Transcript Chapter 18

Chapter 18
Price Setting in the Business World
How are prices set by business
people?
• Costs provide a price floor.
• See what substitute products are priced at
• Can you offer something of additional value
that people will pay a price premium for?
• Use this information and market responses
to set your prices.
• Remember, price increases & decreases
have a direct impact on unit profits
Markup Pricing
• Markup - a dollar amount added to the cost
of products to get a selling price (638)
• Many retailers apply a standard markup to
everything they sell.
• However, with modern data information
price setting is changing to more of a
market response method for many firms.
Markup Formulas
• Markup On Selling Price =
– (Selling Price - Cost) / Selling Price
• Markup on Cost =
– (Selling Price - Cost)/ Cost
Markup Conversions
• Percent Markup On Selling Price =
– (Percent Markup on Cost)
– (100% + % Markup on Cost)
• Percent Markup on Cost =
– (Percent Markup on Selling Price)
– (100% - % Markup on Selling Price)
Markup Example 1
• Your cost is $20 each and your selling price
is $25. What is your markup on selling
price and your markup on cost?
Answer 1
• Markup on selling price =
– ($25 - $20) / $25 = 20%
• Markup on cost =
– ($25 - $20) / $20 = 25%
Markup Example 2
• Your cost is $100 each and your selling
price is $130. What is your markup on
selling price and your markup on cost?
Answer for # 2
• Markup on selling price =
– (130 - 100) / 130 = 23.08%
• Markup on cost =
– (130 - 100) / 100 = 30%
Markup Example 3
• Your cost is $50 each and your selling price
is $70. What is your markup on selling
price and your markup on cost?
Answer to #3
• Markup on selling price =
– (70 - 50) /70 = 28.57%
• Markup on cost =
– (70 - 50) / 50 = 40%
Markup Example #4
• A] You have a 30% markup on selling price.
What would this be if it was a markup on
cost?
• B] You have a 20% markup on cost. What
would this be if it was a markup on selling
price?
Answer # 4
• A] 30 / (100 - 30) = 42.86%
• B] 20 / (100 + 20) = 16.67%
Stockturns
• Stockturn rate (498)
• Stockturn rate =
– (sales in units) / (avg. inventory in units)
• Faster stockturn rates lower inventory
holding costs. What is a “high” or “low”
stockturn rate depends on the industry.
Average Cost Pricing
• Average Cost Pricing (490)
• Problems:
– does not consider cost changes at different
output levels.
– Does not consider the impact price has on
quantity demanded
Average Cost Pricing Is Common and Can Be Dangerous (E: 18-3)
Cost Relations (Exhibit 18-4)
Break Even Analysis
• Break - even analysis (505)
• Break - even point (505)
• BEP (in units) =
– (Total Fixed Cost) / (Fixed Cost Contribution
per Unit)
Break-Even Analysis (Exhibit 18-8)
Break Even #1
• Your fixed costs are $100,000, your variable
cost per unit = $15 and your unit price =
$40. What is the break-even quantity?
• If you sell 3000 units, what is the profit?
• If you sell 6000 units, what is the profit?
Answer #1
• Break-even Quantity =
– (100,000) / (40-15) = 4,000 units
• At 3000 units?
– 3,000 ($40 - 15) - $100,000 = $25,000 loss
• At 6000 units?
• 6000 ( 40 - 15) - $100,000 = $50,000 profit
Break-even #2
• Your fixed costs are $25,000, your variable
cost per unit = $5, and your unit price =
$15. What is the break-even quantity?
• If you sell 1000 units what is the profit?
• If you sell 3000 units, what is the profit?
Answer #2
• Break-even
– ($25,000) / ($15 - 5) = 2,500 units
• For 1000 units:
– 1000 ($15 - 5) - $25,000 = -$15,000
• For 3000 units:
– (3000 ($15 - 5) - $25,000 = $5,000
Break-Even #3
• Your fixed costs are $500,000, your
variable cost per unit = $2.50, and your unit
price is $10. What is the break-even
quantity?
• If you sell 50,000 units what is the profit?
• If you sell 80,000 units, what is the profit?
Answer #3
• Break-Even
– ($500,000) / ($10 - 2.5) = 66,667 units
• For 50,000 units
– 50,000 ($10 - 2.5) - $500,000 = $125,000 loss
• For 80,000 units
– 80,000 ($10 - 2.5) - $500,000 = $100,000
BE & ROI
• A target profit amount can be added to
break even analysis to give the quantity
needed to hit a certain profit goal. The
target profit amount is added to the fixed
costs in the equation.
BE & ROI Problem
• Take the last example. Our goal is now a
10% ROI. What is the quantity needed to
hit this ROI target?
BE ROI Answer
• Our new “fixed costs” are
• $500,000 & the profit goal.
– $500,000 + (500,000 x 0.1) = $550,000
• Break even for this ROI level is
• $550,000 / ($10 - 2.50) = 73,334 units
Break Even
• Calculating BEP at several possible prices
and forecasting the probable demand at
those price points can be helpful.
• BE Analysis is also a good illustration of
why managers constantly look for ways to
cut costs. Cost cuts means you can achieve
profitability at much lower sales levels.
Problems with BE Analysis
• Break-even analysis has two big
assumptions
• 1] There is a horizontal demand curve
• 2] Cost curves do not change over the
production horizon
Competitive Bidding
• Six steps a firm should use:
• 1] Decide if the bid is worth the bid preparation
costs
• 2] Calculate the direct & indirect costs of the
contract
• 3] Estimate the probabilities of acceptance at each
of several bid levels
• 4] Calculate the expected profits at each bid level
• 5] Evaluate the process after submission