Northwestern Paper Company
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Northwestern Paper Company
Northwestern Paper Company
Northwestern Paper Company was established in 1916 based in Portland, Oregon. Over several years, the company opened other pulp and paper mills across the nation. By the 1950’s Northwestern was the largest producer of paper products in the United States. Between 1960 and 1970 the company began to expand overseas placing their footprint in Latin America, Asia and Europe. Tapping into international business presented its challenges with Northwestern. This paper will explore the relationship between the parent company Northwestern and its subsidiaries overseas; particularly South Korea. In addition, transferring pricing on intracompany business and the competition between other overseas subsidiaries will be discussed.
Situation Analysis
Northwestern had set a policy that was highly beneficial to its U.S. based paper mill plants. A flat rate based upon U.S. prices was set which Northwestern expected its subsidiaries to adhere to. Additionally, Northwestern included additional allocations for its subsidiaries that did not perform as expected to offset costs from its U.S. mills when production numbers weren’t met.
This approach essentially forced any subsidiary of Northwestern to use its U.S. based paper mills because purchasing at a lower cost elsewhere would be offset by additional expense allocations due to any economic impacts to the parent business.
Strategic Interest
Northwestern had an expectation that it kept its purchasing for source materials “in house” – meaning that its own mills were expected to be used even if it meant purchasing at a higher cost. This was called out in its need to keep capacity utilization of its U.S. mills at adequate levels and therefore directed its foreign based manufacturing facilities to procure pulp from its U.S. mills whenever possible. In contrast, Northwestern expected its foreign subsidiaries to fund their own operations through local means. This included any financing of working capital.
This approach appears a bit heavy handed in that the parent company requires the higher purchasing expense of U.S. milled paper and any attempt to go to an outside source could be met with additional allocations for lost productivity. These expectations were set on a subsidiary by subsidiary basis based upon past performance and future growth expectations.
Subsidiary Interests. Each subsidiary has its own financial goals and while these were not discussed in the case study, it was noted that revenue expectations were set on an annual basis for the purposes of allocating costs from its U.S. based paper mills. Additionally, each subsidiary is free to bid on new jobs without any requirements to work together. Each subsidiary is essentially its own business with its own revenue model responsible for funding its own business.
However, the parent company has set its own revenue growth expectations with the expectation that each subsidiary purchase its paper stock from the U.S. based mills at a fixed cost based upon U.S. rates. This is where a conflict arises because while each subsidiary has to meet certain growth expectations they do not have the freedom to source their own materials from local sources which could save on the raw material costs as well as shipping costs and even taxes.
This scenario creates little incentive to improve its bottom line through more creative procurement and manufacturing processes. It also doesn’t allow for negotiation of milling costs based upon things like volume. The U.S. cost is fixed and non-negotiable.
Parent as Production Center. Northwestern had invested in new mills and paper machinery in the US, but due to a decline in demand and increases in regulations (and costs) they were not operating at full capacity and had “excess production capacity.” In order to increase capacity in the US, there was a minimum pulp purchase imposed on their subsidiaries. This would create revenue and increase usage of mills in the US. By imposing a minimum, the subsidiaries were not able to only purchase from less expensive pulp available in the market and were therefore less competitive in the industry worldwide.
Parent as Production Center. Changes in the international’s marketplace with competitors and suppliers of pulp (as well as a decrease in demand) led to lowered pricing expectations. There were less expensive suppliers available, meaning, less people buy from US suppliers and the US mills & plants. Additionally, subsidiaries were expected to finance their working capital from local sources, creating a foreign exchange exposure. Furthermore, there are also additional costs added to the subsidiary in the form of a conversion cost.
Australian Transaction. The Australian competitive bid, which included Korea and Indonesia, was able to determine whether lowering pricing and removing the minimum order from the US mill would make the Northwestern product more competitive worldwide. The costs for Korea and Indonesia are relatively close enough to draw comparisons, demonstrating that the product is more competitive and has a great opportunity of gaining customers if the pulp pricing was more within the market price. It also demonstrated Northwestern does not necessarily have to be the least expensive product, since those with lower bids did not secure the Australian contract. Although the US mills did not have direct benefit from the usage of the US mills and revenue generated, if the bid had gone to a different company the US mills would still not have usage and Northwestern as a whole would not have secured the bid altogether.
Transfer Pricing Analysis. The transfer prices allocated subsidiaries at Northwest paper were based on resale price method, where prices were set at average sales price charged to an unrelated entity (Northwestern paper, 289). The calculation was a book entry that applied to the subsidiary’s financial performance. This strategy allocated each subsidiary to purchase a certain amount of pulp from one of the company’s US mills and the income generated from that mill was allocated to the subsidiary at a calculated algorithm. The Finance department calculated the average