Implicit Cost Allocation and Bidding for Contracts
Management Science · 1990 · Volume 36 · Issue 9
Abstract
The question of how, or even whether, indirect costs should be allocated for pricing decisions has been controversial and unresolved. This paper takes a step toward answering this question by examining the special case of a firm that must incur incremental fixed costs to complete any or all of the several projects for which it is submitting simultaneous bids. An independent private-values bidding model is employed to endogenously determine an optimal cost allocation; we term such a cost allocation “implicit.” The optimal implicit fixed cost allocation is shown to fully allocate fixed costs ex ante , although the fixed costs may be under, over, or exactly allocated ex post .
Keywords
cost allocation, bidding, full costing
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