Product Pricing: Cost Plus Is Wrong, So What's Right?

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Product managers all want to know what the best way to price their product is. However, we've never been trained on how to go about doing this. All too often we fall back on the product manager's old friend – cost plus pricing.

It turn out that this is the wrong type of pricing for us to be using. It's not going to help our product to be successful. Dr. Jim Anderson takes the time to carefully show why cost plus is the wrong way to price your product, and then he shows you the right way to do it.

For more information on Dr. Jim Anderson and his company, Blue Elephant Consulting, find out more on the web at http://www.BlueElephantConsulting.com

Published in: Business, Technology
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Product Pricing: Cost Plus Is Wrong, So What's Right?

  1. 1. Product Pricing: Cost Plus Is Wrong, So Whats Right?www.TheAccidentalPM.com
  2. 2. Let’s Talk About (Dog) Sweaters What are your costs? • Variable: •Yarn •Knitting •Shipping • Fixed: •Web site •Marketing •Knitting machine All Image (c) 2007 - 2009www.TheAccidentalPM.com
  3. 3. The Problem With Cost Plus Pricing Your Product $10 Cost Your Competition’s $5 Product Quantitywww.TheAccidentalPM.com
  4. 4. Sales & Finance Seem To Always Want You To Change Your Product’s Pricewww.TheAccidentalPM.com
  5. 5. Price Changes: This Is When Things Start To Get Tricky... $10 per dog sweater 4,000 units sold $10 x 4,000 = $40,000 total revenue P1= $10.00 $5.50 variable cost per dog sweater Margin $5.50 x 4,000 = $22,000 in variable costs VC = $40,000 - $22,000 = $5.50 $18,000 total margin Variable Costs Sales Volume = 4,000www.TheAccidentalPM.com
  6. 6. Breakeven Analysis: Would A 5% Price Cut In Dog Sweaters Boost Profits? $0.50 x 4,000 = $2,000 P1= $10.00 Lost Margin P2= $ 9.50 Additional Margin ? Margin Due VC = To Volume $5.50 Additional Variable ? Variable Costs Costs Sales Sales Volume Volume = 4,000 =? Rule: ? > LM = Price Cut Is A Good Ideawww.TheAccidentalPM.com
  7. 7. Breakeven Analysis: A Definition Breakeven analysis allows you to calculate the minimum number of additional sales that you are going to have to make in order to make up for the price change.www.TheAccidentalPM.com
  8. 8. How To Calculate The Minimum Sales Change Needed To Keep Things The Same % Breakeven sales change = - Price Change CM + Price Changewww.TheAccidentalPM.com
  9. 9. How Many More Dog Sweaters Would We Have To Sell If We Cut Prices By 5%? CM = $10 - $5.50 = $4.50 % Breakeven sales change = - Price Change CM + Price Change = -(-$0.50) = 0.125 = 12.5% $4.50 + (-$0.50) Breakeven sales volume = 0.125 x 4,000 = 500 dog sweaterswww.TheAccidentalPM.com
  10. 10. What Happens If We Cut The Price AND Our Variable Costs Go Down At The Same Time? % Breakeven sales change = - (Price Change - VC Change) CM + (Price Change - VC Change) P1= $10.00 Lost Margin P2= $ 9.50 Additional Margin ? Margin Due VC = To Volume $5.50 VC Reduction Margin Additional Variable ? Variable Costs Costs Sales Sales Volume Volume = 4,000 =?www.TheAccidentalPM.com
  11. 11. How Many More Dog Sweaters Would We Have To Sell If We Cut Prices By 5% AND Our Variable Costs Decreased By $0.22? % Breakeven sales change = - (Price Change - VC Change) CM + (Price Change - VC Change) = -(-$0.50 - (-$0.22)) $4.50 + (-$0.50 - (-$0.22)) = 0.066 = 6.6% Breakeven sales volume = 0.066 x 4,000 = 265 dog sweaterswww.TheAccidentalPM.com
  12. 12. One More: What Happens If We Cut The Price AND Our Fixed Costs Go Up At The Same Time? If you only had a new fixed cost & no price change: % Breakeven sales change = $ Change In Fixed Costs $ CM % Breakeven sales change = - (Price Change - VC Change) + $ Change in fixed costs CM+(Price Change-VC Change) CM+(Price Change-VC Change)x Initial Unit Saleswww.TheAccidentalPM.com
  13. 13. How Many More Dog Sweaters Would We Have To Sell If We Cut Prices By 5% AND Our Fixed Costs Increased By $800? % Breakeven sales change = - (Price Change - VC Change) + $ Change in fixed costs CM+(Price Change-VC Change) CM+(Price Change-VC Change)x Initial Unit Sales = 0.125 + $800 = 0.175 = 17.5% $4 x 4,000 units Breakeven sales volume = 0.175 x 4,000 = 700 dog sweaterswww.TheAccidentalPM.com
  14. 14. A Quick Summary... Breakeven analysis allows you to calculate the minimum number of additional sales that you are going to have to make in order to make up for the price change. % Breakeven sales change = - Price Change CM + Price Changewww.TheAccidentalPM.com

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