implied contract

Definition
Related Terms
A legally enforceable agreement that arises from conduct, from assumed
intentions, from some relationship among the immediate parties, or from the
application of the legal principle of equity.
For example, a contract is implied when a party knowingly accepts a benefit
from another party in circumstances where the benefit cannot be considered a
gift. Therefore, the party accepting the benefit is under a legal obligation to give
fair value for the benefit received. Opposite of express contract. See also
express contract, implied in fact contract, and implied in law contract.
Read more: http://www.businessdictionary.com/definition/implied-contract.html

loan for exchange

Definition
Popular Terms
Express or implied contract under which a lender hands over (see delivery)
personal property (such as cash) to a borrower. The borrower is obligated to
return the personal property of equivalent value within a specified or
reasonable period. Type of lend lease.
Read more: http://www.businessdictionary.com/definition/loan-forexchange.html
financial management
Definition
Related Terms
The planning, directing, monitoring, organizing, and controlling of the monetary
resources of an organization.
Read more: http://www.businessdictionary.com/definition/financialmanagement.html

What Is a Lump Sum Construction

Contract?

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ByJuanRodriguez
UpdatedJuly11,2016
Alumpsumcontractisnormallyusedintheconstructionindustrytoreduce
designandcontractadministrationcosts.ItiscalledaLumpSum
becausethecontractorisrequiredtosubmitatotalandglobalpriceinstead
ofbiddingonindividualitems.Alumpsumcontractisthemostrecognized
agreementformonsimpleandsmallprojects,forexample,projectswitha
welldefinedscopeorconstructionprojectswheretheriskofdifferentsite
conditionsisminimal.

Lump Sum Contract Basics

Alumpsumcontractorastipulatedsumcontractwillrequirethatthe
supplieragreetoprovidespecifiedservicesforastipulatedorfixedprice.In
alumpsumcontract,theownerhasessentiallyassignedalltherisktothe
contractor,whointurncanbeexpectedtoaskforahighermarkupinorder
totakecareofunforeseencontingencies.Asupplier

beingcontractedunder
alumpsumagreementwillberesponsiblefortheproperjobexecutionand
willprovideitsownmeansandmethodstocompletethework.Thistypeof
contractusuallyisdevelopedbyestimatinglaborcosts,materialcosts,and
addingaspecificamountthatwillcovercontractorsoverhead

andprofit
margin.
Theamountofoverheadcalculatedunderalumpsumcontractwillvary
frombuildertobuilder,butitwillbebasedontheirriskassessmentstudy
andlaborexpertise.However,estimatingaverylargeoverheadcostcan
leadthecontractortopresenthigherconstructioncoststotheprojectowner.
Theexpertiseofthecontractorwilldeterminehowtheirestimatedprofit
willactuallybe;furthermore,apoorexecutedandlongdelayedjobwill
raiseyourconstructioncostsandeventuallydiminishthecontractor'sprofit.

When to Use This Type of Contract

Alumpsumcontractisagreatcontractagreementtobeusedifthe
requestedworkiswelldefinedandconstructiondrawingsarecompleted.

Thelumpsumagreementwillreduceownerrisk,andthecontractorhas
greatercontroloverprofitexpectations.Itisalsoapreferredchoicewhen
stablesoilconditions,completepreconstructionstudies,andassessments
arecompletedandthecontractorhasanalyzedthosedocuments.The
stipulatedsumcontractmightcontain,whenagreeduponparties,certain
unitpricesforitemswithindefinitequantitiesandallowancetocoverany
unexpectedcondition.Thetimetoawardthistypeofcontractisalsolonger;
however,itwillminimizechangeordersduringconstruction.

Lump Sum Contract Advantages

Alumpsumcontractoffersthefollowingadvantages:

Lowrisktoowner.

'Fixed'constructioncost.

Minimizechangeorders.

OwnersupervisionisreducedwhencomparedtoTimeand
MaterialContract.

Contractorwilltrytocompletetheprojectfaster.

Acceptedwidelyasacontractingmethod.

Biddinganalysisandselectionprocessisrelativelyeasily.

Contractorwillmaximizeitsproductionandperformance.

Lump Sum Contract Disadvantages

Thistypeofcontractinghasalsolimitations:

Itpresentshigherrisktocontractor.

Changesaredifficulttoquantify.

TheOwnermightrejectchangeorderrequests.

Theprojectneedstobedesignedcompletelybeforethe
commencementofactivities.

Theconstructionprogresscouldtakelongerthanother
contractingalternatives.

