Question

Transfer Price Decisions

The Consulting Division of IMB 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 wquipment form 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 comapany, 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 pruchase 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 managment 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?

Answer 1

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?

Since a consulting company is required to provide its client with the best solutions to its client, which should encompass quality, cost-effectiveness and most importantly trust. As mentioned in the case that the consulting arm is independent of the computer equipment arm, it has the authority the supersede the computer equipment arm if it thinks that its clients' is needs would be better fulfilled by a competitors products. After all the consulting arm has to take care of its vertical, which operates primarily on the ethos of domain expertise, industry best practices and its ability to solve complex problems. Moreover, it would not be an ideal situation for either of the parties, the consulting arm, the corporate arm or the computer equipments division if word gets out about IBM trying to shove their own products despite having knowledge about a better alternative being available. It can be termed as a short sighted move which could affect the brand equity and brand perception in a negative way, which take years to be built into people's minds.

However, the corporate arm of IBM should be worried about this situation as despite being a computer behemoth and industry pioneer since the past few decades, it does not have a suitable product for its clients. IBM should use this information gathered from its consulting arm to build capabilities, which can be used to offer products to a wide market.

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?

A transfer pricing arrangement can be between the parent company and a subsidiary or between two subsidies of the same company, which is the case here. Since, both the subsidiaries belong to the same company neither should under-cut or overcharge the other, which create an unfair playing field for the other. Arrangements can obviously be made for one of the parties, since it is bringing in extra customers to the other. There can be a pre-arranged cut or percentage of gross profit, which is received by the subsidiary that brings in business for the other.

One of the most important benefits of transfer pricing also happens to be tax saving, especially for transactions occurring overseas. Another avenue to save on deductions is by exploring the domain of customs and duties. This can be a very profitable and agreeable aspect for all the three parties - the two subsidiaries and the parent company.

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?

The most important factor in developing a mutually benefiting relationship would be to develop a transparent system for communication and information sharing. The corporate arm should provide flexibility and incentives to both the subsidiaries, which could lead to development of trust and sharing of valuable data. Insights must be shared in order to develop capabilities and broaden the market for both the subsidiaries, through which they can generate more business for each other by developing synergies and could position the parent company as a leader and a pioneer in a newly developed niche.