Break-even

Break-even is the output level where total costs equal total revenue.

A vital part of any business plan is to see what output level or sales level is necessary before you are going to break-even. Break-even does not specify a time that it will take to reach this level. This will depend on how quickly sales are generated. In some cases it can be many years before a firm would reach its break-even sales level. A bank or other investor will almost certainly want to see break-even information. To work out break-even we need to know various bits of information:

1. The price you are charging
2. The variable costs (direct costs) of each unit - these are the costs of raw materials, labour and so on that can be directly attributed to each unit.
3. The fixed costs (or indirect costs/overheads) - these are the costs that stay the same whatever the level of output and will be things like rent, marketing costs, admin costs and so on.

Once we have this information, we can work out the break-even level of output. Let's look at an example:

Price = £5
Variable costs = £3 per unit
Fixed costs = £1,000

From this information we can see that every time we sell one more unit we have an excess of income over variable costs of £2. We call this figure the contribution. However, this is NOT the same as profit, because we still have to pay the fixed costs of £1,000. We therefore need to work out how many we need to sell for the total contribution to be equal to the fixed costs. In this case, the contribution is £2 per unit and the fixed costs are £1,000, so if we can sell 500 units then we will have had enough contribution to pay the fixed costs. Any units we sell beyond that level will then make a profit of £2 each. So if we sell 501 units, our total profit will be £2. If we sell 502 units our total profit will be £4 and so on.

The break-even level of output can therefore be calculated from the following formula:

Break-even output =	Fixed costs
	Contribution (per unit)

However, we can also work out the break-even level of information by plotting the figures on a graph. To do this, we need to go through the following steps:

Stage 1

Plot the total cost line - remember this will be the sum of the fixed costs and variable costs. This means that it will start from part way up the y-axis because of the fixed costs.

Stage 2

Add the total revenue curve. This can be plotted by working out the total revenue at the maximum capacity of the firm, e.g. if they can produce 50,000 units of a good and they sell them at £28 each, then the TR line will go from the origin to a point given by 50,000 units and £1.4m.

The diagram should now look like this:

Stage 3

The point where the TR and TC lines cross is the break-even level of output. At this point the firm will break-even. Any level of output above this point they will make a profit, but any level of output below this point they will make a loss. We can see this from the diagram below:

Stage 4

We can also identify from the diagram the margin of safety of the firm. The margin of safety shows how far from break-even output the firm is currently producing. It shows, in other words, how much output could fall before the firm started making a loss. We can see the margin of safety on the diagram below:

On the diagram below, estimate the company's position if it produced 10,000 and 20,000 units respectively.

	£ ( 10,000 units)	£ (20,000 units)
Total Revenue	0.2m	0.4m
Total cost	0.42m	0.5m
Profit/ loss	0.22m (loss)	0.1m (loss)

The total revenue from selling 10,000 units would be £0.2m. The total cost of producing 10,000 units would however be £0.42m. The company would therefore be making a loss of £0.22m if it continued producing at this level. However, if it increased output and sales to 20,000 units, then the revenue would rise to £0.4m and the costs of producing 20,000 units would have risen (because of the variable costs) to £0.5m. The fixed costs of producing 10,000 units and 20,000 units are however the same so the revenue is rising at a faster rate than the costs. The loss at this level of sales therefore would be £0.1m. This figure is lower than the loss made at 10,000 units. If you follow through the logic here you can identify the level of profit or loss at different levels of sales and output.

This is all based on an assumption about the structure of the total revenue curve. Total revenue is price times the quantity sold (TR = P x Q). If the business decided to charge a different price, the total revenue curve would be a different shape. If the company decided to charge a lower price, the total revenue curve would be flatter. This would mean that the company needs to sell a greater volume before they will break-even. It does not mean that they will never sell enough, it merely means they have to sell more.

On the other hand, if they decided on setting price at a higher level, the TR curve would now be steeper. This would imply that the number of sales needed to break-even would be less. The decision on the price level will depend on a host of factors - the level of competition, the type of product and what market it is aimed at (for example, is the product aimed at groups A and B in the 'social class groupings' or at a mass market?) and the results of market research conducted by the company that may inform their decisions. Using break-even analysis therefore allows a business to be able to plan and be informed of the impact of its decisions.

Break-even analysis is therefore an example of a quantitative decision making technique. The decision on the actual price to charge will largely be a qualitative one albeit based on other forms of information such as the results of market research.

