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208
Marshall School of Business
University of Southern California
Zumwald AG
ERRATUM
Instructors using the Zumwald AG case from the first print of the 3rd Edition of the book
BUT INSTEAD SHOULD BE REPLACED IN ITS ENTIRETY BY:
Marshall School of Business
University of Southern California
Zumwald AG
Teaching Note
Purpose of Case
This case describes a transfer pricing issue that is common in decentralized, divisionalized
firms. The case raises issues about internal pricing and, more generally, the operation of a
decentralized management structure.
Suggested Assignment Questions
1. What sourcing decision for the X73 materials is in the best interest of
a. The Imaging Systems Division?
c. The Electronic Components Division?
d. Zumwald AG?
2. What should Mr. Fettinger do?
Case Analysis
The suggested assignment points students in the right direction. Zumwalds ISD division is
sourcing displays for its X73 system. The division solicited three quotes. The lowest quote, for
100,500 was from a British company, Display Technologies PLC. Another quote, for
120,500, came from a Dutch company, Bogardus NV. The high quote, for 140,000, came
from Zumwalds Heidelberg Division.
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
210
Should ISD choose the Display Technologies quote? Possibly yes. But the Display
Technologies quote causes some worries. One is about quality. Display Technologies is a new
entrant to the market, and it has not yet had a chance to demonstrate the high quality that
Bogardus, and presumably Heidelberg, has demonstrated. And the Display Technologies bid
The issue in the case arises because the manager of Heidelberg complained about not getting the
ISD order. His arguments are the following:
1. Zumwald is better off if Heidelberg supplies the displays to ISD. Students should do the
calculation to understand this conclusion.
The Heidelberg quote to ISD is better for Zumwald taken as a whole because it includes
some contribution both for Heidelberg and for ECD, Zumwalds internal electronic
subassembly supplier. The variable costs for Heidelberg are 50,000. The fixed costs are
2. Heidelberg engineers helped ISD develop the X73. Heidelberg was reimbursed for the cost
of those engineers, but it earned no profit for this work. Does this assistance imply a
partnership that would include future sourcing of parts?
Students presenting this analysis showing the advantage to Zumwald of internal sourcing should
be asked whether this means that Mr. Fettinger should order ISD to source the displays from
Heidelberg. They will almost assuredly say yes. But then the issue is the price at which the
transaction should be made.
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
211
The case has enough information to show that this X73 business promises to be highly
profitable for ISD:
Revenue for one X73 system................................................................................... 340,000
Clearly, there is room to force ISD to pay Heidelberg more than the Display Technologies
price. That extra cost could provide additional margin to Heidelberg and ECD. But,
alternatively, any price greater than 37,400 provides a contribution to Heidelberg and/or ECD.
Why shouldnt Heidelberg shave its price to get this internal business? And if Heidelberg shaves
its price, then it might as well ask ECD to shave its price below its normal 20% mark-up. So in
some sense, these transfer prices are just moving profits from one division to another. What is
fair to all parties?
Heidelbergs manager, Paul Bauer, claims that he has been pleading with his salespeople not to
shave prices, that he needs full margin business in order to achieve his plan. Does Mr. Bauer
just not want to acknowledge the price competition in this segment of the market? Is he ignorant
of the marginal cost and contribution margin concepts? Should he be fired?
Or is Mr. Bauer merely willing to lose this business in order to emphasize the importance of his
pricing policy to his salespeople? This latter possibility can be illustrated with the following
hypothetical figures:
Price policy Price
(000)
Volume Unit
Contribution
Total
Contribution
So what should Mr. Fettinger do? Mr. Fettinger should probably listen to the arguments in order
to learn the managers thinking processes? Are they all aware of the key facts in the situation?
Does Mr. Bauer, in particular, understand the concept of marginal cost pricing and contribution
margin?
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
212
If the managers are all making rational arguments, then strong arguments can be made here for
having Mr. Fettinger do nothing. Zumwald operates in a highly decentralized fashion. Why not
let it continue to do so? Let the managers have their autonomy and freedom of sourcing. If there
The final question that can be explored is the systemic question. Is the Zumwald responsibility
center/performance measurement system faulty in that it motivates managers to make decisions
that are not in the best interest of the corporation as a whole? There is no easy answer to this
Pedagogy
This case is relatively short and straightforward. Students do not need a lot of guidance to reach
the conclusion that Zumwald is better off if the sourcing is done internally. Then, we suggest
