1. Why do many firmsuse cost-plus pricing for supply contracts?Cost-plus pricing is when firmschoose rates by raising average total cost by the amount that is fixed toproduce a preferred return (Brickley, Smith, & Zimmerman, 2016, p. 228).Many firms use cost-plus pricing for supply contracts because they want toguarantee that there will not be a chance of an upsurge in production costs.
Firmswant to give these production cost increases to clients without losing them.Cost-plus pricing allows the firm to move the increase to the customer ratherthan dealing with it themselves. 2. Whatpotential problems do you envision with cost-plus pricing?Potentialproblems that may occur with cost-plus pricing is if there happens to be nocontract between the firm and consumer, they may begin to lose customers due tothe price increase. Also, the consumers may not want to renew their contractwith the firm because they may feel as if they’re being cheated out of moneywhich is where customer loyalty comes in. Once a firm has lost customer loyaltyit may be difficult to recover from it.
At this point, customers will begin tolook at other suppliers in search for similar products that achieve the samepurpose. 3. ShouldGina contest the price increase? Explain. Unfortunately,in this case, Gina is unable to contest the price increase due to the contractspecifying that Rich Manufacturing Company will pay Bhagat Incorporated for itsproduction cost plus a $5 markup. There needs to be labor in order for there tobe production, so Gina cannot contest the price increase since she in factneeds the labor to be done in order to for the parts to be manufactured for herto purchase. Now, Gina could attempt to convince Bhagat’s employees to reducethe price, but this may not be a good idea due to the fact of their workforcebeing “heavily unionized” (Brickley, Smith, & Zimmerman, 2016, p. 185).
Once Gina’s contract with Bhagat Inc has expired, she should begin to look forother firms to do business with. She may also choose to do business with Bhagatonce again but edit her contract to fix the costs of labor. 4. Isthe increase most likely to be justified in the short run or the long run?Explain.Theincrease is likely to be justified in the long run. In the long run, laborcosts will increase then the firms will be able to adjust. During short termthere will be an increase in costs in order to keep up with the contract withBhagat Inc.
It is in her best interest to finish up the contract with Bhagat,then during long term Gina should look into finding a new and differentsupplier with a better price. With this, Gina will be able to raise productionand release more products. 5. Howwill a $3 increase in the price of machine parts affect Gina’s own productiondecisions?The $3 increase will be a part ofRich Manufacturing’s cost. Due to this, some issues may arise and Gina may notwant to work with this company in the future.
A $3 increase will result in anincrease in the products overall price which will also cause hostility betweenconsumers and Rich Manufacturing. Currently, Gina’s costs are $10 for labor and$10 for other costs, with an increase this may lead her to the completelyminimum. Now, this may lead to a downfall in production.