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This paper is exclusively submitted to Supriyadi, M.Sc., C.M.A., Ph.D.

Management Control System Course

GADJAH MADA UNIVERSITY | MBA |

INTERNATIONAL CLASS
October, 2016

By:
Ahmad Fahmi Mubarok

Case 6-3, General Appliance Corporation

A. Problems
The General Appliance Corporation was an integrated manufacturer of all types of
home appliances. The company had a decentralized organization, consisting product
divisions, manufacturing divisions, and six staff offices (Finance Staff, Engineering Staff,
Manufacturing Staff, Industrial Relation Staff, Purchasing Staff, and Marketing Staff).
The staff offices had functional authority over their counterparts in the divisions, but had
no direct line authority over the general division managers. All divisions personnel are
responsible to the division manager. The product divisions designed, engineered,
assembled, and sold various home appliances.
Manufacturing divisions made approximately 75% of their sales to the product
divisions. Parts made by the manufacturing divisions were generally designed by the
product divisions. Although all the manufacturing divisions had engineering department,
these departments did only 20% of the total company engineering.
B. Reasoning
Transfer price is the price one subunit of an organization charges for a product or
service supplied to another subunit of the same organization. The two segments can be
cost centers, profit centers, or investment centers. The transfer prices should be designed
to accomplish different objectives like provide each business unit with the relevant
information it needs to determine the optimum trade-off between company costs and
revenue, induce goal congruent decisionsmeans the decisions which can improve
business unit profit will also improve company profits, help measure the economic
performance of the individual business units, motivate management effort, preserve a
high level of subunit autonomy in decision making, the system should be simple to
understand and easy to administer.

The determination of a fair Transfer Price may be adversely affected by constraints

placed on sourcing either because of the corporate policies or due to certain constraints.
Limited Markets and Excess or shortage of industry capacity will also affect the
determination of a fair transfer price. There are 3 general methods for in transfer price:
1. Market-based transfer prices
2. Cost-based transfer prices

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3. Negotiated transfer prices:

C. Case Evidence
1. Stove Top Problem
The Electric Stove Division objected to proposed price increase.
Chrome Products Division:
Required by manufacturing staff to add operations at cost of 80 cents per unit,
operations resulted in improved quality, present price $10 was based on old
quality standards.
Electric Stove Division:
No change in engineering specifications, electric Stove Division had not requested
that quality be improved nor consulted, improvement in quality from customer
point of view was doubtful, it is not worth 90 cents, cost of improved quality
included in $ 10 price.
Finance Staff review:
Engineering Dept. of the Manufacturing Staff was asked to review added
operations and comment on acceptability of the proposed increased cost.
Engineering Dept. stated that the proposed costs were reasonable and represented
efficient processing. The quality control stated that the quality was improved and
new parts were of superior quality to parts purchased from outside vendors.
Solution:
No price changes, because the quality was improved, while the price itself was
competitive.
2. Thermostatic Control Problem
Electric Motor Division and Refrigerator Division were negotiating 1988 prices.
Refrigerator propose $2.15 as price paid to Monson. But Electric Motor Division
refused the price below $2.40 to either Refrigerator or Laundry Equipment.
Electric Motor Division:
The price from Monson was made as a last, desperate effort to supply GA Corp.
the price was a distress price and not a valid basis for determining an internal
price. The GM of EM Division was going to take all his ability and ingenuity to
make a profit even at $2.40. If forced at $2.15, he would make plans to close the
plant.
Laundry Equipment Division:
It based its case for $2.15 on intra company pricing rules. With higher volume
(100,000) he could probably obtain an even more favorable price if he were to
procure his requirements from outside of the corp.
Refrigerator Division:
It was sure that Monson had capacity to produce all requirements and happy to do
so for $2.15 a unit.
Finance Staff review:
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 comparable units
increased or when some of the suppliers went out of business. The purchase staff
had no doubt that Refrigerator Division could purchase all its requirements for
next year or two at $2.15 a unit, or even less. The purchase staff believed if all the
corp.s requirements for this unit were placed outside suppliers, the price would
rise to at least $2.40.
Solution:

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Purchase Staffs estimation is irrelevant, because they do not mention more details
on their estimation. The company buy all of their thermostatic control units from
Monson for $21.15, and sell the EM Division.
3. Transmission Problem
The Laundry Equipment Division bought a transmission unit from two sources, the
internal Gear and Transmission Division and the external Thorndike Machining
Corporation. After a 10year agreement with Thorndike, General Appliance Corp
decided not to extend the contract with Thorndike and expand the facilities on the
Gear and Transmission Division to fulfill the needs of the Laundry Equipment
Division. After deciding to end the contract with Thorndike, development of price
proposal was made for the new low-cost transmission unit:
Gear and Transmission: $12,00, refused by Laundry Equipment.
Laundry Equipment: $11,21, refused by Gear and Transmission.
Laundry Equipment Division:
Found the transfer price was too high, since the identical device can be obtained in
the external market at a lower rate. It will hurt overall performance of the entire
company in the market (the competitiveness), and also it will create Gear and
Transmission Division benefit on Laundry Equipment Divisions expense.
Gear and Transmission Division:
Got indication for expanding facilities by first agreeing on not renewing the
agreement with Thorndike. Turning to Thorndike afterwards means that they have
made excessive investing.
Finance Staff review:
Adjust price for performance characteristics and increases in price level (proper
price was $11,25), buy from Thorndike can be done at quoted price for all
foreseeable future, turn down profit target for the Gear and Transmission will
more likely induce goal congruence.
Solution:
Buy internally at a transfer price of $11,25, since this will be the most correct
price for the new transmission unit, or buy from Thorndike because competition is
important to keep prices down and to get the best quality.
D. Conclusion & Recommendation
Cost and market price information are often useful starting points in the negotiation
process. Costs, particularly variable costs of the "selling" division, serve as a "floor"
below which the selling division would be unwilling to sell. Prices that the "buying"
division would pay to purchase products from the outside market serves as a "ceiling"
above which the buying division would be unwilling to buy. The price negotiated by the
two divisions will, in general, have no specific relationship to either costs or prices. But
the negotiated price will generally fall between the variable costs-based floor and the
market price-based ceiling. Under this approach the Transfer Price includes two charges.
First for each unit sold, a charge is made that is equal to the standard variable cost of
production. Second a periodic (usually monthly) charge is made that is equal to the fixed
cost associated with the facilities reserved for the buying unit. One or both these
components should include a profit margin. The transfer pricing should be focus on:
1. Short term profit maximization
2. Quality needs to be factored into buying the decision.
3. Negotiation is the key.

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Upper management should develop a set of rules that govern both pricing and
sourcing.
Line management should not spend an undue amount of time on a transfer pricing
negotiations.