EXERCISE 12-17 (20 MINUTES)

4. It is in the best interests of the company and of the divisions to come to

an agreement concerning the transfer price. As demonstrated in part (3)

above, any transfer price within the range $7.50 to $13.50 would im-

prove the profits of both divisions. What happens if the two managers

Case 12-34 (continued)

In this case, top management knows that there should be a transfer and

could step in and force a transfer at some price within the acceptable

range. However, such an action, if done on a frequent basis, would un-

dermine the autonomy of the managers and turn decentralization into a

sham.

Our advice to top management would be to ask the two managers to

meet to discuss the transfer pricing decision. Top management should

not dictate a course of action or what is to happen in the meeting, but

should carefully observe what happens in the meeting. If there is no

agreement, it is important to know why. There are at least three possi-

ble reasons. First, the managers may have better information than the

top managers and refuse to transfer for very good reasons. Second, the

managers may be uncooperative and unwilling to deal with each other

even if it results in lower profits for the company and for themselves.

Third, the managers may not be able to correctly analyze the situation

and may not understand what is actually in their own best interests. For

example, the manager of the Brake Division may believe that the fixed

overhead and administrative cost of $8 per brake unit really does have

to be covered in order to avoid a loss.

If the refusal to come to an agreement is the result of uncooperative at-

titudes or an inability to correctly analyze the situation, top management

can take some positive steps that are completely consistent with decen-

tralization. If the problem is uncooperative attitudes, there are many

training companies that would be happy to put on a short course in

team building for the company. If the problem is that the managers are

unable to correctly analyze the alternatives, they can be sent to execu-

tive training courses that emphasize economics and managerial account-

ing.

Case 12-35 (75 minutes)