{"id":4484,"date":"2016-02-13T01:22:31","date_gmt":"2016-02-13T01:22:31","guid":{"rendered":"https:\/\/courses.candelalearning.com\/marketingxwaymakerxspring2016\/?post_type=chapter&p=4484"},"modified":"2016-02-18T18:21:35","modified_gmt":"2016-02-18T18:21:35","slug":"reading-break-even-pricing","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/clinton-marketing\/chapter\/reading-break-even-pricing\/","title":{"raw":"Reading: Break-Even Pricing","rendered":"Reading: Break-Even Pricing"},"content":{"raw":"

Introduction<\/h2>\r\nRegardless of the pricing strategy a company ultimately selects, it is important to do a break-even analysis beforehand. Marketers need to understand break-even analysis because it helps them choose the best pricing strategy and make smart decisions about the short- and long-term profitability of the product.\r\n\r\nThe break-even price is the price that will produce enough revenue to cover all costs at a given level of production. At the break-even point, there is neither profit nor loss. A company may choose to price its product below the break-even point, but we'll discuss the different pricing strategies that might favor this option later in the module.\r\n

Understanding Breakeven<\/h2>\r\n\"Balls<\/a>\r\n\r\nLet's begin with a very simple calculation of breakeven and build from there.\r\n\r\nImagine that you decide to hold\u00a0a bake sale and sell cookies in the student union as a social event for students. You don't want to lose money on the cookies, but you are not trying\u00a0to make a profit or even cover your time. You spend a very convenient $24 on groceries and bake 4 dozen cookies (48 cookies). What is your break-even price for the cookies? It's the total cost divided by the number of cookies that you expect to sell, represented by the formula below:\r\n\r\nBreak-Even Price = Costs \/ Units \u00a0<\/strong>\r\n\r\nSo, it\u00a0would be $24 \/ 48 = $.50, or 50 cents per cookie. What if you sell only 40 cookies? The calculation would be $24 \/ 40 = $.60. Your break-even price goes up if you sell fewer cookies.\r\n\r\nOne challenge\u00a0of calculating breakeven is that all of the variables can change, and some are unknown. For instance, it may be impossible to know\u00a0exactly the quantity that you will sell. For that reason, companies often calculate the break-even quantity<\/em> rather than the break-even price<\/em>. Focusing on quantity\u00a0enables\u00a0the marketer to answer the following question: \"Given this set of costs and this\u00a0price, how many products must I sell to break even?\" The break-even quantity is shown by the following formula:\r\n\r\nBreak-Even Quantity (in terms of units) = Costs \/ Price\u00a0<\/strong>\r\n\r\nIn our cookie example, once you have spent $24 on groceries, you know your cost. What if you plan\u00a0to sell the cookies for\u00a0$1 apiece? According to\u00a0the equation above, units = cost \/ price, so in our case, units = $24 \/ $1, or 24 cookies.\r\n\r\nOf course this is a very simple example, but it gives you a sense of why breakeven matters, and how you would calculate it.\r\n\r\n[caption id=\"attachment_5289\" align=\"aligncenter\" width=\"502\"]\"A<\/a> Helen, the baker. She also makes capes.[\/caption]\r\n

Including Fixed and Variable Costs<\/h3>\r\nLet's add one more complication to make\u00a0our example a little more realistic and interesting. Your cookies have been such a hit that you decide to sell them more broadly. In fact, you rent a commercial kitchen space and hire an experienced baker named Helen\u00a0to do the baking. Your break-even point just went up dramatically. Now you need to cover the costs of your kitchen and an employee. For the sake of this exercise, let's assume that Helen\u00a0works a set number of hours every week\u201420 hours\u2014and that you pay her\u00a0$20 per hour including all taxes and benefits. You rent the kitchen for $100 per week, and that\u00a0price includes all the equipment and utilities. Those are costs that are not going to change no matter how many cookies you sell. If you baked nothing, you would still need to pay $100 per week in rent and $400 per week in wages. Those are your fixed costs. Fixed costs<\/em> do not change as the level of production goes up or down. Your fixed costs are $500 per week.\r\n\r\nNow you need to buy ingredients\u00a0for\u00a0the cookies. Once you add up\u00a0the food costs of making a single large batch of cookies, you find that it's a total of $7.20 for a batch of 12 dozen (144) cookies. If you divide that out, you can tell\u00a0that each cookie costs $.05 in food costs ($7.20 \/ 144 cookies = $.05). In other words,\u00a0every cookie you sell is going to have a variable cost of $.05.\u00a0Variable costs\u00a0<\/em>do change as production is increased or decreased.\r\n\r\nAdding these different types of costs makes the break-even equation more complicated, as shown below:\r\n