Contractorwillselectitsownmeansandmethods.

Highercontractpricesthatcouldcoverunforeseenconditions.

Lump Sum Critical Items

Lumpsumcontractsareagreattoolforsmallerjobsandquitesimple
projects.However,lumpsumcontractscouldeventuallyproduce
largedisputeandclaimsthatwillarisefromcontractdocuments.Themost
commonarguingfactorsare:

UnbalanceBidsSomeprojectsmightrequiretoproduce
anapplicationforpaymentusingunitquantitiesandunitprices.
Manycontractorswillproduceanunbalancedbidbyrisingunit
pricesonitemstobecompletedearlyintheproject,suchas
mobilization,insurances,andgeneralconditions,andloweringunit
pricesonitemsneededinlaterstages.

ChangeOrdersIftheownerproducesorreceivesachangeorder
proposalfromthecontractor,thepricequotationcouldbepossibly
disputed.TheOwnermightappealthattherequestedchangewas
alreadycoveredundercontractprovisions.Itisimportanttoprepare
specificcontractclausesspecifyinghowchangeordersaregoingto
bemanagedandtowhatextentthecontractorcouldclaimdelay
damages.

ScopeandDesignChangesAcontractormaysuggestdesign
changesbasedontheirexperience.Contractprovisionsshouldbe
clearonhowthosechangeswillbeaddressedandhowthose
costswillbedividedorwhowillberesponsiblefortheeconomic
impactoftheproposedchanges.

EarlyCompletionLumpsumcontractsmightincludeanearly
completioncompensationforthecontractor.Earlycompletion
mightproducehighersavingsfortheprojectowner;however,those
clausesmightbeexplicitintheconstructioncontract.

What is A Construction Contract Agreement?

ImportantPartsandTermsofaContractAgreement

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UpdatedJune15,2016

What is A Construction Contract Agreement?

Aconstructioncontractagreementisthedocumentthatsetsadateand
specifieswhichpartiesaregoingtoparticipateintheconstructionprocess.
UsuallythecontractagreementisexecutedbetweentheOwnerofthe
projectandthecontractororsupplierthatisprovidingtherequestedservices
andcontainsseveralsectionsofclausesdefiningthescope,termsand
conditionsofsuchagreement.

Contract Agreements Sections

Acontractagreementshouldhavethefollowingsections:
1. ProjectDescriptionThissectionofthecontractagreementcontainsa
blurborextractofwhattheprojectisabout.Themostimportantideaor
descriptionoftheproblembeingaddressed.Itcanbeasummaryofitems
orjustaparagraphdefiningwhatneedstobesolved.
2. ContractPriceThisareawilldescribethetypeofcontractpricebeen
awardedandthetotalamountofmoneybeingcontracted.Itwillalsoset
possibleadditionsordeductionstothecontractandhowtheyaregoingto

bereleased.Therearemanyvariationsanddifferentschemesonhowto
negotiatetherightpricingstructure.
3. PaymentBasisHowthemoneyisgoingtobepaidtothecontractor.
Eitheronamonthlybasisorwhateverpaymentmethodispreferred,it
shouldalsospecifywhatpercentageofmoneyshouldberetainedon
everyapplicationforpayment.Itwillalsodefinewhenthepaymentisdue,
thepenaltyforlatepayments,interestbeingaccruedandotherapplicable
situationsrelatedtothepaymentandinvoicingterms.
1. ConstructionScheduleorCalendarThetotalofdaysorhowtheproject
schedulewillbedivided.Itshoulddescribeeithercalendardaysor
businessdaysandcanbepresentedeitherthroughaCPM,GanttChart,or
justabarchart.
2. ContractDocumentListAlistofallcontractdocumentsthatformpartof
thecontractagreement.Drawings,exhibits,specsandsupplemental
conditionscanbepartofthislist.
1. ConstructionScopeDescriptionofallconstructionactivitiesincluding
somedescriptionsofthingsthatwillformpartoftheproject.Thescope
normallycanbemeasuredorquantifiable.
2. ConstructionConditions&ResponsibilitiesThesectionofconditions
andresponsibilitiesistheonethatsetsresponsibilitiesfortheownerand
thecontractor,andtheextentsofwhoisresponsibleforproviding
documentsandinformation.Itcontainsspecifictermsforliens,penalties,
withholding,arbitrationrulesandspecificinstructionsonhowtoprocess
claimsandproceedwithdisputes.
3. ContractLawsGoverninglaws,liensrequirements,claimsprocedures,
arbitrationprocedures,insurance,substantialcompletionrequirements,
finalcompletion,andliquidateddamages.Itcanalsoprovideprocedures
onhowtoterminateorsuspendtheworkandtheagreementwiththe
contractor.

