Page 126 - Marketing the Basics 2nd

118 Marketing: the Basics
Variable costs (including labour): $5 Fixed costs: $1,000,000
Expected sales (units): 80,000
Before calculating the mark-up, our entrepreneur must know the cost per unit. The formula is as follows:
Unit cost = Variable Cost + (Fixed Costs/Unit Sales) Plugging our numbers into the formula yields:
Unit Cost = $5 + ($1,000,000/80,000) therefore
Unit Cost = $17.50
Each plate costs her $17.50. To calculate the mark-up price, the formula is:
Price Mark-up = Unit Cost/(1−Rate of Return Expected ), so $17.50/(1−0.30) = $25
So, she would have to charge $25 per plate to achieve a 30 per cent rate of return.
Mark-up pricing is often referred to as fair pricing. It allows the producer to cover its costs and earn a fair rate of return. However, mark-up pricing ignores the consumer’s perceived value of the product. As we demonstrated in the last chapter, products that offer many benefits command a higher price in the marketplace. Fair pricing also ignores the hard reality of competitors’ pricing which, in effect, provides a ceiling which we cannot rise above unless we have successfully differentiated our product in a way relevant to the customer so that they are willing to pay a premium.
TARGET RETURN PRICING
Target return pricing involves setting a price that yields an expected return on investment. Do not confuse return on investment (ROI) with the expected rate of return. The former calculates the effectiveness of the capital spent, the latter, is the opportunity cost. The formula for ROI is expressed as follows.