If the repair and replace options are equally safe

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If the repair and replace options are equally safe and effective, White will choose to get the clutch plate repaired for $270 (rather than spend $390 on a replacement plate). 4. Mazzoli Brothers will earn a greater contribution toward overhead in the replace option ($145 = $390 – $245) than in the repair option ($125 = $270 – $145). If we assume that Mazzoli Brothers earns a constant profit margin on each job, it will earn a larger profit by replacing the clutch plate on Johanna White’s car for $390 than by repairing it for $270. Therefore, Bariess will recommend the replace option to White, which is not the one she would prefer. Recognizing this conflict, Bariess may even present only the replace option to Johanna White, or suggest that the repair option will result in a less-than-safe car. Of course, he runs the risk of White walking away and thinking of other options (at which point, he could present the repair option as a compromise). The problem is that Bariess has superior information about the repairs needed but his incentives may cause him to not reveal his information and instead use it to his advantage. It is only the seller’s desire to build a reputation, to have a long-term relationship with the customer, and to have the customer recommend the seller to other potential buyers of the service that encourages an honest discussion of the options. COST COST COST Labor Labor Labor Materials Materials Materials Total Total Total Cost Cost Cost Repair option (3.5 hrs. $30 per hr.; $40) $105 $ 40 $145 Replace option(1.5 hrs. $30 per hr.; $200) 45 200 245 PRICE PRICE PRICE (100% (100% (100% markup markup markup on on on labor labor labor cost; cost; cost; 50% 50% 50% markup markup markup on on on materials) materials) materials) Labor Labor Labor Materials Materials Materials Total Total Total Price Price Price Repair option ($105 2; $40 1.5) $210 $ 60 $270 Replace option ($45 2; $200 1.5) 90 300 390
12- 12-32 12-32 12-32 (25 min.) Cost-plus Cost-plus Cost-plus and and and market-based market-based market-based pricing. pricing. pricing. 1. California Temps’ full cost per hour of supplying contract labor is Variable costs $12 Fixed costs ($240,000 ÷ 80,000 hours) 3 Full cost per hour $15 Price per hour at full cost plus 20% = $15 1.20 = $18 per hour. 2. Contribution margins for different prices and demand realizations are as follows: Fixed costs will remain the same regardless of the demand realizations. Fixed costs are, therefore, irrelevant since they do not differ among the alternatives. The table above indicates that California Temps can maximize contribution margin ($500,000) and operating income by charging a price of $17 per hour. 3. The cost-plus approach to pricing in requirement 1 does not explicitly consider the effect of prices on demand. The approach in requirement 2 models the interaction between price and demand and determines the optimal level of profitability using concepts of relevant costs. The two different approaches lead to two different prices in requirements 1 and 2. As the chapter describes, pricing decisions should consider both demand or market considerations and supply or cost factors. The approach in requirement 2 is the more balanced approach. In most cases, of course, managers use the cost-plus method of requirement 1 as only a starting point. They then

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