Why A Contract Agreement Is Important?

Acontractagreementisareallyimportantdocumentthatwilldefineyour
scopeofworkandthatwillbindtheownertoyourservices,includingthe
paymentterms.
Itisreallyimportantthatyouunderstandthescopeofworkspecifiedinthe
contractagreement,completetheworkasscheduled,invoiceperinstructed
todosoandfinallyitwillbethetoolusedsoyoucangetpaid.
However,contractagreementsmust:

BeInWriting

Containadescriptionoftheproductorservicebeingoffered

Understoodandclearbetweenbothparties

Includeservicesbeingcontractedclearly

Includecancellationorterminationpolicy

Havefinancialtermsclear

Contract Agreement Types

Contractagreementsvaryorcouldhaveseveralmodificationsdependingon
thecontractbeingexecuted.Forexample:

ExpressThistypeofagreementdefinesrealwellthepurpose
andscopeoftheagreement.Underthisalternative,thestipulationsand
termsofthecontractareunderstandclearlybyeachpart.

ExecutedAnexecutedcontractagreementprovidesawarrantyperiodor
malfunction.Underthisagreementserviceshavebeenrenderedbutthe
contractprotectsonepartywhentheother'sperformancefailstoprovide
theproperwarrantyfordefectiveorincorrectinstallation.

ConditionalAconditionalcontractagreementisanagreementusedwhen
servicescouldnotbeprovidedatthetimethecontractwassigned.It
stipulatesafuturedatewhenserviceswillberenderedifcertainconditions
aremet.

ARTICLE

All About Cost-Plus Contract Basics and More Options

CostplusContractBasicInformation

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UpdatedAugust06,2016

Acostpluscontractreferstoacontractwhenthecontractorgetspaidforall
constructionrelatedexpensesaspreviouslyagreed.Somecostpluscontract
canbedraftedtosetalimitthatwillbeusedtorestraintthecontractoron
nottoexceedthatspecifiedamount.Thetermplusreferstothe
profitallowedtobeearnedbythecontractor.Acostpluscontractprovidea
winwinsituationforthecontractor,becauseallrisksarebasicallycovered,
andallexpensesarelikelytobepaid.

Cost Plus: What to Charge on a Cost-Plus Contract?

Acostpluscontractisatoolthatthecontractorusestogetpaidforalmost
everyexpenserelatedtotheconstructionjob.However,thecontractor
mustjustifyandpresentevidencethatjustifiesthatthecostisrelatedto
thejob.Furthermore,thecontractorcouldbedeniedtorecover
associatedcostsifanegligenceactorotherrelevanterroris
attributabletocontractor'sresponsibility.
ThethreemaincomponentsofaCostpluscontractare:

1. DirectCosts:Labor,materials,supplies,equipmentandprofessional
consultantsbeingcontractedbythegeneralcontractor.
2. OverheadCosts(orIndirectCosts):Businessrelatedexpensesthatare
necessarytoperformthecontract.Overheadcostsareusuallyapercentage
oflaborcostsandcanincludeofficerent,insurances,officesupply,
communicationexpenses,mileageanddrawingprintingorreproduction.
1. Fee(orProfit):Theprofitisusuallyafixedpercentagebasedon
thelaborcostsdirectlyassociatedwiththework.

Cost-Plus-Contract: When to Use It

Acostpluscontractmightbeusedwhenbudgetisbeingrestrictedor
whenthereisahighprobabilitythatactualcostmightbereduced.Thistype
ofcontractispreferredwhenthereisnoenoughdatatoperforma
detailedestimateofthework,orwhenthedesignisnotcompleted.
Itisalsoapreferredbygovernmentalagenciesbecausetheycanselectthe
contractorbasedontheirqualification,insteadofthelowbidder.Itis
widelyusedtoperformresearchanddevelopmentworks,becausethe
riskcanbecontrolledbythecontractingofficer.

Cost-Plus-Contract: Pros and Cons

Acostpluscontracthaveadvantagesandsomedrawbacksdependingon
whichsideyouare,contractororprojectowner.
Someoftheadvantagesofacostpluscontractare:

Thecontractorwillnotbeabletoreduceworkmanship.

Itcanfocusonqualityinsteadofcost.

