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 = 23.08% Markup on cost = –( ) / 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 = 28.57% Markup on cost = –( ) / 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 / ( ) = 42.86% B] 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 ($ ) - $100,000 = $25,000 loss At 6000 units? 6000 ( ) - $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 –($500,000) / ($ ) = 66,667 units For 50,000 units –50,000 ($ ) - $500,000 = $125,000 loss For 80,000 units –80,000 ($ ) - $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 $550,000 / ($ ) = 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