Purchase

of
inputs from
vendors
upstream in the
value chain

Zumwald
ECD

Hiedelberg

Sale of finished
products
downstream in
the value chain

ISD

Parts moved over at transfer price

agreed upon b/w parties

In 2001, ISD designed a new piece of ultra-sound equipment called the X73. The new system offered
advantages in processing speed and costs, and took up less space i.e. all in, a much better piece of
equipment.
Hiedelberg engineers took up the task of participating in the design process of the equipment. Hiedelberg
was compensated for the cost of design engineering but did not benefit from the profitability associated
with designing the new equipment.
Also, it is worth noting that, ISD is the end manufacturer of the product, but it procures parts that can be
either procured from outside the firm, or internal vendors. Thus, that is the relationship between the
three internal parties.

As can be seen in the appendix the competitive bids for all firms (internal/external) are different. The
source of conflict comes from the fact that Hiedelbergs bid as an internal party is not competitive
enough, in comparison to other external parties.
This conflict also arises from the fact that - each party is thinking about their own personal incentives
(most likely bonuses which are tied to margin generation), rather than thinking about the company as a
whole.
If transfer pricing is taken into account the problem of sub-optimization of individual department is
resolved. Also, it seems like fixed costs are being taken into account at the sub-entity level, but they
should be taken into account at the company level. If only contribution margin was considered, then we
observe that the cumulative contribution margin of procuring internally is larger than procuring
externally.
Thus management should incentivize group P&L, rather than departmental P&L or ROIC.

ES1 Prashant Khorana Assignment #3 - Zumwald Corp.

APPENDIX
PROFIT MARGINS OF ALL FIRMS:
Item

Bidding Supplier
Heidelberd

Bogardus

Display Tech

Price X 73

340,000 340,000

340,000

Direct Material

140,000 120,000

100,500

Other Component

72,000 72,000

72,000

Conversion cost

Variable overhead 27,000 27,000

27,000

Fixed cost 117,000 117,000

117,000

Total cost

356,000 336,000

316,500

Profit Margin

(16,000) 4,000

23,500

PROFIT MARGIN DETERMINATION BY HEIDELBERG:
Item

Heidelberg
Current Bid

Competitive Bid

Direct Material

21,600

21,600

Conversion cost

Variable overhead 28,400

28,400

Fixed cost 55,000

Total cost

105,000

50,000

Markup (@ 33% of

35,000

16,500

Price to Offer

140,000

66,500

Cost)

ES1 Prashant Khorana Assignment #3 - Zumwald Corp.

BIDS OF ALL FIRMS:

Supplier

Cost per X73 System ()

Heidelberg Division

140,000

Bogardus NV

120,000

Display Technologies Plc

100,500

ES1 Prashant Khorana Assignment #3 - Zumwald Corp.