Difficulty: Intermediate | Prerequisites: Basic understanding of cost accounting, cost-volume-profit analysis, and pricing concepts.
This case sits at the intersection of cost accounting and pricing strategy. Sheridan Carpet Company, a market leader in high-grade automotive carpeting, faces a classic dilemma: one product line (Carpet 104) has unique, expensive production requirements that have pushed the company's prices well above competitors. The case asks you to evaluate whether Sheridan should hold, raise, or cut its price, and what cost and market factors should inform that decision.
You should already be comfortable with the idea that costs drive pricing floors, that market structure affects pricing power, and that a firm's competitive position shapes how much latitude it has on price. If those concepts are fuzzy, revisit your notes on cost behaviour and market structure first.
Sheridan Carpet is the largest player in automotive carpeting but charges $5.20 per unit while competitors sit at $3.90, because one product (Carpet 104) requires dedicated, costly equipment. The company must decide whether to hold the premium price and rely on customer loyalty, or cut the price to protect volume, all while funding future capital expenditure.
Price leader / price leadership
The practice where the dominant firm in a market sets its price first, and smaller competitors follow. In this case, Sheridan announces its price before rivals because of its market size.
In simple terms, the biggest company goes first and everyone else adjusts around it.
Dedicated equipment / specialised production
Machinery or tooling that can only be used to produce one specific product and cannot be shared across other product lines. Carpet 104 runs on equipment that is useless for Sheridan's other carpets.
Think of it as a machine that does one job and nothing else, so its cost sits entirely on that one product.
Cost-plus pricing
A pricing method where the selling price is set by calculating the full cost of production and adding a margin. Sheridan's price of $5.20 reflects the higher costs driven by Carpet 104's specialised process.
In simple terms, you add up what it costs to make, then add your profit on top.
Price elasticity of demand (implied)
The degree to which customer purchasing behaviour changes in response to a price change. Sheridan fears that the gap between $5.20 and the competitors' $3.90 will erode sales volume over time.
Think of it as how sensitive your buyers are to price differences.
Customer loyalty / brand stickiness
The tendency of existing customers to continue buying from a supplier despite price differences, often due to quality, relationship, or switching costs. Sheridan believes its loyal base will absorb the premium.
Capital expenditure (CapEx)
Spending on long-lived assets such as new equipment or plant expansion. Even though Sheridan is financially stable, it needs to fund significant CapEx in the near term, which constrains its pricing flexibility.
Sheridan Carpet Company produced high-grade carpeting for automobiles and recreational vans
Customers were finishers: captive operations of major auto assembly divisions building custom vans or premium cars
Largest company in its segment, with sales exceeding $40 million (1981)
Salespeople earned salaries and sold the entire product line
As market leader, Sheridan typically announced prices before competitors
Industry norm: prices announced every six months unless production circumstances changed
Carpet 104 had a unique material composition requiring a dedicated, specialised machine
That equipment could not be repurposed for any of Sheridan's other carpet lines
The dedicated production process made Carpet 104 significantly more expensive to manufacture
This cost pressure forced Sheridan's overall price upward to $5.20 per unit
Competitors held steady at $3.90 per unit, creating a $1.30 gap
Sheridan was financially stable at the time of the case
However, substantial capital was needed in the near term for equipment replacement and plant expansion
This need for CapEx limited how aggressively Sheridan could cut prices or absorb margin compression
The $1.30 price gap risked gradually eroding Sheridan's sales volume
Management believed its loyal customer base would tolerate the premium
Two unresolved questions before any price decision:
Would competitors match a Sheridan price cut? (Believed unlikely, as competitors were in weaker financial condition)
Would a price change on Carpet 104 spill over into sales of Sheridan's other carpet lines?
Hold the $5.20 price in the short term, relying on customer loyalty
Investigate whether production costs for Carpet 104 can be reduced
If costs can come down, then consider a price cut to recapture volume
Estimate required production volumes to assess the break-even impact of any price change
This case mirrors the pricing tension any manufacturer faces when one product line drives up average costs across the business. Automotive suppliers today deal with exactly this when a bespoke part (say, a component for a low-volume luxury model) requires tooling that sits idle for the rest of the product range. The question of whether to cross-subsidise, spin off the expensive line, or renegotiate with the customer is a live one in supply-chain management across industries.
