BIRCH PAPER COMPANY

Group N

Deepak Pahuja (S-20) Ravindra Sudehely (N-99) Pushp Prakash Pankaj (S-45) Gopal Yadav (S-26) Narendra Yadav (S103)

BACKGROUND

BIRCH

Northern

Southern

Thompson

Division 4

Timberland

Medium sized, partly integrated company 3 products-white and Kraft papers and paperboard Divisions operate as profit centres/Investment Centres Each divisional manager was normally free to buy from inside or outside The corrugated boxes produce by the Thompson Division which also printed and colored the outside surface of the boxes

ABOUT BIRCH PAPER COMPANY

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Northern Division: Manager- Mr. William Kenton: Designed a special display box in conjunction with Thompson division. In need of corrugated boxes and received bids from Thompson division (in house), West paper company, Eire papers.

ABOUT BIRCH PAPER COMPANY

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Thompson Division: Manager Mr. Burner Package design, perfecting the design, production methods, made corrugated boxes. Southern Division: produce linerboard and corrugating medium and sometimes sell to Thompson division. Working on below capacity and had excess inventory. Out of pocket cost:60% of Selling Price.

BIRCH PAPER COMPANY

Evaluation in Decentralized System:

a policy of decentralizing responsibility for all decisions except those relating to overall company policy Birchs division managers normally were free to buy from whichever supplier they wished, and even on sales within the company, divisions were expected to meet the going market price if they wanted the business. each division is judged on the basis of its profit and return on investment it would be possible for top management to order the acceptance of another bid if the situation warranted such action.

SITUATION
Northern and Thompson divisions together designed box for Northern division Thompson division was reimbursed by northern division for its designing and development. After finalization, apart from Thompson's bid it also get offers from two outside companies. Company policy where each division manager had full freedom and discretion to buy from anywhere .

SITUATION
Thompsons most materials from within company, but sales mostly to outsiders. Thompson gets bid Materials to be procured from southern division. 70% of out of pocket costs of $400 were of above materials This constituted 60% of selling price

BIDS(PER 1000)

Thompson - $480 West Paper Company $432 Eire Paper Company $430*

Q1 Which bid should Northern Division accept that is in the best interest of the company?
Thompson West Paper Erie Papers Inc. 430.00 $ 430.00 $ $ $ $ $ 430.00 $ 432.00 432.00 25.00 (30.00) 54.00 (90.00) 391.00

Divisional perspective: Cost Company Overall perspective: Cost (external) Thompson variable costs Southern variable costs Cost to Company

480.00 $ $

$ $ $

120.00 168.00 288.00 $

Detail of the calculation:

THOMPSON DIVISION: Thompsons selling price to Northern Division = $ 480 20% profit margin (profit margin: ($ 480 - $ 400)/ $ 400 = 20%) Thompsons out-of-pocket costs Southerns selling price to Thompson (transfer pricing: 70% x $ 400) Other overhead costs (outsider suppliers) = $ 400

= $ 280 ----------- = $ 120

SOUTHERN DIVISION : Southerns out-of-pocket costs (60% x $ 280) Southerns profit ($ 280 - $ 168 = $ 112)

= $ 168 = $ 112 67% ($ 112/$ 168)

Conclusion:
As shown in the calculations, Northern should accept the bid from Thompson division as it has the lowest cost if all transfer prices within the company were calculated at costs. Incurring the lowest costs would also enable Birch Paper Company to earn the highest profits possible

THE ISSUE
Should Mr. Kenton accept this bid ? Why or Why not ?

Mr. William Kenton as a manager of Northern Division should not to accept the bid, because:
Birch Paper Company gave a decentralizing responsibility and authority for each division based on profit and return on investment. Mr. Kenton should not accept the bid from Thompson Division and chose either Eires or West Paper bids which offered lower price cost on the interest of Northern Division
1.

Since Eire bought the materials from Southern Division which means that Eire gives a contribution to Birch Paper Company as a whole. Southern Division could be more optimalizing its capacity and reduced its excess inventory by taking the order from Eire Paper company.
2.

THE ISSUE
Should the vice president of Birch Paper Company take any action?
Without any intervention from the vice president of Birch Paper Company, the Northern division would most probably accept the lowest bid from

West Paper Company. This might result in the highest profits for Northern division but it is not in the best interests of Birch Paper Company. Accepting the bid from Thompson division would boost demand for the two other divisions. The losses cut would most probably be more than the costs saved by Northern division which is $50 ($480-$430). The vice president should give specific orders to Northern division to accept the bid from Thompson division. However, as the transaction in this case represents less than 5% of the volume of any of the divisions involved, it might not be possible for the vice president to intervene other transactions when similar problems arise.

THE ISSUE
In the controversy described, how, if at all, is the transfer price system dysfunctional ? Does this problem call for some change, or changes, in the transfer pricing policy of the overall firm ? If so, what specific changes do you suggest ?

Firstly, we look at the transfer price that Thompson quoted. It is about $50 more than the market price. This shows that their price is not competitive enough. Thompson is operating below capacity and yet it quoted a price which is higher than the market price. The reason given was that anything less than $480, they will not be able to earn a profit and also, given that they did not get any profit from developing the product for Northern, Brunner feels that they are entitled to a good markup.

THE ISSUE
This is inconsistent with the expectation that the division must meet the market price if they wanted the business. Market price should be used as it reflects how well is the division doing as compared to competitors. The amount of upstream fixed costs and profits that are included in the final price that was sold to the outside customer could be substantial if Thompson's bid was accepted. And Northern might not be willing to reduce it sown profit to optimize company profit. Hence, Thompson, if unwilling to follow the market price blindly, could use the two-step pricing to calculate their transfer price.

THE ISSUE
That is, transferring the goods to Northern on standard variable cost on a per unit basis and fixed cost and profit on a lump sum basis. In this way, Thompson will not be transferring majority of their fixed cost to Northern because they are operating on excess capacity. But of course, this method must be discussed with Northern. The problem of the transfer price system could be that each division is judged based on profits and return on investment. This causes the division to over-emphasize on profits and encourages goal incongruence. Each division aims at achieving short-term profits so as to look better in the company's eyes. In their bid to achieve a high profit figure, they fail to optimize the company's profit as a whole. This will affect the company long-term profits.

THANK YOU
Group M
Deepak Pahuja (S-20) Ravindra Sudehely (N-99) Pushp Prakash Pankaj (S-45) Gopal Yadav (S-26) Narendra Yadav (S103)