Chapter 18 Price Setting in the Business World. How are prices set by business people? Costs provide...
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Transcript of Chapter 18 Price Setting in the Business World. How are prices set by business people? Costs provide...
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 - 100) / 130 = 23.08%
• Markup on cost =– (130 - 100) / 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 - 50) /70 = 28.57%
• Markup on cost =– (70 - 50) / 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 / (100 - 30) = 42.86%
• B] 20 / (100 + 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 ($40 - 15) - $100,000 = $25,000 loss
• At 6000 units?
• 6000 ( 40 - 15) - $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) / ($10 - 2.5) = 66,667 units
• For 50,000 units– 50,000 ($10 - 2.5) - $500,000 = $125,000 loss
• For 80,000 units– 80,000 ($10 - 2.5) - $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 / ($10 - 2.50) = 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