Price Setting in the Business World

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Chapter 18

• 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 (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.

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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 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)

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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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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?

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Answer for 2

• Markup on selling price
• (130 - 100) / 130 23.08
• Markup on cost
• (130 - 100) / 100 30

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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?

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Answer to 3

• Markup on selling price
• (70 - 50) /70 28.57
• Markup on cost
• (70 - 50) / 50 40

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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?

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Answer 4

• A 30 / (100 - 30) 42.86
• B 20 / (100 20) 16.67

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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.

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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

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Average Cost Pricing Is Common and Can Be
Dangerous (E 18-3)
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Cost Relations (Exhibit 18-4)
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Break Even Analysis

• Break - even analysis (505)
• Break - even point (505)
• 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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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?

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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

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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?

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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

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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
• 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

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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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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