Itcouldcoverallrelatedexpenses.

Contractor'sriskisminimized.

Whileitlooksliketherearesomeadvantages,becarefulasthereare
somedisadvantagestoo:

Presentuncertaintytotheprojectowners,becausethefinalcostcouldnot
beeasilydetermined.

Requiresadditionalresourcesandmanagementtoreproduceandjustify
allrelatedcosts.

Mightleadtodisputeswhentryingtorecoverconstructionrelated
expenses.

Theproject'sdurationcouldbelongerthanexpected.

How to Protect Your Business When Using Cost-Plus

Contracts
ACostpluscontractpresentsagreatopportunityforthecontractorto
recoverallconstructionrelatedexpenses.However,ifagoodrecord
keepingisnotenforced,somecostsmightbeirrecoverable.Followthese
simpletipstostayoutoftrouble.

Readcarefullythecostpluscontractprovisions.

Negotiatecriticalitemsthatcouldleadtodisputes,suchasoverhead
expensesandmainofficeassociatedcosts.

Controlthematerialusage.Acostpluscontractcanleadtomisuse
ofconstructionmaterial,soyoumightendupacquiringmore
materialthanreasonablyexpected.

Donottakeadvantageovertheprojectowner.Behonestbut
bewareofexorbitantcosts.

Controlyour'hard'and'soft'costs.

Cost-Plus-Contract Variations

Costpluscontractcanhavesomevariationsthatwilldependontheneeds
andspecialcircumstancesofeachconstructionprojects.Someofthe
variationofacostpluscontractare:

CostPlusIncentiveFeeIsacostpluscontractthatprovidefor
incentivefees.Theincentivefeesarebasedonthecontractor's
performanceandaresetunderthecontractprovisions.Theamount
andtypeofincentivecouldvarydependingontheachieve
milestone.

CostPlusAwardFee.Acostplusawardfeeprovidesforaward
fees,predeterminedandsetforthundercontractdocuments.Thefee
couldbeapenaltyoragratitudefee.

CostPlusFixedRateCostpluscontractfixedrateisacontract
thatsetpredeterminedlaborratesbasedonthecontractors'history
andlaborcosts.Itisacontractusedonspecializedcontractorsthat
reallyknowtheiractualcosts,butprovidelittlespacefor
contingencies.

CostPlusFixedFeeCostpluscontractthatcoversdirectand
indirectcostsplusapredeterminedfixedfee.

Situations That Might Trigger a Change

Order Request

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ByJuanRodriguez
UpdatedAugust13,2016
Thereasonsbehindachangeordermightvaryfromprojecttoproject.
Sometimesduetoscopechanges,orunforeseenconditions,thesesituations
mightpromptyoutorequestadditionaltimeandfundsinordertocomplete
thenewcontractualobligations.Changeorders,sometimesareaheadache
whenthecomplexityandtimeframeoftherequestedadditionhave
scheduleconstraints.Changeordermanagementshouldformpartofevery
contractandagoodprojectmanagementshouldbeabletonavigateand
understandallcontractdocuments.
Manyofthesechangescanleadtolegalbattles,disputesandarbitration.

Drawings Errors and/or Omissions

Themostcommonsituationforchangeorderscanbeerrorsandomissions
intheprojectscope.Inadequatedetails,misrepresentationorsimply
avoidancetoprepareacompletesetofdetaileddrawingscanleadtoserious
changeorderrequests.Sometimesinaccuratedetailsandmisrepresenting
theexactenvironmentinwhichtheconstructionwillbeheldat,canalso
leadtochangeorderclaims.Besuretoreviewallcontractdocumentsand
verifythattheownerprovidedinformationisaccurateandisreferencingto
thelateststandardsandspecs.

Design Changes
Severalouterfactorscanleadustostartaconstructionprojectwithouta
completescopeoftheprojectandstarttheconstructionwithoutfinal
drawings.Thistypeoferrorisalsocommonondesignbuildprojects,
wheretheongoingprocessofdesigncaninducetoworkstoppageor
produceeconomicimpactintheproject.
Designchangescanleadtostopworkorders,andmajorchangesthatcan
evencauselaborissuesduetodelaysinprojectexecution.Besuretoreview
someformulasthatcanbeusefulwhencalculatingoverheadcosts.

