Cost-Plus Decision Making Case Study Rich Manufacturing By Ghagat

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Rich Manufacturing Case Study

The cost-plus pricing strategy uses the expenses associated with producing a product and

adding an additional amount, called a markup, to generate a profit. Rich Manufacturing’s

production manager Gina Picaretto purchases 100,000 machine unit parts from Ghagat

Incorporated each year. Ghagat uses cost-plus pricing in their contract with Rich Manufacturing.

Ghagat’s costs per part include $10 for labor, $10 for other costs, and a markup of $5. The

contract between Rich Manufacturing and Ghagat states that a minimum of 50,000 units must be

purchased, however up to 100,000 parts can be purchased at this price. Due to contract

negotiations between Bhagat and the union, Bhagat announced an increase
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Cost-plus pricing also ensures a positive rate of return because the full

production amount plus markup means full recovery of production costs. Due to the costs

remaining constant it is easy for a company using the cost-plus strategy to estimate revenue for a

particular period time. With these benefits of using cost-plus pricing also comes with some

disadvantages. According to Vivian Guo, “the guarantee of a target rate of return creates little

incentive for cutting cost or for increasing profitability through price differentiation” (Guo,

2012). However, the largest problems with using this strategy are that cost-plus pricing does not

take into consideration the price elasticity of demand for the product, competitors’ pricing, or the

value of the product being provided. These are all important factors to pricing that are lost when cost-plus pricing is used.

As Rich Manufacturing production manager, it is Picaretto’s obligation to

evaluate the announcement that Bhagat will be increasing prices. When cost-plus pricing

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