Learning Curve in Contract Price Negotiation. Catonic Inc. recently developed a new product that includes a rather complex printed circuit board as a component (Catonic’s part number PCB-31). Although Catonic has the ability to manufacture PCB-31 internally, the circuit board is purchased from an independent sup¬ plier because the company’s printed circuit line has been operating at capacity for some time.

The first contract for 50 units of PCB-31 was awarded to Rex Engineering Company in September, 19A, on the basis of a competitive bid. Rex’s bid was significantly lower than those of other bidders. Additional orders for 50 units each were placed with Rex, as shown in the following purchase history schedule: LO3 Date Ordered Quantity Unit Price Total Price September 15, 19A 50

$374

$18,700 November 15, 19A 50 374 18,700 January 1, 19B 50 374 18,700 February 1, 19B 50 374 18,700 Mark Polmik, a buyer for Catonic, has determined that the next order for PCB-31 should be for 600 units. He has contacted Kathy Wentz, a Rex salesperson. Polmik indicated that the next PCB-31 order would be for 600 units and that he believed that Catonic should receive a lower unit price because of the increased quantity. A few days later, Wentz provided a proposal of $355 per unit for the 600-unit contract.

Polmik has scheduled a meeting with Wentz for next week for the purpose of negotiating the 600-unit contract. He has asked Catonic’s Cost Accounting Department for assistance in evaluating the $355 unit price.

The price bid on the original contract for 50 units was estimated to be based on full cost, because at that time Catonic was not sure if there would be future contracts for the PCB-31 board. The cost of materials included in PCB-31 is estimated to be $180 per unit. The Cost Accounting Department is fairly sure that Rex applies overhead at 100% of direct labor and employee benefit cost. Because Rex Engineering recently received a good deal of coverage by the local media when a strike was narrowly averted, the labor and fringe benefit costs at Rex are known to be approximately $20 per hour. The printed circuit line at Rex is similar to the one at Catonic, and Rex’s overhead is believed to be approximately 50% variable and 50% fixed. Similar work at Catonic evidences a 90% learning curve effect. However, it is assumed that the learn¬ ing curve effect on fixed overhead per unit is negligible.

Based on foregoing data, the price of a 50-unit order is estimated to comprise the following cost components:

Materials. $ 180 Labor and employee benefits (4 labor hours x$20). 80 Overhead (100% of labor and employeebenefits). 80 Full cost of PCB-31component. $ 340 Profit contribution (10% of fullcost). 34 Unitprice. $ 374 Unitspurchased. 50 Total contractprice. $18,700 Required:
(1) Prepare a schedule that can be used by Mark Polmik during his meeting with Kathy Wentz next week. This schedule should incorporate the learning curve effect that Rex would have experienced on the first 200 units already produced, which should be of use to Polmik in negotiating a contract with Rex Engineering. (Past production was, and future production will be, in lots of 50 units each.)
(2) What are the implications of an 80% learning curve as opposed to a 90% learning curve?
(3) Identify factors that could reduce the degree of learning that takes place in an industrial operation.
(ICMA adapted)