Two key factors determine the price of an item: – the cost of doing business – the profit the company wants to make Simple formula: Price = Cost of Doing Business + Profit DETERMINING THE PRICE
The HMV Scenario HMV charges $24.99 for a Blu-ray Expectations: – HMV expects customers to pay $24.99 plus taxes to own the Blu-ray – Customers expect to pay $24.99 plus taxes to own the Blu-ray, since most cost that amount – HMV paid less than $24.99 for the Blu-ray, added an amount to get to that figure – markup – HMV gets to keep the money left after all expenses have been paid – profit DETERMINING THE PRICE
The HMV Scenario cont’d HMV charges $24.99 for a Blu-ray Expectations cont’d: – The Blu-ray costs the manufacturer less to make than what they charge HMV – The manufacturer uses that money to pay for the factory, materials, salaries… – Money left over is theirs to keep (profit) – The makers of the materials used in the Blu-ray production sell items for more than they cost …and so on… DETERMINING THE PRICE
Important Terms MARKUP A percentage of the cost of an item added to cover expenses and make a profit Example: If a blu-ray costs the customer $30, and costs HMV $20, the markup is then 50%: markup 10 –––––– = ––– = 50% cost to retailer 20 cost to customer > $30 DETERMINING THE PRICE
Important Terms cont’d… MARGIN The percentage of the price charged for the item which is not used to pay for the cost of the item Example: for a $20 item, if customer pays $30 there is a $10 markup and the margin would be: markup $10 ––––––––– = ––– = 33.3% selling price $30 DETERMINING THE PRICE
Important Terms cont’d GROSS PROFIT Money left over after all “variable costs” have been paid. business gross profit = markup - expenses DETERMINING THE PRICE
Wal*mart / Skittles Markup Example $0.20 +.11 $0.34 Expenses = $0.11 Markup = $0.20 Store Cost = $0.34 Markup as % = = 91% DETERMINING THE PRICE
Wal*mart / Skittles Margin Example Therefore, every time Wal*Mart sells Skittles it makes a 48% profit margin DETERMINING THE PRICE
Breakeven Analysis How many units must be sold at a given price to cover all operating costs? Three parts to break-even analysis: 1.Variable Costs: Costs that depend on the quantity of products or services sold. 2.Fixed Costs: Costs that are constant. Do not depend on # of sales and remain the same for long periods of time (rent, salaries, utilities, etc) 3.Gross Profit: The selling price minus the variable costs (money left over after variable costs have been paid)
Breakeven Analysis Gross Profit Ice Cap Example Selling Price = $1.49 Variable Cost = $0.35 GP = Selling Price - VC Therefore, $1.14 of Gross Profit is made with every sale of an Iced Cap
Breakeven Analysis Break-Even Point: BEP is the # of units that must be sold at a given price to cover all operating costs BEP = Fixed Costs Gross Profit
Breakeven Analysis The BEP for just Ice Caps is hard to calculate because Tim Horton’s sells many other items ( Bagels, donuts, coffee, etc), however, lets say a typical Tim’s has a fixed cost of $57 on Ice Cap sales per day: $57 (Fixed Costs) = 50 (BEP) $1.14 (Gross Profit) Tim’s must sell 50 Ice Caps per day to reach the BEP.
Breakeven Analysis Subway Pricing and BEP Example Subway has the following costs for a “Footlong” assorted sub it sells: Bread= $0.27 Meat= $1.08 Toppings = $0.20 Expenses= $1.05 (includes all other VC ) Subway wants to make $2.40 per sub. What should the price be? $5.00 Duh…!
Breakeven Analysis What is subway’s cost of a footlong? (.27+1.08+.20)= $1.55 What is the margin? (1.05+2.40)/5= 69% [ Margin = Markup + Expenses / Selling Price ] Total Variable costs? 1.55+1.05=$2.60 What is the markup? $3.45 As a percentage: (2.40+1.05)/1.55= 222% [ cost of an item added to cover expenses and make a profit / base cost of item ] What is the gross profit? 5 – 2.60 = 2.40 The Numbers: Base Costs: Bread= $0.27 Meat= $1.08 Toppings = $0.20 Expenses = $1.05 (includes all VC) Subway MARKUP = $2.40 Cost to customer = $5.00 Subway Pricing and BEP Example
Breakeven Analysis Subway Pricing and BEP Example So what is the BEP? Assume Subway pays the following monthly Fixed Costs: Wages $10,400 Rent $1,900Hydro $650 FC = $12,950 BEP = $ 12,950 / $2.40 = 5,395 subs Therefore, Subway needs to sell 5,395 subs per month just to break even! If a subway is open 30 days a month that would require a typical subway to sell 180 subs a day (or 15 an hour) to reach the BEP.
Approaches to Reaching the Breakeven Point Faster… 1.↓ selling price, ↑ demand, higher sales = reach the BEP sooner 2.↑ sales costs (ads, promos) to try to ↑ demand, resulting in ↑ sales = reach the BEP sooner 3.↓ fixed costs to reduce BEP
Product / Price / Promotion / Place End of Part 1 To do: complete work sheet Go to Part 2