[MUSIC] Whoa, you are thinking. All these graphs. All these lines. What do they mean? How do they cross? What are each one of these points? It's very simple as you will see. Let's take the case of a lemonade stand. Let's assume that you're running a lemonade stand during the summer holidays, next to a very popular beach. And that you operate only in the afternoon hours. And you ran the stand for approximately, and you have the rights to sell lemonade during six hours of the day, okay? For example, the green line on the graph illustrates the fixed cost. That can be the cost of the employee per day. For example, which I have set over here as an example, at 75 Euros per day, okay? And those are fixed. And they cost the same, irrespective of whether he sells ten lemonades, or whether he sells 40 lemonades in a day. Okay? Fixed at 75. Then there are the variable cost. In this particular case, because you are selling very fancy lemonade. I have assumed that the variable cost of producing an extra cup of lemonade is three Euros. Fancy lemonade, right? So that's indicated by the purple line. Which as you can see, it climbs up at a constant rate. So three Euros per extra cup of lemonade. Those are the variable costs, which we had been referring to in the previous slide. Then on top of that you have the total cost. So how do you determine the total cost? In this case it's very simple. It is the red line. And it's simply the addition of the variable costs on top of the fixed cost, which is the cost of the employee or 75 Euros a day for six hour of the day. And finally, you have your revenue. Let's assume that you're selling this fancy lemonade In the hot summer months, roughly speaking five Euros per glass, right. So there you have the blue line, which indicates how your revenues grows as a function of the number of glasses of lemonade that you sell. So what is the break-even point? How many cups of lemonade do you need to sell to become profitable? That's exactly the break even point, which is indicated over here by this point that sits at 38 cups of lemonade. This is the point above which your company will become profitable. And you will have recouped your daily total cost of operating the lemonade stand. Above 38 cups of lemonade you will start generating profits for the business. Below that, you will not have recovered your total cost of operating the lemonade stand per day. Now that we've understood how the costs operate, you may ask. Why are there companies that actually price below variable costs? Well it's not because sometimes they don't know how to estimate it. But, typically speaking they may be pursuing other objectives. Oftentimes when you introduce a new product, or a new category. Sometimes you would price below variable cost simply to facilitate trial. Sometimes our companies are trying to price below variable cost to try to keep competition at bay. Or to actually eliminate competition, which is not always legal by the way. In addition, even if we exceed the variable cost, still some companies price are below the total cost. Why would that be the case? There are many instances as to why this can be the case. The prototypical example is when your fixed costs are very high. For example, let's say that you own a manufacturing plant. And you have a set of employee that are obviously part of the fixed cost of the company. So in this particular case, once you have a lot of spare capacity. For example, typical of some manufacturers that decide to produce private labels for certain retailers, to sell those products under the retailers brand. And they price those private label products, or those units below the total cost. Because it simply has positive unit contribution margin. And it helps them to amortize, or to cover some of the fixed costs investments in the manufacturing plants, or in their respective factory lines. Okay. But, as a general rule of pricing. Now that you've understood the break-even point. The general rule of pricing is that you should be able to price above the total cost to produce a particular unit of a product, or a service. [MUSIC]
