Break even pricing

Break even pricing
See also

Break even pricing is "the price where sellers earns zero profit". It means that this is the point, where revenues are equal to total costs of this company. Break even point is also called BEP[1].

Break even analysis

We can calculate break even volume by using the following formula[2]\[BEP_{Volume}=\frac{TFC}{Price - VC}\] Where:

  • BEPVolume - Break Even Pricing Volume
  • TFC - Total Fixed Cost
  • VC - Variable Cost

For example, Fixed Cost is $300000, Price is $20 and Variable Cost is $10. \(BEP_{Volume}=\frac{$300000}{$20 - $10}=30000\) We must sell 30000 units at $20 to break even. And it's break even volume. If we want profit, we must sell more than 30000 units at $20 each. We can also calculate something else\[BEP_{Value}=BEP_{Volume} \cdot Price\] It's break even value. For example, Break Even Point Volume is 30000 and Price is $20. \(BEP_{Value}={30000 \cdot {$20}}=$600000\) It shows what value must reach the sale. If we reach $600000, we also reach break even point.

We can calculate percentage break even by using a demand\[BEP_{Percentage}=\frac{TFC}{Demand} \cdot 100%\] And we receive percentage break even result.

Break even pricing method

Break even pricing method is widely used. By BEP we can calculate and analyse some aspects of our company. We can learn about prices. It helps us to set a good prices. There are some issues, where BEP helps us perfectly[3]:

  • BEP for pricing new products under uncertainty: New products are focus on downside risk and ignore upside gains. Hence companies is likely to set a high prices for new products.
  • BEP for risk-averse company: Companies can use break even pricing to price new products under uncertainty. Companies generally set a high prices for new products.
  • BEP for risk-differentiated products: BEP depends of three interacting components: ability to price above break even depends of customers price sensitivity, pricing strategy depends of customer segment choices and degree of customer risk aversion.
  • BEP for calculate profitability: We can calculate profitability of already developed products. Thanks to BEP we can fit our production to gain better profit.
  • Potential pitfalls for new products: The company must be careful to include all relevant economic costs. BEP should be based on correct measure of fixed costs, including hidden costs.

Footnotes

  1. (Kotler P., 2010, 322-326)
  2. (Landsburg S., 2010, 192-212)
  3. (Jagpal S., 2018, 93-111)

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References

Author: Adam Widła