Zumwald AG, headquartered in Cologne, Germany, produced and sold a range of medical diagnostic imaging systems and biomedical test equipment and instrumentation. The company was organized into six operating divisions. Total annual revenues were slightly more than €3 billion.
Zumwald manages ran the company on a highly decentralized basis. The managers of each division were allowed considerable autonomy if their performances were at least on plan. Performance was evaluated, and management bonuses were assigned, based on each division’s achievement of budgeted targets for return on invested capital (ROIC) and sales growth. Even though the company was partly vertically integrated, division managers were allowed to source their components from external suppliers if they so chose.
In August 2002, a pricing dispute arose between the managers of 3 of the divisions of Zumwald AG: Imaging Systems Division (ISD), the Heidelberg Division (Heidelberg), and the Electronic Components Division (ECD).
The case describes a transfer pricing issue that is common in decentralized, divisionalized firms. The case raises issues about internal pricing and, more generally, the operation of a decentralized management structure.
If we see the facts that came out in ensuing the discussion: [pic]
It is obvious why ISD take Display tech as their supplier, a total cost difference of € 39,500. Thus, Heidelberg price would result in ISD negative gross margin. Even though if we look in terms of contribution margin, ISD will still get positive numbers if they took the display monitor from Heidelberg, but looking at the objective of having the X73 as the next best thing in a competitive market, longer term it would not be viable for ISD to continue having a negative gross margin.
Now if we try to analyze further on Heidelberg and ECD facts:
Looking at the top part, look like Heidelberg applies standard markup policy for their customers (33.3% from its total cost). This makes the price not competitive to Display tech. As a newcomer in the industry that look for growing its market share, obviously Display tech are willing to compete in price.
Furthermore, if we look on bottom part, with Heidelberg still having excess capacity, especially in bidding process, it should apply the contribution margin concept, which they should only consider relevant cost. In this case relevant cost would be € 50,000. With the target price of €140,000 Heidelberg would get €90,000 contribution margin. The context of X-73 project was clear, that it wants to acquire share in the competitive market, and it can’t compete if the price isn’t match with what customer are willing to pay.
Answering the questions:
1. What sourcing decision for the X73 materials is in the best interest of?
a. The Imaging Systems Division?
It is better for ISD to focus on marketing the X-73 in pricing that is competitive. It is obvious that Display tech can give better price to offer for the X-73 display monitor. If we look at ISD contribution margin in analysis 1, it still shows a contribution (€101,700) even though they buy the display from Heidelberg, however in a long term; X-73 may not be a profitable product to market.
b. The Heidelberg Division?
Mr Halperin says that he needs full margin business in order to achieve his plan. In my opinion, this is the way Mr Halperin manage his division and been emphasizing this to his salespeople. This can be illustrated with below hypothetical figures:
Maybe because of market conditions and customer price sensitivities, Heidelberg is better of giving up some business to retain higher margins, even though they are operating in a below capacity mode. If this is the principal that Mr Halperin apply, then he should understand Mr Bauer Argument, that his quoted price can’t compete with display tech. but if this is not case, he...