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    Performance Measures & Transfer Pricing: Pros Cons

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    1. Mario and Lucy opened an ice cream shop in Kissimmee. Their goal is to maximize profit and to make the business appealing to customers. The cream shop was a big success, so they decide to open an ice cream shop in many cities including Orlando. They hire Luis to manage the shop in Orlando. Mario and Lucy are considering different sets of performance measures for Luis. The first set would grade Luis based on the cleanliness of the restaurant and customer service. The second set would use accounting numbers including the profit of the shop in Kissimmee.


    a) Explain the advantages and disadvantages of each set of performance measures.
    b) How do they must design the organizational architecture to control the agency problems?

    2. When goods are transferred from one profit or investment center to another, an internal price is assigned to the units transferred. Although the general rule for transfer prices is the outlay cost plus opportunity cost, may companies instead use different methods to price their goods and services. What is the transfer price that maximizes the firm value? What are the main reasons for transfer price within firms? What are the advantages and disadvantages of the most common transfer pricing methods?

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    Solution Preview

    Performance measures:

    a) Explain the advantages and disadvantages of each set of performance measures.

    Measures based on cleanliness and service would increase the chances of a clean store with prompt friendly service. However, these are subjective measures and so it is hard to really measure them exactly. What is a "5" in clean? It might vary based on who was doing the inspecting. What is a "5" in service? Scoop speed? Length of line? Duration of the smile? You get the idea. It is subjective and so it is hard to define the criteria for "good service" and "clean." However, if the store is clean and has good service, it is likely to improve business so just because it is hard, does not mean it would help to measure it and encourage it. It is just hard to define and measure consistently.

    Profit measures are easier to measure as the dollar amounts are known and countable. Any it doesn't change based on who is doing the measuring (like a measure of "clean" does). Another advantage is that it is directly related to the main goal of the store: cash flow. The downside is that it is a lagging measure. That is, it results from a range of activities so that when it is good or bad, it requires diagnosing the reason. Sometimes it is from the economy or weather or season rather than the ...

    Solution Summary

    Your discussion is 738 words and two references and gives bullet list of advantages and disadvantages of the four common transfer price methods (cost, market, negotiated and set centrally). The advantages of both performance methods as well as the drawbacks are discussed and an idea to blend the two is given.