General Appliance Corporation

Group members Roll nos.

Swapna Rao 09
Salman Khatri 22
Vani Mangalur 28
Frenzina 38
Rodrigues
Sohini Surani 52
Aniruddha 57
Tulaskar
Monday, March 7, 2011
 Transfer Pricing

Definition:
The term “transfer price” is the
internal price charged by a selling
department, division, or subsidiary of a
company for a raw material,
component, or finished good or service
which is supplied to a buying
department, division , or subsidiary of
the same company.

Monday, March 7, 2011

 Productio Manufacturin
g Marketing
n
Monday, March 7, 2011
 Objectives of Transfer Pricing

To provide each business unit relevant information to determine

trade-off between company costs & revenues.

To induce goal congruent decisions that will improve business unit

profits & company profits

To measure economic performance of individual business unit.

The system must be simple to understand & easy to administer.

Monday, March 7, 2011

 • The fundamental principle is that the
transfer price should be similar to the
price that would be charged if the
product was sold to outside customers or
purchased from outside vendors.
2 vital questions to be
asked
• Sourcing decision: To produce in-house
or outsource
• Transfer Price decision: If produced in-

Monday, March 7, 2011

 Market based price

• Definition:
• The ideal transfer price is based on a
well- established, normal market price
for the identical product being
transferred—
i.e., a market price reflecting the same
conditions (Quantity, Delivery Time &
Quality) as the product to which the
transfer price applies.

Monday, March 7, 2011

 Cost based price

• Definition:
• If competitive prices are unavailable
transfer prices may be set on basis of
cost + profit although such prices are
complex to calculate & results are less
satisfactory than market based cost.
How to arrive at cost?
• The usual basis is standard cost
(budgeted cost), in order to avoid
production inefficiencies from being
passed to the buying profit center.
Monday, March 7, 2011
 How to arrive at Profit markup?

Percentage of cost Percentage of

investment

No account taken Account taken of

of capital required capital required

Monday, March 7, 2011

 Cost based transfer pricing involves

Profit
Two

Monday, March 7, 2011

 Two step pricing

First step
• For each unit sold, a charge is
made = Standard (budgeted)
Variable cost of production

Second step
• Periodic (monthly)charge is made
= Fixed Cost associated with
facilitiesOne or both for
reserved of these steps
buying should
unit
include a Profit Margin
Monday, March 7, 2011
 • Firstly, the product is transferred to
marketing unit at standard variable cost
• After the product is sold the biz unit
share the contribution earned . i.e. ,

Selling Price
(-) Variable Manufacturing &
Marketing costs

____________________________________
= Contribution
Monday, March 7, 2011
 3 ways of Pricing Corporate Services

Biz unit should pay

Standard Variable cost of
services

Biz unit should pay

Std Variable Cost + Std Fixed Cost
i.e. Full Cost of services

Biz unit should pay

Standard Full cost + Profit Margin
for services

Monday, March 7, 2011

 Negotiation
• Biz units negotiate transfer prices with each
other.
• Top Mgmt. doesn’t get involved in transfer
pricing decisions

Arbitration
• 2 parties involved in a dispute submit a
written case to a Third person known as
Arbitrator for resolution
• Mainly performed by Single Executive or a

Conflict Resolution
• 4 ways to resolve conflicts namely
Forcing, Smoothing, Bargaining &
Problem Solving.

Monday, March 7, 2011

 Organizatio Board of Directors

nal Chart Of
President
GAC

Finance EngineeringManufacturing Industrial Purchasing Marketing

Relations staff staff staff

Group vice president Group vice president

Manufacturing divisions Product divisions

Chrome Electric Laundry

Electric Equipment
Product Stove
Motor division
division

Stamping Miscellaneous
Gear Refrigeration
division Appliance
And division

Monday, March 7, 2011

 • They assembled the
appliances from parts
purchased either from
• The product division the manufacturing
designed, engineered, divisions or from
assembled , and sold outside vendors.
various home
appliances.

• The manufacturing
divisions made
approximately 75
percent of their sales
to the product
divisions.

Monday, March 7, 2011

 • Transfer prices were arrived at by negotiation
between the divisions.
• These prices generally were based on the actual
prices paid to outside suppliers for the same or
comparable parts.
• If the divisions could not agree on a price, they
could submit the dispute to the finance staff for
arbitration.

Monday, March 7, 2011

 Problems in the
case

Monday, March 7, 2011

 Issue no. 1 Board of Directors

President

Finance EngineeringManufacturing Industrial Purchasing Marketing

Relations staff staff staff

Group vice president Group vice president

Manufacturing divisions Product divisions

Chrome Electric Laundry

Electric Equipment
Product Stove
Motor division
division

Stamping Miscellaneous
Gear Refrigeration
division Appliance
And division

Monday, March 7, 2011

 • Chrome Products Div (CPD) sold to Electric
Stove Div(ESD) – chrome plated unit fitted
on top of stove: it had to be resistant to
corrosion, stain from spilled food.
• Initially outsourced, since 1 Jan 1986, manf
by CPD.
• Rise in customer complaints in quality--mid
1986
• Manf VP was asked to improve quality of
product.
• Solution: Copper plating and buffing

