Aurora Mfg has multiple divisions that make a wide variety of products. Recently the Bearing Division and the Wheel Division got into an argument over a transfer price. The Wheel division needed bearings for garden tractor wheels. It normally buys its bearings from an outside supplier for $24 per set. The company's top management recently initiated a campaign to persuade the different division to buy their materials from within the company whenever possible. As a result, Steve Hamblin, the purchasing manager for the Wheel Division received a letter from the vice president of Purchasing, ordering him to contact the bearing Division to discuss buying bearings from this division.
To comply with this request, Steve from the Wheel Division called Terry Tompkin of the Bearing Division, and asked the price for 15,000 bearings. Terry responded that the bearings normally sell for $35 per set. However, Terry noted that the Bearing Division would save $3 on marketing costs by selling internally, and would pass this cost savings on to the Wheel Division. He further commented that they were at full capacity and therefore would not be able to provide any bearings presently. In the future, if they ad available capacity, they would be happy to provide bearings.
Steve responded indignantly, Thanks but no thanks. He said, We can get all the bearings we need from Falk Mfg. for $24 per set.â? Terry snorted back, Falk makes junk. It costs us $22 per set just to make our bearings. Our bearings can withstand heat of 2,000 degrees centigrade, and are good to within .00001 centimeters. If you guys are happy buying junk, then go ahead and buy from Falk.
Two weeks later, Steve's boss from the central office stopped in to find out whether he had placed an order with the Bearing Division. Steve responded that he would sooner buy his bearings from his worst enemy than from the Bearing Divisions.
The questions involves finding at least two solutions (managerial decision) that would satisfy the needs of the Wheel Division and the Bearings Division that would benefit the company.
The issue for the Wheel Division is that they can get $32 (net of marketing costs) from the market and they are at capacity so selling internally at lower than $32 will decrease overall company profits. So, they need to get $32 or better.
The issue for the Bearing ...
Your tutorial offers three ideas for solving this transfer price problem. The issue for each is clarified for you.