Why do many firms
use cost-plus pricing for supply contracts?
Cost-plus pricing is when firms
choose rates by raising average total cost by the amount that is fixed to
produce a preferred return (Brickley, Smith, & Zimmerman, 2016, p. 228).
Many firms use cost-plus pricing for supply contracts because they want to
guarantee that there will not be a chance of an upsurge in production costs. Firms
want to give these production cost increases to clients without losing them.
Cost-plus pricing allows the firm to move the increase to the customer rather
than dealing with it themselves.
potential problems do you envision with cost-plus pricing?
problems that may occur with cost-plus pricing is if there happens to be no
contract between the firm and consumer, they may begin to lose customers due to
the price increase. Also, the consumers may not want to renew their contract
with the firm because they may feel as if they’re being cheated out of money
which is where customer loyalty comes in. Once a firm has lost customer loyalty
it may be difficult to recover from it. At this point, customers will begin to
look at other suppliers in search for similar products that achieve the same
Gina contest the price increase? Explain.
in this case, Gina is unable to contest the price increase due to the contract
specifying that Rich Manufacturing Company will pay Bhagat Incorporated for its
production cost plus a $5 markup. There needs to be labor in order for there to
be production, so Gina cannot contest the price increase since she in fact
needs the labor to be done in order to for the parts to be manufactured for her
to purchase. Now, Gina could attempt to convince Bhagat’s employees to reduce
the price, but this may not be a good idea due to the fact of their workforce
being “heavily unionized” (Brickley, Smith, & Zimmerman, 2016, p. 185).
Once Gina’s contract with Bhagat Inc has expired, she should begin to look for
other firms to do business with. She may also choose to do business with Bhagat
once again but edit her contract to fix the costs of labor.
the increase most likely to be justified in the short run or the long run?
increase is likely to be justified in the long run. In the long run, labor
costs will increase then the firms will be able to adjust. During short term
there will be an increase in costs in order to keep up with the contract with
Bhagat 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 different
supplier with a better price. With this, Gina will be able to raise production
and release more products.
will a $3 increase in the price of machine parts affect Gina’s own production
The $3 increase will be a part of
Rich Manufacturing’s cost. Due to this, some issues may arise and Gina may not
want to work with this company in the future. A $3 increase will result in an
increase in the products overall price which will also cause hostility between
consumers 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 completely
minimum. Now, this may lead to a downfall in production.