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This paper is exclusively exclusively submitted to Supriyadi, M.Sc., C.M.A., Ph.D. Management Control System Course
GADA! MADA "#$%&'S$T( ) M*A ) $#T&'#AT$+#A CAS CA SS October, 2016
By:: By Ahmad Fahmi Mubarok
Case 6-3, General Appliance Corporation A. Pro Proble blems The General Appliance Corporation was an integrated manufacturer of all types of home applianc appliances. es. The company company had a decentra decentralize lized d organiz organizati ation, on, consisti consisting ng product product divisions, manufacturing divisions, and six staff offices (Finance taff, !ngineering taff, "anufacturing taff, #ndustrial $elation taff, %urchasing taff, and "ar&eting taff'. The staff offices had functional authority over their counterparts in the divisions, ut had no direct line authority over the general division managers. All divisions personnel are respon responsi sile le to the divis division ion manag manager er.. Th Thee produc productt divisi divisions ons desig designe ned, d, engin engineer eered ed,, assemled, and sold various home appliances. "anufacturing divisions made approximately )*+ of their sales to the product divisions. %arts made y the manufacturing divisions were generally designed y the product divisions. Although all the manufacturing divisions had engineering department, these departments did only -+ of the total company engineering. B. Reas Reaso onin ning Transfer price is the price one suunit of an organization charges for a product or service supplied to another suunit of the same organization. The two segments can e cost centers, profit centers, or investment centers. The transfer prices should e designed to accompl accomplish ish differ different ent oectiv oectives es li&e li&e provide provide each usiness usiness unit with the relevant relevant information it needs to determine the optimum trade/off etween company costs and revenue, revenue, induce induce goal congruent congruent decision decisions0me s0means ans the decisio decisions ns which which can improve improve usiness unit profit will also improve company profits, help measure the economic performance of the individual usiness units, motivate management effort, preserve a high level of suunit autonomy in decision ma&ing, the system should e simple to understand and easy to administer.
The determination determination of a fair Transfer Transfer %rice may e adversely affected y constraints constraints placed on sourcing either ecause of the corporate policies or due to certain constraints. 1imi 1imited ted "ar&e "ar&ets ts and !x !xce cess ss or sho shorta rtage ge of indust industry ry capaci capacity ty will will also also affe affect ct the the determination of a fair transfer price. There are 2 general methods for in transfer price3 4. "ar&e "ar&et/ t/as ased ed tra transf nsfer er pric prices es . Cost/ Cost/a ased sed transf transfer er price pricess
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2. 5egotiated transfer prices3 C. Case Evidence 4. tove Top %rolem The !lectric tove 6ivision oected to proposed price increase. Chrome %roducts 6ivision3 $e7uired y manufacturing staff to add operations at cost of 8- cents per unit, operations resulted in improved 7uality, present price 94- was ased on old 7uality standards. !lectric tove 6ivision3 5o change in engineering specifications, electric tove 6ivision had not re7uested that 7uality e improved nor consulted, improvement in 7uality from customer point of view was doutful, it is not worth :- cents, cost of improved 7uality included in 9 4- price. Finance taff review3 !ngineering 6ept. of the "anufacturing taff was as&ed to review added operations and comment on acceptaility of the proposed increased cost. !ngineering 6ept. stated that the proposed costs were reasonale and represented efficient processing. The 7uality control stated that the 7uality was improved and new parts were of superior 7uality to parts purchased from outside vendors. olution3 5o price changes, ecause the 7uality was improved, while the price itself was competitive. . Thermostatic Control %rolem !lectric "otor 6ivision and $efrigerator 6ivision were negotiating 4:88 prices. $efrigerator propose 9.4* as price paid to "onson. ;ut !lectric "otor 6ivision refused the price elow 9.<- to either $efrigerator or 1aundry !7uipment. !lectric "otor 6ivision3 The price from "onson was made as a last, desperate effort to supply GA Corp. the price was a distress price and not a valid asis for determining an internal price. The G" of !" 