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Chapter 7 . Financial Responsibility Centers
In August 2002, a pricing dispute arose between the managers of some of the divisions of Zumwald AG. Mr. Rolf Fettinger, the company's managing director, had to decide whether to intervene in the dispute.
ECD sold application-specific integrated circuits and subassemblies. ECD was originally established as a captive supplier to other Zumwald divisions. but in the last decade its managers had found external markets for some of the division's vroducts. Because of this, ECD's managers were given profit center responsibility.
THE COMPANY Zumwald AG, headquartered in Cologne, Germany, produced and sold a range of medical diagnostic imaging systems and biomedical test was equipment and instrumentation- The organized into six operating divisions. Total annual revenues were slightly more than €3 billion. Zumwald managers ran the company On a decentralized basis. The managers of each division were allowed considerable autonomy if their performances were at least On plan. Performance was evaluated, and management bonuses were assigned, based on each division's achievement invested of budgeted targets for retum (RolC) and growth. Even the 'Ompany was partly integrated, managers were to source their from external suppliers if they so chose. Involved in the were three of the the Imaging Systems Division (ISD), the Heidelberg Division (Heidelberg), and the Electronic Components Division (ECD).
THE DISPUTE
1, 2001, ISD designed a new ultrasound imaging system, called the ~ 7 3H~~~~ . were high for ~ 7 3 . The new system offered users advantages in processing speed and cost, and it took up less space. ~ ~ i d engineers ~ l b participated ~ ~ ~ in the design of ~ 7 3 but , ~ ~ i d ~ was l b e ~ ~ for the full cost of the time its employees spent on this pro,ect. managers ~f~~~ the specifications were set, solicited bids for the materials needed to produce X73 components. Heidelberg was asked to bid to supply the displays needed for production of the X73 system. So were two outside companies. One was Bogardus NV, a Dutch company with a reputation for producing high-quality products. Bogardus had been a long-time supplier to Zumwald, but it had never before supplied display units and systems to any Zumwald division. Display Technologies PIC was a British company that had ISD sold complex ultrasound and magnetic reson- recently entered the n~arketand was known to be ance imaging systems. These systems were expen- pricing its products aggressively in order to buy market share. The quotes that ISD received were as sive, typically selling for €500,000-1 million. Heidelberg sold high-resolution monitors, graphics controllers, and display subsystems. ApproximCost per X73 system (€) ately half of its sales were made to outside cus~ ~ i d ~ i ,~, i ~ il~ , , b ~ ~ ~ 140,000 tomers. ISD was one of Heidelberg's major inside 120,500 Bogardus NV 100,500 customers. Display Technologies PIC ,
This case was prepared by Professors Kenneth A. Merchant and Wim A. Van der Stede. Copyright O 2003 by Kenneth A. Merchant and Wim A. Van der Stede.
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Zumwald AG
After discussing the bids with his management team, Conrad Bauer, ISD's managing director, announced that ISD would be buying its display systems from Display Technologies Plc. Paul Halperin, Heidelberg's general manager was livid. He immediately complained to Mr. Bauer, but when he did not get the desired response, he took his complaint to Rolf Fettinger, Zumwald's managing director. Mr. Fettinger agreed to look into the situation. A meeting was called for August 29, 2002. Mr. Halperin asked Christian Schonberg, ECD's GM, to attend this meeting to support his case. If Heidelberg got this order from ISD, it would buy all of its electronic components from ECD. At this meeting, Mr. Bauer immediately showed his anger:
1. ISD's tentative target price for the X73 system was €340,000.' 2. Heidelberg's standard manufacturing cost (material, labor and overhead) for each display system was €105,000. When asked, Mr. Halperin estimated that the variable portion of this total cost was only €50,000. He treated Heidelberg's labor costs as fixed because Geman laws did not allow him to lay off employees without incurring expenses that were "prohibitively" high. 3. Because of the global business slowdown, the production lines at Heidelberg that would produce the systems in question were operating at approximately 70% of capacity. In the preceding year, monthly production had ranged from 60-90% of total capacity. 4. Heidelberg's costs included €21,600 in electronic subassemblies to be supplied by ECD. ECD's full manufacturing costs for the components included in each system were approximately €18,000, of which approximately half were out-of-pocket costs. ECD's standard policy was to price its products internally at full manufacturing cost plus 20%. The mark-up was intended to give ECD an incentive to supply its product internally. ECD was currently operating at 90% capacity.
Paul wants to charge his standard mark-up for these displays. I can't afford to pay it. I'm trying to sell a new product (X73) in a very competitive market. How can I show a decent ROIC if I have to pay a price for a major component that is way above market? I can't pass on those costs to my customers. Paul should really want this business. I know things have been relatively slow for him. But all he does is quote list prices and then complain when I do what is best for my division. Near the end of the meeting, Mr. Bauer reminded We're wasting our time here. Let's stop fighting everybody of the company's policy of freedom of amongst ourselves and instead spend our time figuring sourcing. He pointed out that this was not such a out how to survive in these difficult business conditions. big deal, as the volume of business to be derived Mr. Fettinger asked Mr. Halperin why he from this new product was only a small fraction could not match Display Technologies' price. Paul (less than 5%) of the revenues for each of the divireplied as follows: sions involved, at least for the first few years. And he also did not like the potential precedent of his Conrad is asking-meto shave my price down to below being forced to source internally because it could cost. If we start pricing our jobs this way, it won't be long before we're out of business. We need to price adversely affect his ability to get thoughtful quotes our products so that we earn a fair return on our from outside suppliers in the future. investment. You demand that of us; our plan is put together on that basis; and I have been pleading with my sales staff not to offer deals that will kill our mar- THE DECISION gins. Conrad is forgetting that my engineers helped As he adjourned the meeting, Mr. Fettinger him design X73, and we provided that help with no promised to consider all the points of view that had mark-up over our costs. Further, you can easily see been expressed and to provide a speedy judgment. that Zumwald is better off if we supply the display He wondered if there was a viable compromise or systems for this new product. The situation here is clear. If Conrad doesn't want to be a team player, then if, instead, there were some management principles you must order him to source internally! That deci- involved here that should be considered inviolate. sion is in the best interest of all of us. In the ensuing discussion, the following facts came out:
' The cost of the other components that go into X73 is €72,000. ISD's conversion cost for the X73 system is €144,000, of which €1 17,700 is fixed.
