Cost Pricing: Breakeven Method
Breakeven pricing is associated with breakeven analysis, which is a forecasting tool used by marketers to determine how many products must be sold before the company starts realizing a profit. Like the markup method, breakeven pricing does not directly consider market demand when determining price, however it does indicate the minimum level of demand that is needed before a product will show a profit. From this the marketer can then assess whether the product can realistically achieve these levels.
The formula for determining breakeven takes into consideration both variable and fixed costs (discussed in the Pricing Decisions tutorial) as well as price, and is calculated as follows:
Fixed Cost = # of Units to Breakeven
Price – Variable Cost Per Unit
For example, assume a company operates a single-product manufacturing plant that has a total fixed cost (e.g., purchase of equipment, mortgage, etc.) per year of (US) $3,000,000 and the variable cost (e.g., raw materials, labor, electricity, etc.) is $45.00 per unit. If the company sells the product directly to customers for $120, it will require the company to sell 40,000 units to breakeven.
$3,000,000 = 40,000 units
$120 - $45
Again we must emphasize that marketers must determine whether the demand (i.e., number of units needed to breakeven) is realistically attainable. Simply plugging in a number for price without knowing how the market will respond to that figure means that this method has little value. (Note: A common mistake when performing this analysis is to report the breakeven in a monetary value such a breakeven in dollars (e.g., $40,000). The calculation presented above is a measure of units that need to be sold. Clearly it is easy to turn this into a revenue breakeven analysis by multiplying the units needed by the selling price. In our example, 40,000 units x $120 = $4,800,000.)