Zumwald Case Study Solution

To:                        Mr. Fettinger

From:                        XXXXXXXXXXXX

Subject:                Recommendation to establish transfer price policy for internal divisions

Date:                        October 9, 2018

The memo advises the appropriate course of action for the dispute of transfer pricing. The clash originates due to performance monitoring system design, as each division is trying to maximize their ROI, the company’s objective is getting overlooked. To solve this problem, the goals of divisions must be aligned to the ultimate objective of higher profits of Zumwald as a whole. The recommendation is to establish a transfer pricing policy for products such as the display units for X73 from Heidelberg Division.

The analysis of advantages for buying internally is organized below:

1. The monetary advantage of ISD to source from Display Technologies rather than Heidelberg is €39,500. This is far smaller than the total contribution margin Zumwald’s divisions ISD and Heidelberg earns which is €102,600 that would be foregone if Heidelberg does not get this order. The difference is a loss of €63,100 if not ordered internally. Refer to Appendix 1 – Part I.
2. The Display Technologies is a new entrant to the market and its quality is unproven, unlike Heidelberg’s product. Thus, going with former poses a risk of brand deterioration and even can cause costs of switching suppliers later as they can increase prices later.
3. The contribution margin for ISD when sourced from Heidelberg is €101,700 which is decent enough to promise highly profitable business in the long run. Alternatively, any price greater than €37,400 provides contribution margin to Heidelberg and ECD, so it can easily shave price to gain internal business to minimize unused capacity. Please refer Appendix 1 – Part I for calc.

The significant disadvantages of FORCIBLY ORDERING to buy internally are explained below:

1. It will harm the policy of divisional freedom to source a product and can jeopardize its entrepreneurial culture and decentralized style of working.
2. Also, the dilution in policy could really hurt the future of business units for only 5% of total revenues. This can potentially reduce the incentive to explore and capture external markets. This can affect efficiency and may lead to long-term losses.
3. And Mr. Fettinger may have to interfere in similar cases for all divisions in the future.

The recommendation is to establish and announce a transfer price policy within the internal organization at variable cost plus normal 30% markup only if divisions still have excess capacity to produce. This will solve the problem for divisions in this situation as well as without intervention in future issues too. Also, division managers’ KPI must be revised accordingly. Following this policy, €52,130 will be the transfer price for the display unit. See Calculations in Appendix 1 – Part II.