Dollinger index

218 ENTREPRENEURSHIP

Break-even volume= Fixed cost/(Price-variable cost) = $100,000/($200-$100) =

1000 hours

Target profit pricing bases its calculations on simple break-even analysis. Let’s

change our example to a product, a small digital MP3 player. Now look at the break-

even volume at different prices based on these data assumptions:

Investment $1,000,000

Fixed costs per year $1,300,000

Variable cost $1,000,020

If the entrepreneur wants a 20 percent return on investment, that is $200,000. Consider

the effects of various prices on sales estimates and profits by building a break-even vol-

ume and profit table.

At $28 per unit, the venture will lose $16,000. Since this price is too low, the entre-

preneur moves it up in $4 increments to find out where the venture becomes profitable

and approaches the target of $200,000. Note that as price rises, unit demand falls. At

$36 per unit, the product reaches its maximum estimated profit of $180,000. This falls

short of the target, but if prices go higher, the demand falls and so does the projected

profit. The only way to reach the target is to reduce the amount invested by using cap-

ital more efficiently or by reducing our variable costs to allow for more margin per prod-

uct. Reworking investment levels, cost estimates, demand estimates, and profit targets

is often necessary for a new venture.

Skimming the marketidentifies a price-insensitive segment and charges the highest

price the market can bear for short-term profits. It works when:

• No comparable products are available.


• Costs are uncertain.


• The product has an extremely short life cycle.


• A drastic innovation or improvement has been made.


• Competitors are unlikely to enter the market (due to high entry barriers, high pro-
  motion costs, expensive R & D costs, or other isolating mechanisms).

1

Price per

unit

28

32

36

40

44

2

Unit demand to

break even

37,500

30,000

18,750

15,000

12,500

3

Expected unit

demand at

given price

35,500

33,500

30,000

21,000

11,500

4

Total revenue

(1 x 3)

$ 994,000

1,072,000

1,080,000

840,000

506,000

5

Total costs*

$1,010,000

970,000

900,000

720,000

530,000

6

Profit (4 – 5)

$ 16,000

102,000

180,000

120,000

24,000

*Assumes fixed costs of $300,000 and variable cost of $20/unit

TABLE 6.3 Break Even Volume and Target Pricing

($) –