Monday, March 7, 2011

 Present price $10
Cost of added operation 0.80 cents
Profit mark up 0.10 cents
New price $ 10.90

Chrome Products Div

Situation Finance Staff Review
Electric Stove Div
• Added processes to • ESD was not •Engr dept stated
manf. cycle at cost of responsible for so proposed cost of 90
80 cents called improvement cents was reasonable.
in quality that it
•Process resulted in neither requested nor •Quality control dept
improved quality approved stated new parts were
of superior quality as
•The cost of 90 cents •Marketable Features compared to outside
was justified since if could have been vendor.
procured from added instead of
outside vendor, it quality improvement.
would cost the same.
•New Product quality
level raised to outside
vendor’s product
quality, hence it
Monday, March 7, 2011
 Issue no. 2 Board of Directors

President

Finance EngineeringManufacturing Industrial Purchasing Marketing

Relations staff staff staff

Group vice president Group vice president

Manufacturing divisions Product divisions

Chrome Electric Laundry

Electric Equipment
Product Stove
Motor division
division

Stamping Miscellaneous
Gear Refrigeration
division Appliance
And division

Monday, March 7, 2011

 Issue 2: Thermostatic Control
• Electric motor Div (EMD) produced
Thermostatic Control units.
• Refrigeration Div procured this unit from
outside vendor till 1985.
• At request of EMD, Ref Div purchased 25%
from EMD in 1985 & subsequently
increased its procurement to 100 % in
1987.
• Supply increased & Demand reduced
leading to decline in price level.
• Outside vendor offered to supply the
product at a reduced price of $ 2.15.
However, EMD refused to reduce its price

Monday, March 7, 2011

 Situation
Electric Motor Div Refrigeration Div Finance Staff Review
•EMD stated the • RD stated they did •Purchasing staff
outside vendor’s price actually purchase the asked to review the
of $ 2.15 was a product for $ 2.15 outside market
distress price to save from outside vendor situation. They
his business, & not concluded that prices
valid basis for •Moreover outside reduced as a result of
determining an vendor had capacity excess capacity.
internal price. to produce its full
requirement at $ •It was concluded that
•At $2.15, EMD would 2.15/unit. RD could purchase
never realize profits. its requirements for
•RD should be next 2 yrs at $2.15/
•If forced to accept allowed to request unit.
this price, EMD would quotations from
shut down its plant & outside in the event
ask outside suppliers of major pricing

Monday, March 7, 2011

 Issue no. 3 Board of Directors

President

Finance EngineeringManufacturing Industrial Purchasing Marketing

Relations staff staff staff

Group vice president Group vice president

Manufacturing divisions Product divisions

Chrome Electric Laundry

Electric Equipment
Product Stove
Motor division
division

Stamping Miscellaneous
Gear Refrigeration
division Appliance
And division

Monday, March 7, 2011

 Issue 3: Transmission Problem
• Laundry Equipment Div(LED) produced
automatic washers. It purchased its
transmission from 2 sources: Gear &
Transmission Div(GTD) & Thorndike
Machining Corp(TMC)-outside vendor.
• Agreement between GAC & TMC, its renewal.
• President of TMC proposed a reduction in
price if the agreement was extended from
$12 to $10.
• GTD agreed to produce the product in-
house at same price & so no question of

Monday, March 7, 2011

 Situation
Laundry Equipment Gear & Transmission Finance Staff Review
Div
• LED stated they could Div
• the $10 quote by • it was concluded that
procure from out at $ TMC was invalid as it quote of LED of $
11.25. was a desperate effort 11.25 was appropriate.
•GTD agreed to for business •Quote of $12 by GTD
produce all sustenance. was faulty, as they
transmissions at this •It was not a valid basis didn’t allow for design
price & avoid business for determining an elimination, which
with TMC. internal price. would reduce costs/
•Intra-company pricing •Project was approved unit by 50 cents.
policy stated buying & at $12/unit. •The purchase staff
selling at competitive •LED didn’t comment stated that
prices. on proposal on time, transmissions should
hence they could not be obtained at quoted
object later on. price level of $ 11.25.

Monday, March 7, 2011

 SWOT

Monday, March 7, 2011

 Strength

Unit/Division could procure or

sell the product at competitive
prices because of existence of
Intra-company pricing policy.
A separate committee called
Finance Staff Review for smooth
& quick settlement of intra-
divisional disputes.

Monday, March 7, 2011

 Weakness

Product Divisions did not have

the autonomy to take sourcing
- make/buy decisions.

Miscommunication between
divisions leading to transfer
pricing disputes.

Monday, March 7, 2011

 Opportunity

GAC’s Manufacturing division

had the opportunity to tap
outside markets.

Scope for GAC to increase

production capacity to nullify
the threat from outside
vendors.

Monday, March 7, 2011

 Threat

Outside vendors supplied

similar products at competitive
prices.

Outside vendors had large

production capacity installed
thereby giving benefits of
economies of scale to GAC.

Monday, March 7, 2011

 Recom Need to have a formal
channel of
communication for

mendati smooth biz

transactions.

In depth scrutiny of
Authority to take projects by top
sourcing mgmt & concerned
decisions. divisions before
project approval.

Need to devise Increase in-

an accurate house
measuring tool production
for checking capacity as per
Monday, March 7, 2011
Monday, March 7, 2011