General Appliance Corporation

Kristy PrameswaryPrita WidiastutiTrine PuntervollWicaksono Hendro

COMPANY BACKGROUND

TRANSFER PRICESThe transfer price should induce goal congruence, and hence fulfill the following conditions• Competent people – the managers should be able to take long-term

considerations• Good atmosphere – the managers should take profitability of their division

into consideration• Market price – well-established, normal market prices should exist for the

identical product transferred• Freedom to source – there should be alternative sources for the product.

The managers of the buying division should be free to buy from an external source

• Full information – the managers should be well aware of the external alternatives

• Negotiations – negotiating contracts on process between the divisions.

STOVE PROBLEM

Stove top problemThe Chrome Products Division sold to the electric stove division a chrome plated unit that fitted on the top of the stove.

Producing this unit since Jan 1, 1986; prior to that time it had been produced by outside vendor.

About middle of 1986, the president of GAC became concerned over complaints from customers and dealers about the quality of the company’s products.

Accordingly early in 1987,he called in the manufacturing vice-president and told him to bring the quality of all products to satisfactory level.

Total cost of added operations was 80 cents a unit.

Added copper-plating and buffing operations .

In July 87, chrome Products division proposed to increase price of the stove top by 90 cents.

The Electric Stove Division objected to proposed price increase.

Chrome Products Division:• Required by manufacturing staff to add operations at cost of 80 cents per unit.• Operations resulted in improved quality• Present price $10 was based on old quality standards.

Electric Stove Division:• No change in engineering specifications.• Electric Stove Division had not requested that quality be improved nor consulted.• Improvement in quality from customer point of view was doubtful.• Not worth 90 cents.• Cost of improved quality included in $ 10 price.

Finance staff review:

Finance staff reviewed the dispute. Engineering dept. of the manufacturing staff was asked to review added operations and comment on acceptability of the proposed increased cost.

Engineering dept. stated that the proposed costs were reasonable and represented efficient processing.

The quality control stated that the quality was improved and new parts were of superior quality to parts purchased from outside vendors.

CORE PROBLEM

Quality Communication

Transfer Prices

ALTERNATIVE SOLUTIONS• GROUP SOLUTION • ADVANTAGES • DISADVANTAGES

• A.NO PRICES CHANGES $10 on improved quality

• LOWER PRICES•HIGHER STANDARD

QUALITY

INFLUENCE GOAL CONGRUEN

REDUCE PROFIT

• B. OUTSIDE SUPPLIER SUITABLE WITH STANDARD QUALITY

GIVING PROFIT TO OUTSIDE SUPPLIER

QUALITY COST >$0.90 HIGHER THAN CHROM INFLUENCE GOAL

CONGRUNECE REDUCE CHROM PRODUCT CAPACITY

• C. $10.90 HIGHER STANDARD QUALITY

HIGHER PRICES INFLUENCE GOAL

CONGRUENCE LOSING CUSTOMER REDUCE PROFIT

OUR GROUP DECISIONS

ALTERNATIVE A:1. HIGHER QUALITY2. IT’S COMPETITIVE PRICES

Thermostatic Control Problem

Thermostatic Control ProblemLaundry Equipment Division bought all requirements for thermostatic control

units (100,000 a year) from Electric motor Division.

Refrigerator Division used similar unit, until 1985 purchased all requirements

(20,000 a year) from Monson Control Corp.

In July 1987, Refrigerator Division inform Monson that beginning Jan 1, 1988, it would buy thermostatic units from Electric Motor Division for “the best interest of the company.”

Because of declining of thermostatic control price in 1987 ($2.40), Electric

Motor Division gain nearly zero profit.

In Oct 1987, Electric Motor Division and Refrigerator Division were negotiating

1988 prices. Refrigerator propose $2.15 as price paid to Monson. But Electric Motor Division refused the price below $2.40 to either Refrigerator or Laundry Equipment.

Electric Motor Division

They thought that the price from Monson was made as a last, desperate effort to supply GA Corp. the price was a distress price and not a valid basis for determining an internal price.

The GM of EM Division was going to take all his ability and ingenuity to make a profit even at $2.40. If forced at $2.15, he would make plans to close the plant.

Laundry Equipment Division

It based its case for $2.15 on intra company pricing rules.

With higher volume (100,000) he could probably obtain an even more favorable price if he were to procure his requirements from outside of the corp.

Refrigerator Division

It was sure that Monson had capacity to produce all requirements and happy to do so for $2.15 a unit.

Finance staff review

The purchase staff replied that there was excess capacity and as a result, prices were very soft.

The price would rise – either when the demand for comparable units increased or when some of the suppliers went out of business.

The purchase staff had no doubt that refrigerator Division could purchase all its requirements for next year or two at $2.15 a unit, or even less.

The purchase staff believed if all the corp.’s requirements for this unit were placed outside suppliers, the price would rise to at least $2.40.

SolutionsOption A: purchase staff’s estimation is relevant

Therefore the company should buy 20,000 of its thermostatic control units from Monson for $21.15, and buy the rest (100,000) from EM Division for $24.

To avoid the conflict between two product divisions, each product divisions should purchase the units by 1/6 of division’s unit supply from Monson, and 5/6 from EM Division.

Option B: purchase staff’s estimation is irrelevant

Purchase staff do not mention more details on their estimation.

The company buy all of their thermostatic control units from Monson for $21.15, and sell the EM Division.

OUR GROUP DECISION:

OPTION B

The Transmission Problem

BackgroundThe Laundry Equipment Division bought a transmission unit from two sources, the internal Gear and Transmission Division and the external Thorndike Machining Corporation. After a 10 year agreement with Thorndike, General Appliance Corp decided not to extend the contract with Thorndike and expand the facilities on the Gear and Transmission Division to fulfill the needs of the Laundry Equipment Division

The Transmission Problem

Disputes ariseAfter deciding to end the contract with Thorndike, development of price proposal was made for the new low-cost transmission unit

• Gear and Transmission: $12,00, refused by Laundry Equipment

• Laundry Equipment: $11,21, refused by Gear and Transmission

Laundry Equipment DivisionFinding the transfer price to high, since the identical device can be obtained in the external market at a lower rate

Will hurt overall performance of the entire company in the market – the competitiveness

The Gear and Transmission Division benefit on our expense

Gear and Transmission DivisionGot indication for expanding facilities by first agreeing on not renewing the agreement with Thorndike

Turning to Thorndike afterwards means that they have made excessive investing

Financial Staff ReviewAdjust price for performance characteristics and increases in price level – proper price $11,25

Turn down profit target for the Gear and Transmission

Will more likely induce goal congruence

By from Thorndike can be done at quoted price for all foreseeable future

Our recommendationBuy internally at a transfer price of $11,25, since this will be the most correct price for the new transmission unit

Or

Buy from Thorndike – competition is important to keep prices down and to get the best quality

Overall recommendationBoard of Directors

President

Finance staff Engineering staff

Industrial Relations

Staff

Purchasing staff

Marketing staff

Group Vice PresidentProduct Divisions

Electric Stove Division

Laundry Equipment

Division

Refrigerator Division

MiscellaneousAppliance Division