You are on page 1of 18

Company Profile

Organizational Structure:
Vcu is a French company that produces cars, lorries, buses and
agricultural machinery. Vcu organization is composed of various independent
divisions in which each division is further divided into business units. The three
divisions are MA, MB, and MC division. Kamp Motors of Roosendonk, is a
business unit and profit center within MA division in Netherlands that has more
than 2,300 employees. The organization structure of Vcu is as follows:

Vecu
Parent
Company

MA

MB

MC

Division

Division

Division

Kamp
Motors
Business
Unit

Figure 1. Organizational Structure of Vcu Corporation

Vcu: Manufacturer of cars, lorries, buses and agricultural machinery


MA: Expensive and exclusive models only (strong position in the market,
superior in design and high-quality engine).
MB&MC: Less cost, sporty, stylish and fun car model (the glamour of Kamp
engine enhances the image of their cars).
Kamp: Car engines (International leader in producing engine which has efficient
fuel

consumption,

power-full

and

noiseless).

Produced

Type1

Engine

(Conventional type, supply to business outside the Vcu concern) and Type 2, 3
and 4 Engine (high-tech and supplied internally).

Financial Data of Kamp Motors, 2013 (in 1 million)

Accounts

Amount

Sales

361

External costs*

204

Staff cost

98

Depreciations

20

*External cost: Costs of raw materials and auxiliary materials, purchased components,
contracted work, etc.

Assignments
As consultant for the Board of Vcu try to make a report by answering the 4
questions as follows:
Question 1
What transfer price should Kamp insist on, in your opinion, if it were to supply the
type 2a engine to the MB division now and in the future? Please give arguments
for your proposal.
You should at least consider the principle minimum transfer price = variable
cost per unit + opportunity costs for the supplier and the Vcus transfer
pricing policy.
Please draw attention to the interests of Kamp Motors as well as those of Vcu
as a whole.
Taking into consideration Vcus transfer price policy, what do you think of Guy
Merciers attitude?
E
E

E
E

Answer 1
The case scenario that is expected by Question 1:
Kamp will receive the request for supplying MB division and prepare the proposal
of the price by considering the companys policy and the principle of minimum
transfer price. Based on the information from the case description, as follow the
case flow as expected by Question 1:
2

MB
division
want to
buy from
Kamp,
Guy
Mercier's
attitude?
Type 2a
Engine.
To be
installed in
MB 99
(new car
model).
Give the
specificatio
n of the
engine.
Assume
that they
paid high
to Kamp in
the
previous
transaction
s.
2 external
suppliers
sent
offering,
the price
was not
opened by
Guy
Mercier.
Send
request/sp
ecification
expected
to Kamp.

Kamp
consider
the
request
from MB
division
Capability
to meet
the
Technical
specificatio
n
requireme
nt as per
request.
Demand
expected
to rise
steeply in
the coming
year.
Threat
from
external
supplier
(competito
r).
Production
is still
under
capacity.
Support
the
company
objectives
as a whole.

Decide to
receive

Price
Proposal?

Considered
Transfer
Pricing
Method:
At least
consider
Minimum
transfer price
principle.
Vecus transfer
price policy:
Cost plus Mark
up.
Market-based
transfer pricing.
Negotiated
pricing.

Figure 2. The Case Scenario that is expected by Question 1

Here are some probabilities the transfer pricing based on some difference
method:
A. Using the principle of minimum transfer as consideration in this
assignment, the transfer price would be: 2,500 + 750 = 3,250. We use
750 as the opportunity cost as it is it cost for not selling to external party,
while Kamp still has unused capacity. We use 2,500, the variable cost
per engine in the calculation, not 4,000 as the full cost, as it is an internal
selling that should be net of irrelevant cost such as development cost. This
computation of priceis easier and the lowest price Kamp can offer. I think
there is no need of bargaining in this process that could spend much
energy and time. The transfer pricing of 3,250 is still below the lowest
3

