Marketing 19: Price 2

Markup Pricing

see slide 19 of chapter 19 slides.

Total Costs

the sum of fixed + variable costs for any given level of production

Unit costs

the total expenditure incurred by a company to produce and sell one unit of a product (includes all fixed costs and all variable costs)

Review: Mark up

-According to Reuters, the entry-level iPhone X costs Apple around $360 to make. Apple sells that model for $999. -What is the iPhone X's markup percentage on price? (Assume $360 = unit cost) a) $ markup?: $999-$360 = $639 b) % markup on price?: ($639/$999)*100 = 63.9% c) % markup on cost? ($639/$360)*100 = 177%

Break-even Example 4: Cannibalization

-Assume that Spalding sells 20 millions of basketballs a year, with price of $20, unit contribution of $10 -To expand their customer base, it is planning to add a low-end basketball that they can sell for $10 (unit contribution: $5) -Potential problem: some people who would have bought the high-end ball now can buy the less expensive one. (cannibalization) -New product is expected to steal 5 million units from the current product. How many units of the new product the firm must sell to recoup the cost of cannibalization? -Expected cost of the cannibalization (reduction in profits): 5 million old units * $10 = $50 millions -Number of units of the new product the firm must sell a) $50 million / $5 = 10 million balls (this includes 5 million balls took from the current product)

Break-even Example 2: Price Change

-Chipotle charges $10 for a burrito. Variable cost = $4. -Last year, they sold 5M burritos -Assume the fixed cost is 10M a year -They are thinking about reducing the price by $1. -How many additional burritos would Chipotle need to sell this year to have the same amount of profit? a) How much profit are they currently making? ($10-$4)*5M-10M=20M b) How many sales would they need to make that same amount of profit? 20M=($9-$4)*X-10M; X=6 million burritos -Would you do it? Why / Why not?

Types of Costs

-Fixed costs -Variable costs -Total costs -Unit costs

When to use break-even analysis?

-Fixed marketing expenditures a) Volvo's Super Bowl ad campaign -Pricing change a) How many extra sales are needed to make up for a price decrease? -Short-term, variable marketing expenditures a) Coupon promotion. How many extra units must be sold to recoup loss of profits from each sale at discounted price? -New product that cannibalizes existing products

Break-even analysis

-How many units must be sold at a given price to cover one's costs? -Break-even volume: the number of units that need to be sold to cover the costs -Break-even analysis: fixed costs/(price-unit variable cost)=fixed costs/unit contribution -Unit contribution = selling price per unit - the variable cost per unit -Break-even pricing: setting price to break even on the costs

Cost-based pricing 2: Markup pricing

-Markup? The difference between a company's selling price for a product and its cost to manufacture -Markup pricing: Adding a standard markup to the cost of the product -Dollar mark up = selling price - unit cost -Markup percentage on selling price = (Dollar markup price/selling price) ×100 -Markup on cost: (selling price - unit cost)/unit cost

Break-even Example 3: Cover short-term expense

-PJ's decides to give out 200 coupons for $2 off a) They expect 50% of coupons to be redeemed -On average, unit contribution of their products (coffee, muffins, etc.) is $1. -How many unit sales (of coffee, muffins, etc.) would you need to make in order to recoup this expense? a) Expected cost of the promotion (reduction in profits): 100 coupons * $2 off = $200 b) Number of incremental sales needed to be generated by the promotion: $200/($1) = 200 -Is this feasible? What would be the concerns about this promotion?

Break-even Example 1: Marketing Expense

-Price of a Volvo truck: $120,000 -Variable cost: $108,000 -Fixed Cost of SuperbowlCampaign = 2.7 Million -Q: What is its unit contribution? a) What is its breakeven Quantity? =

Endless Snow Crab Legs for $23 (2003)

-Red Lobster set the price ($23) assuming that customers will order 1-2 plates -"It wasn't the second helping, it was the third that hurt (the profit)" -They underestimatedthe cost -CEO was replaced

Eat My Junk is a food truck selling burgers. It usually spends $1000 for designated parking slot. For each burger set, it costs $4 for food and beverage and $1 for paper supplies (e.g., paper box). -How much are the variable costs? -How much are the fixed costs? -If it makes 500 units of burgers, how much are the total costs? -What is its unit cost?

-Revenue = # of units sold × unit price -Profit = Total Revenue - Total Costs -Q: Eat My Junk is a food truck selling burgers. It usually spends $1000 for designated parking slot. Each burger set costs $5 to make. a) What is revenue if it sells 500 burgers for $6 each? $3000 b) What is profit? $3000 - $3500 = -$500 -How many $6 burgers should the truck sell to cover the costs?

The unit cost for iPhone 7 is $234. If Apple wants 64% markup on iPhone 7, how should it set the selling price? Markup price (selling price) =unit cost/(1 - markup ratio on price)

=$234/(1-.64)=$650

Nike's markup % on selling price is 43%. How much does Nike actually spend on a pair of sneakers of which wholesale price is $50? Markup price (selling price) =unit cost/(1 - markup ratio on price) Unit cost = Selling price*(1-markup ratio on price)

=$50(1-.43)=$28.5

Fixed Costs

costs that do not vary with production or sales level

Variable Costs

costs that vary directly with the level of production