Pricing For Profit

CWCF Conference 2006

By

Peter Hough, MBA

Objective

• To gain an understanding of the basics of pricing in order to determine at what level of sales at a particular price, will enough revenue be produced to generate the wages and profits which the co-op requires.

Why is pricing important

• Price is often a key determinant of market acceptance of the product or service.

• Pricing is a key factor in determining the amount of revenue a co-op will generate.

• Since revenue is required to pay expenses and to produce profit, pricing is crucial.

Setting Prices

• Value– Does your product have unique features– Position (niche or mass market)

• Competition – Similar products– Alternative products– Price strategy– Market Share

Setting Prices

• Price sensitivity– Is it an essential or discretionary purchase

• Size of the market and diversity of market– How much market share do have or need?

• At what stage of business development is your co-op?

The Fundamental Question

• At this particular price will enough customers purchase this particular good or service to cover your costs and produce the required profit?

Financial Concepts

• Revenue

• Fixed Expenses

• Variable Expense

• Cost of Goods Sold

• Mark-up

• Gross Margin

• Profit

Revenue

• Revenue is generated from the sale of goods and services– Revenue is determined by the number of units

sold and the price per unit

Fixed Expenses

• Expense for a particular period (say 1 year) which are incurred no matter what is the co-op’s level of sales.

Cost of Goods Sold (COGS)

• COGS is the amount the co-op must spend to purchase and/or produce the products or services so that they are ready to sell.

• For a retailer this would include cost of the goods plus freight.

• For the manufacturer it would include the cost of raw materials with freight and all production inputs such as labour that are required to produce the item ready for sale.

Mark-up

• The mark-up is the percentage of the cost of an item which is added to the cost to determine the selling price.

• COGS - $1.00

• Mark-up 50% = $1.50

• Mark-up 10% =

• Mark-up 100% =

Gross Margin

• The gross margin is the difference between the revenue generated from the sales of goods and services and the COGS

• It can be expressed in dollars or as a percentage of revenue.Revenue $200COGS $160$ Gross Margin $ 40 40% Gross Margin $40 / 200 x 100 = 20%

Mark-up Versus Gross Margin

• It is important to note these are very different concepts.

% Mark-up = % Gross Margin

10% 9.1%

25% 20%

50% 33%

100% 50%

Profit

• Profit is the difference between revenue generated and the total expenses incurred for a particular period.

• The benefit a member of a worker co-op gains includes both wages and a share in profits. Since wages are an expense, increasing or decreasing members’ wages will decrease or increase profits respectively.

Breakeven

• Number of units required to breakeven

• Fixed Costs = Number of UnitsUnit Price – COGS/Units

$10,000 = 10,000 = 200 Units$100 - $50 50What is the mark-up?What is the Gross Margin?

Breakeven

• In dollars of revenue

• Fixed Cost = Dollar SalesGross Margin

$10,000 = 10,000 = $20,000($100 - $50) .5

$100

Breakeven Plus Target Profit (PT)

• Number of units required

• Fixed Costs + PT = Number of Units

Unit Price – COGS/Units

$10,000 + $5,000 = 15,000 = 300 Units

$100 - $50 50

Breakeven Plus Target Profit (PT)

• In dollars of revenue

• Fixed Cost + PT = Dollar Sales

Gross Margin

$10,000 + $5000 = 15,000 = $30,000

($100 - $50) .5

$100