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Marketing Basics - Kotler Philip

Price calculation based on breakeven analysis and target profit provision

Another cost-based pricing method is profit-based settlement. The company seeks to set a price that will provide it with the desired amount of profit. General Motors Corporation uses a similar method. She sets prices for her cars in such a way as to get 15 - 20% of the return on invested capital. The same method is used by utilities, for which there are restrictions on the size of the rate of profit.

The pricing methodology with the expectation of generating a targeted profit is based on a break-even chart . This graph shows the total costs and the expected total revenues at different levels of sales. A hypothetical breakeven chart is shown in Fig. 64. Regardless of the volume of sales, fixed costs are equal to $ 6 million. Gross costs (the sum of fixed and variable costs) increase simultaneously with sales growth. The gross revenue curve starts at zero and rises as the number of units sold increases. The steepness of the slope of the gross revenue curve depends on the price of the goods. In our example, the price of a commodity unit is $ 15 (based on the receipt of $ 12 million for 800 thousand pieces of goods sold).

At such a price to break even, i.e. To cover gross costs with revenues, the company must sell at least 600 thousand units. If she wants to earn $ 2 million in gross profit, she needs to sell at least 800 thousand units at a price of $ 15 apiece. If a company is willing to charge a higher price for its product, say $ 20 a piece, then it does not have to sell as many units of the product to make a profit. However, at a higher price, the market may not want to purchase even less. Much depends on the elasticity of demand at prices, which the break-even chart does not reflect. This pricing method requires the company to consider different price options, their impact on the sales volume necessary to overcome the break-even level and obtain the target profit, as well as analyze the probability of achieving all this at every possible price of the goods.

Break-even chart for determining the target price of goods

Fig. 64. Break-even chart for determining the target price of goods