Your business provides a service to local residents. Your fixed costs are $2,000 per month, and you expect 40 customers per month. The variable cost associated with each service is $35.
1. Using cost-based pricing and a markup of 20%, what should the price be? Show calculations.
2. Using breakeven analysis, what should the break-even volume of production be? Hint the formula is Break-even volume = Total fixed costs / (Price – Average variable cost). Note: This formula needs manipulated algebraically to be able to solve for price. Show calculations.
3. Using target costing, a price you think is acceptable to customers ($99) and an acceptable profit margin (20%), what should the price be? Hint the formula is Target cost = cost customers are willing to pay – acceptable profit margin to obtain the desired cost. Show calculations.
4. If your nearest competitor charges $95, what should the price be? Explain.
5. With all this information and the results you calculated for parts 1-4, what do you think your price should be?
1. To calculate the price using cost-based pricing and a markup of 20%, we need to consider the fixed costs, variable costs, and the desired profit margin.
Fixed costs: $2,000 per month
Variable cost per service: $35
Total cost per service = Fixed cost + Variable cost
Total cost per service = $2,000 + $35 = $2,035
Markup price = Total cost per service + (Markup percentage * Total cost per service)
Markup price = $2,035 + (0.20 * $2,035)
Markup price = $2,035 + $407
Markup price = $2,442
Therefore, the price should be $2,442.
2. To calculate the break-even volume of production using breakeven analysis, we need to determine the number of units that need to be sold to cover the total fixed costs.
Break-even volume = Total fixed costs / (Price - Average variable cost)
Price = Markup price = $2,442
Average variable cost = Variable cost per service = $35
Break-even volume = $2,000 / ($2,442 - $35)
Break-even volume = $2,000 / $2,407
Break-even volume ≈ 0.83 (rounded to the nearest whole number)
Therefore, the break-even volume of production should be approximately 1 (rounded to the nearest whole number).
3. To calculate the price using target costing, a price acceptable to customers ($99), and an acceptable profit margin (20%), we need to consider the desired cost.
Target cost = Cost customers are willing to pay - Acceptable profit margin
Cost customers are willing to pay = $99
Acceptable profit margin = 20% = 0.20
Target cost = $99 - (0.20 * $99)
Target cost = $99 - $19.80
Target cost = $79.20
Therefore, the price should be $79.20.
4. If your nearest competitor charges $95, the price should be lower than their price to attract customers. Setting a lower price can be a market strategy to gain a competitive advantage and attract more customers. Lowering the price below the competitor's price could help capture market share.
5. Based on the calculations from the previous steps and considering the competition, you could consider pricing your service around $79.20, which was calculated using target costing and an acceptable profit margin. However, it is important to also consider market demand, customer perception, and additional factors when determining the final price for your service.
1. To calculate the price using cost-based pricing and a markup of 20%, you need to add the variable cost per service to the desired profit margin.
Price = Variable Cost + Markup
Price = $35 + (20% * $35)
Price = $35 + ($7)
Price = $42
Therefore, the price should be $42.
2. To calculate the break-even volume of production using breakeven analysis, you need to divide the total fixed costs by the difference between the price and the average variable cost per service.
Break-even volume = Total Fixed Costs / (Price - Average Variable Cost)
Break-even volume = $2,000 / ($42 - $35)
Break-even volume = $2,000 / $7
Break-even volume = 285.71 (rounded to the nearest whole number)
Therefore, the break-even volume of production should be approximately 286 customers.
3. To calculate the price using target costing, an acceptable price to customers ($99), and an acceptable profit margin (20%), you need to subtract the acceptable profit margin from the price customers are willing to pay.
Target Cost = Cost Customers are Willing to Pay - Acceptable Profit Margin
Target Cost = $99 - (20% * $99)
Target Cost = $99 - ($19.8)
Target Cost = $79.2
Therefore, the price should be $79.2.
4. If your nearest competitor charges $95, you should consider setting a price that is competitive with your competitor. It is important to assess factors such as your company's unique value proposition, quality of service, and any additional features or benefits you provide compared to your competitor. If your services are perceived as offering greater value or advantages, you could potentially price slightly higher. On the other hand, if your competitor has a substantial advantage in terms of reputation or features, you might consider pricing slightly lower to attract customers.
5. Based on the calculations above:
- Cost-based pricing with a 20% markup suggests a price of $42.
- Break-even analysis suggests a break-even volume of 286 customers.
- Target costing with an acceptable price to customers of $99 and a 20% profit margin suggests a target cost of $79.2.
- Considering your nearest competitor's price of $95, you could consider pricing your service close to this amount or slightly higher or lower, depending on the value your company provides compared to the competition.
Ultimately, the final price should be determined by thoroughly evaluating market conditions, customer expectations, competitor pricing, and profitability goals. It may be beneficial to conduct market research, analyze the competitive landscape, and consider customer feedback to arrive at the optimal price point.