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Mr. Ahilan, you haven't specified from whose perspective the question is. I assume it is from the perspective of service provider( contractors). The advantages to Contractor are as follows:
1. The risk of cost overrun is transferred to the client.
2. The contractor doesn't have to worry about price escalation, currency fluctuation, time extension etc.as all these uncertainties are part of the cost to be taken by client.
3 The quantity is not required to be measured. The value is paid by the client at agreed percentage of cost as profit + cost.
4. If the costing is transparent and costing mechanism is adequately worked out, the chances of dispute on valuation with client are relatively less.
5. Since the costs are paid by the client, the contractor may not compromise on quality where prices are linked to the quality. The quality of end product might be good and lesser possibilities of disputes on quality front.
6. The client will get the product at reasonably predictable price and quality and doesn't have to worry a lot when specifications and prices are pre-contracted with suppliers.
7. Disputes on pricing for variations would be limited as though the variations might be material in terms of amount, the pricing between client and contractor is indirectly pre-determined.
In practice cost is one of the most important influences on price. Many firms base price on simple Cost-plus rules ( costs are estimated and then a profit margin is added in order to set the price. Cost-plus pricing is a method of determining the sales price by calculating the full cost of the product and adding a percentage mark-up for profit.
The full cost may be fully absorbed production, or it may include some absorbed administration, selling and distribution overhead.
ADVANTAGES.
. * It is a quick, simple and cheap method of pricing which can be delegated to junior managers.
* Since the size of the profit margin can be varied, a decision based on a price in excess of full cost should ensure that a company working at normal capacity will cover all of its fixed costs and make a profit.
* Cost- plus pricing approach to pricing draws attention to net profit and the net profit margin.
Cost plus pricing may be “perceived” by some customers as low price point as they only focus on the margin. Because client pays percentage of cost as profit to the vendor, as per Dipesh reply, it create conflict of interest between the vendor and client when selecting different cost options. The higher the cost, the higher the profit for vendor.
