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Marshall School of Business
University of Southern California
Axeon N.V.
Teaching Note
Purpose of Case
The Axeon N.V. case was written to illustrate the effects of a management control system and
the supporting management processes on one specific, major decision in a decentralized,
multinational corporation. The situation, which is real, but disguised, illustrates the real world
application of many management accounting concepts, including incremental cost analysis,
capital budgeting, sensitivity analysis, and transfer pricing. But perhaps more importantly, the
case is about managing the cost/benefit trade-offs that are inherent in a decentralized firm. The
Suggested Assignment Questions
1. Is construction of the new factory in the UK in the best interest of Axeon N.V.?
2. Ignoring your answer to question 1, if the plant were not built and AR-42 was shipped from
the Netherlands to the UK, what transfer price would be appropriate?
3. What should Mr. van Leuven do?
P
rofessors Kenneth A. Merchant, Wim A. Van der Stede, and research assistant Xiaoling (Clara) Chen wrote this teaching note as
an aid for instructors using the Axeon N.V. case.
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
131
Case Analysis
A. Product Sourcing Alternatives
Despite the existence of many relevant data in the case, the answer to the first assignment
question is not an easy one. There are two alternatives for producing AR-42: UK and
Netherlands.
The best place to start is with the discounted cash flow analysis, a summary of which is
presented in Exhibit 2 of the case. Case Exhibits 3 to 5 provide back-up detail. The analysis is
Was there anything wrong with this initial analysis? The analysis looks sophisticated, and most
students will instantly empathize with Mr. Wallingford. However, criticisms can be made of his
analysis:
1. The end-of-project recovery value of equipment and working capital is a surrogate for the
cash flows after the end of 7 years. It is likely that this is biased downward. Why would all
sales and profits stop after that date? Is there no learning that has come from this project?
Does the project have no option value?
2. Wallingford might well have presented some sensitivity analyses, reflecting more
3. Most importantly, although he appears to be taking a corporate perspective and, hence,
comes across as an appealing character with whom most MBA students will identify,
Wallingford is really parochial. He did not consider the investment opportunity using a
corporate-focused perspective. Wallingford is indignant about Axeon managers rejection of
his idea, but he is not as innocent as he portrays himself. The main defect in his analysis
So we see in the case that the Dutch managers argue that producing the AR-42 in the
Netherlands is an even better alternative than that proposed by Mr. Wallingford. Some of their
arguments question some of the numbers in the Hollandsworth analysis. The Axeon director of
sales (Mr. De Rijcke) questioned the sales forecasts. But who understands the UK market better,
the local general manager or the functional specialist in a foreign country?
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
analysis. The analysis of the variable costs (as shown in Exhibit 6 of the case) is misleading. As
shown in Exhibit-TN 1, an average variable cost of 1860 on the full 1000 tons of production
Next the instructor can turn to the discounted cash flow comparisons. Exhibit-TN 2 shows an
analysis of the Netherlands proposal. The revised analysis still favors the Netherlands proposal,
mainly due to the much greater initial investments for the UK proposal.
UK Proposal Netherlands Proposal
Net present value @ 8% 916,000 £1,288,790
Internal rate of return 20% 26%
In addition, taking into account the higher risks involved in the UK startup relative to the
Netherlands expansion, the UK hurdle rate should be higher, which makes the Netherlands
alternative even more attractive.
On the other hand, sensitivity analyses would show that the UK managers could face significant
sales shortfalls and manufacturing problems and still have a project with a positive net present
value. In terms of that criterion, or even the Axeon 12% hurdle rate criterion, perhaps the impact
of the startup complications are not as significant as the Axeon functional managers believe
them to be.
Further, the irrelevance of the fixed costs in the Netherlands proposal makes sense only if the
Netherlands has, and will always have, excess capacity for producing AR-42. In other words,
Other issues such as nationalism and perceived autonomy are also important. Axeon N.V. is
increasingly embracing a philosophy of decentralization. Therefore, even if the UK proposal is
not optimal, forcing manufacturing of AR-42 in the Netherlands will undercut the perceived
decentralization in the company. Another consideration is the nationalistic sentiments of the
English. This is suggested by the requirement of a majority of local directors for the
Hollandsworth board and the threatened resignation of Mr. Nobel. An increase in duties on AR-
42 is likely if the UK viewed Axeon as exploiting the UK market from the Netherlands.
