Adapting to Dynamic Pricing and Cost Structures
- You're running a business that sells handmade candles.
- You've calculated your break-even point and are confident about your pricing strategy.
- But what happens when your supplier raises the cost of wax, or you decide to increase your prices to match competitors?
Dynamic pricing and cost structures are realities every business faces.
Price Changes: Impact on Break-Even and Margin of Safety
How Price Increases Affect Break-Even
- Higher Selling Price: Increases the contribution per unit.
- Lower Break-Even Quantity: Fewer units are needed to cover fixed costs.
If you raise the price of a candle from \$15 to \$18, and the variable cost remains \$5, the contribution per unit increases from \$10 to \$13, reducing the break-even quantity.
How Price Decreases Affect Break-Even
- Lower Selling Price: Reduces the contribution per unit.
- Higher Break-Even Quantity: More units are needed to cover fixed costs.
If the candle price drops to \$12, the contribution per unit falls to \$7, increasing the break-even quantity.
Impact on Margin of Safety
- Price Increase: Increases the margin of safety, reducing risk.
- Price Decrease: Lowers the margin of safety, increasing risk.
A higher margin of safety means your business can withstand a drop in sales without incurring losses.
Cost Changes: Variable and Fixed Costs
Variable Cost Increases
- Higher Variable Costs: Reduce the contribution per unit.
- Higher Break-Even Quantity: More units are needed to cover fixed costs.
- Lower Margin of Safety: Increases risk.
If the variable cost of a candle rises from \$5 to \$7, and the selling price is \$15, the contribution per unit drops from \$10 to \$8, increasing the break-even quantity.
