Birch Paper Company

Birch Paper Company

As the authority and responsibility have been decentralized to divisions managers, it’s totally up to Kenton to choose an external or an internal bid that shows a better result. Because divisions are evaluated, independently of each other’s, as profit centers, Kenton would decide to go with West Paper Company’s bid of $430, which represents the lowest bid from his prospective. West Paper’s bid would result in the highest profit for the Kenton’s division but it’s not in the best interest of the of Company.

However, if bids are evaluated from the prospective of Birch Company as whole, only costs should be considered. Therefore, Kenton should accept Thompson Division’s bid, which is the least cost bid to the company ($288). The following table shows the calculations:

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In my opinion, the main reason behind this problem is that managers are free set their own transfer prices without any boundaries and the fact that divisions are evaluated based on profit and return on investment, managers are not encouraged or motivated to think about how their decisions are impacting the whole Company. This leads managers to focus solely on their own division’s profit which could lead to goal incongruence and eventually impacting the company’s future profits and growth. For example, setting a transfer price above the market price does not make sense specially that Thompson Division is operating under capacity ($480 compared to 430 and 432). But because Brunner wants to improve the division’s performance, on which his incentives are based, he overstated the bid.

Additionally, I believe setting a transfer price is a matter related to the whole Company and should have not been decentralized to divisions manager. The use of cost-based transfer price by Thompson Division is not ideal due to the availability of the market prices, which is the easiest to use. Further, market prices will allow divisions to earn some profit from intercompany transactions.

Therefore, I believe that the vice president should get involved in this situation and order the acceptance of Thompson’s bid which is in the best interest of the Company. For the long run, divisions need to be evaluated not only on financial factors, but also on other nonquantitative factors for better achievement of Company’s objectives and better alignment among all divisions.

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