pn = Vn + FC<\/strong><\/p>\r\np = price<\/strong>\r\n\r\nn = number of units sold<\/strong>\r\n\r\nV = variable cost per unit<\/strong>\r\n\r\nFC = fixed costs<\/strong>\r\n\r\nWith this\u00a0equation we can calculate either the break-even price or the break-even quantity.\r\n

Calculating Break-Even\u00a0Price<\/h3>\r\nChances are good that you can only bake a certain number of cookies each week\u2014let's say it's 2,500 cookies\u2014so, based on that information, you can\u00a0calculate\u00a0the\u00a0break-even price. The formula to do that is the following:\r\n

p = (Vn + FC) \/ n<\/strong><\/p>\r\nn = 2,500\r\n\r\nV = $.05\r\n\r\nFC = $500\r\n\r\nTherefore, p = (($.05 x 2,500) \u00a0+ $500) \/ 2,500\r\n\r\np = ($125 + $500) \/ 2,500\r\n\r\np = $.25\r\n\r\nYour break-even price for your cookies is 25 cents. That doesn't mean it's the right market price for the cookies; nor does it mean that you can definitely sell 2,500 cookies at whatever price you choose. It simply gives you good information about the price and quantity at which you will\u00a0cover all your costs.\r\n

Calculating Break-Even Quantity<\/h3>\r\nNow let's assume that you have set your price and you need to know\u00a0your break-even quantity. You are an exceptional marketing student, so you have talked to the people who are likely buyers for your cookies, and you understand what price is a bargain and what price is too expensive. You have compared the price with competitor prices. And, you have considered the price of your cookie compared\u00a0to the price of doughnuts and ice cream (both are \"substitutes\" for your product). All of this analysis has led you to set a price of $2 per cookie, but you want to make sure that you don't lose money on your\u00a0business: You need to calculate the break-even quantity. The formula to do that\u00a0is the following:\r\n

n =\u00a0FC \/( p - V)<\/strong><\/p>\r\nUsing the same inputs for the variables, your\u00a0equation looks like this: n = $500 \/ ($2 - $.05)\r\n\r\nn = $500 \/ $1.95\r\n\r\nn = 256.41 cookies\r\n\r\nSo, let's round up and just call the\u00a0break-even quantity 257 cookies. Does that mean that you keep the full $2 as profit for every cookie after 257? Sadly, no. First, you have to cover the variable cost for each\u00a0cookie ($.05 per cookie), which means\u00a0you make\u00a0just $1.95 per cookie you sell (after you've surpassed the\u00a0break-even point).\u00a0Second,\u00a0our simple break-even example did not include all<\/em>\u00a0of the costs. After\u00a0you've locked down the product costs and the pricing, you will need to invest in promotion and distribution of the cookies. You'll also probably want to cover your time (i.e., pay yourself) and add some profit into the total fixed costs. For instance, if you wanted to earn a profit of $600 each week, then you would need to add that to the\u00a0$500 fixed costs of\u00a0the kitchen and Helen.\r\n

Breakeven in the Marketing Strategy<\/h2>\r\nNow that we have a cost example, it's a little easier to think about the pricing objectives. If you decided\u00a0to price your cookies with a profit orientation, then you would simply add a profit ($1 per cookie, say,) to the break-even price. That approach doesn't\u00a0take the customer into account at all, though, since a profit orientation is only about the business.\r\n\r\nWhat if you found that your campus stores and vending machines sell a national chain of cookies for 75 cents? Using a competitor-oriented pricing approach, you might decide to\u00a0match that price and compete on that basis. The drawback is that this approach does not take into account the value your customers find\u00a0in a fresh, local product\u2014i.e., your<\/em> cookies\u2014made from high-quality ingredients.\r\n\r\nA customer-oriented pricing approach allows you to treat\u00a0the break-even data as one input to your pricing, but it goes beyond that\u00a0to bring your customers' perceptions and the full value of your product into the pricing evaluation.","rendered":"

