Suttipun Boontawee, Esther Walker
Produced and sold a range of medical diagnostic imaging systems, biomedical test equipment and instrumentation. Headquartered in Cologne, Germany Total annual revenues were slightly more than ½3 billion.
Performance was evaluated. and management bonuses were assigned.Zumwald AG
managers of each division allow considerable autonomy.
. based on each division·s achievement of budgeted targets for return on invested capital (ROIC) and sales growth.
Involved in the dispute mentioned from three of the company·s divisions:
Imaging Systems Division (ISD) the Heidelberg Division (Heidelberg) Electronic Components Division (ECD)
Heidelberg sold high-solution monitors.
ECD sold application-specific integrated circuits and subassemblies. graphics controllers and display subsystems. These systems were expensive.
half of its sales were made to outside
customers. typically selling for ½500.000-½1million.Zumwald AG
ISD sold complex ultrasound and magnetic resonance imaging systems. ISD was one of Heidelberg·s major inside customers.
but Heidelberg was compensated for the full cost of the time its employees spent on this project. and it took up less space. called the X73. The new system offered users advantages in processing speed and cost.The Dispute
In 2001. Heidelberg engineers participated in the design of X73. ISD designed a new ultrasound imaging system.
.000 120.Comparing 3 sources
Suppliers Heidelberg Division Borgardus NV Display Technologies Plc Cost per X73 System (¼) 140.500 100.
What sourcing decision for the X73 materials is in the best interest of:
Imaging Systems Division? The Heidelberg Division? The Electronic Components Division?
The issue in the case arises because the manager of Heidelberg complained about not getting the ISD order.
Fettinger should probably listen to the arguments in order to learn the managers· thinking processes
they all aware of the key facts in the situation? Do they understand the concept of marginal cost pricing and contribution margin?
. CEO of Zamwald do? Mr.Zumwald AG
What should Mr. Fettinger.
000 to Heidelberg in the ½140. The variable costs for Heidelberg are ½50.
.000 quote to ISD. So there is a contribution of ½90.000. The fixed costs are not relevant because:
Heidelberg is not operating at full capacity. The Heidelberg quote to ISD is better for Zumwald taken as a whole because it includes some contribution both for Heidelberg and for ECD.Question 1
Zumwald is better off if Heidelberg supplies the displays to ISD. Zumwald·s internal electronic subassembly supplier.
there is a contribution of ½12.600 minus the variable costs of ½9.000.100.
. The difference is ½63.Question 1
In addition.600 for ECD built into this quote. This is far smaller than the total contribution to Zumwald divisions of ½102.600 that would be unavoidable if Heidelberg does not get this order. This is ECD·s internal price of ½21. The advantage to ISD of sourcing from Display Technologies rather than Heidelberg is ½39.500.
Cash outflow if sourced from Display Technologies ½100.400 ½37.500
Cash outflow if sourced internally: Heidelberg variable costs excluding the ECD-supplied materials ECD variable costs Difference ½9.000 ½28.
Does this assistance imply a partnership that would include future sourcing of parts?
Heidelberg engineers helped ISD develop the X73. but it earned no profit for this work. Heidelberg was reimbursed for the cost of those engineers.
The case has enough information to show that this X73 business promises to be highly profitable for ISD
124.300 98.Revenue for one X73 system ½340 Non-display material costs Variable conversion costs Contribution before display costs ½241 Fixed conversion costs ½117 Gross margin before display costs ½124 ISD contribution if sourced from Display Technologies ½141 ISD contribution if sourced at Heidelberg·s price of ½140 140.
Why shouldn·t Heidelberg shave its price to get this internal business?
And if Heidelberg shaves its price. alternatively.Question 3
Clearly there is room to force ISD to pay Heidelberg more than the Display Technologies· price.400 provides a contribution to Heidelberg and/or ECD. But. So in some sense. these transfer prices are just moving profits from one division to another. then it might well ask ECD to shave its price below its normal 20% mark-up. That extra cost could provide additional margin to Heidelberg and ECD. any price greater than ½37.
Bauer just not want to acknowledge the price competition in this segment of the market? Is he ignorant of the marginal cost and contribution margin concepts? Should he be fired? Or is Mr. claims that he has been pleading with his salespeople not to shave prices. Paul Bauer. that he needs full margin business in order to achieve his plan.
Does Mr.Question 3
Heidelberg·s manager. Bauer merely willing to lose this business in order to emphasize the importance of his pricing policy to his salespeople?
Maybe because of market conditions and customer price sensitivities.Price Price policy (000) Volume
Full price Cut price
6. Heidelberg is better off giving up some business to retain higher margins.
. even though they are operating in a below-capacity condition.300 5.
even though internal sourcing of this deal seems to be in Zumwald·s best interest. Heidelberg can probably earn the business by cutting its price to Display Technologies. If there is a deal to be made.What should Fettinger DO?
If the managers are all making rational arguments. If this deal were a more substantial part of Zumwald·s total business. by itself. Why not let it continue to do so? Let the managers have their autonomy and freedom of sourcing. let the managers work it out themselves. then a stronger argument could be made for intervention. Zumwald operates in a highly decentralized fashion.
. but maybe it is not in its best interest to do so. But this deal. Fettinger do nothing. then strong arguments can be made here for having Mr. is worth less than 5% of each division·s revenues.
Is Zumwald Management faulty?
motivates managers to make decisions that are not in the best interest of the corporation as a whole!
Answer to that!
In most situations where local knowledge and fast decision-making is important:
a highly decentralized system has great advantages. or at full (or variable) cost plus a normal markup. But would such policies really lead to better organizational decisionmaking?
. This case provides one common example of suboptimization. for example. at best outside market price. Such a policy could require internal transfers to be.
But with decentralization comes risks of suboptimization.
A policy like Zumwald·s could require internal transfers to be at best outside market price or at full (or variable) cost plus a normal markup.
Zumwald·s is better off if the sourcing is done internally.