Banks lend more and charge more at the same time

Commercial loans and overdrafts and other forms of credit for businesses are hugely important to sustain businesses fighting a recession or those in better shape and looking to expand. It is a truism that the UK economy will not engineer a durable recovery unless the international financial and economic backdrop improves. Increasing the availability of bank lending especially to small and medium-sized enterprises is another essential building block to an upturn in output and jobs.

In this sense the news that Barclays has lent £17 billion to UK households and business in the first half of 2009 - already outstripping the £11 billion target it set for the whole of 2009 - is welcome. But that figure hides the actual cost of servicing loans. Even if a business can maintain an overdraft facility or gain access to fresh credit, it is likely to be paying more for the privilege. The cost of debt can be as important as the supply.

Given that thousands upon thousands of smaller businesses use credit cards as a way of tiding them over from month to month (something the business studies textbooks and exam boards seem strangely reluctant to recognise despite overwhelming evidence), it will come as little comfort to entrepreneurs to be paying upwards of 40 times base rate (policy rate) for their loans.

UEFA: Clubs face financial ruin if they match City

Premier League clubs risk financial ruin if they attempt to compete with the spending power of Manchester City, according to UEFA general secretary David Taylor.

Khaldoon Al Mubarak: The new City chairman.

City have embarked on a huge summer spending spree with the high-profile signings of Carlos Tevez, Roque Santa Cruz and Emmanuel Adebayor, backed by their mega-rich owners from Abu Dhabi.

But Taylor believes the Eastlands club, and Spanish giants Real Madrid, are setting a dangerous precedent.

"I would say in this financial climate, it is surprising, a little bit destabilising of the market," Taylor told the BBC.

"It is raising the ante in terms of the player costs, in terms of the general market place, which is not a thing that gives us a great deal of comfort in these difficult times.

"There is certainly disquiet in the corridors of power here (at UEFA)."

The demise of Leeds United, who were relegated from the Premier League in 2004 saddled with debts and now play in League One, is often used as an example of how a big club can hit the rocks and Taylor said their plight should be a warning.

"There are stories concerning some English clubs that are of significant concern," he said. "There are a number of English clubs where the value of the club itself has fallen significantly and they are effectively on the market.

"We've seen what has happened in recent years with a number of very high-profile clubs, Leeds United for example. They fell into serious financial difficulties by over-extending themselves.

"In this current economic environment, I would never say never to anything like that. Clearly we do not see that as imminent but the concern is that we have to establish a stronger financial basis on which clubs can compete."

Liverpool's parent company Kop Holdings, owned by Americans Tom Hicks and George Gillett, announced a loss of £42.6m last year mainly due to interest payments to service the debt taken out to buy the club.

They recently renegotiated the club's debt with the Royal Bank of Scotland, believed to be around £290m.

Manchester United's American owner Malcolm Glazer also borrowed heavily to complete a takoever of the English champions in 2005, sparking unrest among supporters.

Sample Question and a Model Answer.

Imgaine your case study focuses on a new company in a breakfast cereal market.

Analyse why company A has decided to focus on segmentation so carefully.

Compare these two answers:

Answer 1
Company a have decided to segment their market so that they know who they are trying to target. This will make it easier for them to market their products and will lead to more profits. They may decide to segment their market according to income, age, gender or lifestyle so that they can earn more profit and be more successful.

Answer 2
Segmentation is the process of dividing up your market into groups of people sharing common characteristics eg. Age, gender or lifestyle. Company A operates in the highly competitive cereal market which already has a wide range of cereals for different segments. For example, the market is segmented by age or lifestyle. Coco Pops target children and Special K targets the health conscious. Company A may decide to focus on a segment which offers more potential, for example they may bring out an organic range specifically for the segment interested in how foods are produced. By doing this, they will better understand who their customers are and how to reach them with advertising. Thus may lead to higher sales as there are not so many organic cereals available at the moment and ultimately it may lead to more profit.

Company A may also develop a name for itself for organic cereals and may gain higher levels of customer loyalty, making it better able to cope with competition.

Note: Text in Red = Knowledge (Level 1); Blue = Application (level 2); Purple = Analysis (Level 3); Green = shows some extra bit of knowledge that you possess and insert into your answer.

What is the link between product differentiation and a USP?

An important part of the marketing of the product is through product differentiation. This means making the product different from its competitors. Product differentiation can be achieved through…

• Distinctive design– e.g. Dyson; Apple iPod
• Branding - e.g. Nike, Reebok
• Performance - e.g. Mercedes, BMW

A key term to remember is USP, which is the acronym for Unique Selling Point.