6ivision was going to ta&e all his aility and ingenuity to ma&e a profit even at 9.<-. #f forced at 9.4*, he would ma&e plans to close the plant. 1aundry !7uipment 6ivision3 #t ased its case for 9.4* on intra company pricing rules. =ith higher volume (4--,---' he could proaly otain an even more favorale price if he were to procure his re7uirements from outside of the corp. $efrigerator 6ivision3 #t was sure that "onson had capacity to produce all re7uirements and happy to do so for 9.4* a unit. Finance taff review3 The purchase staff replied that there was excess capacity and as a result, prices were very soft. The price would rise, either when the demand for comparale units increased or when some of the suppliers went out of usiness. The purchase staff had no dout that $efrigerator 6ivision could purchase all its re7uirements for next year or two at 9.4* a unit, or even less. The purchase staff elieved if all the corp.>s re7uirements for this unit were placed outside suppliers, the price would rise to at least 9.<-. olution3 •
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%urchase taff>s estimation is irrelevant, ecause they do not mention more details on their estimation. The company uy all of their thermostatic control units from "onson for 94.4*, and sell the !" 6ivision. 2. Transmission %rolem The 1aundry !7uipment 6ivision ought a transmission unit from two sources, the internal Gear and Transmission 6ivision and the external Thorndi&e "achining Corporation. After a 4-year agreement with Thorndi&e, General Appliance Corp decided not to extend the contract with Thorndi&e and expand the facilities on the Gear and Transmission 6ivision to fulfill the needs of the 1aundry !7uipment 6ivision. After deciding to end the contract with Thorndi&e, development of price proposal was made for the new low/cost transmission unit3 Gear and Transmission3 94,--, refused y 1aundry !7uipment. 1aundry !7uipment3 944,4, refused y Gear and Transmission. 1aundry !7uipment 6ivision3 Found the transfer price was too high, since the identical device can e otained in the external mar&et at a lower rate. #t will hurt overall performance of the entire company in the mar&et (the competitiveness', and also it will create Gear and Transmission 6ivision enefit on 1aundry !7uipment 6ivision>s expense. Gear and Transmission 6ivision3 Got indication for expanding facilities y first agreeing on not renewing the agreement with Thorndi&e. Turning to Thorndi&e afterwards means that they have made excessive investing. Finance taff review3 Adust price for performance characteristics and increases in price level (proper price was 944,*', uy from Thorndi&e can e done at 7uoted price for all foreseeale future, turn down profit target for the Gear and Transmission will more li&ely induce goal congruence. olution3 ;uy internally at a transfer price of 944,*, since this will e the most correct price for the new transmission unit, or uy from Thorndi&e ecause competition is important to &eep prices down and to get the est 7uality. •
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D. Conclusion Recommendation Cost and mar&et price information are often useful starting points in the negotiation process. Costs, particularly variale costs of the ?selling? division, serve as a ?floor? elow which the selling division would e unwilling to sell. %rices that the ?uying? division would pay to purchase products from the outside mar&et serves as a ?ceiling? aove which the uying division would e unwilling to uy. The price negotiated y the two divisions will, in general, have no specific relationship to either costs or prices. ;ut the negotiated price will generally fall etween the variale costs/ased floor and the mar&et price/ased ceiling. @nder this approach the Transfer %rice includes two charges. First for each unit sold, a charge is made that is e7ual to the standard variale cost of production. econd a periodic (usually monthly' charge is made that is e7ual to the fixed cost associated with the facilities reserved for the uying unit. ne or oth these components should include a profit margin. The transfer pricing should e focus on3 4. hort term profit maximization . Buality needs to e factored into uying the decision. 2. 5egotiation is the &ey.
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@pper management should develop a set of rules that govern oth pricing and sourcing. 1ine management should not spend an undue amount of time on a transfer pricing negotiations.