Introduction<\/h2>\n

Regardless of the pricing strategy a company ultimately selects, it is important to do a break-even analysis beforehand. Marketers need to understand break-even analysis because it helps them choose the best pricing strategy and make smart decisions about the short- and long-term profitability of the product.<\/p>\n

The break-even price is the price that will produce enough revenue to cover all costs at a given level of production. At the break-even point, there is neither profit nor loss. A company may choose to price its product below the break-even point, but we’ll discuss the different pricing strategies that might favor this option later in the module.<\/p>\n

Understanding Breakeven<\/h2>\n

\"Balls<\/a><\/p>\n

Let’s begin with a very simple calculation of breakeven and build from there.<\/p>\n

Imagine that you decide to hold\u00a0a bake sale and sell cookies in the student union as a social event for students. You don’t want to lose money on the cookies, but you are not trying\u00a0to make a profit or even cover your time. You spend a very convenient $24 on groceries and bake 4 dozen cookies (48 cookies). What is your break-even price for the cookies? It’s the total cost divided by the number of cookies that you expect to sell, represented by the formula below:<\/p>\n

Break-Even Price = Costs \/ Units \u00a0<\/strong><\/p>\n

So, it\u00a0would be $24 \/ 48 = $.50, or 50 cents per cookie. What if you sell only 40 cookies? The calculation would be $24 \/ 40 = $.60. Your break-even price goes up if you sell fewer cookies.<\/p>\n

One challenge\u00a0of calculating breakeven is that all of the variables can change, and some are unknown. For instance, it may be impossible to know\u00a0exactly the quantity that you will sell. For that reason, companies often calculate the break-even quantity<\/em> rather than the break-even price<\/em>. Focusing on quantity\u00a0enables\u00a0the marketer to answer the following question: “Given this set of costs and this\u00a0price, how many products must I sell to break even?” The break-even quantity is shown by the following formula:<\/p>\n

Break-Even Quantity (in terms of units) = Costs \/ Price\u00a0<\/strong><\/p>\n

In our cookie example, once you have spent $24 on groceries, you know your cost. What if you plan\u00a0to sell the cookies for\u00a0$1 apiece? According to\u00a0the equation above, units = cost \/ price, so in our case, units = $24 \/ $1, or 24 cookies.<\/p>\n

Of course this is a very simple example, but it gives you a sense of why breakeven matters, and how you would calculate it.<\/p>\n

\"A<\/a><\/p>\n

Helen, the baker. She also makes capes.<\/p>\n<\/div>\n

Including Fixed and Variable Costs<\/h3>\n

Let’s add one more complication to make\u00a0our example a little more realistic and interesting. Your cookies have been such a hit that you decide to sell them more broadly. In fact, you rent a commercial kitchen space and hire an experienced baker named Helen\u00a0to do the baking. Your break-even point just went up dramatically. Now you need to cover the costs of your kitchen and an employee. For the sake of this exercise, let’s assume that Helen\u00a0works a set number of hours every week\u201420 hours\u2014and that you pay her\u00a0$20 per hour including all taxes and benefits. You rent the kitchen for $100 per week, and that\u00a0price includes all the equipment and utilities. Those are costs that are not going to change no matter how many cookies you sell. If you baked nothing, you would still need to pay $100 per week in rent and $400 per week in wages. Those are your fixed costs. Fixed costs<\/em> do not change as the level of production goes up or down. Your fixed costs are $500 per week.<\/p>\n

Now you need to buy ingredients\u00a0for\u00a0the cookies. Once you add up\u00a0the food costs of making a single large batch of cookies, you find that it’s a total of $7.20 for a batch of 12 dozen (144) cookies. If you divide that out, you can tell\u00a0that each cookie costs $.05 in food costs ($7.20 \/ 144 cookies = $.05). In other words,\u00a0every cookie you sell is going to have a variable cost of $.05.\u00a0Variable costs\u00a0<\/em>do change as production is increased or decreased.<\/p>\n

