blogs.csuglobal.org/KUPsansSourcer

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.

This entry was posted on Tuesday, March 31st, 2009 at 8:23 am and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.