Students often assume Sheridan should simply match the competitors' $3.90 price. This ignores that Carpet 104's production costs may make $3.90 unprofitable, and that a price cut from the market leader could trigger a price war nobody can afford.
Students sometimes treat customer loyalty as a permanent shield. Loyalty erodes over time when the price gap is large enough; it buys time, not immunity.
It is tempting to view the pricing decision in isolation. In reality, changing the price of one product in a line can cannibalise or boost sales of other products in the same range.
Some students overlook the CapEx constraint. A price cut that sacrifices margin may leave Sheridan unable to fund the equipment replacements it needs, creating a longer-term strategic problem.
⚠️ Be prepared to calculate or discuss the break-even volume at different price points. If Sheridan cuts to $3.90, how many more units does it need to sell to maintain the same contribution margin?
⚠️ Expect questions on cross-subsidisation: when one product's costs inflate the price of the entire line, how should management allocate costs and set prices per product?
⚠️ The competitor response question is a classic game-theory setup. If competitors are financially weak, a Sheridan price cut might not be matched, giving Sheridan a temporary volume advantage. But if competitors do match, everyone loses margin.
⚠️ Understand the tension between short-term pricing and long-term capital needs. An exam might ask you to weigh immediate volume gains against the ability to fund future investment.
True or False: Sheridan's competitors were in strong financial condition and likely to match any price cut. ______
Carpet 104 required specialised equipment that could also be used for Sheridan's other product lines. True or False? ______
Fill in the blank: Sheridan's price was $______ per unit, while competitors charged $______ per unit.
True or False: Sheridan was the smallest company in its market segment. ______
Fill in the blank: The two factors the chief accountant and marketing director wanted to resolve before setting a new price were competitor ______ and the effect on sales of ______ products.
Q: Why has Sheridan's price risen to $5.20 while competitors remain at $3.90?
A: Carpet 104 requires a dedicated, specialised machine that cannot produce any of Sheridan's other carpets. The high cost of this unique production process has forced the company to raise its overall price to cover the additional manufacturing expense.
Q: What are the two key uncertainties Sheridan's management wanted resolved before making a pricing decision?
A: First, whether competitors would follow with their own price decrease if Sheridan cut its price. Second, whether a price change on Carpet 104 would affect the sales of Sheridan's other carpet products.
Q: Why were competitors unlikely to match a Sheridan price cut?
A: The competitors were believed to be in weaker financial condition than Sheridan, meaning they likely lacked the resources to absorb lower margins from a price reduction.
Q: What strategic risk does a price cut pose for Sheridan beyond immediate margin loss?
A: Sheridan needs substantial capital in the near term for equipment replacement and plant expansion. Cutting price would compress margins and could leave the company unable to fund these critical investments, undermining its long-term competitive position.
Q: Outline a more analytical approach Sheridan could take before deciding on a price change.
A: Sheridan could examine the full production process for Carpet 104 to identify cost reduction opportunities. If unit costs can be lowered, a price cut becomes more viable without sacrificing needed margin. The company should also estimate the volume increase needed at a lower price to at least maintain total contribution, effectively running a break-even or CVP analysis at different price points.
This case connects directly to cost-volume-profit (CVP) analysis. Any recommendation to cut or hold price should be backed by a break-even calculation showing how volume must change to compensate for a different margin.
It also ties into product costing and cost allocation. How Sheridan allocates the dedicated equipment cost of Carpet 104 across its product line determines how each product's profitability appears, and whether Carpet 104 looks like a drag on the whole business or simply an expensive standalone line.
Finally, the competitor-response question is an entry point to game theory in pricing, which comes up in strategy and microeconomics courses. The idea that financially weak competitors may not retaliate is a form of strategic reasoning about rivals' capacity to respond.
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