Birch Paper Company Case Summary
Question #1. Which bid should Mr. Kenton accept?
Assuming Birch Paper’s current transfer pricing policy and rewarding system as given, Mr. Kenton should accept the West Paper Company bid for $430. By accepting this bid, the Northern Division will incur in the lowest cost possible and be able to generate a higher mark-up when selling the product. Because the division will be rewarded based on its own profit, this is the best decision.
The company currently has a competitive profile, in which the divisions are measured based on profit generated and are incentivized to do what is optimal to the own division, even though that might represent purchasing from an outside supplier.
However, this is not the best choice from the perspective of …show more content…
the entire company. I believe that both the transfer pricing policy and rewarding system should be reviewed in order to improve the company’s decision making process and alignment of interests among the divisions. Currently, the divisions are only incentivized to look at their own profits, but that focus sometimes create a conflict of interest between the division’s objective and the firm’s.
In order to help solve that conflict, Birch Paper should implement a dual pricing system for transfer prices, in which the buying division would receive the transferred good at cost and the selling division would sell the product at market price. Consequently, the selling unit would be willing to generate profits and the buying unit would be incentivized to purchase internally. At the same time, the divisions would book as revenues the market price of the transferred good, instead of the cost. The divisions would be rewarded based on the profit generated, which would include revenue at market prices discounted by both the out-of-pocket costs and any additional costs incurred (overhead, idle capacity). This option solves the conflict faced by Birch and allows the company to make optimal decision that maximizes profits.
Question #2. Which bid is in the best interests of Birch Paper?
In order to answer the question above I analyzed what is the actual costs incurred and profits generated in each bid. Below is a summary of each bid: …show more content…
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West Paper Company: this is a full cost bid for Birch Paper, as the company will purchase the product at $430 and resell it at a given price. No intermediate profit was generated. In the case of the bid offered.
Eire Papers: Birch Paper sells part of the raw material to Eire for $90 at a cost of 60%*$90
= $54, generating $36 in profits for the Southern Division (and the company). Also,
Thompson Division charges $30 for printing the product and incur in a cost of $25, generating a profit of $5. Consequently, the bid represents a cost for Birch Paper of: $432
- $36-$5 = $391
Thompson Division: Southern Division sells raw materials for 70%*$480 = $280 to the
Thompson Division at a cost of 60%*$280 = $168, generating a profit of $112 for the company. Also, the Thompson division is adding 20% overhead and profit charges to the out-of-pocket costs, totaling $80, which are not out-of-pocket expenses. Consequently, this bid represents a cost that could vary from $288 to $368 (depending on how the $80 is interpreted) to Birch Paper.
Below is a summary of the analysis:
Bid 1: West Paper Company
430
0
430
Purchase cost Accrued profit for Actual cost for
Birch
Birch
Bid 2: Eire Papers
432
5
36
Purchase cost
Accrued profit for Birch profit in the Thompson division (+$5=$30-$25)
Accrued profit for Birch Profit in the Southern
($36=60%*(1-70%)*$90)
391
Actual cost for Birch
Bid 3: Thompson Division
480
112
368
80
288
Purchase cost
Accrued profit for Birch - profit in Southern division
(112=280*40%) + zero profit for Thompson
Actual cost for Birch
Additional potential gain - Potential cost for Birch - after reduction in overhead costs at operational improvements
Thompson
The bid that represents the lowest cost to be incurred by Birch Paper is Bid 3 offered by Thompson
Division.
Consequently, this is the bid that is in the best interest of Birch Paper, as the company will be able to generated higher profits.
Question #3. Should the commercial vice-president intervene? If so, why?
Under the current transfer pricing policy and rewarding system the commercial vice-president should intervene to make the Northern Division purchase the product from the Thompson
Division. As presented in question #2, the Thompson Division bid is the one that represents the lowest cost to be incurred by Birch Papers, and consequently is the one that maximizes the profit generated by the company. However, the vice-president should allow the Northern Division purchase the product from the Thompson Division at a price of $430, which is the market price, and not $480, in order to be fair and coherent with the rules in place. This decision would make the rules clearer and would avoid incentivizing any division to sell transfer goods for more than
market price, which is not the internal policy of the company. If the vice-president decides
to intervene and force the Northern division to purchase from Thompson at $480, he would not be fair. The Northern Division would be measured in profits generated, which would be reduced by the additional cost incurred from the higher bid. At the same time, if the vice-president does not intervene, the company will be making a non-optimal decision that represents lower profits.
As mentioned in question #1, I do not think that this is the optimal system in place for Birch Paper and having the vice president intervene in the decision would possibly generate internal conflicts.
Therefore, I think the best way of solving the conflict is by reviewing the systems as indicated in question #1. By doing that, Birch Paper would avoid creating this conflict among the divisions and the decision to purchase internally would be natural, as it would represent the optimal decision for both the company and the divisions. At the same time, the divisions would be measured based on the profit generated, including costs that represent inefficiencies, such as idle capacity.
Consequently, the company would be incentivizing each division to make optimal purchase decisions and keep track of costs in order to become as efficient as possible.
