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Chapter 9b Price Setting in the Business World

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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

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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.

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Markup Formulas Markup On Selling Price = –(Selling Price - Cost) / Selling Price Markup on Cost = –(Selling Price - Cost)/ Cost

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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?

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Answer 1 Markup on selling price = –($25 - $20) / $25 = 20% Markup on cost = –($25 - $20) / $20 = 25%

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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.

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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

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Break Even Analysis Break - even analysis Break - even point BEP (in units) = –(Total Fixed Cost) / (Fixed Cost Contribution per Unit)

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Break-Even Analysis (Exhibit 18-8)

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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?

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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

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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.

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BE & ROI Problem Take the last example. Our goal is now a 10% ROI. What is the quantity needed to hit this ROI target?

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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

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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.

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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

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