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ZUMWALD AG

Suttipun Boontawee, Esther Walker


Zumwald AG
 Produced and sold a range of medical diagnostic
imaging systems, biomedical test equipment and
instrumentation.
 Headquartered in Cologne, Germany
 Total annual revenues were slightly more than €3
billion.
Zumwald AG
 Decentralized management
 The managers of each division allow considerable
autonomy.
 Performance was evaluated, and management
bonuses were assigned, based on each division’s
achievement of budgeted targets for return on
invested capital (ROIC) and sales growth.
Zumwald AG
 Involved in the dispute mentioned from three of the
company’s divisions:
 the Imaging Systems Division (ISD)
 the Heidelberg Division (Heidelberg)
 Electronic Components Division (ECD)
Zumwald AG
 ISD sold complex ultrasound and magnetic resonance
imaging systems. These systems were expensive,
typically selling for €500,000-€1million.
 Heidelberg sold high-solution monitors, graphics
controllers and display subsystems.
 Approximately half of its sales were made to outside
customers.
 ISD was one of Heidelberg’s major inside customers.
 ECD sold application-specific integrated circuits and
subassemblies.
The Dispute
 In 2001, ISD designed a new ultrasound imaging
system, called the X73. The new system offered
users advantages in processing speed and cost, and
it took up less space.
 Heidelberg engineers participated in the design of
X73, but Heidelberg was compensated for the full
cost of the time its employees spent on this project.
Comparing 3 sources
Suppliers Cost per X73 System
(€)
Heidelberg Division 140,000

Borgardus NV 120,500

Display Technologies 100,500


Plc
Zumwald AG
 What sourcing decision for the X73 materials
is in the best interest of:
 The Imaging Systems Division?
 The Heidelberg Division?
 The Electronic Components Division?
Zumwald AG
 The issue in the case arises because the
manager of Heidelberg complained about not
getting the ISD order.
Zumwald AG
 What should Mr. Fettinger, CEO of Zamwald do?
 Mr. Fettinger should probably listen to the
arguments in order to learn the managers’ thinking
processes
 Are they all aware of the key facts in the situation?
 Do they understand the concept of marginal cost
pricing and contribution margin?
Question 1
 Zumwald is better off if Heidelberg supplies the displays
to ISD.
 The Heidelberg quote to ISD is better for Zumwald taken
as a whole because it includes some contribution both for
Heidelberg and for ECD, Zumwald’s internal electronic
subassembly supplier.
 The variable costs for Heidelberg are €50,000. The fixed
costs are not relevant because:
 Heidelberg is not operating at full capacity. So there is a
contribution of €90,000 to Heidelberg in the €140,000 quote to
ISD.
Question 1
 In addition, there is a contribution of €12,600 for
ECD built into this quote. This is ECD’s internal
price of €21,600 minus the variable costs of €9,000.
 The advantage to ISD of sourcing from Display
Technologies rather than Heidelberg is €39,500.
This is far smaller than the total contribution to
Zumwald divisions of €102,600 that would be
unavoidable if Heidelberg does not get this order.
The difference is €63,100.
Question 1
Cash outflow if sourced from Display €100,500
Technologies

Cash outflow if sourced internally:

Heidelberg variable costs excluding the ECD- €28,400


supplied materials

ECD variable costs €9,000 €37,400

Difference €63,100
Question 2
 Heidelberg engineers helped ISD develop the X73.
 Heidelberg was reimbursed for the cost of those
engineers, but it earned no profit for this work.
 Does this assistance imply a partnership that would
include future sourcing of parts?
Revenue for one X73 system €340,
000
€340

Non-display material costs €72,000

Variable conversion costs €26,300 €98,300

Contribution before display costs €241,700

€241

Fixed conversion costs €117,700

€117

Gross margin before display costs €124,000

€124

ISD contribution if sourced from Display Technologies €141,200

€141

ISD contribution if sourced at Heidelberg’s price of €140 €140,000 €101,700

Question 3
The case has enough information to show that this X73 business promises to be
highly profitable for ISD
Question 3
 Clearly there is room to force ISD to pay Heidelberg
more than the Display Technologies’ price. That extra
cost could provide additional margin to Heidelberg and
ECD. But, alternatively, any price greater than €37,400
provides a contribution to Heidelberg and/or ECD.
 Why shouldn’t Heidelberg shave its price to get this
internal business?
 And if Heidelberg shaves its price, then it might well ask
ECD to shave its price below its normal 20% mark-up. So in
some sense, these transfer prices are just moving profits from
one division to another.
Question 3
 Heidelberg’s manager, Paul Bauer, claims that he has been
pleading with his salespeople not to shave prices, that he
needs full margin business in order to achieve his plan.
 Does Mr. Bauer just not want to acknowledge the price
competition in this segment of the market?
 Is he ignorant of the marginal cost and contribution margin
concepts?
 Should he be fired?
 Or is Mr. Bauer merely willing to lose this business in order to
emphasize the importance of his pricing policy to his
salespeople?
Price Unit Total

Price policy (000) Contribution Contribution


Volume

Full price 140 70 90 6,300

Cut price 100 100 50 5,000

Question 3
Maybe because of market conditions and customer price sensitivities, Heidelberg is better off giving up
some business to retain higher margins, even though they are operating in a below-capacity condition.
What should Fettinger DO?
 If the managers are all making rational arguments, then strong arguments
can be made here for having Mr. Fettinger do nothing.
 Zumwald operates in a highly decentralized fashion.
 Why not let it continue to do so?
 Let the managers have their autonomy and freedom of sourcing.
 If there is a deal to be made, let the managers work it out themselves.
 If this deal were a more substantial part of Zumwald’s total business, then
a stronger argument could be made for intervention.
 But this deal, by itself, is worth less than 5% of each division’s revenues.
 Heidelberg can probably earn the business by cutting its price to Display
Technologies, but maybe it is not in its best interest to do so, even though
internal sourcing of this deal seems to be in Zumwald’s best interest.
Is Zumwald Management faulty?
 motivates managers to make decisions that are not
in the best interest of the corporation as a whole!
Answer to that!
 In most situations where local knowledge and fast decision-
making is important:
 a highly decentralized system has great advantages.
 But with decentralization comes risks of sub-optimization.
 This case provides one common example of
suboptimization.
 Such a policy could require internal transfers to be, for
example, at best outside market price, or at full (or variable)
cost plus a normal markup. But would such policies really
lead to better organizational decision-making?
Answer Continued
 A policy like Zumwald’s could require internal
transfers to be
 at best outside market price
 or at full (or variable) cost plus a normal markup.
Conclusion
 Zumwald’s is better off if the sourcing is done
internally.

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