#### Transcript Chapter 9B, Pricing problems

Chapter 9b 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 • 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 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% Stockturns • Stockturn rate 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 Problems: – does not consider cost changes at different output levels. – Does not consider the impact price has on quantity demanded Break Even Analysis • Break - even analysis • Break - even point • 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 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 • $100,000 & the profit goal. – $100,000 + (100,000 x 0.1) = $110,000 • Break even for this ROI level is • $110,000 / ($40 - 15) = 4,400 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