Calculation of profits?

Question

How does an enterprise, a corporation, or an entity related to business, production, and/or finances calculate the margin of profit that would be reasonable to establish on a certain product?

How does an enterprise, a corporation, or an entity related to business, production, and/or finances calculate the margin of profit that would be reasonable to establish on a certain product?
(By the way, when I mention "reasonable", I mean the fact that the public would accept paying a certain price for the product or service promoted, a so called "crowd-pleaser")

Answer 1

Your questions asks how companies "calculate the margin of profit that would be reasonable".

To answer your question, we begin with four fundamental economic facts:

(1) Price is unrelated to cost.

(2) Price is determined _solely_ by supply and demand.

(3) Cost is not a factor in price.

(4) Profit is determined by both price and cost, so profit (and the profit margin) is a factor of supply, demand and cost.

Bottled water and Starbucks coffee have extremely low costs, but their prices (and their profit margins) exceed that of gasoline. Why? Because price is determined by supply and demand, not by cost.

Thus, the question is not "how does a company determine the profit margin", but instead "how does a company determine price".

A company should determine the price of its products by reference to the prices charged by other companies for identical or similar products. (To repeat: the company's cost of making the product is completely irrelevant to the price it charges.)

Then the company's sales and marketing department will conduct studies in "test markets" to determine more precisely where the price of the company's products should be, in relation to the competition. For example, if Starbucks plans to introduce a "Pumpkin Pie Coffee" in the US at Holloween, it may test market the product in a few small markets to determine what people will pay (and what they won't).

Hope this helps.

Answer 2

This is a basic economics issue. If the product is new and there is now substitute in the market, the markup will be very high. Examples are the first VCR's, IPOD's etc. As compitition grows, the consumer will choose which price will be paid and for how long.

If the product is introduced to a crowded market with lots of substitutes, pricing will be based on a more competitive level with the alternative products. As always, each company wants to maximize the profit and tries to set themselves apart from the compititon. The sales success depends on that separation.

Answer 3

There are several publications that provide industry norms for different types of businesses. A commonly used index is RMA (Robert Morris Associates), which not only gives the industry averages for profit margin, but also many other commonly used financial ratios.

Although there may be a cutting edge new business that would be difficult to compare to an existing industry, RMA would be a very good starting point to gain an idea of what should be expected for a given type of business.

Note - this publication is provided by paid subscription to many businesses. I don't think it's available on-line, but you could probably access it at the reference section of the library. Good luck.

Answer 4

There is No "reasonable margin of profit" that I have ever heard of .
Companies always go for max , they are NOT a charitable organization .
If they can get a 500% mark up , they go for it .
The profit margin is limited 'by what the market will bear ' , don't believe they have ever factored in reasonable except maybe as a low end , like no less than 50% .

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Answer 5

Some industries, like the grocery business, are very competitive and operate on very low margins, like 1 percent. I'm sure that there are other businesses, like maybe Intel, that operate with huge profit margins. You can't really compare across industries because they are so different.