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MANAGEMENT CONTROL SYSTEM

“CASE STUDY ANALYSIS ON BIRCH PAPER COMPANY”
Enrollment No. :-
Ganesh Joshi(187370592017)
Shabaz Shaikh (187370592049)
Jinal Sheth (187370592051)
Faculty Guided: Dr. Chetna Makwana
MBA SEM 4
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1. Which bid should Northern Division accept that is in the best interests of Birch Paper Company?
Ans: Northern Division should accept the bid of the Thompson division even though the bid from West
Paper seems at first to be the best choice. Thompson division has the lowest cost if all transfer prices within
the company were calculated at costs. Costs for Thompson are as follows:

 Linear-board and corrugating medium: Cost $400x70%= $168 plus Out of Pocket: $400x30%=120
for a total cost of $288.
 Costs for West Papers would be a total of $430, and
 Costs for Eire Papers:
Eire papers buy the outside liner from the southern division for a price of $ 90. The out of pocket
costs from the southern division are 60% of its selling price, so ($90x60%= $54) (Southern). The
profits for the southern division are ($90 – $54= $36).
Eire papers will print the outside liner by the Thompson division and pay 30 for this. Of this $30,
$25 are out of pocket costs. So the profit for the Thompson division will be $5.
Costs bid Eire papers: $432 + out of pocket costs divisions $79($54 + $25) =$511.
Less the price which Eire papers pay to Thomas division & southern division $120 ($90 + $30).
So costs for the Birch company if accepting the Eire papers bid is $511 - $120 = $391
There are also other ways to calculate the costs for the Birch Company if accepting the Eire
papers bid. The costs of the bid of Eire papers $432 less the profit of the Thompson & southern
division, $41 ($4 + $36), so $432 - $41 = $391.

As shown in the calculations above, Northern should accept the bid from Thompson division as it has the
lowest cost if all transfer prices within the company were calculated at costs. Incurring the lowest costs
would also enable Birch Paper Company to earn the highest profits possible.

2. Should Mr. Kenton accept this bid? Why or why not?

Ans: As alternatives for sourcing exists, Mr. Kenton should be permitted to choose the alternative that is
in Northern division's own interests. The transfer price policy gives him the right to deal with either insiders
or outsiders at his discretion. If he is unable to get a satisfactory price from the inside source which is
Thompson division, he is free to buy from outside.

Mr. Kenton, manager of the Northern division should not accept the bid from Thompson division. The three
bids from Thompson division, West Paper Company and Eire Paper Company are $480, $430 and $432
respectively. Accepting the bid from Thompson division would be accepting the highest bid amongst all
three offers (highest costs). This would result in the lowest profits. As the Northern division is evaluated as
an investment center, it is judged independently on the basis of its profit and return on investment. Mr.
Kenton should not accept the bid from Thompson division.
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3. Should the vice president of Birch Paper Company take any action?
Ans: On the one hand, the vice president should not intervene. The top officials believed that in the past few
years the concept of decentralization had been successfully applied & company’s profit & competitive
position had improved. So if the vice president intervenes it will distort the concept of decentralization.
Besides this, the volume of the transactions was less than 5%of the volume of any of the divisions involved,
so it’s a small volume.

The method of using transfer price to decide whether to source is optimum if the selling profit center can
sell all of its products to either insiders or outsiders and if buying center can obtain all of its requirements
from either outside or insiders. The market price then represents the opportunity costs to the seller of selling
the product inside. In this case, Thompson division had been running below capacity and Southern division
also had excess inventory. The transfer price of $480 offered by Thompson division does not represent the
opportunity costs of selling inside as there is no demand market for the product outside. Also, the transfer
price of $480 is higher than the market price which is around $430. Deciding based on transfer price will not
induce goal congruence as the situation is not ideal.

On the other hand, Without any intervention from the vice president of Birch Paper Company, the Northern
division would most probably accept the lowest bid from West Paper Company. This might result in the
highest profits for Northern division but it is not in the best interests of Birch Paper Company. Accepting the
bid from Thompson division would boost demand for the two other divisions. The losses cut would most
probably be more than the costs saved by Northern division which is $50 ($480-$430).

The vice president should give specific orders to Northern division to accept the bid from Thompson
division. However, as the transaction in this case represents less than 5% of the volume of any of the
divisions involved, it might not be possible for the vice president to intervene other transactions when
similar problems arise.

4. In the controversy described, how, if at all, is the transfer price system dysfunctional? Does this
problem call for some change, or changes, in the transfer pricing policy of the overall firm? If so, what
specific changes do you suggest?
Ans: Ideally, when there is an availability of market price, the division should use it. However, Thompson
used a cost-based transfer price instead. Cost-based transfer price should only be used when the market price
is not available.

The transfer price system is dysfunctional because it focuses too much on individual sectors making profit
and return on investment. Some alternatives should be present to bring balance between both.