How Big Does Your Company Need to Be?

When thinking about creating your new venture a good starting point is to first conduct a Break-Even Analysis (BEA). A BEA will flag the required scale of the business to be profitable. You can also model the price point against expected demand at that price point – assuming that is, you have separately conducted a price point market analysis.

Two scenarios are presented below as examples.

Scenario 1 shows that with fixed costs of $92,500 and a sell price of $32.00 and variable costs of $5.35 the scale of the business will require the capacity to produce 3471 units of ‘product’.  Drop the sell price to $20.00 and the units to be sold just to break even nearly doubles to 6,314 units.

Scenario 1. Small capacity – high unit price.

Total Fixed costs ($)

Sales price per unit ($)

Total Variable costs/Unit ($)

BEP

     92,500

32.00

5.35

    3,471

Scenario 2. Large capacity – low unit price.

Total Fixed costs ($)

Sales price per unit ($)

Total Variable costs/Unit ($)

BEP

     92,500

20.00

5.35

    6,314

 

 

 

If your market research tells you that your target market will has demand for only 3,000 units then you need a small capacity enterprise selling at a higher price. However, if the market place is price sensitive, then you have little choice but to upscale the business to a higher product capacity level.

Furthermore, you can assess how much market share you need to capture for a profitable slice of the total market. For example, if the total market demand is 10,000 units then in Scenario 1 you will need to capture 34.71% of the market or 63.14% for the low unit price scenario – just to break even.

These metrics also give an indication of how difficult it may be to create a profitable business. Capturing market share of either dimension in these scenarios is not likely to be easy, thus, you need to be in business for the long-haul or develop and implement a major and highly expensive marketing campaign – which only raises the Break-Even bar even higher. One obvious solution is to aggressively drive down overall costs.