Chapter 18

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# Chapter 18 - PowerPoint PPT Presentation

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?

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### 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?
• 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?
• 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?
• 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?
• 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
Break Even Analysis
• Break - even analysis (505)
• Break - even point (505)
• BEP (in units) =
• (Total Fixed Cost) / (Fixed Cost Contribution per Unit)
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?
• 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?
• 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?
• 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?
• 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