Business Studies

Review the “Pricing and Breakeven Analysis” study material. Explain how a price decrease that increases volume and sales can result in a profit decrease. Discuss why implementing proper pricing strategies is important to profitable business operations. Support your ideas by citing the study materials. In replies to peers, evaluate their ideas and provide feedback.

ANSWER

Pricing and Break-Even Analysis

Introduction

Profit is the main goal for any business venture; hence before investing, business persons consider the profit they will earn. Since the efforts to earn profit are not easy, business people have to plan their activities effectively. The most crucial tool to help one figure out whether their business will profit is the break-even analysis. A break-even analysis is a financial tool that helps decide at what point a company will be profitable (Oppusunggu., 2020). Businesses can use the break-even analysis to compute the break-even point, hence decide the minimum amount of revenue they must generate to achieve the expected profit.

Pricing is one of the cornerstones of marketing; thus, the fastest and most effective way for a business to gain profit is by getting its pricing right. Increasing or decreasing prices affect a business’ profitability; for instance, lowering product prices results in high volume sales with small profit margins. However, lowering the price to make more sales could result in a profit decrease. For example, a business that sells 5,000 products at $50 each makes a sale of 5,000 x $50 = $250,000. If the cost of each product is $35, the total cost is 5,000 x $35= $175,000. The gross profit is therefore $250,000-$175,000=$75,000. The business expenses are $35,000, giving a net profit of $75,000-$35,000=$40,000. Assuming the expenses remain constant, the business lowers the cost by 10%, increasing the volume by 20%. Similarly, if the cost increases by 10%, the volume of sales decreases by 20%.

If the price lowers by 10%, it becomes $45, and sales increase by 20% to 6,000 units. Total sales will be 6,000 x $45= $270,000. Total cost of the products will be 6,000 x $35=$210,000, gross profit becomes $270,000-$210,000=$60,000. The expenses remain at $35,000, therefore net profit reduces to $60,000-$35,000=$25,000. However, the price increases by 10%, the sales would reduce by 20%. Therefore, the price rises to $55, and the volume of sales lowers to 4,000 units. Total sales would result in 4,000 x $55=$220,000. The total cost of the products is 4,000 x$35,000=$140,000. Gross profit becomes $220,000-$140,000=$80,000. Gross profit less expenses, $80,000-$35,000=$45,000. From the example, lowering the product’s price increases the sales but reduces the net profit from by $15,000. However, increasing the price lowers the volume of sales but increases the net profit by $5,000.

Implementing a proper pricing strategy is crucial to the profitability of any business. Increasing the price of products could result in reduced sales but with high-profit margins. However, a price reduction could mean increased volume of sales, which lowers the cost of the product for the business, therefore, improving the profit margins. A company that fails to manage its prices loses control over them (Toni et Al. 2017). Enterprises ought to evaluate the effect that prices will have on the business and understand how consumers will perceive the prices. Pricing strategy also sends a message to consumers and influences the way they view a business. For instance, consumers often associate higher prices with higher quality and lower prices with lower quality. Additionally, the price of a business makes it either more or less competitive in the marketplace. Some businesses lower their prices temporarily or provide discounts and offer to gain more share in the market than their competitors.

Conclusion

Knowing what to sell is crucial for a business; however, knowing how to sell it is more crucial. Strategic pricing entails setting a product’s price based on its value to the consumer and competitive strategy rather than on the cost of production, because consumers often buy products from a psychological point of view, not logical. Therefore, what is important to a consumer may not necessarily be the most expensive. Lowering the price of products may increase sales volume; however, it could reduce profits. Increasing profits could lower the volume of goods sold but lead to high-profit margins. Pricing requires an in-depth understanding of consumer behavior, which can be understood by creating strategic policies, analytics, and processes.

References

Oppusunggu., L. S. (2020). Importance of Break-even Analysis for Micro, Small, and Medium            Enterprises. International Journal of Research – Granthaalayah, 8(6), 212-218.

https://doi.org/10.29121/granthaalayah.v8.i6.2020.502

Toni, D. D., Milan, G. S., Saciloto, E. B., & Larentis, F. (2017). Pricing strategies and levels and their impact on corporate profitability. Revista de Administração, 52(2), 120-133.            https://10.1016/j.rausp.2016.12.004