Break-even pricing refers to the price point at which a business's total revenue from selling a product or service equals its total costs associated with producing and selling it. Understanding this critical lever helps businesses with informed decision-making and avoids pricing strategies that lead to losses.
Break-even pricing is deliberately set at a level that doesn't yield any profit but ensures that the generated revenues can offset all the costs involved. This approach to pricing is based on the cost of manufacturing and selling.
The break-even price of any product must be understood through break-even analysis. However, as a pricing strategy, it focuses on covering all costs at any level of production. The result is neither a net profit nor a net loss.
In simple mathematical terms: Break-even price = costs / units
Naturally, your break-even price will decrease as you sell more units of an item. This is one of the biggest difficulties in calculating break-even costs. While you can establish a fixed price for your product, predicting the exact quantity you will sell can be challenging.
Fixed and variable costs
Another complication of break-even pricing is the connection between fixed and variable costs. Fixed costs do not change because of changing production, while variable costs do change because of increasing production.
In this case, you also need to account for variable costs:
Price(n) = Variable costs per unit(n) + Fixed costs per unit
When to use break-even pricing
Break-even pricing is a conservative pricing strategy that usually makes the most sense when entering a new market or launching a new product:
This is because:
- Break-even pricing covers your minimal expenses
- It ensures a high level of competitiveness
- It’s a relatively simple strategy that is relatively straightforward to implement.
Paths to profitability
It is very common for companies to take this approach when trying to gain market share. It is not a profitable choice by design. But the logic is that long-term gains in market share will offset the lack of profitability at the start.
Over time, a company using break-even pricing may increase production volumes to a level that reduces costs and thus earns a profit. They may also consider alternative pricing and monetization strategies once they have secured their place in the market.
Break-even pricing challenges
Break-even pricing has several vital weaknesses that can make it undesirable.
As a pricing strategy, it does not account for the following:
- Customer demand
- Profit margins
- Long-term sustainability
- Challenges arising from accusations of anti-competitive behaviour
All need careful examination and risk mitigation. Even in terms of competition, there are more competitive pricing strategies.
The name itself alludes to its lack of profitability. But even in the long term, there are more effective ways to increase future profit than break-even pricing.
Competitive pressure
When engaging in break-even pricing strategies, you are vulnerable to competitive pressure. You are bound to cause concern and invite aggressive responses from your competitors. This is why competitor and market research is essential, as is choosing the right situation for break-even pricing.
The wrong implementation can lead to the following:
- More intense competition in the short-term
- Price wars
- Eroded profitability across your industry
- Depending on the market and situation, accusations of anti-competitive behaviour
Cost variability
For most manufacturers, much of their manufacturing costs are variable. Break-even pricing assumes that costs are near-static by default. However, any level of variability in costs can undermine this logic.
Any changes in material costs, labour costs, or other categories jeopardize your chances of succeeding with break-even pricing. This is particularly true in periods of high inflation.
Sustainability of a break-even strategy
For all the reasons outlined above, relying on break-even pricing in the long term is not viable. However, you can use it temporarily to achieve a stated goal, such as market entry, before moving on to alternatives.
Your alternative: Value-based pricing
One such alternative is value-based pricing strategies, where your pricing is aligned with the value proposition of your product or service. This way, you can maximize profitability and ensure your prices aren’t tied to your costs alone.
Value-based pricing is based on “value drivers”. These are the value-adding features that are accounted for in value-based pricing. They speak to the value offered to your customers and often focus on niche features that make your offering stand apart.
Simon-Kucher can help guide you through creating a more profitable value-based strategy. Generally, the process follows these key steps:
- Map the key value drivers
- Calculate the monetary benefits
- Adapt your revenue model
- Retrain your sales team to sell products based on value, not on price
Dynamic pricing
Dynamic pricing refers to pricing strategies where prices vary over time to reflect changing market conditions. Most commonly, when demand increases, prices increase and vice versa.
Dynamic pricing is more complex and requires careful attention. You need to know what to do and what not to do. In the long run, dynamic pricing is profitable and crucial for maximizing profits.
Any business can take advantage of dynamic pricing. Although it originated in the travel industry during the 70s, now many other industries benefit from it.
Now more than ever, data drives everything. Pricing can also be optimized thanks to the proliferation of more accurate data. Prices can be adjusted quickly and effectively to account for changing conditions.
At Simon-Kucher, we encourage companies to use pricing research and analytics as foundational tools in their pricing strategy toolkit. Our expertise in pricing and growth can help you optimize your business strategies.
Contact us today to learn more and how we can help you optimize your pricing strategy.