price (3,750) the assumed competitors lowest price could offer to the MB
division.
B. In this case, it has mentioned that Vcu implements transfer pricing policy:
Cost plus Mark-up, but unfortunately there is no information in the case
that explain how much the company can put additional mark up when they
conduct transfer pricing, so this methodology cannot be implemented in
Question 1.
C. Due to limited information in the case, market-based transfer pricing also
cannot be used without additional information. Ideally the market-based
transfer pricing is used in perfectly competitive market that requires
homogeneous product, open information, and no individual buyer or
sellers can affect the price.
D. Kamp can use transfer price that have been calculated in point A (principle
of minimum transfer price) amounting to 3,250 and price information that
have been already got by MB division from the Black and FER as starting
point to use negotiated pricing method. If we assume that the price that
was offered by the Black and FER is 3,750 (the lowest estimation), Kamp
can get higher price if the proposal price is at least just below the
competitors, assumed of 3,600 (just assumption). At this price, Kamp can
get higher profit with better price while the MB division still can get benefit
as to the transfer pricing is below the price that is offered by external party.
The goal objective of Vcu group could be achieved with this method, but
could spend much energy and time in the bargaining process.
Guy Merciers attitude, as described in this case, is that he only focus on his
(division) objective without care and interest to other managers, divisions, and
business units of Vecu as a whole. The impact of this to the organization is
categorized as competitive organization based on his character. This
organization has multidivisional structure and profit contribution as a key word in
performance evaluation. The situation could be worst in this case due to the
management process, including its cost information system/transfer pricing
method. In Vcu, the use of Top-down approach, not as the competitive
organizations concept that used bottom-up approach could lead to the unfairness
4

in transfer pricing transaction. To mitigate the behavior of Guy Merciers attitude,


and if Vcu want to retain the characteristic of its organization (competitive
organization), Vcu need to change the management process approach from
top-down to bottom-up approach, specifically regarding with the price method
policy.

Question 2

Please discuss the possibilities of increasing Kamps profit by using the


formula for basic cost per unit and by reorganizing. Please use a concrete
example to indicate how the board of Kamp can manipulate the unit costs
for the types 2, 3, and 4 by reorganizing its cost information system.
How, do you think, can the boards of the Vcu concern and the MB

division determine whether Kamp manipulates data on unit costs?


Answer 2
The case scenario that is expected by Question 2:
The board of Kamp wants to increase profit and then improve their performance
that could bring impact to their bonus by reorganizing cost information system
and also reorganizing its organization. Based on the information from the case
description, the case flow is as follow as expected by Question 2:
3
1

Figure 3. The Case Scenario that is expected by Question 2

E
3 Cost Information System. Current Model:
E BCPU = External Cost + Staff and Administration Cost
E
E Notes:
1. At 90% of maximum production capacity.
2. External cost: Cost of raw materials and auxiliary materials, purchased
components, contracted work, etc.
3. BCPU: The Basic Cost per Unit.
Possibility to reorganize the Cost Information System Based on the BCPU.
The Board
of Kamp
want to
increase
profit and

Assignme
nt:
1.Propose
the new
cost

New Cost
Information
System of
Kamp &
New

How Vecu's
5
board and
MB division
ensure that
Kamp is not

n.
system.
g data on
2.
unit cost?
Recommendations
for reorganization.
The following table simulation
present to Board of Kamp of how the Board of
improve
their
perfomance
appraisal

New cost

By

is without fraud actions:


Kamp can reorganizatio
manipulate the BCPU system
properly
n its
organization.

By
Unit Cost
reorganizatio
Structure
n cost
information
system of
External engine
Cost:Type
2, 3 , and 4.

developed
from BCPU
(the basic
Existing Cost
cost per
unit).
System

Reorganizing Cost System

Cost of raw
material and
auxiliary
materials

XXX

XXX

Purchased
component

XXX

XXX

Salary for
administration
staff

XXX

XXX - (XX). Staff that work in office


is proposed to be reduced in this
component due to it is more proper
as GA expense.

Depreciation

XXX

XXX - (XX). Asset is proposed to be


reduced/removed so that the
depreciation in overhead cost will
be reduced. It can use sales and
lease back scheme transactions.

