Birch Paper Company
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The responsibility structure of the Birch Paper Company and all of its divisions is an Investment Centre. In the case it is stated that “for several years, each division had been judged on the basis of its profit and return on investment.” This verifies that BPCs structure is an investment centre, since an investment center has a manager who is responsible for the divisions profits as well as its invested capital.
However, as stated in class, “some organizations use the terms profit centre and investment centre interchangeably,” this is evident by the managers of BPCs divisions continually stressing profit as a major concern. As James Brunner, Thompsons division manager stated, “The division cant very well show a profit by putting in bids that dont even cover a fair share of overhead costs, let alone give us a profit.”
By applying the concept of decentralization, each division in the Birchwood Company was given authority to make decisions except for those related to overall company policy. By having this authority to make decisions, each division manager was able to invest in capital that it felt was needed to maximize overall company profit. Each division manager is evaluated on ROI, which shows how much profit was generated from the capital invested.
Out-of-pocket costs are the payments (usually cash or obligations to pay cash) made for resources. Out-of-pocket costs can be the same as opportunity costs, but may not be the some because of imperfect markets and changes in the decision-making environment between when a resource was acquired and when it is used. The following is a calculation of the out-of-pocket costs to Birch Paper Company on the proposed bids.
BIRCH PAPER COMPANY
Per 1,000 boxes
WEST PAPER CO: Out of pocket Cost to Birch
EIRE PAPER, LTD:
Less:
Southern profit ($90*40%)
Thompson profit ($30-$25)
Out of pocket cost to Birch
THOMPSON
Less:
Southern profit ($280*40%)
Thompson profit ($480-$400)
Out of pocket cost to Birch
The best bid for Birch Paper Company would be with Thompson, one of its own divisions, since it represents the lowest out of pocket cost to BPC. As well, if the Northern Division chooses the Thompson division then it may avoid other costs that may be incurred from choosing an external bid.
The Northern Division received bids of $480 from Thompson, $430 from West Paper Company, and $432 from Eire Papers, Ltd. Since Birch Paper Companys responsibility structure is an investment centre as stated above in question one, in order to maximize divisional profits Northern would chose the $430 bid from West since it represents the lowest cost, thereby resulting in higher profits.
The question of whether or not the vice president of Birch Paper Company should take action in this matter is a dilemma that has no outright solution, for there are pros and cons on each side. If the vice president gets involved in the bidding process they may face the peril of “undermining the autonomy” of the division managers. However, by not taking action they will loose the cost saving associated with in-sourcing to Thompson. Central managers will only want to intervene if the negative financial consequences are significant. It is stated in the case that, “the volume represented by the transaction in question was less than five percent of the volume of any of the divisions involved,” therefore, since it is a relatively small volume the vice president may feel that their involvement is unnecessary. However, as stated “other transactions would conceivably raise similar problems later.” Due to the possible reoccurrence of these problems it is to the companys benefit that the vice president should get involved, thereby setting precedence for all division to follow, avoiding future problems.
The transfer pricing system is dysfunctional since it is possible for each internal division to price their product above the going market price.