# Major Project

Using the Major Project Report Template (attached), write a report explaining your strategy, results, and observations from the Major Project Scenario of Universal Rental Car Pricing Simulation. Target length is 2,500 words (max 3,500) not including tables and other appendixes.

**Major Project: Step-by-Step Guidance**

Follow the materials listed below (find attached documents and links in Course Content, Period 3, Study Materials) and practice with the pricing simulation. The material is foundational to your developing and implementing a pricing strategy to maximize profits in the rental car simulation. Study and practice with these materials. Then, replicate these steps with the Major Project simulation scenario. The Major Project Report is essentially your explanation of these steps.

The Major Project will utilize two spreadsheets that don’t apply to the Scenario A (Introductory). You will use the Seasonality spreadsheet mentioned in the section below on Demand in the Orlando Rental Car Market, and you will use the elasticity spreadsheet titled *Elasticities for Major Project Scenario w Compet charging 36,32* rather than the one for the constant demand scenario (A). Both are available in Period 3 Study Materials.

**********Begin with Overview in Week 4****************

**Overview**

· *Purpose and Goals of Pricing Simulation*. **Word document** orients you to how the pricing simulation helps you learn concepts taught in the Textbook

· *Introduction to Pricing Simulation*. **Panopto** (27 min.) of simulation screens. Orients you to the pricing simulation dashboard, tabs, and decision variables (weekday and weekend prices) so you can experiment and become familiar with it.

*****************Being reviewing in Week 5*******************

**Economics of Car Rental Business in Orlando**

· *Supply and Demand in Pricing Simulation* **Panopto **(8 min.) Explains what the supply and demand curves look like in the simulation, and how to price with a vertical supply curve, making sure you don’t have unfilled orders.

· *Economics of Universal Rental Cars ***Panopto **(12 min.) Discusses each line in the Net Income tab to familiarize you with the cost structure of Universal.

· *Demand and Elasticity* **Panopto **(25 min.) explains demand concepts, such as meaning of a demand curve, difference between the Demand Curve and Quantity Demanded, what causes a demand curve to shift, price elasticity of demand as an efficient way to measure the responsiveness of Quantity demanded (Q) to changes in Price (P), how to compute price elasticity, the error of calculating elasticity (ε) with P,Q points from different demand curves, using the formula for elasticity to compute rental car price elasticity, comparing weekend vs weekday demand (magnitude & elasticity), effect of competitor price on Universal’s own-price elasticity, and limits on elasticity—infinity (horizontal demand curve & zero (vertical demand curve).

· *Addendum to Demand and Elasticity* **Panopto** (5 min.) discusses simulation screens demonstrating how to collect P,Q data from pricing simulation to estimate elasticities for two points (P=44 and 46).

· *Wkday and Wkend elasticities scenario w constant demand* **Spreadsheet** provides elasticity results for weekday & weekend over wide range of prices. Calculated from simulation scenario with constant demand. These are useful for Scenario A (Introductory). **Do not** use them for the Major Project. Instead, use* Elasticities for Major Project Scenario w Compet charging 36,32*. You must be able to explain the elasticities in the table, but you **DO NOT** need to recompute them for the Major Project. Price responsiveness of customers is measured by price elasticity of demand. How does knowing this help you as manager of Universal? Explain how to estimate price elasticity conceptually and with data from the simulation (i.e., explain how elasticities in spreadsheet were computed). Referring to spreadsheet, why do price elasticities increase (in absolute value) as rental price increases? Why is weekend demand more elastic (i.e. higher price elasticity in absolute value) than weekday demand?

· *Relationship between Price Elasticity and Revenue * **Panopto **(8 min.) explains how revenue responds to price increases when demand is inelastic (rev increases) and when demand is elastic (rev decreases). Explain how revenue changes with changes in price over the price ranges represented in elasticity spreadsheet. What are the implications for Universal’s pricing decisions?

**Demand in the Orlando Rental Car Market**

· *Estimating Background Demand in the Pricing Simulation * **Panopto** (11 min.) explains the Market Demand Tab in the pricing simulation and how to estimate background demand from it. Explain how it combines shifts in background demand with changes in quantity demanded in response to price changes. Explain how to disentangle the two.

· *Estimating Seasonality in Background Demand ***Panopto **(11 min.) explains data and calculations that show how it changed monthly from Nov-Sep. *Seasonality for Wkday and Weekend at Prices of 36 and 31* is a **Spreadsheet **you can use with your own data from the Major Project Scenario. You will then report trend (if any) and seasonality (if any). Provide plausible explanation of what might cause the observed background demand.

**Optimal price**

· *Using Contribution Margin to Find Profit Maximizing Price–* **Panopto** (22 min.) explains the steps for using contribution margin analysis to find optimal price. Full results are shown in the **Spreadsheet–** *Finding Optimal Price Using Contribution Margin*. Optimal price is the set of monthly prices (weekday and weekend) from Nov-Sep that maximize cumulative pre-tax profit for the eleven months (Nov-Sep). Optimal price occurs where MR = MC. Explain why this principle is true.

