Module 2- Developing an Idea- Part 2
Estimating Total Profit
Profit is one of the measures that we use to assess the success of MyBnk businesses. It’s important that teams estimate their potential profit before they get to their marketplace.
Put simply, profit is the surplus left from revenue after paying all costs. Profit is found by deducting total costs from revenue. In short:
Profit = total revenue - total costs.
Total costs
Costs are the expenses involved in making a product. As MyBnk teams are start-ups, their costs will mainly be for raw materials to make their product or marketing to advertise their service.
Higher ability teams may consider costing the time needed to create the products or service. They may also consider variable costs that change with the amount produced. For example, the cost of raw materials rises as more output is made.
It’s unlikely that MyBnk teams will have fixed costs that stay the same even if more is produced. However, teams might want to consider how their costs would be affected if they did have to pay rent or salaries.
Revenue V Profit
Revenue is the income earned by a business over a period of time, e.g. one month. In the case of MyBnk teams, their revenue will be the money that they earn at the marketplace. The amount of revenue earned depends on two things - the number of items sold and their selling price.
Revenue= price x quantity e.g. revenue for selling 30 items priced at £2 each is 30 x £2= £60
Revenue is sometimes called sales, sales revenue, total revenue or turnover.
It is important that teams understand the difference between revenue and profit. They will not be able to keep all of the money that receive at the marketplace as they will have to repay their loan (which will cover their total costs).
Pricing Strategies
As part of estimating their potential profit, teams will have to consider their pricing strategies. Teams need to think about a number of factors to take into account when reaching a pricing decision:
Customers. Price affects sales. Lowering the price of a product increases customer demand. However, too low a price may lead customers to think you are selling a low quality ‘budget product’.
Competitors. A business takes into account the price charged by rival organisations, particularly in competitive markets. This is crucial in MyBnk programmes, where there are other teams competing for the same customers at the same marketplace (in addition to highstreet shops and online retailers)
Teams may consider competitive pricing and have their own price based on that charged by rivals. Setting a price above that charged by the market leader can only work if the product/service is better and/or different to what is already on offer.
Costs. A business can make a profit only if the price charged eventually covers the costs of making an item. One way to try to ensure a profit is to use cost plus pricing. For example, adding a 50% mark up to a sandwich that costs £2 to make means setting the price at £3. The drawback of cost plus pricing is that it may not be competitive.
Teams can think about where to place their price in the market:
Penetration pricing means setting a relatively low price to boost sales. This could be an advantage for the short-length of MyBnk marketplaces but relies on teams selling all of their products/service.
Price skimming means setting a relatively high price to boost profits and slowly lowering the price if and when needed. This may be appropriate for teams that want to sell high-quality, premium products e.g. bespoke paintings and T-shirts. This could be an advantage as there may only need to be a handful of sales to make a profit but relies on customers that are willing to pay the higher prices.
Neither strategy is better than the other, teams need to choose the one that is best for their business.
EXAMPLE- Apple uses a price skimming strategy- they charge a high price to capitalise on customer’s willingness to pay premium prices for new technologies. Apple lower the prices of earlier models each time a new model is released. Apple ‘s price skimming has been massively successful, in 2012 Apple garnered 69% of all mobile phone profits with only 8% of the total market share.
EXAMPLE- Android uses a penetration pricing strategy- they charge lower prices with the goal of securing a large market share. It is predicted that in 2014, Android will have 80.2% of the market share (source)