Assuming Birch Paper’s current transfer pricing policy and rewarding system as given, Mr. Kenton should accept the West Paper Company bid for $430. By accepting this bid, the Northern Division will incur in the lowest cost possible and be able to generate a higher mark-up when selling the product. Because the division will be rewarded based on its own profit, this is the best decision.
The company currently has a competitive profile, in which the divisions are measured based on profit generated and are incentivized to do what is optimal to the own division, even though that might represent purchasing from an outside supplier.
However, this is not the best choice from the perspective of …show more content…
the entire company. I believe that both the transfer pricing policy and rewarding system should be reviewed in order to improve the company’s decision making process and alignment of interests among the divisions. Currently, the divisions are only incentivized to look at their own profits, but that focus sometimes create a conflict of interest between the division’s objective and the firm’s.
In order to help solve that conflict, Birch Paper should implement a dual pricing system for transfer prices, in which the buying division would receive the transferred good at cost and the selling division would sell the product at market price. Consequently, the selling unit would be willing to generate profits and the buying unit would be incentivized to purchase internally. At the same time, the divisions would book as revenues the market price of the transferred good, instead of the cost. The divisions would be rewarded based on the profit generated, which would include revenue at market prices discounted by both the out-of-pocket costs and any additional costs incurred (overhead, idle capacity). This option solves the conflict faced by Birch and allows the company to make optimal decision that maximizes profits.
Question #2. Which bid is in the best interests of Birch Paper?
In order to answer the question above I analyzed what is the actual costs incurred and profits generated in each bid. Below is a summary of each bid: …show more content…
-
-
-
West Paper Company: this is a full cost bid for Birch Paper, as the company will purchase the product at $430 and resell it at a given price. No intermediate profit was generated. In the case of the bid offered.
Eire Papers: Birch Paper sells part of the raw material to Eire for $90 at a cost of 60%*$90
= $54, generating $36 in profits for the Southern Division (and the company). Also,
Thompson Division charges $30 for printing the product and incur in a cost of $25, generating a profit of $5. Consequently, the bid represents a cost for Birch Paper of: $432
- $36-$5 = $391
Thompson Division: Southern Division sells raw materials for 70%*$480 = $280 to the
Thompson Division at a cost of 60%*$280 = $168, generating a profit of $112 for the company. Also, the Thompson division is adding 20% overhead and profit charges to the out-of-pocket costs, totaling $80, which are not out-of-pocket expenses. Consequently, this bid represents a cost that could vary from $288 to $368 (depending on how the $80 is interpreted) to Birch Paper.
Below is a summary of the analysis:
Bid 1: West Paper Company
430
0
430
Purchase cost Accrued profit for Actual cost for
Birch
Birch
Bid 2: Eire Papers
432
5
36
Purchase cost
Accrued profit for Birch profit in the Thompson division (+$5=$30-$25)
Accrued profit for Birch Profit in the Southern
($36=60%*(1-70%)*$90)
391
Actual cost for Birch
Bid 3: Thompson Division
480
112
368
80
288
Purchase cost
Accrued profit for Birch - profit in Southern division
(112=280*40%) + zero profit for Thompson
Actual cost for Birch
Additional potential gain - Potential cost for Birch - after reduction in overhead costs at operational improvements
Thompson
The bid that represents the lowest cost to be incurred by Birch Paper is Bid 3 offered by Thompson
Division.
Consequently, this is the bid that is in the best interest of Birch Paper, as the company will be able to generated higher profits.
Question #3. Should the commercial vice-president intervene? If so, why?
Under the current transfer pricing policy and rewarding system the commercial vice-president should intervene to make the Northern Division purchase the product from the Thompson
Division. As presented in question #2, the Thompson Division bid is the one that represents the lowest cost to be incurred by Birch Papers, and consequently is the one that maximizes the profit generated by the company. However, the vice-president should allow the Northern Division purchase the product from the Thompson Division at a price of $430, which is the market price, and not $480, in order to be fair and coherent with the rules in place. This decision would make the rules clearer and would avoid incentivizing any division to sell transfer goods for more than
market price, which is not the internal policy of the company. If the vice-president decides
to intervene and force the Northern division to purchase from Thompson at $480, he would not be fair. The Northern Division would be measured in profits generated, which would be reduced by the additional cost incurred from the higher bid. At the same time, if the vice-president does not intervene, the company will be making a non-optimal decision that represents lower profits.
As mentioned in question #1, I do not think that this is the optimal system in place for Birch Paper and having the vice president intervene in the decision would possibly generate internal conflicts.
Therefore, I think the best way of solving the conflict is by reviewing the systems as indicated in question #1. By doing that, Birch Paper would avoid creating this conflict among the divisions and the decision to purchase internally would be natural, as it would represent the optimal decision for both the company and the divisions. At the same time, the divisions would be measured based on the profit generated, including costs that represent inefficiencies, such as idle capacity.
Consequently, the company would be incentivizing each division to make optimal purchase decisions and keep track of costs in order to become as efficient as possible.