The Break-Even Analysis: Find the Pricing Sweet Spot

To continue the topic of pricing,  in this case pricing a new product or service,  it is a must to know when fixed costs will be covered by unit sales at a given price and determine when in time the item or service breaks into profitability.  Performing a break-even analysis will reveal how many units must be sold,  or how many times the workshop must be delivered,  at a given price,  before production costs are behind you.  Integral to that question is unit selling price.  Costs are recouped faster when selling at $100.00 rather than $50.00.  Also related to pricing is what customers expect and agree to pay.  Appropriate pricing can increase profits faster than increasing sales volume.  One can sell fewer items and make more money per item.  Conducting a break-even analysis is Step 1 in locating your ideal price range.  Here’s the Break Even Volume (BEV) formula:

Fixed costs                                                      Fixed costs

BEV     = ______________________________        =         __________

Revenue per unit – Variable cost per unit                         Unit margin

Let’s add some numbers to the formula and assume that the fixed costs associated with delivery of your service is $5, 500.00: $1,700.00 went to the graphic artist for Power Point slides; $1,300.00 paid to the wordsmithing wizard for marketing collaterals used for promoting the service; and $2,500.00 for the wholesale value of your labor,  the time you spent crafting the intangible service.  These costs are fixed because they will not change,  no matter how many times the service will be delivered.  Variable costs associated with service delivery would be printing hand-outs for participants ($50.00) and the advertisement placed in an industry newsletter read by the target audience ($400.00),  meaning that the unit variable cost =$450.00.  If the service is priced at $750.00,  the profit,  or unit margin,  is $300.00 each time the service is delivered at that price.

$5,500.00

BEV     =        _________     =   18.33

$300.00/unit

At a per unit price of $750.00,  the service must be delivered 18+ times before a profit will be made.  From there,  a series of  “what if”  scenarios can be floated.  Chiefly,  what are competitors charging or is there a spike in demand that makes the product more valuable and can you increase the price?  Also,  can you lower fixed costs and obtain graphics services for a couple of hundred dollars less?  What if the marketing collaterals text was produced in-house by you and not outsourced?  How much will that increase the price of the time you spent developing the service,  another fixed cost?

Let’s say that you find graphics services for $1,500.00 and ask a marketing communications wizard to edit text that you write yourself for $800.00 (your personal labor increases: 6 hours writing at $50.00/hour = $300.00 + $2,500.00 = $2, 800.00).  Now,  the fixed cost is $5,100.00 and you think that $950.00 is a price that clients just might accept.  The variable costs will remain unchanged at $450.00,  because your printer is good,  his price is right and you’ll definitely need to advertise since you may want to charge more for the service.  At a unit price of $950.00,  the unit margin would be $500.00.   As shown,  by raising the price of the service by $200.00,  fixed costs are covered by delivering the goods 10+ times,  rather than 18+ times.

$5,100.00

BEV=             ________      =   10.2

$500.00/unit

As you can see,  the impact of other values such as increased advertising or higher quality materials or labor,  can also be assessed for impact on the pricing sweet spot and timeline for reaching BEV.  When bringing a new product or service to market,  take steps to identify the ideal pricing structure.

It is also useful to calculate the profit margin,  that is the percentage of sales revenues retained after all expenses are paid,  for each product and for the total line.  From the P & L Statement,  divide net profits by total sales revenues  (bottom line divided by top line).

 

Thanks for reading,

Kim

expert_author_1

 

 

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