A Print Shop Weighs a College Contract Below Retail
Ravi runs a print-and-copy shop 200 metres from a management college. Monthly fixed costs are rent ₹22,000, staff ₹18,000, and electricity plus internet ₹8,000 - ₹48,000 in all. Paper and toner cost ₹1.20 a page, and walk-in students pay ₹2.50 a page. Last month the shop printed 40,000 pages, and its two machines can produce 90,000 pages a month before print quality drops. The college examinations department now offers a twelve-month standing contract: 30,000 pages a month at ₹1.80 a page, invoiced monthly and paid on the 10th of the following month. Three cost clauses matter. The lease on the second machine steps up by ₹6,000 a month once output crosses 65,000 pages. Output above 65,000 pages also requires one staff member to stay two extra hours, costing ₹4,000 a month. Output above 80,000 pages triggers a second lease step-up of ₹9,000 a month. Ravi’s cousin, who keeps the accounts, says the contract should be refused because ₹1.80 is well below the ₹2.50 retail rate.
1. Is the cousin’s reasoning sound? Decide whether Ravi should accept the 30,000-page contract at ₹1.80, showing the relevant costs.
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The cousin is benchmarking against the wrong number. The retail price of ₹2.50 already recovers ₹48,000 of fixed cost, and none of that fixed cost changes if the contract is signed. The only test is incremental contribution.
- Extra revenue: 30,000 × ₹1.80 = ₹54,000
- Extra variable cost: 30,000 × ₹1.20 = ₹36,000
- Contribution before step costs: ₹18,000
- Output becomes 40,000 + 30,000 = 70,000 pages, which crosses 65,000 but not 80,000, so the step costs are ₹6,000 lease + ₹4,000 late shift = ₹10,000
- Net monthly gain: ₹18,000 − ₹10,000 = ₹8,000, or ₹96,000 a year
Accept it. But state the margins honestly: the contract earns ₹8,000 ÷ 30,000 = about ₹0.27 a page against ₹1.30 on walk-ins, and ₹54,000 sits as a receivable until the 10th of the next month, so roughly one month of contract value must be financed. The decision is right; the reasoning behind it has to be contribution, not price comparison.
2. The college asks for a lower rate. At what price does the 30,000-page contract stop adding anything to Ravi’s profit?
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Set incremental contribution equal to the ₹10,000 of step costs that the contract triggers.
30,000 × (p − 1.20) = 10,000 p − 1.20 = 0.3333 p = ₹1.5333, so the floor is ₹1.54 a page.
At any price above ₹1.54 the contract adds profit; below it, Ravi is better off idle. Two refinements belong in the answer. First, ₹1.54 is a harsh floor because it prices the step costs into this one customer: a single buyer carrying the full ₹10,000 is fragile, so Ravi should try to fill the same 65,000-plus pages with a second small client and spread the step cost. Second, the floor assumes payment on the 10th of the following month. If the college stretches payment to 45 or 60 days, the effective floor rises by the cost of the extra working capital - roughly ₹54,000 × 12% × 1.5/12 ≈ ₹800 a month at a 12% borrowing rate, which pushes the floor to about ₹1.57.
3. The department increases its demand to 45,000 pages a month, still at ₹1.80. Should Ravi accept, renegotiate, or decline?
Read the worked answer
Recompute. Output becomes 40,000 + 45,000 = 85,000 pages, which clears the 80,000 threshold but stays inside the 90,000 capacity.
- Revenue: 45,000 × ₹1.80 = ₹81,000
- Variable cost: 45,000 × ₹1.20 = ₹54,000
- Contribution: ₹27,000
- Step costs: ₹6,000 + ₹4,000 + ₹9,000 = ₹19,000
- Net gain: ₹8,000 a month
The profit is identical to the smaller deal for 50% more volume, more machine wear and ₹81,000 tied up in receivables. That is the judgement: the contract is not loss-making, but the marginal return has collapsed, and the risk has not. The break-even price at this volume is (19,000 ÷ 45,000) + 1.20 = ₹1.62. So the answer is to renegotiate - ask for ₹1.85, which gives 45,000 × ₹0.65 − ₹19,000 = ₹10,250, or keep ₹1.80 and move to payment within seven days. Decline only if the college refuses both, since ₹8,000 a month is still better than nothing provided capacity is genuinely spare.