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