Total Cost:

XXX+XXX+XXX+XX

XXX+XXX+XXX-XX+XXXX-XX

Staff &
Depreciation
Cost:

X
Table 1. Concrete Example to indicate How the Board of Kamp Can
Manipulate the Unit Cost Based on the BCPU

Based on the BCPU, we found that the components of the cost information
system unit can be identified, analyzed and reorganized. The implication of the
cost reorganization as illustrated in the table above, Kamp will have lower
production cost than before that is expected to boost the selling of the product.

The production cost per unit also will decrease if Kamp get approval to sell their
products to external party with full capacity production.
Reorganizing Its Organization
There are 2 main things that mentioned in the case:

Changing the department of Research and Product Development. The


company will redesign this department by remaining the leader in the field
of technology instead of employing all the staff for this department as it
used to do to decrease the development cost. This will decrease the fixed

cost so that the total cost will decrease.


Contemplating much closer collaboration with technical universities. By
collaboration with technical universities, it will take more advantages from
technology to save cost and increase profits.

The reorganization of its organization as explained in fact will reduce the cost,
but it could harm the companys strategy as a whole (Vcu). It will be explained
in more detail in Question and Answer 4.
Data Manipulation.
There are some alternative ways for the Board of Vcu and MB division to
ensure that Kamp do not manipulate data on unit cost:
1. Comparison between unit cost of product selling by Kamp with the offering
from external party (other company). If the gap of the unit cost of Kamps
product is significant, it could be a signal that there is something wrong
with the unit cost of Kamps product.
2. Assign an internal auditor to audit the cost information system frequently
to ensure the accuracy and reliability of the system as well as the data.

Question 3

Within the Vcu concern, Kamp is obliged to supply engines at cost per unit plus
a mark-up for profit. Please compare Vcus transfer price system with Vcus
system of responsibility centers and with Eccless theory on transfer pricing.
Answer
3
Vecus Transfer
Pricing System Improvement?
The case scenario that is expected by Question 3: Compare the Vcus transfer
price system with Eccless theory on transfer pricing. Based on the comparison,
consultant expected can give recommendations for improvement. Based on the
information from the case description, the case flow as expected by Question 3:

Vertical Integration
Fairness in Transfer
Pricing

Transfer Pricing
Based on Eccless
Theory

VS

Cost Per Unit +


Mark-up For Proft
Responsibility
Centre

Vcus transfer
pricing system

Figure 4. The Case Scenario that is expected by Question 3

Robert G. Eccles is a Professor at Harvard Business School, his major areas of


research are integrated reporting and innovating for sustainability. There were
8

many papers and books written by Eccles regarding to the transfer pricing topics,
two (2) of the most famous publications are Control With Fairness in Transfer
Pricing and The Transfer Pricing Problem: A Theory for Practice that were
published in 1985 and 1983 respectively. Most of the discussion that I will be
presented in this assignment refers to these publications.
The main conclusions that can be inferred from the studies that were conducted
by Eccles that no best transfer pricing method exist. The methods implemented
varied and any particular method to be chosen probably was based on the
primary objective of the company. Whats the company trying to accomplish
through transfer pricing process. Eccles emphasized that vertical integration is
the most important reason for establishing transfer-pricing policies. Vertical
integration means unification of different activities of the business within the
boundaries of a single firm to achieve economics of production and securing
supply or demand.
As impact of the conclusion that was explained before, for understanding the
transfer pricing method that most suitable with the specific company, Eccles
developed organization characteristic models that are summarized (concluded) in
the table below:

Characteristic of
Organization:

Competitive

Cooperative

Collaborative

Strategy:

Aggregate of
division's
strategies

Total company
strategy

Mutually defined
total company
business
perspectives

Structure:

Functional

Multidivisional
Functional Matrix

Multidivisional
Functional Matrix

Systems:

Profits, ROI
compared with
budget, internally
and externally

Costs compares
with budgets and
history

Combination of
costs, profit, and
ROI compared
with budget

Processes:

Bottom-up;
distributive
bargaining

Top-down;
integrative
bargaining

Iterative, mixedmode bargaining

Vertical
Integration
Level:

Low

Very Strong

Strong

Performance
evaluation base:

Depend on the
result of the
business unit
itself

The company
performance as a
whole

Business unit and


manager
achievement
considered to
measure
separately

Top
management
control:

Through systems
of outcomes

Through structure
on actions

Through
processes
balancing
structure and
systems

Most proper
Transfer Pricing
Method:

Market-based

Full Cost/ CostBased

Market-Based/
Negotiated

Table 2. Organization Characteristics Based on Eccless Theory

To understand the relation between Vcus transfer pricing system and Eccless
Theory, we need to explain the organization characteristic of Vcu based on the

10

category in Eccless Theory and information available in this case as follows:


Characteristic of
Organization:

Competitive

Strategy:

Aggregate of divisions strategies

Structure:

Multidivisional

Systems:

Profits, ROI compared with budget, internally


and externally

Processes:

Top-down; distributive bargaining

Vertical Integration Level:

Low

Performance evaluation
base:
Top management control:
Most proper Transfer Pricing
Method:

Depend on result of business unit itself


Through systems of outcomes
Cost-based (mandated)

Table 3. The Organization Characteristic of Vcu based on the Category in


Eccless Theory

As presented in the table, Vcus organization characteristic is more closer to


competitive organization. However, as competitive organization Vcu has
deviance in characters that differ with Eccless Theory. It practice Top Down
approach in management process, including in deciding transfer-pricing method,
and implement (mandated) Cost-Based. As implication of these deviances, as
competitive organization it will raise issues both in fairness of transaction and
performance measurement issues internally as occurred in Vcu Group between
Kamp and MB division. In this case, as they are obligated to use cost information
system and sell specific engine internally to Vcu Group only which limits the
opportunity of Kamp to maximize its profit that directly give impact to
11

performance appraisal and bonus of managers in Kamp.

Based on information explained before and consider other factors that


significantly different such as market and product characteristic of each division
and business unit (perfectly-competitive-market for product of MB and MC, while
oligopoly market for product of Kamp), by using the Eccless Theory I
recommend to the Board of Vcu to change the characteristic of its organization
from inconsistent competitive organization to be collaborative organization. It will
ensure

that

transfer-pricing

system

implemented

can

promote

goal

congruence/vertical integration and overcome unfairness issue both in


transaction and performance evaluation.
Question 4:
Taking into consideration the product differentiation strategy adopted by Kamp
and Vcu, what do you think of Kamps idea to collaborate more closely with
technical universities and to sell the types 2, 3, and 4 externally as well?
Answer 4:
The case scenario that is expected by Question 4:

Explain the product differentiation strategy adopted by Kamp and Vcu.


Explain the relation between the differentiation strategy adopted by Kamp
and Vcu with their idea to collaborate with technical universities that is
expected to reduce their cost and increase their profit, and then assess
the idea.

12

As follow the case flow as expected by Question 4:

13

Diffrentiation Strategy.

Organization (Vcu) Strategy

R & D Department proposed to be changed for reducing cost.


Multidivisional -> MA, MB, MC.
Collaboration
with
universities.
Business Units ->
Kamp (as part
oftechnical
MA Division).

mps Cost Information System (effect of transfer


pricingStructure
policy)
Organization

Ordain

Does it a proper and good decision???


Reorganization Kamp's Organization (Effect of transfer pricing policy)

14

Figure 5. The Case Scenario that is expected by Question 4

What is the advantage & disadvantage received by Kamp (and Vcu


group as a whole) so far by running Research and Development
Department internally? The chart below explain the advantage and
disadvantage
Ensure high quality
and the availability
of engine supply with
expected
specifications.
Uniqueness of
features product as
per customer
segment targeted.
Advantages

R & D Department is
run internally.

Confidentiality of
the company's
products and
technology
invention.
Responsiveness and
strong integration
between company's
strategy and
innovation programs.

Disadvantages

Higher fixed cost

Figure 6. The Chart of Advantage and Disadvantage to run the R & D


Department internally in Kamp Motors

Why does the Board of Kamp propose to reorganize their organization by


changing the R & D Department through collaboration with technical
universities?
o The main motive of the Board is to reduce the cost, increase the
15

profit and better performance appraisal result of their business unit


that expected will impact to their bonus. The motive is triggered by
the transfer pricing policy that is ordained by the Board of Vcu that
caused the Kamp and its manager got low performance appraisal
result and bonus compared with other divisions, although Kamp
can produce high quality product and ensure the supply for the

other divisions.
What are the risks/negative impacts that would happen if the Board of
Kamp implements the idea of collaborating with technical universities?
o The risks/negative impacts would be:

Lack of supply for the Company as a whole (Vcu Group)


with high quality and specifications engine as expected.

Threat to the confidentiality of the company's products and


technology invention.

Weak/low divisions and business units integration both


internally and inter-division/business unit. It could be also an
impact on the congruence objective of them to achieve the
companys objective as a whole.

Vcu

implements

Differentiation

Strategy,

specifically

Product

Differentiation. Product differentiation is an organizations ability to offer


products or services perceived by its customers to be superior and unique
relative to the products or services of its competitors.
A differentiation strategy strives to increase customer value by
increasing what the customer receives (customer realization) and
creating competitive advantage; the main source of strength of the
company that implements the differentiation strategy is innovation.
Providing something to customers that is not provided by
competitors creates a competitive advantage, the main objective of
Research and Development Department in a company is to create

16

or develop product as part of innovation program. The company


that choose differentiation strategy but fail or late to innovate will be
a loser company, so that they must innovate sustainably to ensure
they can offer differentiated product more earlier and timely than its
competitors, and retain their position in the market. The idea to
reorganize the R & D department is proper if the idea is based on
strategic considerations (motive or reason) of the company and will
support the Companys objective as a whole, not just based on the
motive or reason to increase the performance of Kamp or its
manager only. Based on the information in this case and my
analysis, as a consultant I recommend to the Board of Vcu and
Kamp to cancel the implementation of the idea.
General Conclusions and Recommendations:
1. The transfer pricing systems implemented in Vcu, Cost-Based Transfer
Pricing, is not proper due to:
I.

It could cause the company to be exposed to risks related with

II.

confidentiality and missed its competitive advantage.


Unfair to the performance measurement and reward of certain

III.

division or business unit.


It has triggered the idea or actions of certain division or business
unit for their own benefit without care to the companys objective as

IV.

a whole.
It is not in line with the characteristic of organization that is more
closer with competitive organization.

2.

The idea (or action) of the Board of Kamp to reorganize its organization by
changing the R & D Departments is not proper.

3.

The Board of Kamp can manipulate the current cost information system to
reduce product cost, while the Board of Vcu can trace and detect manipulation
of data on unit cost by its auditing divisions and business unit.

17

Recommendations
1. To achieve the companys objective as a whole, the transfer pricing system of
the Vcu need to be improved by:
a. Retaining the current transfer pricing system. But, to ensure the
congruence of the objective and actions of each division and
business unit to achieve the companys objective as a whole and
the fairness of performance evaluation of its divisions, business unit
and manager, the company need to change the transfer pricing
policy formulation process from top-down to be bottom-up
approach. The company also must change the transfer pricing
method from cost-based to be market-based.
b. Using the Eclless theory, as alternative of the recommendation
No.1, to ensure the congruence of the objective and actions of each
division and business unit to achieve the companys objective as a
whole and the fairness of performance evaluation of its divisions,
business unit and manager, the company needs to change its
category of its organization from the competitive organization to be
collaborative organization.
c. Cancelling the idea to reorganize its organization by changing the R
& D Department, as it is based on the narrow and short-term
interest that could harm the companys objective as a whole.
2. To reduce unit cost of product, the Board of Kamp can use BCPU as a base
to evaluate the cost of items to avoid or reallocate to other post through
proper accounting techniques without fraud actions.
3. To ensure that no manipulation on the data of unit cost which would violate
the companys policy or categorized as fraud actions that can be traced and
detected by the Board of Vcu. The Board needs to conduct cost analysis
and assign auditor for conducting audit regularly on the cost information
system so that any violation can be traced and detected properly and timely.

18

You might also like