These days a great deal of importance is attached to cost-volume-profit relationship, which, as the name itself indicates, is an analysis of three distinct factors — cost, volume and profit. The study of cost-volume-profit relationship is frequently refered to as the Break-even Analysis. A break-even point  is that quantity of output at which the total sales revenue equals the total cost, assuming a certain selling price. As BEP represents a no-profit-no loss point, sales beyond BEP result in profits and the further the sales are from the BEP, the higher are the profit profits. Sales below the BEP represent losses to the marketers.

Determination of BEP: There is a company whose fixed overhead is constant at Rs. 6000. It produces and selles an out put of 25 tonnes. Its selling price is Rs. 600 per tonne and its variable costs are Rs. 200 per tonne. Thebreak-even point may be found using the following:

Break-even point ( In Quantity ) = Total Fixt Cost/ Unit Contribution to Overheads

=Total Fixed Costs/ Selling Price – Variable Costs

= 6000/ 600 -200

= 15

Here, the assumption is that fixed costs remain constant for a specified level of activity. The production may vary from zero to the full projected capacity and yet the fixed costs do not change. This is valid for a limited short period. The second assumption is that the variable costs vary directly and proportionately with the volume of production. Thus double the level of activity and the variable costs would be twice the previous one. Another break-even point will be found for another selling price. The break-even point is for Rs. 600 per tonne price only. Break-even point of 15 at a price Rs. 600 per tonne means that if the market buys less than this quantity,  the firm will be at a loss. The output produced and sold in our example is 25 and it is 10 units beyond the BEP.

Very popular, this method tries to cover the total cost consisting of prime cost, office cost, selling cost, taxes etc. After covering the total cost, a certain margin of profits is added to mark-up the price.

Selling Price = Total Cost + Margin of Profit

= ( Prime Cost + Office Overheads + Selling Overheads + Taxes )

+ Margin of Profit

Where Prime Cost = Direct Labour Cost + Direct Material Cost + Direct Expenses

Overheads = Indirect Costs

This method is very useful for engineering products  and job costing. It is also useful for marketing intermediaries. It is also useful when we operate in a seller’s market.

In a high cost economy like ours, the consumer is at disadvantage when this method is used. As the cost is recovered from the consumer, there is no incentive to reduce the costs. This method is also not useful for a very competitive market. In a buyer’s market, we should adopt some other method.

China produces things at a price no one around the world can seem to match. Alexandra Harney has written a book The China Price — The True Cost of Competitive Advantage. Chinese products sell at ultra low prices but China pays a high price in terms of human and environmental cost to become the world’s largest manufacturer. Though China has very good labour laws in place, the working conditions in the factories around China continue to be poor. There is no enforcement of laws at the local government level whose offices are evaluated on the basis of their track record in promoting economic growth.Besides,  there is a dual factory system — the five-star factory which follows the best practices and the shadow factories which violate every law on the books.These shadow factories allow China to offer Wal-Mart low prices. In China, social benefits are tied to the place of birth which is registered and called hokou. Migration deprives people their legal benefits. As factories do not pay social benefits, they can keep prices low. People in north China work in illegal shadow coal mines.Their health deteriorates over a period of time. There are deaths due to pollution. Coal lies at the heart of China price. More than two-third’s of China’s energy supply comes from coal. Though MNCs conduct audits while dealing with the Chinese factories, these audits are perfunctory. Besides MNCs want goods at developing world prices under developed world conditions. This is simply not possible.Factories provide a façade of compliance while dealing with the MNCs, but keep running sweatshops. Falsification of documents have become an art.

Price may exert a non-conscious influence on expectations of product quality. These expectations affect the actual product performance. These expectations can be induced through advertising. Baba Shiv, University of Iowa ( Stanford ) and his colleagues Dan Ariely, Ziv Carmon did a fascinating study to examine this phenomenon. The findings were summarised by Akshay R. Rao, University of Minnesota. In the study, two groups were given a mental acuity enhancing drink—one costing $ 1.89 and the other $ 1.0. They were asked to solve the puzzles after consumption of the drink. The group which had consumed full-priced drink solved more puzzles than the group that received discounted price drink. The discounted price receiving group had less expectations about the efficacy of the drink as far as their problems solving ability is concerned. These lessened expectations sub-consciously and affected the actual product performance. It is a demonstration of price-quality effect. In many instances, psychology is more important than engineering in product design.