In the one-time-only special-order decision in the previous section, Surf Gear’s managers had to decide whether to accept or reject Azelia’s offer to supply towels at $11 each. Sometimes managers must decide on the price to bid on a one-time-only special order. This is an example of a short-run pricing decision—decisions that have a time horizon of only a few months.
Consider a short-run pricing decision facing managers at Surf Gear. Cranston Corporation has asked Surf Gear to bid on supplying 5,000 towels in September after Surf Gear has fulfilled its obligation to Azelia in August. Cranston is unlikely to place any future orders with Surf Gear. Cranston will sell Surf Gear’s towels under its own brand name in regions and markets where Surf Gear does not sell its towels. Whether Surf Gear accepts or rejects this order will not affect Surf Gear’s revenues—neither the units sold nor the selling price—from existing sales channels.
As before, Surf Gear’s managers estimate how much it will cost to supply the 5,000 towels. There are no incremental marketing costs, so the relevant costs are the variable manufacturing costs of $7.50 calculated in the previous section. As before, the extra production of 5,000 towels in September from 30,000 to 35,000 towels does not affect fixed manufacturing costs because the relevant range is from 30,000 to 45,000 towels per month. Any selling price above $7.50 will improve Surf Gear’s profitability in the short run. What price should Surf Gear’s managers bid for the order of 5,000 towels?
Based on market intelligence, Surf Gear’s managers believe that competing bids will be between $10 and $11 per towel, so they decide to bid $10 per towel. If Surf Gear wins this bid, operating income will increase by $12,500 In light of the extra capacity and strong competition, management’s strategy is to bid as high above $7.50 as possible while remaining lower than competitors’ bids. Note how Surf Gear chooses the price after looking at the problem through the eyes of its competitors, not based on just its own costs.
What if Surf Gear was the only supplier and Cranston could undercut Surf Gear’s selling price in Surf Gear’s current markets? The relevant cost of the bidding decision would then include the contribution margin lost on sales to existing customers. What if there were many parties eager to bid and win the Cranston contract? In this case, the contribution margin lost on sales to Surf Gear’s existing customers would be irrelevant to the decision because Cranston would undercut the existing business regardless of whether Surf Gear supplied towels to Cranston.
In contrast to the Surf Gear case, in some short-run situations, a company may experience strong demand for its products or have limited capacity. In these circumstances, managers will strategically increase prices in the short run to as much as the market will bear. We observe high short-run prices in the case of new products or new models of older products, such as microprocessors, computer chips, cell phones, and software.