The breakeven price formula and how to apply it
Okay, so this is a crucial part of understanding how breakeven price works. But before writing down the formula, there are 3 notions you need to get accustomed to:
1. Selling price
I don’t think there is too much introduction required here, because the notion is pretty much self-explanatory. The selling price is what the buyer ends up paying for the end product, after the provider’s added value.
2. Fixed costs
Fixed costs are defined by the fact that they don’t vary, regardless of how many units you end up selling. This is because, for the most part, there is no production process to elevate the costs or make them vary, according to specific fluctuations in the manufacturing process.
Here we include things like regular subscriptions, insurances, rent and anything that falls in the same category.
3. Variable costs
Variable costs represent the fluctuation in the value of a given unit, depending on the amount of units you sell. And here you include a lot of things like materials, labor, when we are talking about part-time, commissions and so on.
In this context, it comes natural that the breakeven price formula can be summed by dividing the fixed costs by selling price minus variable costs. What this formula does is to show you the number of units you have to sell in order to make a profit. Or increase your profit, for that matter.
Why should you use this formula in your business?
Well, for start, because you can’t have a business without it. Who goes into any type of business without calculating its net profits and losses and knowing how much to produce and when to increase or cut the prices or the production costs?
But, aside from that, there are several other benefits to performing a regular check on the breakeven price, like:
– Lets you know when to increase or decrease production – If you are on the verge of losing money either because of not producing enough units or producing too many, there is no way of knowing what measures to adopt without putting the formula to work.
– The profit chart – A thorough breakeven analysis allows you to identify the profit for specific sales thresholds. This will help you realize what you need to do to increase the sales, whether we are talking about marketing or financial strategies.
– Control the fixed and variable costs – The lower the costs are, the higher the profit. And since nothing should be more important to you than your business’s profitability, resorting to the breakeven price formula is a must.
– Putting together a solid pricing strategy – Producing assets, whether we are talking about products or services, translates into moving capital. Simply put, you spend money to get money. Spending money is the easy part, because, whether you do it smart or completely disastrous, spending is what you do. The tricky part is getting it back. As a surplus. And having a solid pricing strategy simply isn’t possible without rigorous breakeven price analysis.
Because it is so effective in not only maintaining your business afloat, but also in making it highly profitable and opening a lot of future opportunities, resorting to a steady breakeven price analysis is what you need to do.
It doesn’t matter whether we are talking about starting a new business, creating a new product or an innovative service or changing the business model, in part or completely. The requirement remains the same.
Are there any limitations to the breakeven price analysis?
In other words, what you should and should not expect in terms of breakeven formula outcomes? And here we have several specifications we need to take into account.
1. The formula doesn’t tell you about consumer preferences
It may seem like it does, but it doesn’t. And I know where the confusion comes from. The problem is that the formula only tells you how many units you need to sale to go over the breakeven price and make or increase the profit. It doesn’t tell you in advance how your units will perform on the market or how many you will sell in a given timeframe.
Those buying your units will express their choices depending on your price per unit or on your quality. In this context, the formula is pretty much useless.
2. Unreliable in some cases
More precisely, in cases where you develop charts without having reliable or sufficient data. And doing so could actually work against you, because it will make you take measures where measures are not needed. This is why it is imperative to make sure all the data you use in applying the formula is 100% reliable, because even the slightest misstep could have dire consequences.
3. It ignores timeframes
For an exhaustive analysis on the behavior of the units on the market, you need to include price variations over time. Unfortunately, the breakeven formula doesn’t include that aspect in the calculus. Hence, the results may be irrelevant in case you want to know how your sales evolve over shorter periods of time.
4. It doesn’t take the effects of the competition into account
On a free market, it is competition that sets the pace. No matter what your plans are in terms of price or quality, you are always forced to abide by the rules of the market. And the rules of the market are set by competition. You can’t sell at any given price, if you are moving in a sector where others sell the same type of units cheaper. You will be forced to lower your prices as well. And the main problem with this formula is that it can’t tell you the reason your sales are going down, so you won’t know if it is because of poor pricing strategies or other factors.
You could probably find several other downsides, but that will not change the essence, which is: there is no way to build any type of business without having a good grasp on how the breakeven analysis formula works.
Breakeven price strategies to increase your profit
There may be times when you apply the aforementioned formula and realize your breakeven price is set extremely high. In other words, that you need to sell a lot of units just to be able to cover your costs. The higher your costs are, the harder it will be for you to make profit.
It works the same regardless of what area of expertise we are talking about or what specific marketing sector. If your breakeven price is too high, you need to lower it so that you can enter the realm of profit. This is your goal and, in many cases, your entire business will depend on it.
Which means you need some well detailed strategies to help you lower the breakeven price as much as needed for you to start making a profit. Among these strategies we include:
1. Lowering the fixed costs
It is the most natural strategy that you can think of and it makes sense. You want to shift more money to the profit zone? Cut some of the fixed costs, when possible, and the number of units you need to sell to hit the breakeven point will decrease accordingly.
2. Increase prices
Strategy number 2, equally popular. Extremely easy in theory, because, once you have increased your prices, you will need fewer sells to break even. The major problem is that this is not an apply-whenever-wherever formula. It is regulated by the competition, in the sense that you simply can’t increase prices while on a heavily competitive business market. The competition won’t let you and you might end up losing more money in the process. Because buyers will not pay more for the same unit, if your competition has it cheaper.
3. Lowering the variable costs
This is among the most difficult strategies to adopt, especially for young businesses that don’t have the advantage of fame to weigh in during negotiations. Because, as you may have already guessed it, it is all about negotiating your variable costs with the third-parties that they depend to, like lenders, suppliers or landlords in some cases.
4. Use tested selling techniques like cross-sell
Such a system could actually bring you substantial benefits, including lowering the breakeven price dramatically. I am talking about cross-sell, which relies on selling additional products or services as complementary assets, part of a bundle of other products or services. For instance, for every 2 pair of shoes bought, offer a free t-shirt as well. Or with a serious discount, around 80% or so. All you can think of is the fact that you are giving away a t-shirt for free. All I can think of is you are selling 2 pair of shoes instead of 1.
Know your breakeven point
There is no profit to be made when the breakeven point works against you. Every decision you make will eventually reflect onto your profit, which means you have a very low margin of error.
And it all starts with keeping the breakeven price under control and elaborating an efficient set of strategies to deal with the unexpected.