At the time, there was some second guessing as to whether the price cut to
$189 made sense for the company—indeed whether the marginal revenue from
additional units sold exceeded Amazon’s marginal cost of producing the Kindle.
Amazon CEO Jeff Bezos appeared to be playing a market-share strategy, predi-
cated on establishing the Kindle as thedominant platform for e-books and count-
ing on maximizing profits from e-book sales (rather than profits from the Kindle
itself). Bezos reported that the price cut was successful in igniting Kindle sales,
claiming that the price cut to $189 had tripled the rate of sales (implying annual
sales of 3 million units at this lower price). Furthermore, it was estimated that
Amazon earned a contribution margin of $4 on each e-book and that each
Kindle sold generated the equivalent of 25 e-book sales over the Kindle’s life. In
other words, besides the marginal revenue Amazon earned for each Kindle sold,
it gained an additional MR (per Kindle) of $100 due to new e-book sales.52 Chapter 2 Optimal Decisions Using Marginal AnalysisCHECK
STATION 6a. The sales figures listed above imply that the Kindle’s (linear) inverse demand curve is
described by the equation: P $ 294 35Q. Check that the two quantity-price points
(Q 1 million at P $259 and Q 3 million at P $189) satisfy this equation.
b. The marginal cost of producing the Kindle is estimated at $126 per unit. Apply the
MR MC rule to find the output and price that maximize Kindle profits.
c. Considering that each Kindle sold generates $100 in e-book profits, determine Ama-
zon’s optimal quantity and price with respect to the totalprofit generated by Kindle
and e-book sales. What is the implication for Amazon’s pricing strategy?Conflict in Fast-Food
Franchising
RevisitedThe example that opened this chapter recounted the numerous kinds of conflicts
between fast-food parents and individual franchise operators.^6 Despite the best inten-
tions, bitter disputes have erupted from time to time at such chains as McDonald’s, Burger
King, Wendy’s, and Subway. A key source for many of these conflicts is the basic contract
arrangement between parent and individual franchisee. Virtually all such contracts call
for the franchisee to pay back to the parent a specified percentage of revenue earned. This
total royalty comprises a base percentage plus additional percentages for marketing and
advertising and rent (if the parent owns the outlet). Thus, the franchisee’s profit begins
only after this royalty (typically ranging anywhere from 5 to 20 percent depending on the
type of franchise) and all other costs have been paid.
Thus, a key source of conflict emerges. Under the contract agreement, the parent’s
monetary return depends on (indeed, is a percentage of) the revenues the franchisee
takes in. Accordingly, the parent wants the franchisee to operate so as to maximize rev-
enue. What does the pursuit of maximum revenue imply about the franchisee’s volume
of sales? Suppose the revenue and cost curves for the franchisee are configured as in
Figure 2.8a. (Ignore the numerical values and reinterpret the quantity scale as numbers(^6) Franchise conflicts are discussed in R. Gibson, “Franchisee v. Franchiser,” The Wall Street Journal
(February 14, 2011), p. R3; R. Gibson, “Burger King Franchisees Can’t Have It Their Way,” The Wall
Street Journal(January 21, 2010), p. B1; and E. Noonan, “Bad Feelings Brewing among Shop
Owners,” The Boston Globe(February 14, 2008), p. E1.
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