Inaccurate Specifications Can Lead to Change Orders

Sometimethedrawingasksforoneproductbutthespecscallsforanother.
Thissituationisverycommononconstructionprojectswherethedrawings
areassignedtodifferentconsultants,eachoneofthemactingontheirown,
withoutanykindofdirectionfromateamleader.Thisleavesthecontractor
withthedifficulttaskofassumingandquotingononearticle,butwhenthe
installationisgoingtobemade,theowner,requiresanotherarticletobe
installed,insteadoftheonethatyouhavealreadyquoted.

Unforeseen Conditions
Howmanytimesdoyouhavetocompleteasoilboring?Soilproblems,in
particular,arethemostcommonproblemswithunforeseenconditions.Soil
studiescanleadyoutoexpectsomeconditionsbasedonspecifictesting
butasthesoilprofilevary,itmightpresentadditionalchallengesand
soiltypesthroughoutyoursite.Yourassumptionsonthesoilconditionsor
anyotherissueregardingtheconstructionoftheprojectcanbedifferent
fromtheactualconditionsthatyoufindonthesite.Also,ifthedrawings
specifiesacertainamountorquantityofwork,when,infact,theamount
ofmaterialsisalmostdouble,thenachangeordermustbeissued.

Substitutions Could be Problematic

Thisisnormallyacontractorsideatosubstitutematerial,whenhecannot
getthespecifiedmaterialsorthereisashortageinsupplies.Thisiskind
ofdifferentbecauseitcanleadtoanotherissue:acreditwillbeaskedifthe
materialcostisless,orsometimesthecontractorwillhavetomakeupthe
differenceincostsbetweenmaterialsand/orproducts.Sometimes,the
owneralsoasksforupgradesduringtheconstructionprocess,inthiscase
youmustsubmitachangeorderrequestrequestingextracompensationand
timeassociatedwiththeproposedmodifications.

COMPETITIVE PRICING
Home Knowledgebase Here
By Gal Grasset, July 2015
Competitive pricing consists of setting the price at the same level as
ones competitors. This method relies on the idea that competitors have
already thoroughly worked on their pricing. In any market, many firms
sell the same or very similar products, and according to classical
economics, the price for these products should, in theory, already be at
an equilibrium (or at least at a local equilibrium). Therefore, by setting
the same price as its competitors, a newly-launched firm can avoid the
trial and error costs of the price-setting process. However, every
company is different and so are its costs. Considering this, the main limit
of the competitive pricing method is that it fails to account for the
differences in costs (production, purchasing, sales force, etc.) of
individual companies. As a result, this pricing method can potentially be
inefficient and lead to reduced profits.
For example, a firm needs to price a new coffee maker. The firms
competitors sell it at $25, and the company considers that the best price
for the new coffee maker is $25. It decides to set this very price on their
own product. Moreover, this pricing method can also be used in
combination with other methods such as penetration pricing for
example, which consists of setting the price below that of its competition
(for instance, in this example, setting the price of the coffee maker at
$23).

Concept and Advantages

As previously mentioned, competitive pricing consists of using
competitors prices to set ones own. According to a companys
objectives in terms of brand, penetration tactics or market
aggressiveness, the exact price level can somewhat vary. For example, if
a firm wants to gain market share, then its objective is to have one of
the lowest prices on the market. On the contrary, if a firm wants to
create a successful brand image, it would be more effective to sell
higher-priced products In order to communicate a signal of quality to its
consumers.
Moreover, this pricing method is often used within well-established and
highly competitive markets. This is due to the assumption that the
equilibrium level of price is already reached in this type of market,
meaning that competitors are setting their prices at the equilibrium
price. This method is simple in terms of economic theory and also entails
a low risk of setting an inefficient price, allowing a company to move
towards an economic equilibrium.
This method is simple because competitors prices are most
often publically displayed and it is therefore easy to copy
them. When products are identical or highly similar (as is widely the
case in retail industries), it is often simpler to copy competitors prices

rather than implement another pricing strategy. With this method, the
firm allows its competitors to incur the costs of establishing an optimum
price.
This method carries low-risk. If the prices used by competitors do not
lead them to bankruptcy, it will likely be the same for other firms on the
market too. And while there could potentially be some punctual
inefficiencies (on one specific product) resulting from this method which
could then spread to the entire market, such situations are rare.
This method leads to equilibrium. In the retail industry, there are
millions of customers and millions of sales that take place every day.
Therefore, assuming that most retail players on the market are using the
competitive pricing method, the entire market can reach a stabilized
equilibrium price.
Firm A has been selling coffee makers for years and they have 2
distinct products: an entry-level product priced at $25 and a top-notch
product at $50. They experimented with different prices for years before
reaching this equilibrium. If the entry-level product was cheaper, firm A
would lose margin; and if it was higher they would lose market share.
The same goes for the top-notch coffee maker. Another firm lets call it
B - enters the market with two coffee makers, an entry-level one and a
top-notch one. The best prices to be used by firm B are the prices
already set by firm A, as firm B can assume that A has identified
the best prices aimed at maximizing their profit and reaching the price
equilibrium. It is worth mentioning that the market for coffee makers is
mature and consumer preferences are well-known.

