Analyzing Your Costs and Overhead

April 13, 2006

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The most common errors in pricing are:

pricing products or services based only on the cost to produce them
pricing products based only on competitors' prices

Several objectives need to be addressed in determining correct product pricing:

Cover the cost of producing the goods or services.
Cover marketing and overhead expenses.
Provide profit objectives.
Afford distribution margin discounts.
Afford sales commissions.
Be competitive.

Breakeven analysis. Breakeven analysis is a commonly used method that focuses on the volume of sales at which total revenues will equal total costs. The idea is to set the price of a unit of product or service at a level where it will cover all of its own variable costs (material, labor, marketing etc.) plus its portion of the fixed costs of the company (overhead). At the point where enough units have been sold to cover all fixed and variable costs, breakeven is achieved. After that point, the sales price of a unit sold minus the variable (direct) cost to produce it equals pure profit.

For example, a case of bottled tea beverages in 12-ounce ready-to-drink bottles has a cost of goods of $3.82 per case of 12. Factory price to distributors is $6.54/case. Gross margin (price minus cost of goods) is $2.72/case. If the company's fixed costs (e.g., overhead, factory expenses, etc.) are estimated at $75,000.00 per year, then the breakeven point would be 27,573.5 cases of tea ($75,000 divided by $2.72/case).

For more information on breakeven points, see our discussion of breakeven analysis.

For more information on cost considerations as they relate to pricing, consider the following: