Introduction:The General Appliance Corporation is a manufacturer of all types of home appliances. The company has a decentralized, divisional organizational structure, which consists of four product divisions (electric stove, laundry equipment, refrigeration and miscellaneous appliance division), four manufacturing divisions (chrome products, electric motor, gear and transmission and stamping division) and six staff offices (finance, engineering, manufacturing, industrial relations, purchasing and marketing staff). The staff offices do not have functional authority over the divisional general managers, who are each responsible for their own divisional personnel.
The manufacturing division made approximately 75 percent of their sales to the product division. In addition, the parts made by the manufacturing division is designed and engineered by the product divisions. Since the eight divisions are expected to act like independent companies, the transfer prices are negotiated amongst themselves. But, if two divisions could not agree on a price, they submit the dispute to the finance staff for arbitration. The product division does not have the power to decide whether to buy from within the company or from outside. If there was a disagreement with the sourcing, the manufacturing division could appeal to the purchasing staff to reverse the decision.
Problem:At the General Appliance Corporation, the purchasing staffs are the personnel that decide which part would continue to be manufactured within the company (org. chart may need to be revised). When the part is decided to be manufactured internally, the manufacturing division must hold the price at a level the product (purchaser) division could purchase it outside. Currently, the managers do not have the freedom to source and choose the alternative that is in their best interest, even though an alternative for sourcing does exist.
The three problems that exist in the company are:-Determining a transfer price that includes the extra $0.80 per unit spent on developing the new quality standards. Also, the arbitration committee should determine whether the appearance is a subjective or objective matter.
-An excess capacity (supply is greater than demand) caused a temporary decrease in the selling price.
-The standard price used for calculations of the total cost, profit and proposed price is determined from the price given in a competitor’s proposal – this is not a definite price.
Investment Centres – don’t know when to produce or when to outsource (what role does innovation or engineering for lower costs play?)For each case, calculate if it’s better to outsource or manufactureArbitration committee which considers all “staff” functionsDo something quick & fast (cheap) and easy to doAnalysis:Stove Top Problem – Survey has shown that the company’s reputation as a producer of quality products has deteriorated, and resulted in the Chrome Products Division implementing quality improvements to the stove tops. Chrome has proposed to increase the price of the stove top by $0.90; $0.80 represents the additional costs of quality improvements and a $0.10 profit mark-up.
The Electric Stove Division does not see the improvements as necessary changes since there is no change in engineering specifications, the changes made were never requested or approved, consumers may not even notice or want the change, and believes that the improvements made will only bring the quality level of the stove tops to the competitor’s level. Ultimately, Electric Stove sees these quality changes as being more subjective rather than objective. The engineering department of the manufacturing staff has verified that the new improvements were of superior quality then of their competitors and the costs were reasonably allocated.
Thermostatic Control Problem – Electric Motor Division has been able to consistently reduce the price of the thermostatic control units to mirror the price of Monson Controls Corp. from $3.00 in 1984 to $2.40 in 1987. Monson has decided to further reduce their price to $2.15, which according to the general manager of Electric Motor Division, would result in selling at a loss rather than a profit. The GM believes that they are just as efficient as Monson, therefore Monson must be selling at a loss at $2.15. Laundry Equipment and the Refrigeration Division both require a total of 120 000 units for their division (100 000 units for Laundry and 2 000 units for Refrigeration).
Refrigeration has made an agreement with Electric Motor that they will be able to competitively source to the lowest bidder, in this case, Monson for $2.15. Laundry Equipment believes that for such a large order, they could probably obtain a lower price than $2.40 if they were to outsource. In reviewing this dispute, the Finance Staff stated that there was excess capacity in the market that results in soft prices. The purchasing staff believed that Refrigeration could purchase their requirements at $2.15 for the next year but if the corporation’s orders were all place externally, the price would rise to $2.40 through increase in demand or limited supply.
Considering the 120 000 units of thermostatic control that is required by both the Laundry Equipment and the Refrigeration Division, and the fact that their requirement is large enough to increase Monson’s price of $2.15 to $2.40, General App. will have to outsource and purchase from within. Assuming that the more units General App. outsources, the price will gradually increase due to the increase in demand.
The best combination of outsourcing and purchasing from within would be to outsource 60 000 units at an estimated price of $2.25 and purchase 60 000 units internally for $2.40. This would cost the organization $279 000, a savings between $1 000 and $9 000. The average price per unit is $2.325, less than the cost of the market price if the required volume was entirely outsourced. It is also less then purchasing the entire volume internally. This would result in Laundry Equipment saving $7 500 and costing $3 500 to Refrigeration as oppose to purchasing their required volume at $2.15.
Transmission Problem – Laundry Equipment has previously entered into an agreement with Thorndike Machining Corp to purchase one-half of its transmission for 10 years. Two years before the expiration of the agreement, General App. decided to manufacture their own transmissions to extend their capacity. Thorndike proposed a price reduction of $0.50 consistently for the next two years with a new economy transmission unit at a price of $10. The Gear and Transmission Division estimates that they can replicate a comparable model of the economy transmission at a competitive price of $9. The Gear and Transmission Division’s proposal failed to eliminate the cost of design features of $0.50 per unit. This would bring the proposed total unit cost for G&T from $11.66 to $11.11. This error makes Thorndike’s proposed price of $11.21 appear more favourable.
Anthony, Robert N., and Vijay Govindarajan. Management Control Systems. New York: McGraw-Hill/Irwin, 2000.