Background Birch Paper Company is a medium sized partly integrated company that produces Kraft papers and paperboard. There are four producing divisions and one timberland division which supplies part of the company’s pulp requirements. The divisions are – Northern Division – Southern Division – Thompson Division – Division 4 – Timberland Each division is operating independently with its own division manager. Also, each division’s performance had been judged on its profit and return on investment (ROI).
The company policy of decentralizing responsibility and authority for all decisions except those relating to overall company policy, has been operated with the divisions. Company policy states that each division manager is free to buy from whatever supplier he/she wished and also it could be on sales within the company. Improvement has attributed upon the concept of decentralization that has applied to the company. (as the company’s profits and competitive position has been improved) 2. Facts The Northern Division had designed a special display box for one of its papers in conjunction with the Thompson Division, which was equipped to make the box. – Thompson Division was reimbursed for the cost of its design and development work – Thompson Division usually sourced its supply’s in house from the Southern division. In this case material cost $280 of the total cost of $400 per thousand boxes. 3 – Southern division sold its materials at market price of $280 with a cost of about $168 leaving it with a profit of $112 or 40%. – Northern division received 3 Quotes to make the box’s, – Thompson division : $480, – West Paper Company : $430 – Eire Paper Company : $432 5 – Eire paper would purchase outside liner from southern division for $90 per 1000 & it would be printed by Thompson division for $30 per thousand with a profit of $5 or 16%. 6 – Southern Division was running below capacity and had excess inventory but still charged 40% profit. 7 – Thompson Division at times was also running at below capacity but also charged 20% profit. ISSUES; There appears to be an issue on transfer pricing. – Transfer Pricing. There is an issue on transfer pricing. – Issue – Transfer pricing. – Why is transfer pricing an issue? Because Thompson division Manager does not want to meet the market price. – Why does the Thompson division not want to pay market price? Because the division manager wants to protect the divisions profits – Why does the Thompson division want to protect its profits? Because of company policy on Performance Evaluation, that each manager is responsible for their divisions profits. – Who owns the problem of company policy on performance evaluation.
Top management own the problem as they are responsible for company policy. PERFORMANCE EVALUATION – Company Policy on Performance Evaluation. Each division has been judged independently on its profit and ROI. The companies great emphasis on judging each division on profit has lead to each division trying to maximise its profits margins even at the expense of other other divisions. This policy is also effecting goal congruence, as managers goals for increasing profits for their division at the expense of other divisions it is not helping the overall goal of the company.
The facts show that top management own the problem. This is because its not Thompson Divisions problem as they are free to quote whatever they like. It is also not Northern Divisions problem as they are free to accept the best quote that suits them. It should be noted that this problem may only be a short term problem and in the long term market prices force should even things out. 3. Questions Which bid should Northern Division accept that is in the best interests of Birch Paper Company?
Northern Division should accept the bid of $480 from the Thompson Division as Birch Paper Company would profit most overall from this bid. The Northern Division received 3 different bids: $480 – Thompson Division $430 – West Paper Company $432 – Eire Papers, Ltd [Calculation] Thompson Division tota Costs to Birch Paper = $288, being $400 made up of $280 for materials (linerboard and corrugating medium) and $120 for other costs.
However because Thompson sources its materials from Southern division who make a $112 profit on materials, the total Cost to Birch Paper Company is materials $168 + other cost $120 = $288 West Paper Company Costs = $430 Eire Papers, Ltd Costs to Birch Paper Company = $391 that being $432 less sourcing profits from Southern Division ($90 x 40%) = $36 and Thompson Division Contribution $5 = $391 Although the West Paper Company looks at first to be the best choice, the truth is to be the Thompson Division as it has the lowest cost if we assume that all transfer prices within the company were calculated at costs.
The lowest costs that associated within the company would make Birch Paper Company to earn the highest profits and revenues. [pic] Should Mr Kenton accept this bid? Why or why not? Mr Kenton has two options, 1 – To accept the lowest bid of $430 from West Paper. By doing so would result in the best interests for the Northern Division as it would gain the most profits . Other reasons to accept the lowest bid is – $430 is the true market price. Brunner is wanting more then the market price. Brunner is trying to gain an unfair profit for his division at the xpense of an other division. By Mr Kenton accepting the lowest bid would mean in the future Brunner would have to bid market prices or he would not win the tenders which would result in falling profits for his division. – for true decentralisation to work you must allow Manager to make decisions and all things being equal that is the best decision for Northern Division and in the long term for the company. – This issue has now gone to a management issue, with James Brunner refusing to meet the market price of $430 appears to be a bad management decision. – the other option Mr Kenton has is to not accept the bid from West Papers Company because of the following reasons: – The costs involved in Thompson Division would give higher profits to Birch Paper Company as whole and it also encouraging other divisions to buy / deal within the company. – West Papers Company is not in the best interest of the company However, the manager of the division as a management team needs to decide which bid they should accept with the transfer price policy that exists.
All divisions had been judged independently on the basis of its profit and ROI. (3) Should the vice president of Birch Paper Company take any action? The vice president of Birch Paper Company should not take any action against their divisions as the divisions had been judged and made their own decisions independently over the past years. The vice president of the Company should not be involved in the matters of divisions unless it’s relating to overall company policy or matters.
The policy of decentralizing responsibility and authority would be affected by any actions taken from the vice president as each division was both profit and investment centres as itself. Normally the vice president should not get involved in division matters as it would defeat the purpose of decentralised system, where managers make decisions for their divisions. However it would not be a bad idea for the vice president to remind Brunner of his responsibilities to the company of goal congruence. This is because of the unique situation that it would be a bad management decision not to meet the $430 for these reasons.
The market price for this instance is $430, and the only reason Thompson would not be willing to sell at market price would be only if he could get better price else where. Brunner wants to increase his profits by keeping his bid high where what he should be doing is improving productivity. The vice president could also take actions against the whole company to remedy the overall problems associated with this transfer pricing policy. (4) In the controversy described, how, if at all, is the transfer price system dysfunctional?
Does this problem call for some change, or changes, in the transfer pricing policy of the overall firm? If so, what specific changes do you suggest? The transfer price system is not dysfunctional because invariably it has been shown in the long term the market price is the best price and should be used. If market price were met then there would not be an issue. In the long term market forces would force Thompson division to pay market prices or they would start missing out on contracts which would effect their profits.
As mentioned the problem lies with the manager thinking he can increase his profits by keeping his bids high where what he should be doing is improving productivity. The company could introduce some policys that would allow the transfer pricing system to run more smoothly. These could include policy like forcing managers to accept market prices when purchasing internally. Reference http://www. slideworld. com/slideshow. aspx/birch-paper-company-case-study-ppt-2765141 http://www. 123helpme. com/birch-paper-company-case-view. asp? id=163833