3b) I have decided to choose the following two pricing strategies for my product:
-
Cost plus pricing – because I will have to cover the cost of my product plus make a percentage of profit. (Selling Price = £310)
- Competition based pricing – this is because I will need to take into consideration the prices that the competitors are offering for the similar product as charging high prices may mean losing customers to competitors. However, this method of pricing could lead to a low profit margin.
(Selling Price = £350)
Break Even Analysis (price 1)
Equation for average price = Total Costs / Max. Quantity of Sales
Average Price = £298200 / 1200 = £248.5
Variable Cost = Average Price * Quantity of Sales
Variable Cost = £248.5 * Quantity of Sales
(If Quantity of Sales is 600, then the formula would be:
Variable Cost = £248.5 * 600 = £149,100)
(The values in bold are used in the graph)
Break Even Analysis (price 2)
Equation for average price = Total Costs / Max. Quantity of Sales
Average Price = £298200 / 1200 = £248.5
Variable Cost = Average Price * Quantity of Sales
Variable Cost = £248.5 * Quantity of Sales
(If Quantity of Sales is 600, then the formula would be:
Variable Cost = £248.5 * 600 = £149,100)
(The values in bold are used in the graph)
Task 6a:
After analysing the spreadsheets and break-even charts, I can say that my business will benefit more from using the second pricing strategy, competition-based pricing. This is due to the fact that it provides me with a larger profit margin over a period of one year.
According to the charts, I can work out the exact number of sales needed to break even. The formula for working out the break-even point will be:
Break-even point = Fixed Costs / Contribution
Contribution = Selling Price – Variable Price per unit
Therefore…
Break-even point = Fixed Costs / (Selling Price – Variable price per unit)
Break-even point = £64,300 / (£310 – £248.5)
Break-even point = £64,300 / £61.5
Break-even point = 1046 units
Therefore…
Break-even point = Fixed Costs / (Selling Price – Variable price per unit)
Break-even point = £64,300 / (£350 – £248.5)
Break-even point = £64,300 / £101.5
Break-even point = 634 units
As shown, I will need to sell 1046 units of my product using cost-plus pricing (pricing strategy 1) and 634 units using competition based pricing (pricing strategy 2) in order to break even. Everything sold after that will contribute to my margin of safety. I now know that I will be making a profit no matter what pricing strategy I use, but in order for me to make a higher amount of profit, I should use pricing strategy 2.
Task 6b:
Using pricing strategy 1, I will make £27,950 in profit. Using pricing strategy 2, I will make £87,950 in profit.
If I had to reduce the price due to competition, my profit margin is likely to decrease. I have made a graph using which shows this:
Although it may be hard to tell by looking at the graph, but the table clearly states that the profit margin has decreased from £27,950 to £12,950 when using £290 as my selling price rather than £310.
I will now show a graph and table for pricing strategy 2, using £330 as the selling price rather £350:
Once again, it is not too clear in the graph, but visible in the table, that the profit margin has decreased from £87,950 to £57,950 simply because I lowered the selling price from £350 to £330.
However, it can be said in both cases that just because the price had to be reduced due to competition doesn’t necessarily mean that the business may have a lower profit margin. This is because when the selling price is reduced, the demand for the product may increase and consequently this may not lower the business’s profit much, if not give it a larger profit margin.
Even when having a lower selling price, in both pricing strategies, the business is able to make a profit margin and therefore, is successful.
On the other hand, if the costs were to increase, then the profit margin will decrease. This is because the business will need to sell more units in order to cover the costs and break even. However, this decrease in profit may be avoided if the selling price was increased. But nevertheless, this may reduce demand and once again, lead to a lower profit margin.
(What you estimated your margin safety point to be)
Task 7a – Conclusion:
In this coursework, I have found out how a business is able to predetermine its likelihood of making a profit and also estimating how much it needs to sell in order to make a certain amount of profit. I have also found out how to estimate the fixed and variable costs the business needs and how these costs affect the overall income of the business. Plus, I have realized how important it is for a business to decide on an appropriate price for its products as it definitely affects the ultimate profits of the business.
As for my business, I have had to make a few assumptions whilst working the break-even point. These assumptions have depended upon different prices, varying costs and other external factors such as competition and public demand. However, the break-even charts that I have made have several weaknesses which make them less accurate. These weaknesses include considering external factors such as:
- Demand may increase or decrease which may result in higher or lower levels of sales. The break-even graphs can only show a specific number of sales for a year, not a varying number.
- There may be more competition which will result in lowering prices in order to keep customer loyalty.
- Interest rate fluctuation which will affect my business as I may have to pay more back on my loans leading to an increase in costs and consequently, a lower profit margin.
My predictions can be made more accurate by:
- Assessing the firm’s strengths, weaknesses, opportunities and threats. I can do this carrying internal and external audits in order to find out what is happening inside and outside the business.
- Doing a P.E.S.T. analysis – by doing research about how the business is doing technologically; what more does it need? Also, by researching about new political policies which can benefit my business e.g. governmental grants. Furthermore, finding out about the economic forecast in order to predict the future trends according to the rise and fall in interest rates which affect my liabilities. Finally, finding out what is happening socially around the business - looking at the media response about my business, which affects my demand and the overall profit.
The contingency plans that my business may take in order to avoid relying on inaccurate break-even predictions are as follows:
- Doing analysis such as S.W.O.T. and P.E.S.T. will indicate internal factors such as the firm’s strengths and weaknesses. In addition, it will help to identify external hazards such as the threats and opportunities for the organisation. Furthermore, identifying the political, economical, social and technological changes which may be a risk to the business.
- Doing more research in order to have strategic plans when the product reaches different phases of the product life cycle. Also when considering to enter new and existing markets with new or existing products (ANSOFF Matrix).
To make it possible for my business to break-even earlier, I can use the following methods:
- I could increase the selling price of my product. This would mean that I would make more make profit by selling the products at a higher price compared to my current selling after selling the same amount of products. However, an increase in selling price may lead to a lower demand for the product.
- I could reduce the selling price of the product in order to sell a larger quantity of the product. It is likely that a larger quantity would be sold at a lower price as demand for the product would increase. However, in this case, I will also have to reduce my costs to make more profit and break-even earlier.
- I could simply reduce my costs which would give me a larger profit per each product as there would be more difference between the selling price and the cost of the product. However, to use this method, the business will need to economies of scales which is possible by buying the product in bulk.
I will improve my project next time by doing further research by finding out the economic forecasts which may affect the costs, opportunities, demands and profits of my business.