Birch Paper - Western Paper Company

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Question 1:

The best bid for Birch Paper Company as a whole is that of their own division Thompson. With this option, the out-of-pocket cost is the lowest for Birch as shown in the following arrangement:

Western Paper Company - Birch cost: $ 430

Eire Papers Ltd. - Costs Birch: $ 432
Profit Southern Division ($ 90 * 40% 1) $ 36 - / -
Profit Thompson Division ($ 30- $ 25): $ 5 - / -
$ 391

1Winstopslag for Southern is 40% as the case stated that their out-of-pocket "costs 60% of the sales price.

Thompson division - costs Birch: 
'Out-of-pocket costs for Southern division ($ 2,802 x 60%): $ 168
'Out-of-pocket costs for Thompson Division ($ 400- $ 280): $ 120
$ 288

2Verkoopprijs Southern division to Thompson: $ 400 * 70% = $ 280

Question 2:

If Kenton purely for its own sake and looking from his division, he must bid of € 480 from the Thompson Division did not accept. The case states that the divisions are independently assessed on profits and profitability. This makes Northern Division investment center must be typified.

The bid for Northern Thompson brings with it cost more than the bid of Western Paper Company (Northern for the cheapest offer). By accepting the offer of Thompson yet Kenton would harm the profitability and thus the profitability of its division. To this he would be judged by the head office.

However, this is a disadvantage with him for the Birch Paper Company as a whole, because the costs for the entire company would be greater than if they would buy the product internally. There is no question of Goal Congruence.

Question 3:

The case states that transaction is less than 5% of sales of the divisions involved. Also, given the fact that the headquarters consciously followed a decentralization strategy in recent years (and is quite happy with them), it therefore appears necessary / desirable to intervene. Will be more impairing the authority of managers is affected by the divisions involved and harder to make them responsible for the results of their division.

The biggest problem is that this situation is structural in nature. In recent years, margins appear in the sector under pressure which competitors have lowered prices. However, internally, the cost used with a standard storage, which is higher than the market prices. Given the possible repetition of this situation is it wise for the vice president to intervene to indicate how it should be dealt with this problem and how similar problems should be avoided in the future. The managers of the various divisions are aware of the existence of the problem and need to be convinced of the need for the entire company.

Goal Congruence must include all division managers. In this situation, each division has an investment center and thus become settled on the Return on Investment and Residual Income (EVA) of their own division this is virtually impossible. Division managers will always try to make the optimal choice for their own divisions and this is not always the optimal choice for the whole company.

Question 4:

The optimal transfer price between the two divisions is always the market. Also in this case would be the best overall for Birch. Now, each division can determine its price above the market price so that the system is not working. The external party seller than struggling with high costs.

Question 1 has been shown to Thompson's bid the lowest cost for Birch would mean as a whole. Because the internal prices are higher fixed Thompson will be inclined to choose a third-party vendor when this is not the cheapest solution for the company. Thompson If the lowest bid from the market (which Western Paper Company: $ 430) would match, Northern would no longer be tempted to buy referrals. The profit that is assigned to Thompson (€ 480 - € 430 = € 50) lower, but the earnings attributable to Birch in the whole is higher because there are gains nonetheless be attributed to Thompson, which at first not to be the case . The cost thus amounted to € 430 - € 288 = € 142 per 1 000 boxes.

If want to intervene headquarters, then they should compel Thompson to handle the market for sales to Northern because this balance for Birch would mean the lowest cost. By requiring the divisions and maximum price to keep the internal market sales will increase which in turn is positive for the entire company.

Question 5:

In order to give impetus to (temporarily) put excess capacity off the external divisions would no longer investment centers but as revenue centers must be treated. The divisions and their managers are no longer judged on profits and profitability, but only on sales. This gives the divisions the freedom to reduce their margins by lowering their prices in order to sell as much as possible. There must be by the senior management course requirement that can not be sold below cost price.

Also, divisions in this form no longer decide on investments and disposals, which according to the chief executive's desire guarantees the production capacity for the future. It would be opportune for a division to divest generation capacity to reduce costs while it does not support the goals of the Birch Paper Company.

Question 6:

The selling price has been fixed by the head of the division Thomson cost plus 20% surcharge for overheads and profit. The problem with this pricing is that this need not be based on efficient operations and the costs can be unnecessarily high, in this case for example by overcapacity. Also, the storage does not have to be comparable to the threshold to be used on the market. By all transfer rates on market prices to determine the divisions are encouraged to work efficiently to keep costs down. If the internal selling price would be fixed on the full cost, the company runs the risk that the cost is higher than the market and being overpaid. Moreover, the divisions in this way not encouraged to work efficiently, because they do not see any of the profits. It is, of course, always to the advantage of the company to pay the lowest possible cost price.

Since the division manager by setting the transfer price can not exercise any more at the margin the divisions are revenue centers. The profit is allocated to the divisions through the selling price minus the cost or the "out-of-pocket expenses. Since the divisions will no longer be judged on profits and profitability, the main purpose of the transfer price is no longer dividing the profits between divisions.

As the market selling division increased sales, it will also buy more with the other divisions of Birch. The conversion of these divisions will therefore increase in line accordingly. Since they all be judged on the turnover achieved there is no question of conflicts between divisions. So there is Goal Congruence.

Another option is to allow negotiate the various divisions of the transfer prices which the Goal Congruence paramount. Thus, the division managers remain responsible on the margins and the divisions can still be assessed as investment centers. The division managers would view may feel limited in their freedom to make choices when they have nothing more to say about the selling price and in this way they have just a lot of control over the prices they can handle. Another advantage is that the allocation of profits is done in a fair and thoughtful way. They can assess how much profit is being achieved in total and how much of it attributed to each division. A disadvantage is that lost a lot of time to engage in negotiations and that a division whose division manager no strong negotiator is at a disadvantage. Another drawback is that the possibility exists that the negotiations fail (stubbornness) and that is purchased still more expensive outside the company.