What is the break-even price, and when to use it?
The break-even price is the price at which a product generates no profit or loss. In other words, it is the point at which income equals expenses.
A break-even price may help you gain market share. For example, most e-commerce companies are still operating below their break-even threshold. They have, nonetheless, gained market share. This pricing process assists the business in determining the lowest acceptable Price at which you can still maintain cash flow and keep the business running. At the same time, you gain an advantage over your competitors.
Why is break-even pricing important for your business?
You must comprehend the break-even price to pick the optimal pricing strategy and make informed judgments on the product's short- and long-term sustainability.
Here are a few quick explanations about the significance of break-even pricing:
Set a target for the number of units sold
With a break-even price, you can determine how many units must be sold to recoup the initial investment.
Budgeting and defining goals
Since you know the point at which a company may break even, it becomes simpler to establish a goal and budget for your business.
Manage the margin of safety
A margin of safety is the discrepancy between your expected profitability and your break-even point. If you know your margin of security, you can make critical business decisions to avoid cash flow disasters by analyzing your cash flow forecasts.
Cost monitoring and control
Using break-even analysis, you can monitor your costs, see if they will affect your profitability, and then take corrective measures to keep your costs in control.
Redefine pricing and sales strategy
A change in the price of your goods or services may affect the break-even point in your sales volume, which assists in designing a pricing strategy.
For example, if the selling price rises, the number of items sold for breaking even would fall. Similarly, your business will need to sell more to break even if the selling price falls.
Break-even pricing formula and calculation
The break-even point is the point at which your company's revenues equals its costs. A break even point analysis is crucial o calculate your company's break-even point.
You must have the values of the following three variables:
- Fixed Costs: The term "fixed costs" refers to your business's ongoing expenditures. Fixed costs include utilities, rent, insurance, wages, service fees, marketing expenditure, etc.
- Variable Costs: Your company's variable cost rises and falls with the increase or decrease in your production volume. When production increases, variable costs lower, and when output decreases, variable prices rise. Examples of variable expenses include direct labor, packaging materials, freight, etc.
- Selling Price: The selling price is the final amount your customer pays for your products.
To calculate your company's break-even point, use the following formula:
Break Even Price = Total fixed Costs/Production Volume + Variable Cost
Break-Even Pricing Calculation
ABC Limited makes smartphones for the luxury segment and would like to introduce a new model called "XX." The accountant has calculated the following costs:
- Rent $600,000
- Executive Salaries $900,000
- Utility Bills of $200,000
- Insurance $100,000
- Raw Material per unit $350
- Sales Commissions per unit are $150
- Packaging Costs per unit are $250
- Transportation per unit is $150
Now let's calculate the fixed costs:
Fixed Costs = Rent + Executive Salaries + Utility Bills + Insurance
= $600,000 + $900,000 + $200,000 + $100,000
Variable Costs = Raw Material + Sales Commissions + Packaging Costs + Transportation
= $350 + $150 + $250 + $150
Let's assume that the production capacity of ABC Limited is 5000 units.
Break Even sales Price = $1,800,000/5000 + $900
= $360 + $900
Now let's assume due to technological research and development, the production capacity of ABC limited has increased to 6000 Units. How do you think this will change the break-even price? Let's calculate.
Break Even Price = $1,800,000/6000 + $900
= $300 + $900
It is worth noting that as production volume grows, the break-even point decreases. This is because your fixed expenditures are distributed across a more significant number of units sold while variable product costs remain constant, reducing production costs.
These variances in break-even sales prices have ramifications for pricing strategies and the anticipated product demand at varying price points.
Advantages and disadvantages of break-even pricing
Following are some of the advantages of using a break-even pricing strategy:
Keeping prices low helps your business maintain a dominant position in the market, which helps your business reduce the amount of competition it faces.
Barriers to Entry
Break-even prices may also serve as a barrier to entry by discouraging new entrants into the market. This is because your rivals do not have a significant amount of incentives and do not have an early-mover advantage.
Economies of Scale
It also helps your company attain economies of scale, which may be accomplished by taking advantage of the cost benefits of more efficient production.
Following are some of the disadvantages of break-even pricing:
Unable to raise prices
Setting a price lower than the competition to win market share makes future price increases more difficult for your business. Consumers' growing accustomization to reduced costs makes it more difficult to justify a price increase that does not increase product quality or quantity.
If your competitors decide to adopt break-even pricing as well, you may find yourself amid a price war. The elimination of competition and the creation of an obstacle to admission are two ways this approach goes against the free market.
Lack of Sustainability
The main issue with this approach is that it is difficult to maintain. Heavy losses and closure are possible if your business lacks the funds and strategy to sustain this approach.
The bottom line
Your break-even price is a crucial metric for long-term planning. Knowing your break-even point will help you cover fixed costs and assist you with a pricing strategy, have enough incoming cash flow to not lose money, and other aspects of running your business.
However, for your business to successfully implement it, you must have control of both the fixed and variable costs and the necessary resources to maintain your break-even price.