· Explain how contribution margin can increase with increasing price, even though revenues are decreasing. [Aside: In the typical discussion of MR = MC, a company increases the units it sells (by reducing the price) until the MR from raising unit sales just equals the MC of increasing production to that level. In other words, a company increases output when MR > MC. MR typically decreases as units sold increases, and MC typically increases with increasing production, until the two become equal at the profit maximizing output.] In the rental car simulation, we look at the flip side of getting to MR=MC. We raise prices in the elastic range of prices, which causes MR to decrease. If the decrease in MR is less than the decrease in MC, then contribution margin increases. When the decrease in MR = the decrease in MC, we are at the MR = MC optimal price.

· Does optimal price change from month to month? Repeat the contribution margin analysis for December to find optimal weekday and weekend prices for Dec. Explain the conditions under which the optimal price you calculated for Nov would be optimal for Dec-Sep. How would a decrease in background demand from Nov to Dec affect the price elasticity you face at the Nov optimal price? What is the implication for Dec’s optimal price? How would a change in the competitor’s price from Nov to Dec (i.e., price of a substitute) affect Universal’s price elasticity of demand in Dec at the Nov optimal price? What is the implication for Dec’s optimal price? Use your contribution margin analysis for Dec and data on changes in background demand and competitor’s price (Nov to Dec) to confirm the direction of change in optimal price (Nov to Dec) you explained theoretically, and to show the magnitude of the change in optimal price. Based on the magnitude of the change in optimal price from Nov to Dec and the data on background demand and competitor’s prices for the other months (Jan-Sep), would using Nov’s optimal price for all months be a reasonable initial approach as you test for optimal fleet size in Jan, Apr, and June? Discuss.

· *Indirect price discrimination* **Panopto **(9 min.) Explains the concept, its usefulness, and how to estimate it quantitatively. See **Spreadsheet** *Measuring Effect of Indirect Price Discrimination *for computations. What are the benefits or costs to the customer of a seller using indirect price discrimination? What conditions must be met for indirect price discrimination to work in Universal’s case? Are they met? Show and explain the data that answer that question. How much do its profits increase as a result of Universal employing indirect price discrimination? Show your work.

**************Begin reviewing in Week 6********************

**Fleet Size Decision**

· Capacity utilization—when the fleet size is fixed, the profit maximizing price often leaves a significant fraction of the fleet unrented.

· Cost of unrented cars—every car in the fleet incurs an inventory management cost, regardless of whether it is rented. (Note: unrented cars incur no $15 variable cost, because that cost occurs only when the car leaves the lot.) Inventory management costs on unrented cars can be significant. For example, if 8,000 of the 21,700 fleet sits idle (37% of the fleet), they generate no revenue, but they incur inventory management costs of about $345/month each, which is more than $2.7M per month.

· Optimal fleet size—if you know the optimal price and the number of cars that Universal will rent at that price, then you should set fleet size to that number when you have the chance. If you choose a larger fleet size, you will incur unnecessary inventory management costs. If you choose a smaller fleet size, you will incur unfilled orders, which represented wasted profits.

· MR=MC analysis with fleet size. The concept is similar to the one we used with contribution margin analysis to find optimal Nov price. We purposely raised price into the elastic range, knowing that it would cause Revenue to decrease (i.e., MR < 0), because raising price also caused MC to decrease (due to saved variable costs of $15 per car when fewer cars rented). We tested over a range of prices to find the place where MR = MC. With fleet size changes, savings in inventory management costs are analogous to the savings in the $15 variable rental cost. If we choose a fleet size smaller than “optimal” based on renting 100% of the fleet at the optimal price, we will lose revenue. However, we will also save on inventory management costs on the difference in fleet size between the “optimal” and smaller fleet size. Note: when we purposely choose a smaller fleet than “optimal” at the “optimal price”, we will raise price to “soak up” unfilled orders. There is no reason to keep the price at the old optimal price and incur unfilled orders. It is better to raise price to reduce the quantity demanded to match our smaller fleet size. Note: even though we can redeem some revenues by soaking up unfilled orders, our revenues will still be lower than they would have been at the optimal price matched with a fleet size that rented the entire fleet. However, if that decrease in revenues is less than the savings in inventory management costs, then profits will increase (MR > MC). Do a sensitivity analysis, reducing fleet size until lost revenues equal cost savings (MR = MC). That will be the optimal fleet size.

· *Fleet Size Decision: Choose Fleet Size and Prices that Maximize Profits*—**Panopto** (32 min) explains the economics of fleet size/inventory management costs and explains how to find the profit-maximizing fleet size and prices.

· *Finding Optimal Fleet Size Using Contribution Margin*—**Spreadsheet. **Accompanies the Panopto recording above, which explains the concepts and calculations in detail.

**Competitor**

· Keep monthly track of the competitor’s prices, unit sales, market share, and profits. How do they compare with Universal’s results on each measure?

· Based on your observations of the competitor, what is his strategy? Why might a competitor implement such a strategy?

· How did the competitor’s strategy affect your strategy and results? Did the low prices of the competitor influence your optimal price (i.e., If he had charged higher prices, would your optimal price have increased)? If the competitor had charged higher prices (similar to yours), what affect would that have had on your unit sales and profits?

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