A large electronics company is organized into mainly profit-center divisions. Th

Question

A large electronics company is organized into mainly profit-center divisions. The components division and the consumer electronics division are profit-center divisions of the company. The components division produces individual chips and other electronic components. The components division supplies outside vendors in addition to the consumer electronics division. The consumer electronics division assembles components into devices sold to consumers.

Recently, there has been a dispute between the two divisions over a particular chip used in the production of a smart phone. The consumer electronics division argues that they are being overcharged because the transfer price they are being charged is significantly higher than the marginal cost of producing the chip. The transfer price includes a charge to recover fixed overhead costs as well as a mark-up to provide a profit margin for the components division. The components division argues that they need to charge a price commensurate with all their costs and that allows them to earn a reasonable profit for their output. Compounding the issue, the particular chip under dispute is available from other vendors at a price less than the transfer price but higher than the marginal cost of production.

You have been hired to suggest a solution to this problem. What would you recommend the electronics company do?

Explanation / Answer

Here both the divisions are part of the large electronics company, so any dispute between them will affect the profit earned by the company. Both the divisions are profit-centric here, so they will act to increase their own profitability irrespective of the other division

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