Birch Paper

OBJECTIVE : To evaluate present organizational structure and management control system of Birch Paper Company particularly on the decentralized operations of its divisions with respect to its overall performance.

PROBLEM : What effective management control system or systems should the Company adopt to attain maximum profitability not only of its divisionsÐ"ўв‚¬Ð²„Ñž respective operations but that of the Company as a whole?

AREAS OF CONSIDERATION

1. Company Background

Birch Paper Company is a medium-sized, vertically integrated paper company, producing white and kraft papers and paperboard. It has four producing divisions and a timberland division which supplied part of the companyÐ"ўв‚¬Ð²„Ñžs pulp requirement; each division is operating independently headed by its respective division managers.

BirchÐ"ўв‚¬Ð²„Ñžs division managers normally were free to buy materials or inputs from whichever supplier they wished, and even on sales within the company; so divisions were expected to meet the going market price if they wanted the business.

Early in the year, its Northern Division designed a special retail display box in conjunction with the Thompson Division, which was equipped to make the box. Thompson, as one of BirchÐ"ўв‚¬Ð²„Ñžs four producing divisions converted paperboard output into corrugated boxes. It also printed and colored the outside surface of the boxes. BirchÐ"ўв‚¬Ð²„Ñžs Southern Division will supply the lineboard and corrugating medium to Thompson Division in the event the latter got the order from Northern.

2. Decentralization Policy

The Company observes the practice of decentralization where the responsibility and authority in all decision-making for the divisionsÐ"ўв‚¬Ð²„Ñž operations lie in its respective division managers, except those relating to overall company policy.

For several years, top management felt that the decentralization concept had been successfully applied and that the companyÐ"ўв‚¬Ð²„Ñžs profits and competitive position had definitely improved.

3. Performance Evaluation

Each divisionÐ"ўв‚¬Ð²„Ñžs performance had been judged on the basis of its profit and return on investment for several years. The said practice creates competition among the companyÐ"ўв‚¬Ð²„Ñžs divisions because each makes sure that it is more profitable than the others. As such was the case, there was high possibility that one division was enjoying profit at the expense of the other(s).

4. Cost Structure

There was no defined cost structure set by top management for each division. For NorthernÐ"ўв‚¬Ð²„Ñžs retail display box project in conjunction with Thompson, the two had only an informal agreement that the former had to reimburse the latter of the out-of-pocket cost of its design and development work.

ThompsonÐ"ўв‚¬Ð²„Ñžs bid price of $480 for NorthernÐ"ўв‚¬Ð²„Ñžs box requirement had a mark-up of 20% and SouthernÐ"ўв‚¬Ð²„Ñžs mark-up for its liner and corrugating medium for Thompson was at around 40% considering that its out-of-pocket costs were about 60% only of its selling price.

The ControllerÐ"ўв‚¬Ð²„Ñžs comment on the effect that costs that were variable for one division could be largely fixed for the company as a whole is true.

ALTERNATIVE COURSES OF ACTION AND ANALYSES

1. Adopt Transfer Pricing and Enhance Responsibility Accounting Systems

Adopt Transfer Pricing System

One of the problems encountered in the evaluation of performance of different divisions or business segments in a decentralized business operations is caused by the transfer of goods and/or services between or among the divisions. If only all the divisions transact business with outsiders, there would be no problem at all particularly in the determination of selling price. But if one division furnishes goods or services to another division like in this case, a transfer price must be set to determine the buying divisionÐ"ўв‚¬Ð²„Ñžs cost and the selling divisionÐ"ўв‚¬Ð²„Ñžs revenue. This concept or system is called transfer pricing.

A transfer price is a price charged for the transfer of output from one division to another of the same company. So if one division charges high price for a component that another division has to buy, ultimately such division is enjoying profit at the expense of the other division. But such scenario is only normal because divisions are generally managed by each manager which performance is evaluated by the profits of the division not of the company as a whole. As such, the top management plays a vital role on in developing a sound transfer pricing system.

No one transfer pricing method will be best for all situations, so criteria for creating a transfer price should be properly outlined by top management. These criteria are the following:

1. Goal congruence. The transfer pricing system should encourage each manager to make decisions that will maximize profits for the Company as a whole. In decentralized organizations, perhaps one of the most difficult tasks is to get everyone to pull toward the common goal Ð"ўв‚¬Ð²Ð‚Ñš the financial success of the whole firm. Success of each division will not guarantee the optimal success fir the whole firm.

2. Performance evaluation. The transfer pricing system should allow corporate-level managers to measure the performance of division managers in a fair manner.

3. Autonomy. The transfer pricing system should allow division managers to operate their divisions as if they independent businesses.

4. Administrative cost. The transfer pricing system should be easy and inexpensive to operate. Administrative cists also include waiting for decision, hours spend negotiating and internal divisiveness.

These four criteria should be prioritized when forming transfer pricing policies. Different situations will demand different transfer pricing policies. The most common transfer prices are (1) Market Price (2) Cost-based Price (which includes actual full cost, target or predetermined full cost, cost plus