Break-even pricing is associated with break-even analysis, which is a forecasting tool used by marketers to determine how many products must be sold before the company starts realizing a profit. Like the markup method, break-even pricing does not directly consider market demand when determining price. However, it does indicate the minimum level of demand that is needed before a product will show a profit. From this, the marketer can then assess whether the product can realistically achieve these levels.
The formula for determining break-even takes into consideration both variable and fixed costs (discussed in the Pricing Decisions Tutorial) as well as price, and is calculated as follows:
For example, assume a company operates a single-product manufacturing plant that has a total fixed cost (e.g., purchase of equipment, commercial mortgage, etc.) per year of (US) $3 million and the variable cost (e.g., raw materials, labor, electricity, etc.) is $45.00 per unit. If the product is sold directly to customers for $120, it will require the company to sell 40,000 units to reach the break-even point.
Again, it must be emphasize that marketers must determine whether the demand (i.e., number of units needed the break-even point) is realistically attainable. Simply plugging in a number for price without knowing how the market will respond to to this price is not an effect way to approach this method of price setting.
(Note: A common mistake when performing this analysis is to report the break-even in a monetary value such a breakeven in dollars (e.g., results report $40,000 instead of 40,000 units). The calculation presented above is a measure of units that need to be sold. Clearly, it is easy to turn this into a revenue break-even analysis by multiplying the units needed by the selling price. In our example, 40,000 units x $120 = $4,800,000.)