Birch Paper Company- Solution

Birch Paper Company Q. Which bid should Mr. Kenton accept? Ans . The operational control of the Thompson division has been given to James Brunner and so he decides the transfer price. In this case Mr. Kenton should accept the bid of the Thompson Division. There are several reasons for this. In this case Kenton can establish management control. He should ensure that resources are obtained and used effectively and efficiently in the accomplishment of the company's objectives. However, Thomson Division has already incurred overhead costs in developing and designing the new box. Since, this cost has been incurred by an internal division and if a lower price is paid to an outside supplier it would mean a loss to the Thomson Division. Management control lies in managers assuring that the resources are obtained and used efficiently. However, in this case Thomson Division is not charging more because of inefficiencies but is charging more because it is allocating its overhead to the cost of production. That overhead that it has actually incurred in the development and designing of the new box. It is as if the development cost of the product is being charged to the cost of the product. On the other hand the outside suppliers are already having the designed and developed sample and they do not have to allocate any cost for designing the box and so the prices quoted by the outside suppliers are $430 and $432.

Q . Which bid is in the best interests of Birch Paper Company? That is, which course of action is more profitable for the company as a whole? Ans: From the perspective of strategic control, it is the duty of the management to support its own divisions especially in comparison with external companies. Moreover, it is important to understand the boundaries of the organization. The market quotations have been sought from market companies but these companies belong to a class of suppliers. If we use Porter's model these forces represent a competitive force called supplier power. So from the perspective of Birch Paper Company its own division should be selected over that of an outside company. Remember if a product is purchased from a division, there is no external cash flow. No cash flows out of the company. On the other hand if the product is purchased from an external company there will be a cash outflow from the company. From a purely arithmetical point of view if the product was purchased from outside the cost would be $430 and in addition per piece Thomson Division would gain $5 per piece and Southern Division

would gain an additional $36. That is a total of $41. If $41 were subtracted from $430 the net price to Birch would be $389, whereas the cost incurred by Thomson would be $400. However, the wider issue is that Thomson is trying to recover its overhead costs by quoting a higher price. This is the gain that is legitimately due to Thomson and Birch would gain by placing the order with Thompson Division. Q 3. Should the commercial vice president intervene? Is so, how?

Ans . The commercial vice president should intervene and request Northern Division to purchase the box from Thomson Division. The rationale is that the Thomson division is a responsibility center has not quoted a higher figure because of inefficiencies in the production process; however, it has tried to allocate the legitimate overhead costs to the product cost. There is a pressure on Thomson Division to show operational profits and in accordance to the company policy Thompson Division is allocating the legitimate costs to the product it has helped develop. The Northern Division is also trying to protect its profits by outsourcing. However, since the development costs have actually been incurred it would be iniquitous to purchase the boxes from an outside supplier. The commercial vice-president should instruct Northern Division to make purchases from Thompson Division. Northern is the beneficiary of the development process and so it must bear the cost of development incurred by Thomson. Behaviorally, Thompson Division has been displaced because it has incurred the cost of development but has not been compensated for the development cost. What Thompson is trying to do is to recover its legitimate overheads by increasing the markup on the manufacture of the boxes. The commercial manager should take up the role of diffusion the tension in the organization and if he instructs Northern Division, there will be no difficulty faced by Northern in placing the order with Thompson division