Bidding on a Missile Program

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The Answer is Bidding on a price per missile with such high relationship-specific fixed costs leaves Merowak vulnerable to holdup because these costs would be sunk at the time production commences.The common strategy is to separate the contract for the relationship-specific asset from the use of the asset.In this case,Merowak can seek three contracts: 1)an R&D contract for $1 billion to develop the missile,2)a construction contract to produce the unique tools,and 3)a production contract per missile.That way Merowak does not have to include the average fixed costs of the first two into the price of each missile.Of course,this leaves the Pentagon vulnerable to holdup because it could squander the first $1 billion and not develop the missile.​

Bidding on a Missile Program

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