This schema illustrates the principle behind competitive pricing: it allows

firm B to identify prices that are efficient for them without incurring
any price-setting costs.

Limits of Competitive Pricing

Competitive pricing only works when the products sold by different firms
to the same customers are pretty much identical. On the contrary, if
products are just partially similar and are not exactly identical, then the
price is hardly transferrable from one product to another.
In this regard, the main challenges pertain to defining ones competition,
establishing congruency between products as well as collecting and
analyzing data.
Definition of congruency: according to classical economics, two
products are congruent if a consumer can somehow replace a quantity of
one product by a quantity of another product without experiencing any
loss in product utility. In reality, it can be quite difficult for a retailer to
define congruency when comparing its products with those of its
competitors. Are the last Apple iPhone and the last Samsung Galaxy
congruent? Defining congruency is the hard part of competitive pricing.
Definition of competitors: defining competition is essential in order to
know which prices need to be analyzed by the firm. But competition can
take on various forms as an online retailer and an offline retailer can
indeed be competitors in some cases, but not in others. For example, it
is likely that online and offline book sellers are competitors as they are
essentially serving the same customers. But online and offline food
sellers cannot really be seen as competitors as their target market is not
exactly the same. Therefore, before being able to set a competitive
price, a firm needs to carefully identify its relevant competitors.
Gathering and analyzing data: once congruent products and
competitors are defined, the next step consists of collecting relevant
pricing data. In one way or another, most competitors prices are
displayed on the internet and can be scraped by using the necessary
technology. The frequency of scraping needs to be well-defined because
it varies considerably from one business sector to another. For example,
on Amazon, prices can sometimes change almost every minute, but
most retailers do not change their prices that often.

What are the main issues with

competitive pricing?
The main issue with competitive pricing is that it can lead to missed
opportunities as it can create a situation whereby all the players in a
given market are blindly using the same pricing. This results in a static
market and can also create a price war or a race to the bottom.
Competitors prices can lead to setting a non-optimal
price. Some companies must deal with fixed costs that are higher than
their competitors, meaning that they may potentially need to sell larger

product volumes in order to amortize the fixed costs in question.

Therefore, when using competitive pricing and setting the same prices
as their competitors (who do not necessarily have the same fixed costs),
these companies can find themselves in a situation where they are
making a suboptimal level of profit. Taking a slightly different example, if
a competitor sets an incorrect price purely due to human error (for
example, adding an extra zero by mistake and setting the price at $1400
instead of $140), the wrong competitive price would obviously be
suboptimal.
Competitive pricing is used by virtually every player on the
market. The market can become static as a result, and if the market
price equilibrium is suboptimal, the profit of the entire market will be
reduced. The price will remain at the same competitive level until
profits reach a null value.
Aggressive competitive pricing can lead to a race to the
bottom. For example, a firm can decide to employ an aggressive pricing
policy with a mix of competitive pricing and penetration pricing by
setting the price 10% lower than its competitors. If another competitor
decides to do the same thing, the overall market price will slowly
decrease and the profits will decrease too. The new equilibrium will be
one with lower profits and thus largely suboptimal.
Competitive pricing can also lead to a race to the sky. For
example, Amazon sells printed on demand books which web crawlers
(that also operate on the Amazon Market Place) can then sell at a higher
price. If a customer is willing to pay the higher web crawler price, the
web crawler will simply buy the book from Amazon and make profit on
the Amazon price. As a result, the web crawler intending to maximize his
profit will set his price higher and higher, and other web crawlers will use
the competitive pricing method to set the same higher prices which will
in turn lead to a race to the sky.

Main references

Center for Strategic & International Studies (CSIS), Defense

industrial initiatives. Current issues : Cost-plus Contracts

Guilding C., Drury C. & Tayles M., An empirical investigation of

the importance of cost-plus pricing

Hanson W., The dynamics of Cost-plus Pricing, Managerial and

decision economics, vol. 13, 149-161, 1992