Birch Paper Company

Subject: Transfer Pricing

Introduction (key elements):

Background: Medium sized, partly integrated company
Three product: white, Kraft papers and paperboard
Birch composed of: Northern, Southern, Thompson, Division 4 and
Division 4
Working and Assessment:

Judgment based on the basis of its profit and return on investment (ROI)
Concept of decentralization-both authority and responsibility
Improvement attributed to above factor
Situation:

Northern and Thompson division together designed box for Northern

division
Thompson division was reimbursed by Northern division for its designing
and development
After finalization, apart from Thompsons bid it also gets offers from two
outside companies
Company policy where each division manager had full freedom and
discretion to buy from anywhere
Thompsons most materials from within company but sales mostly
outsiders
If Thompson gets bid materials to be procured from Southern division
70% of out of pocket costs of $400 were above materials
This constituted 60% of selling price

The Northern division received bids on 1000 boxes:

From Thompson division - $480
From West Paper Company - $430
From Eire Paper Company - $432
Eire paper Company and dilemma:
It would buy outside linear board from Birch with special printing (to be
done by Thompson) $90 (a thousand boxes) and $30 for printing.
Competitive market where higher costs cannot be passed on, how can we
buy own supplies @10% higher than market rate.

Other Factors:
Thompson division felt not received profit for their development work,
hence entitled to mark up on production of box
Cost variable for one division could be largely fixed for company as a
whole
Without orders from top management Kenton would accept the lowest bid
Transaction involved only 5% of volume of divisions involved

Which bid should Northern division accept that is in best interest of

the company?
Thompson division
In the calculation out the cost that Thompson actually has the lowest costs
associated with them

Cost involved:
Costs for Thompson are; Linear board and corrugating medium: Cost
$400x70%x60%=$168 plus out of pocket: $400x30%=$120, for a total cost
$288
Cost for West Paper would be a total $430
Cost for Eire Papers would be $90x60%=$54 (Southern) plus $25
(Thompson), and their supplies of $432-5-36=$391, total cost $470

Should Mr. Kenton accept this bid?

Mr. Kenton should not accept the bid from West Paper because it is not in
the best interest of the company, but at the same time with the transfer
policy that exists, it is really up to him what is in the best interest of his
division. Mr. Kenton should accept the bid from Thompson because not only
will result in the lowest cost but also it will encourage buying from within the
company

Vice president action:

Yes, the vice president should take any action. As if no orders come from
top management Kenton would accept the lowest bid
The vice president of the Birch should take action in order to remedy the
overall problems associated with this transfer pricing policy

Is transfer pricing system dysfunctional?

Yes
The transfer price system is dysfunctional because it focuses too much on
individual sectors making profit and return on investment
Some alternative should be present which strikes a balance between both