B. Why Did Mr. van Leuven Behave as He Did?
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
133
C. The Transfer Pricing Issue
If the AR-42 for the UK is sourced from the UK, then the analysis is complete. However, if AR-
42 is supplied from the Netherlands to the UK, then a transfer price must be established. There
are a number of transfer pricing possibilities:
2. Cost, or cost plus a mark-up. Cost can be defined anywhere from incremental variable
3. A two-book system. This would involve crediting the Netherlands at market price but
charging the UK only the variable cost. This would make both divisions happy, presumably,
but it would lead to a double counting of profits and require a corporate elimination.
In many decentralized companies, managers would allow the division managers to negotiate a
fair transfer price. But in this case, because of the friction already generated between personnel
in the UK and the Netherlands, negotiation may not be possible. So, here, Mr. van Leuven
probably has to choose a transfer pricing method and a means of implementing his decision.
The total contribution per ton of AR-42 is as follows (using figures from year two and the
following):
Selling price £3,700
Each transfer pricing method allocates this contribution between the UK and the Netherlands.
What transfer pricing/profit sharing arrangement is best? There is no correct solution. Transfer
prices provide one way of shaping managerial behavior. If centralized production is deemed to
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
134
D. Fit Between Strategy, Organization Structure, and Control Systems
At this point in the class discussion, it is useful for the instructor to ask the following question:
What is Axeons corporate strategy? Can you tell from the case what the key success factors are
for Axeon?
The case does not provide much information about Axeons critical success factors. What is
most critical for Axeonidentifying new applications and markets or producing at low cost?
Should the companys critical success factor(s) affect decisions about organization structure and
management control systems? Clearly yes. This observation can lead naturally into a discussion
1. Market sensitivity is enhanced with increased decentralization. Also, a decentralized
2. Economies of scale decrease with increased levels of decentralization. This is because a
decentralized organization loses the cost savings from shared management overhead and
larger, more efficient plants.
In summary, Axeon is facing two sets of pressures:
Centralization Strategy Decentralization Strategy
Key success factor Low cost New product applications
Key function Production Marketing
Responsibility Centers:
To some extent, Axeons control system is a compromise between full decentralization, which
would use highly autonomous local investment centers, and full centralization, which would
have the local organizations be only marketing outposts, revenue centers.
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
135
E. What Should Mr. van Leuven Do?
There is no correct solution here; there are only pros and cons. The options are to source in the
UK, source in the Netherlands, or delay. Delay means possibly source in the UK after the
viability of the market has been demonstrated. Asking students to vote as to their preference will
reveal significant differences in opinion. This vote, if one is taken, should come very late in the
class.
While it appears that the economics of this decision favor the Netherlands, our own take is that
the decision in this case should probably favor the UK. If a decentralized organization structure
What Happened?
In the real world situation, the Hollandsworth project was rejected. The transfer price was set at
£3700, so the full cost to Hollandsworth (including shipping and duty) was £3900. Initially,
Hollandsworth managers tried to sell AR-42 at a price of £4500 per ton, but the volume sold
was miniscule. Eight months later, they lowered the price to £4200. The annualized rate of sales
went to 150 tons, and Hollandsworth managers thought that the potential was there for annual
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
136
Student Takeaways
Students can learn a lot from this case. They can practice their technical skills, such as those
required to do net present value analyses, and they can apply their transfer pricing theories to a
Pedagogy
Many students see this case as difficult. Sound amount of floundering with the numbers is
useful, but if the floundering continues, instructors should be prepared to step in and help clarify
the analysis. That understanding is essential before moving on to the more qualitative aspects of
the case. Suggestd timing in a 75-minute class is as follows:
40 min. The plant investment decision
15 min. Transfer pricing alternatives and behavioral effects
Exhibit TN-1
Relevant cost analysis
Calculation of incremental variable cost per ton of manufacturing AR-42 in the
Netherlands for shipment to the UK:
Projected average variable cost in the Netherlands at 1000 tons 1,860
Projected total variable cost in the Netherlands at 1000 tons 1,860,000
Revised variable cost per ton (Different from Exhibit 6):
Incremental manufacturing variable cost 1,800
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
137
Exhibit TN-2
Discounted cash flow analysis Netherlands proposal
(Figures in rows (2)(4) in ; row (1) and rows (6)(9) in 000)
Year 0 1 2 3 4 5 6 7
(1) Working capital 120 20 20 160
(3) Incremental cost per ton 2,000 2,000 2,000 2,000 2,000 2,000 2,000
(2) (3)
(6) Total contribution
400 510 680 680 680 680 680
(7) Promotion costs 260 150 100 100 100 100 100
(6) (7)
Net present value at 8% 1,288,790
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
138
Exhibit TN-2
Flexibility and Efficiency as a Function of the Level of Decentralization
Axeon
Decentralization
