When deciding on the price to bid on a contract, the most straight forward approach is to start

with projected unit cost and add enough markup to make the desired profit. But what if that

results in a bid that is too high, and the company loses the contract? It may be to the company's

advantage to take a loss on the bid if the increased volume from the contract lowers unit cost on

all other sales. This "indirect profit" can be calculated by:

Indirect Profit = Lower Unit Cost Due to Contract Non-Contract Unit Sales

So for example, if increased production for the contract lowers average unit cost by $0.50, and

non-contract sales are 200,000, the indirect profit from the contract is:

Indirect Profit = $0.50 200,000 = $100,000

In other words, we can afford to lose up to $100,000 on the contract and still not lose money

overall due the lower cost of goods. In the long run, we are actually better off because we have

moved farther down the experience curve, and unit cost on future production will be lower. By

using bid analysis, you can avoid the mistake of, on the one hand, bidding too high and never

benefiting from the potential reduction in cost of goods or, on the other hand, losing money by

bidding too low. To complete the analysis, you will need to know the projected unit sales with

and without the contract, along with the projected unit cost of goods with and without the

contract. For this exercise, we will use the following projections:

Item Estimated Value

Unit Sales Without the Contract 250,000

Contract Units 50,000

Unit Cost Without the Contract $20.66

Unit Cost with the Contract $20.38

1. Let us say you think that a $20.00 bid will win the contract. Using the projections,

what is the anticipated profit or loss on the contract?

2. What is the reduction in unit cost due to the contract? How much is the indirect

profit?

3. Using your results from questions 1 & 2, what is the total impact of the $20 bid on

profit?

4. Calculate the break-even bid on the contract using the following formula:

Break-Even Bid = Unit Cost with Contract Indirect Profit / Contract Units

5. The break-even bid calculation depends on the projections. What factors might affect

those assumptions?