
Delivery. The motorcycle adds MK15,000 to fixed costs, so break-even becomes (90,000 + 15,000) ÷ 800 = 132 loaves, that is 12 extra loaves a day. Delivery is worth testing only on pre-paid orders to nearby households and offices at full price, and only if 12 extra loaves a day is realistically achievable in the first month. Run a four-week trial with a simple record of extra loaves sold and full cost incurred; keep it if contribution rises and drop it if it does not.
Overall. Defend freshness and reliability, sell the second daily bake as a premium to offices and kiosks on a committed-order basis, and avoid a price war the bakery cannot fund.
3. The owner says: 'We already have the ovens, so any loaf we sell above MK1,000 is profit.' Assess this statement in the light of the decision above.
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The statement is half right and dangerously incomplete. In the very short run, with ovens idle and no other use for them, each extra loaf sold above variable cost does add MK800 to contribution and helps cover fixed costs - that is why break-even is calculated in contribution terms rather than by adding a share of rent to each loaf.
But the owner's reasoning breaks down when the price change applies to every loaf, not only the marginal ones. A cut to MK1,500 does not just earn MK500 on the extra 72 loaves needed to break even; it removes MK300 from each of the 120 loaves already being sold. That is MK36,000 a day of contribution lost on existing sales, which is why the 60 per cent volume hurdle exists. Marginal cost thinking is valid for a one-off order that would not otherwise be produced and cannot be resold into the same market; it is not valid for a general price change.
The statement also ignores opportunity cost. If the ovens are used for discounted loaves, they cannot be used for a premium bake for offices, which is the option with the better margin. And in the long run all costs, including the MK90,000 of fixed costs, must be covered or the shop closes. The correct rule is: produce where price exceeds variable cost in the short run, but choose the price and product mix that maximise total contribution, not just any positive contribution.