Transfer Pricing at Southern :: Business and Management Studies

Transfer Pricing at Southern Alternatives 1. Cost Based Transfer Price Maintain the status quo within the company. All cost methods require that standard costs be used; therefore each division is encouraged to meet standard cost levels, instead of working around actual costs. This will increase goal congruence. Currently, the price Southern is charging is based on the market but they are running under capacity and had excess inventory. Therefore, Thompson is charging market price even though he is running under capacity. If Southern’s VC = 60% then the 40% represents OH and profit. To prevent conflicts in the future it must be clear that variable costs of one division are not actually fixed costs for the whole company. Thompson’s VC = $400 some of that could be FC for the whole company. (Align this alternative with Rob’s Analysis). Advantages: increases goal congruence, requires that the vice president perform a routine cost analysis, therefore requires little resources. Southern mostly supplies Northern therefore, a market based system would be difficult due to the intermediate nature of the materials being transferred, adding attractiveness to a cost based system. Disadvantages: will be very difficult to determine what profit markup will be. Northern supplies mostly to outside companies and therefore will require additional resources in his division to price internal sales. The resources needed to work through the complexity of this system might not be justified by such a low volume. Two Step Pricing The standard VC is charged per unit sold then a periodic charge is made equal to the fixed costs associated with the facilities reserved for the buying unit. Since Thompson rarely sells to other divisions this might work because the facilities needed could easily be identified. Advantages: the buying unit would have proper information needed for marketing and long-term decisions Disadvantages: requires that FC be negotiated regularly, since Thompson rarely sells to Northern the resources needed for this negotiation might not be justified. 2. Negotiation Increase communication between divisions. Currently, Northern may not know that Thompson is paying a higher then expected price for the intermediate materials they need from Southern. If Northern was aware of the amount of upstream costs and profit involved internally, it might be encouraged to forgo its own profits for the sake of the company as a whole. Profit sharing could be introduced to motivate Northern to do this. A specified set of rules would be set up when each manager is negotiating a price. Such as if there is a match in price internally and externally, the business must be kept internally. Also if the managers cannot come to an agreement on price the outside market price will be used. If true negotiation occurred at Birch, each division manager would Transfer Pricing at Southern :: Business and Management Studies Transfer Pricing at Southern Alternatives 1. Cost Based Transfer Price Maintain the status quo within the company. All cost methods require that standard costs be used; therefore each division is encouraged to meet standard cost levels, instead of working around actual costs. This will increase goal congruence. Currently, the price Southern is charging is based on the market but they are running under capacity and had excess inventory. Therefore, Thompson is charging market price even though he is running under capacity. If Southern’s VC = 60% then the 40% represents OH and profit. To prevent conflicts in the future it must be clear that variable costs of one division are not actually fixed costs for the whole company. Thompson’s VC = $400 some of that could be FC for the whole company. (Align this alternative with Rob’s Analysis). Advantages: increases goal congruence, requires that the vice president perform a routine cost analysis, therefore requires little resources. Southern mostly supplies Northern therefore, a market based system would be difficult due to the intermediate nature of the materials being transferred, adding attractiveness to a cost based system. Disadvantages: will be very difficult to determine what profit markup will be. Northern supplies mostly to outside companies and therefore will require additional resources in his division to price internal sales. The resources needed to work through the complexity of this system might not be justified by such a low volume. Two Step Pricing The standard VC is charged per unit sold then a periodic charge is made equal to the fixed costs associated with the facilities reserved for the buying unit. Since Thompson rarely sells to other divisions this might work because the facilities needed could easily be identified. Advantages: the buying unit would have proper information needed for marketing and long-term decisions Disadvantages: requires that FC be negotiated regularly, since Thompson rarely sells to Northern the resources needed for this negotiation might not be justified. 2. Negotiation Increase communication between divisions. Currently, Northern may not know that Thompson is paying a higher then expected price for the intermediate materials they need from Southern. If Northern was aware of the amount of upstream costs and profit involved internally, it might be encouraged to forgo its own profits for the sake of the company as a whole. Profit sharing could be introduced to motivate Northern to do this. A specified set of rules would be set up when each manager is negotiating a price. Such as if there is a match in price internally and externally, the business must be kept internally. Also if the managers cannot come to an agreement on price the outside market price will be used. If true negotiation occurred at Birch, each division manager would