A Unique Selling Point (sometimes called a Unique Sales Proposition) is a feature or benefit that separates (or differentiates) a product from its competitors. The concept of a USP is one of the basics of effective marketing and business that has stood the test of time.

The USP could be a lower price, a smaller version of the product, offering extra functions, or even simply producing a standard product in a range of colours or designs.

A business needs to look at its unique selling points compared to competitors. If it doesn’t have any, the business will probably struggle to make the product seem attractive to customers (the remaining option is usually to compete solely on price).

If a business finds that its customers are switching to competitors or buying purely on price, it should be asked whether the business has identified the USPs for its products and services. If it has, then the question is whether it is communicating USPs clearly to customers?

What is a brand name and what are the advantages of having a strong brand?

A brand name is a name used to distinguish one product from its competitors.

It can apply to a single product, an entire product range, or even a company (e.g. Virgin, Ferrari, Bang and Olufsen).

A brand name is usually associated with a logo or other graphical representation of the brand in order to strengthen the brand image.

The main purpose of branding is to differentiate the products and services of one product or business from those of competitors.

The key advantages to having a strong brand include:

· Successful brand-building helps profitability by “adding values” that customers are prepared to pay for.

· Strong brands inspire customer loyalty leading to repeat sales and word-of mouth recommendation

· The brand owner can usually charge higher prices, especially if the brand is the market leader

· Better access to distribution - retailers, distributors and other sellers usually want to stock top selling brands. With limited shelf space it is more likely the top brands will be on the shelf than less well-known brands

What is meant by repeat business and why is it important?

Getting a profitable customer to buy from a business for the first time is often difficult and expensive. The key to a successful business is to persuade that customer to buy again, and again. That is what is meant by repeat business.

However, many businesses focus on amassing new customers and making more sales from them. They will try anything to land a new customer, including making promises they cannot keep or offering more than they can afford. Even when tactics like these do work, the customer will usually leave for a different business when they see the true nature of who they are dealing with!

Repeat business is all about encouraging customers who buy for the first time to buy again and again!

A business invests a lot of effort and cash in trying to get a customer to purchase a product for the first time. This is known as product trial. Much advertising is aimed at encouraging customers to try a new product, or switch from an existing competitor.

After a new product has been tried once, its success can be measured in how quickly, how often, and in what quantity it is repurchased.

The problem with advertising is that it is very expensive. A business is unlikely to be successful and profitable if it has to keep advertising heavily in order to generate demand from new customers. It is much better if customers can be encouraged to become loyal to the product – even better, to recommend the product to their friends and family!

Achieving a high level of repeat purchase is good news for a business. So what is required?

Firstly, the product should be of the right quality. A sub-standard or low quality product is sure to disappoint first-time customers. They are unlikely to buy again or recommend the product to others.

Secondly, it is important to look at the methods that are available to a business to encourage repeat business. Here are some ideas that usually work:

· Regular communication - Regularly remind them of the business – send an email, a postcard or a catalogue periodically

· Treat repeat customers like they are special (they are!). Offer repeat or regular customers special offers, exclusive deals or other promotional incentives - Incentives for loyalty (e.g. promotional discounts)

· Pick up the phone, or jump in the car, and contact them. A visit or phone call can generate new sales and help a business obtain useful information on customer needs

· Make ordering and delivery as easy and efficient as possible

· Research into customer needs and wants (e.g. through customer surveys)

What is meant by having a “customer focus”?

Quite simply, a business that has a “customer focus” is one which takes the time and trouble to understand and address customer needs.

A customer is anyone who buys a product – either a good or a service – from a business. A customer will be satisfied with his/her purchase if the product meets the customer’s needs. So it is essential that a business has a good understanding of what customers want and need from a product.

If customer needs are met, then the customer is generally satisfied.

The following ideas are usually considered to be fundamental in achieving customer satisfaction:

• The product or service must deliver what is promised – i.e. it must be of good quality
• Sales and promotional activities need to create a positive experience for the customer. For example, the attitudes of employees who make contact with customers should be positive and professional.
• After-sales service should also be positive and appropriate (e.g. user training, help lines, servicing). Customers often need reassurance after they have bought something that they have made the right choice, or help in using a product properly.

Customer expectations of good customer service also play a part in customer satisfaction. These expectations typically include factors such as:

• Safety and security – the product is safe to use!
• Clear and accurate information
• Legal rights to be upheld
• Complaints, enquiries and suggestions are dealt with fairly and promptly
• Special needs catered for (e.g. disability access)