Well now that we've actually gone ahead and discussed pricing objectives as well as the
strategy piece, how are we going to achieve those objectives, it's important that we discuss
the actual specifics related to pricing. There are a number of tools that can be used as
a way of fine tuning the actual pricing. Businesses have to consider a lot of different things
if their going to price their going to price their products not only competitively, but
also to the point where they're going to cover a lot of their costs. And so one of the easiest
ways, or easiest tools that you can utilize is what we call a breakeven analysis. And
a breakeven analysis is simply a process that's used to determine the number of units that
you would have to sell to cover your costs. So I'll abbreviate the breakeven point as
BP. And so we're going to refer to the number of units that are needed to cover our costs.
And so ideally as a business you wouldn't just sell whatever this number is because
you're covering your costs you're not necessarily making any money. Ideally you'd be able to
sell more than this. And so this is a great starting point for a discussion, to know that
well is it feasible for us to sell this number of products and if it is great. If it isn't
though what are some of the things that we can do? What are the variables that we can
change so that it is a little more reasonable. So lets go through let me show you first what
the equation is for a breakeven point. And the breakeven point is simply first your fixed
cost. Fixed costs do not vary over time within a certain relevant range. And so these often
include things that plants, property, and equipment and even advertising, insurance,
and taxes. These are commonly fixed costs. The reason that they're fixed is because they
don't vary based on the number of products that you sell. So if I sell nothing, I know
I still have to pay utilities. I still have to pay the lease for the property I'm using.
I still have to pay certain insurance costs and different things. I still pay advertising.
And so they're fixed, they don't vary based on production. So I take my fixed cost and
then what I do is I divide that by first my price of my product so whatever is the selling
price for my product. What consumers have to give up to obtain my product less variable
costs what I'll abbreviate as VC. Variable costs, contrary to fixed costs, vary based
upon the number of units produced. So if you produce five of a particular product then
ultimately you're going to take your fixed costs and multiple it by five. So they go
up with every unit that is produced. Typically variable costs include things like direct
materials, and so the materials that actually went into assembling that product. Typically
includes direct labor. And so the actual people that assembled the product and put it together.
Obviously the more time they spent is based upon how much you produce. So those are all
things that you would essentially consider in variable costs and then a few other things.
So let me show you how you would actually work this here. Lets say that we actually
produce cell phone cases and we have a fixed cost of five hundred thousand dollars. These
are the costs that we incur without any production whatsoever. Whatever this is, plants, property,
equipment, advertising, taxes, those types of things do not vary based upon how many
goods we sell. And we sell these cell phone cases for lets just say twenty dollars each
and it costs us about ten dollars in variable costs to make them. So for every case we can
sell for twenty we pay ten dollars to actually have it made. So with this equation we would
actually have a breakeven point of fifty thousand units. Whether or not this is attractive will
depend on a number of different factors. You make look at this say I have to produce fifty
thousand or sell not product, but sell fifty thousand of these cases in order for me just
to cover the costs that I have. In large part that's driven by the fixed costs which are
rather high, but that may not be feasible. Or it may be fifty thousand, that's nothing,
I was going to sell way more than that or I'm projected to sell a lot more than that.
In that case this might be very encouraging. But if it's not. If this is somewhat of a
concern. If you planning well I thought I was going to sell about five thousand the
first year not fifty thousand I don't want to be in the you know negative for an extended
period of time. That doesn't necessarily mean that you should you know scrap everything
and go back the drawing board. This is a starting point for a good discussion, and the reason
is that you might be able to change a couple of these variables. There are three variables
that are here, fixed cost, price, and variable cost. And so maybe we can actually change
things. We can do a couple of different things. Maybe we have the ability to actually raise
our price a a little bit. Maybe we're not priced competitively, we're under-cutting
ourselves. So if we raise price that means our margins are better, which in turn means
that we don't need to sell as many products to actually break even. The break even point
would be less than fifty thousand units. So that's one thing that we can look at. We can
look at possibly reducing our fixed costs. Thing like the actual plant that we're using.
Maybe it's too big for us. Maybe we can actually downsize, get a smaller plant, still be able
to produce effectively and efficiently but now we're lowering our fixed costs. Maybe
we need to reduce our advertising expenditures. Maybe we need to reduce the utilities that
we pay that would be kind of similar to reducing our plant size we probably wouldn't pay as
much in utilities. And so if you lower your fixed costs that would also make it so that
you wouldn't need to sell as many products to just break even. And then lastly we can
lower those variable costs. The costs that are directly associated with producing products.
And so this can include maybe finding less expensive materials to go into the product.
Obviously try not to sacrifice quality to any significant degree. We can try and find
more efficient ways of producing the product. So maybe we don't have to pay as much in labor
to produce them. We find cheaper ways to do that maybe faster ways to do that. So those
are some things that you could consider. Raising prices, decreasing variable costs, decreasing
fixed costs. The important thing is that these three areas here are variables that you can
change, but you may not be able to change them significantly enough to make the breakeven
point reasonable based upon your business. But it at least is a starting point for a
discussion. And so just because the breakeven point is maybe a little higher than you originally
anticipated you can at least thing through well what are some of the different ways that
we can change it so ultimately maybe it is a little more attractive. But by no means
would you look at the breakeven point and then simply stop at that point. You can go
a little further and do a little more research in those different types of things, but a
very useful tool very easy to use very basic. You'll probably spend more time adding up
all the fixed and variable costs and determining you know what is fixed versus variable than
actually solving the equation, but very very valuable going forward to help you price your
products.