Transfer Price Decisions

The Consulting Division of IBM Corporation is often involved in assignments for which IBM computer equipment is sold as part of a systems installation. The Computer Equipment Division is frequently a vendor of the Consulting Division in cases for which the Consulting Division purchases the equipment from the Computer Equipment Division. The Consulting Division does not view itself as a sales arm of the Computer Equipment Division but as a strong competitor to the major consulting firms of information systems. The Consulting Division's goal is to maximize its profit contribution to the company, not necessarily to see how much IBM equipment it can sell. If the Consulting Division is truly an autonomous investment center, it has the freedom to purchase equipment from competing vendors if the consultants believe that a competitor's products serve the needs of a client better than the comparable IBM product in a particular situation.

REQUIRED
a. In this situation, should corporate management be concerned about whether the Consulting Division sells IBM products or those of other computer companies? Should the Consulting Division be required to sell only IBM products?
b. Discuss the transfer-pricing issues that both the Computer Equipment Division manager and the Consulting Division manager should consider. If top management does not have a policy on pricing transfers between these two divisions, what alternative transfer prices should the division managers consider?
c. What is your recommendation regarding how the managers of the Consulting and Computer Equipment Divisions can work together in a way that will benefit each of them individually and the company as a whole?

Target Costing

The president of Houston Electronics was pleased with the company's newest product, the HE Versatile CVD. The product is portable and can be attached to a computer to play or record computer programs or sound, attached to an amplifier to play or record music, or attached to a television to play or record TV programs. It can even be attached to a camcorder to record videos directly on compact disks rather than on tape. It also can be used with a headset to play or record sound. The proud president announced that this unique and innovative product would be an important factor in reestablishing the North American consumer electronics industry. Based on development costs and predictions of sales volume, manufacturing costs, and distribution costs, the cost-based price of the HE Versatile CVD was determined to be $425. Following a market-skimming strategy, management set the initial selling price at $525. The marketing plan was to reduce the selling price by $50 during each of the first two years of the product's life to obtain the highest contribution possible from each market segment. The initial sales of the HE Versatile CVD were strong, and Houston Electronics found itself adding second and third production shifts. Although these shifts were expensive, at a selling price of $525, the product had ample contribution margin to remain highly profitable. The president was talking with the company's major investors about the desirability of obtaining financing for a major plant expansion when the bad news arrived. A foreign company had announced that it would shortly introduce a similar product that would incorporate new design features and sell for only $350. The president was shocked. "Why," she remarked, "it costs us $375 to put a complete unit in the hands of customers."

REQUIRED
How could the foreign competitor profitably sell a similar product for less than the manufacturing costs to Houston Electronics? What advice do you have for the president concerning the HE Versatile CVD? What advice would you have to help the company avoid similar problems in the future?

Transfer Price Decisions The Consulting Division of IBM Corporat...