Determining the Price of a Product or Service

Two factors to consider:1. The cost of doing business2. Intended profit

Profit: The amount of money left over after all products are paid for and all expenses are covered

Price = Cost of Doing Business + Profit

Example

Cost

$0.34

$0.20

Profit

Expenses

$0.11

Price = $0.34 + 0.11 + 0.20 = $0.65

2 Ways to Examine Price After it is Set

1. Markup The amount of money a business adds to

the cost of a product Expressed as a % Markup is used to cover all expenses plus

make a profit

Markup = $ Amount Store Adds Cost

Example

Markup = $0.11 + 0.20 $0.34

= 91%

Expenses = $0.11

Profit = $0.20

Cost = $0.34

Example

Therefore, Wal-Mart buys Skittles for $0.34 and

marks them up by 91%

2. Margin

The percentage of the price charged to customers that is not used to pay for the product

Margin = $ Amount Store Adds Selling Price

Example

Margin = $0.11 + 0.20 $0.65

= 48%

Expenses = $0.11

Profit = $0.20

Price = $0.65

Example

Therefore, every time Wal-Mart sells Skittles it makes a 48%

profit margin

Markup and Margin Question

Cody needs to make some extra money to buy Christmas presents for all of his ladies so he opens a hotdog stand on Bank St.

Markup and Margin Question

He pays $0.30 for every hotdog that he sells. Propane and condiments cost him an

additional $0.22 per hotdog. He wants to make $0.23 profit per hotdog

Markup and Margin Question

What is his selling price? What is the markup? What is the margin?

Answers

Price = Cost of doing business + profit

= $0.30 + 0.22 + 0.23 = $0.75

Markup = $ Amount store adds / cost

= $0.22 + 0.23 / 0.30

= $0.45 / 0.30

= 1.5 OR 150%

Answers

Margin = $ Amount store adds / selling price

= $0.22 + 0.23 / $0.75

= $0.45 / $0.75

=0.6 OR 60%

Break-Even Analysis

How many units must be sold at a given price to cover all operating costs?

Break-Even Analysis

Three parts to break-even analysis:1. Variable Costs: Costs that depend on the

quantity of products or services sold

Example:

Break-Even Analysis

2. Fixed Costs: Costs that are constant. These do not depend on the quantity of sales.

Example:

Break-Even Analysis

3.

Sometimes called Contribution Margin

Example:

Gross Profit = Selling Price – Variable Costs

Break-Even Analysis

3. Gross Profit 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

This is used to pay for Fixed Costs

Break-Even Point

Again, 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

Break-Even Point

Back to Cody He pays $0.30 for every hotdog $0.22 for gas and condiments per hotdog Sells hotdogs for $0.75 each Pays $200/month to rent the cart (Fixed)

What is Cody’s BEP?

Gross Profit = Selling Price – VC = $0.75 – 0.30 – 0.22 = $0.23

BEP = FC / Gross Profit = $200 / $0.23

= 870 hotdogs

What is Cody’s BEP?

Therefore, Cody has to sell 870 hotdogs in order to cover the cost of renting the cart.

If he doesn’t sell 870 he will lose money!

Pricing and BEP Example

Subway has the following costs for a 6”assorted sub it sells: Bread = $0.37 Meat = $1.68 Toppings = $0.39 Expenses = $1.30 (includes all other FC

and VC) Subway wants to make $1.25 per sub

What should the price be?

Price = $4.99

What it the markup?What is the margin?

Cost = $2.44 Markup = 105% Margin = 51%

What is the Gross Profit?

Assuming that: Bread = $0.37 Meat = $1.68 Toppings = $0.39 Expenses = $1.30 (includes all other FC

and VC) Other VC = $0.90

What it the gross profit?

Total VC = $3.34 Gross Profit = $4.99 – 3.34

= $1.65

What is the BEP?

Assume that Subway pays the following monthly Fixed Costs:

Wages $12,500 Rent $2,100 Hydro $800

What is the BEP?

FC = $15,400 BEP = $15,400 / $1.65

= 9,333 subs

Therefore, every month Subway needs to sell 9,333 subs just to break even!