Adding these different types of costs makes the break-even equation more complicated, as shown below:<\/p>\n

pn = Vn + FC<\/strong><\/p>\n

p = price<\/strong><\/p>\n

n = number of units sold<\/strong><\/p>\n

V = variable cost per unit<\/strong><\/p>\n

FC = fixed costs<\/strong><\/p>\n

With this\u00a0equation we can calculate either the break-even price or the break-even quantity.<\/p>\n

Calculating Break-Even\u00a0Price<\/h3>\n

Chances are good that you can only bake a certain number of cookies each week\u2014let’s say it’s 2,500 cookies\u2014so, based on that information, you can\u00a0calculate\u00a0the\u00a0break-even price. The formula to do that is the following:<\/p>\n

p = (Vn + FC) \/ n<\/strong><\/p>\n

n = 2,500<\/p>\n

V = $.05<\/p>\n

FC = $500<\/p>\n

Therefore, p = (($.05 x 2,500) \u00a0+ $500) \/ 2,500<\/p>\n

p = ($125 + $500) \/ 2,500<\/p>\n

p = $.25<\/p>\n

Your break-even price for your cookies is 25 cents. That doesn’t mean it’s the right market price for the cookies; nor does it mean that you can definitely sell 2,500 cookies at whatever price you choose. It simply gives you good information about the price and quantity at which you will\u00a0cover all your costs.<\/p>\n

Calculating Break-Even Quantity<\/h3>\n

Now let’s assume that you have set your price and you need to know\u00a0your break-even quantity. You are an exceptional marketing student, so you have talked to the people who are likely buyers for your cookies, and you understand what price is a bargain and what price is too expensive. You have compared the price with competitor prices. And, you have considered the price of your cookie compared\u00a0to the price of doughnuts and ice cream (both are “substitutes” for your product). All of this analysis has led you to set a price of $2 per cookie, but you want to make sure that you don’t lose money on your\u00a0business: You need to calculate the break-even quantity. The formula to do that\u00a0is the following:<\/p>\n

n =\u00a0FC \/( p – V)<\/strong><\/p>\n

Using the same inputs for the variables, your\u00a0equation looks like this: n = $500 \/ ($2 – $.05)<\/p>\n

n = $500 \/ $1.95<\/p>\n

n = 256.41 cookies<\/p>\n

So, let’s round up and just call the\u00a0break-even quantity 257 cookies. Does that mean that you keep the full $2 as profit for every cookie after 257? Sadly, no. First, you have to cover the variable cost for each\u00a0cookie ($.05 per cookie), which means\u00a0you make\u00a0just $1.95 per cookie you sell (after you’ve surpassed the\u00a0break-even point).\u00a0Second,\u00a0our simple break-even example did not include all<\/em>\u00a0of the costs. After\u00a0you’ve locked down the product costs and the pricing, you will need to invest in promotion and distribution of the cookies. You’ll also probably want to cover your time (i.e., pay yourself) and add some profit into the total fixed costs. For instance, if you wanted to earn a profit of $600 each week, then you would need to add that to the\u00a0$500 fixed costs of\u00a0the kitchen and Helen.<\/p>\n

Breakeven in the Marketing Strategy<\/h2>\n

Now that we have a cost example, it’s a little easier to think about the pricing objectives. If you decided\u00a0to price your cookies with a profit orientation, then you would simply add a profit ($1 per cookie, say,) to the break-even price. That approach doesn’t\u00a0take the customer into account at all, though, since a profit orientation is only about the business.<\/p>\n

What if you found that your campus stores and vending machines sell a national chain of cookies for 75 cents? Using a competitor-oriented pricing approach, you might decide to\u00a0match that price and compete on that basis. The drawback is that this approach does not take into account the value your customers find\u00a0in a fresh, local product\u2014i.e., your<\/em> cookies\u2014made from high-quality ingredients.<\/p>\n

A customer-oriented pricing approach allows you to treat\u00a0the break-even data as one input to your pricing, but it goes beyond that\u00a0to bring your customers’ perceptions and the full value of your product into the pricing evaluation.<\/p>\n\n\t\t\t

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Candela Citations<\/h3>\n\t\t\t\t\t
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CC licensed content, Original<\/div>