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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?

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chapter 18

Chapter 18

Price Setting in the Business World

how are prices set by business people
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 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 Formulas
  • Markup On Selling Price =
    • (Selling Price - Cost) / Selling Price
  • Markup on Cost =
    • (Selling Price - Cost)/ Cost
markup conversions
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
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
Answer 1
  • Markup on selling price =
    • ($25 - $20) / $25 = 20%
  • Markup on cost =
    • ($25 - $20) / $20 = 25%
markup example 2
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
Answer for # 2
  • Markup on selling price =
    • (130 - 100) / 130 = 23.08%
  • Markup on cost =
    • (130 - 100) / 100 = 30%
markup example 3
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
Answer to #3
  • Markup on selling price =
    • (70 - 50) /70 = 28.57%
  • Markup on cost =
    • (70 - 50) / 50 = 40%
markup example 4
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
Answer # 4
  • A] 30 / (100 - 30) = 42.86%
  • B] 20 / (100 + 20) = 16.67%
stockturns
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
  • 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
  • Break - even analysis (505)
  • Break - even point (505)
  • BEP (in units) =
    • (Total Fixed Cost) / (Fixed Cost Contribution per Unit)
break even 1
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 121
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
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
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
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
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
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
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
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
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
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
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