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My prior post was a primer on establishing price.  Analyzing break-even is an important part of the pricing process; break-even analyses depend on fixed costs, variable production costs, unit price, and projected sales.  The whole point is to calculate the sales volume where the variable and fixed costs of producing the product will be covered.    

So, let’s look at an example of a break-even analysis for a “widget.”

Fixed Costs – The sum of all costs in producing the first unit; does not vary with production (until capital expenditures are needed).

• $10,000 one-time tooling charge 
• $6,000 first year’s phone/secretary ($500 per month)

Variable Costs – Costs that vary directly with production.  “Total Variable Cost” is the product of projected sales (number of units you expect to sell) and “Variable Unit Cost” (costs that vary directly with the production of one additonal unit).

• $3.00 to manufacture each unit (in lots of 10,000)
• $.25 to $.50 per unit shipping
• 10% sales commission (on price to the trade, not to the end customer (aka consumer)) 

Channel Costs:

• 40% retailer margin (percent of the trade’s selling price to the end customer (aka consumer)) 
• 60% mail order marketer margins (percent of the trades’ selling price to the end customer (aka consumer))

Break-even is the number of units that must be sold in order to produce a profit of zero (but still recovering all associated costs).

A break-even calculation for 20,000 units of the widget to be sold to the retail market (don’t forget that sales commission!) at an average shipping cost of $.38 would be: 

($10,000 + $6,000) = 20,000 (.9Price – ($3.00 + $.38)) 

.9Price – 3.38 = 16,000/20,000

.9Price = 4.13

Price = 4.13/.9

 

Price = $4.59 

 

A break-even calculation for 5,000 widgets (half of a lot) to be sold to the mail order market at an average shipping cost of $.38 would be:

(($10,000 + $6,000)/2) = 5,000 (Price – ($3.00 + $.38))

Price – 3.38 = 8,000/5,000

Price = $4.98

Obviously, we are assuming that a half-lot must only cover half of the fixed costs!

The break-even analyses can vary, depending on the assumptions you make around shipping, mix of sales between mail order and retail, etc.  So, you probably will end up figuring several different break-evens.   

Now, what to do with the break-even price?  Well, consider for our widget example that you want to allow 40% retailer gross margin…if you wanted to work purely off break-even, then, your price to the end customer (aka consumer) would be $7.65 ($4.59/.6).  Or, consider for our widget example that you want to allow 60% mail order marketer gross margin…if you wanted to work purely off break-even, then, your price to the end customer (aka consumer) would be $12.45 ($4.98/.4).  Think through your competitive and demand factors given these prices and also how these prices fit into your overall pricing strategy (see my “primer” post).  Tweak as necessary to come up with your final price for the widget!   

This post first appear in Percolating! by Kup & Sourcer (www.kupandsourcer.com/blog) on August 10, 2007.

A lot of theory and proven practice go into effectively pricing your product or service, starting with your overall strategy (skimming, harvesting, or penetration).  If the names alone don’t make the strategies clear to you, here are quick-and-dirty definitions:

• If short-run profits are your goal because you have a ”pioneer” position, then you probably want to adopt a skimming price policy—which means you’ll set your price high.   

• If short-run profits are your goal because of a decling market, then you probably want to adopt a harvesting price policy–which means you’ll set your price high and simultaneously cut costs.   

• If sales rate and/or market share are your focus, then you probably want to adopt a penetration price policy—which means you’ll set your price relatively low. 

Once you’ve figured out the right strategy for your particular situation, you have two options for calculating your actual price.  You can approach the task from a desired retail price angle or from a cost angle.  (Whichever you choose, you should “sanity check” your results from the opposite angle.)  

Taking the desired retail price angle means you’ll base your decision on demand and competitive considerations; then, if you have channel partners, you’ll back through all channel margins to establish your price to the trade.  Taking the cost angle means you’ll base your decision on your break-even analysis (the point at which your product or service stops costing you money to produce/sell, and starts to generate a profit). 

Once you’ve calculated and “sanity-checked” your price, you’d be wise to generate a simple cash flow statement to see if you can actually meet all your business goals at that price.  Then, keep an eye on your market and competition, because odds are you’ll need to adjust your price over time (you might even want to plan on price adjustments up front, when you figure your initial price).

It all sounds simple and it pretty much is, but you would do well to enlist the help of one or more seasoned professionals with marketing and accounting expertise.  Good luck!

This post first appear in Percolating! by Kup & Sourcer (www.kupandsourcer.com/blog) on August 8, 2007.

Working with an MBA student taking a marketing course, I got a chuckle when one particularly challenging assignment caused her to blurt out, “There is a lot more to marketing than writing jingles and planning photo shoots.”  She said she was surprised to learn that marketing “relies heavily on financial data and determining what to spend is difficult.”  

We marketing types—including our sales brethren—have faced this misperception since commerce began thousands of years ago.  But, the point of this post is not to elicit your sympathy or even your respect.  Rather, the point of this post is to motivate you to take your own marketing efforts seriously.  Do your market analyses, do your break-even analyses, plan your pricing startegies, run some financial models for three-year and five-year sales projections, analyze your competition…there really is a lot more to marketing that writing jingles and planning photo shoots.

This post first appear in Percolating! by Kup & Sourcer (www.kupandsourcer.com/blog) on August 3, 2007.

Maytag has spent big dollars over many, many years honing a brand image of quality, dependability, and commitment.  That Maytag repairman embodied reliability; you could count on him.  Well, I’m not so sure!

My husband and I read in the newspaper last week that Maytag is recalling a part on some refrigerators (seems it catches fire).  We did some Internet-based research and discovered our refrigerator was one of those included in the recall.  So, we arranged for the repair.  Yesterday the repairman arrived (on time!) and within three minutes the part was replaced.  All good.  Then, about six hours later, Maytag called…not to ask if all went right with the repair, but to see if we wanted to buy an extended warranty before ours expires in mere days.  Huh.  They knew we had a warranty; they knew it was expiring; they knew they wanted us to buy another warranty.  BUT, they didn’t know our refrigerator had a part under recall…or at least they didn’t bother to call us to tell us that; we had to read about it in the paper and do some research on our own and arrange for the repair on our own.  Not good. 

For all its hype that it does business the old fashioned way and cares about its customers, now what I think of when I think of Maytag is a phone call trying to sell me an extended warranty after no phone calls trying to warn me of a recall.  That’s an example of how reality can negate a brand!