Understanding Breakeven

Because price is one of the components of the marketing mix (along with product, place, and promotion), marketers have to be informed about and involved in the development of pricing strategy for the offered products or services. This begins with the awareness of the minimum pricing point at which a product can feasibly be set.

This is where the principle of breakeven comes in. To truly understand it, you must first have a firm grasp on variable costs, margin, and fixed costs. First, variable cost is how much it costs to produce an additional product unit. If you are selling physical products, like shoes, the variable cost is how much it costs you to make one additional pair of shoes. If you are selling a service, the variable cost could be something like the commission paid to a salesperson for each sale. Margin is the difference between variable cost and selling price. So if each additional pair of shoes costs $5 to manufacture and it is then sold for $25, the margin for that pair of shoes is $20.

Fixed costs, on the other hand, are not dependent on the number of units produced. They are constant over a certain time regardless of the number of units produced. These costs include items such as rent and the wages paid to salaried employees.

As the graphic above implies, breakeven is the point between operating at a loss and operating at a profit. What this means in the terms we have already defined is that the total margin for all units sold is sufficient to cover the company’s fixed costs thus avoiding the possibility of having a net loss, and any margins after that point become profit.

To illustrate, let’s continue with the previous shoe example. Assume we have a shoe manufacturer whose fixed costs are $200,000 per year. If, as previously stated, $5 out of the $25 revenue per pair goes toward covering variable costs thus making the margin $20, we must determine how many pairs of shoes we must sell at that margin amount to cover the fixed costs of $200,000 to break even.

$200,000 / $20 = 10,000 pairs of shoes

Our shoe company needs to sell 10,000 pairs of shoes per year to break even. Breakeven is also often spoken of in terms of revenue needed. To calculate this, one need only multiply the number of units by the selling price.

10,000 pairs of shoes * $25 (selling price) = $250,000 needed in revenue

Understanding these calculations will aid you in beginning your marketing plan. By fully grasping the interactions between your pricing and your costs, you can then begin to think about how to maximize profit, whether by increasing your price per unit, your number of units sold, or a combination of the two.

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