Pricing considerations
Setting a price is very important, but can be difficult. The following need to be considered:
- Profit margins
- Costs involved
- Competition
- Target market
- Type of product
- Inflation
- Brand image
- Quality
Revenue and Price
Revenue—total sales * price of product
A price must be high enough to cover costs and leave a surplus to provide a profit. Bad pricing can cost the business sales.
Total Revenue
Total revenue can be described as:
- income
- revenue
- sales revenue
- sales turnover
- turnover
Total Revenue (TR) can be calculated by multiplying the average selling price (p) by the quantity sold (q).
Types of costs
Some examples of costs include:
- packaging
- rent
- wages
- salaries
- distribution
- raw materials
- promotion
- machinery
- production
- running costs
- administrative costs
Overall, costs can be split into 2 categories -variable and fixed. A fixed cost does not change based on output, an example of fixed costs is salaries, rent and administrative costs.
Variable costs are costs that do change with output. Examples include raw materials, wages (if hours fluctuate or are piece rate), packaging etc.
Fixed costs (FC) + Variable Costs (VC) = Total Costs (TC)
(Units sold * variable cost per unit) + fixed costs = Total Costs
Average costs—how much it costs to produce a single unit or item.
Average cost per unit = Total costs / Total Output
| Output | FC | VC | TC | AC |
|---|---|---|---|---|
| 0 | 4000 | 0 | 4000 | - |
| 10 | 4000 | 500 | 4500 | 450 |
| 20 | 4000 | 960 | 4960 | 248 |
| 30 | 4000 | 1610 | 5610 | 187 |
| 40 | 4000 | 2200 | 6200 | 155 |
| 50 | 4000 | 2800 | 6800 | 136 |
| 60 | 4000 | 4400 | 8400 | 140 |
£175 per unit
| Output | TR | FC | VC | TC |
|---|---|---|---|---|
| 0 | 0 | 5500 | 0 | 5500 |
| 10 | 1750 | 5500 | 500 | 6000 |
| 20 | 3500 | 5500 | 1000 | 6500 |
| 30 | 5250 | 5500 | 1500 | 7000 |
| 40 | 7000 | 5500 | 2000 | 7500 |
| 50 | 8750 | 5500 | 2500 | 8000 |
| 60 | 10500 | 5500 | 3000 | 8500 |
Profit
Profit = total revenue - total costs
Profit is a prime objective for most firms.
To improve profit businesses can:
- increase sales revenue
- decrease costs
A combination of both is the ideal way of achieving additional profit.
Many other ways do exist—such as decreasing price to increase sales volume and therefore sales revenue.
Importance of profit
- Profit is a reward for owners and shareholders
- Profit is a motivator
- Profit is a measure of success
- Profit is a source of finance
- A very good source, because it doesn’t require any repayment or investment
- Profit is a guide for future investment
- Profit is attractive to stakeholders