Assessment of Cost and Contribution Margin

Discuss about the Management Control Systems Performance Measurement.

To,

Mr Fettinger

Zumawald AG

Subject: Discussion relating to ascertainment of best sourcing of X73 materials

Assessment of Sourcing Decision Best for X73 materials is in the best interest of

X73 can be proven highly profitable for ISD, and the same can be accessed from below information management:

Revenue for X73 system on individual system                                                          €340000

Non-Display material cost                                          €72000

Variable conversion cost                                             €26300                          (€98300)

Contribution prior to display cost                                                                               €241700

Fixed conversion cost                                                                                                 €117700

Gross margin before display cost                                                                                €124000

ISD contribution in case X73 is sourced from Display technology                           €141200

ISD contribution in case it is sourced at Heidelberg price at €140000                      €101700

It can be accessed from above calculations that amount is to be paid higher in case Heidelberg’s option is availed in order to source X73. The extra cost paid in case internal sourcing option is availed could provide an additional contribution to Heidelberg or ECD or to both. Further another phase is that Heidelberg should reduce the price in order to get internal business. In case Heidelberg reduces the price, it might also assist ECD to reduce the mark up by 25%. Thus the same can be said as the profits are moving from one department to another. It is being pleaded by the manager of Heidelberg than it will not be possible to reduce the prices as he requires full margin in order to attain objectives as per pre-determined plan. It can further be accessed that possibility exist that Heidelberg might lose some of its business in order to attain high profits (Merchant and Van der Stede, 2007). The decision is being taken even in case they are operating below-capacity condition.

ISD Division of Zumwald is sourcing display for X73 system. In present case three quotes are available to the company in the following manner:

Display Technology Plc                                  €100500

Bogardus NV                                                  €120500

Zumwald’s Hiedelrberg Division                   €140000

The decision is to be taken that which quote should be taken. No doubt that as Display technology Plc has the lowest quote, thus the same option will be financially more viable. But the other issues which are to be considered as quality assurance as Display Technology in new to the market, the possibility might exist that it does not provide quality as high as Bogardus NV and Zumwald’s Hiedelrberg Division. The probability also exists that ISD has to incur additional cost to switch to other suppliers in future. Thus the final decision was taken that quote from Display Technology Plc will be applied.

ISD Division of Zumwald

The other perspective which could be assessed that Heidelberg quote is better for Zumwald as it comprises contribution for both Heidelberg and for       ECD, company’s electronic subassembly supplier. The quote provided by Hiedelberg Division is € 140000 and variable cost relating to same is € 50000; thus the net contribution is € 90000. Fixed costs will not be considered as it is not working at its full capacity. Further a contribution of € 12600 for developing ECD to build the quote. The same has been ascertained after reducing variable cost € 9000 from internal price € 21600, i.e. € 12600.

The advantage in case quote of display technology has been applied rather than of Heidelberg is € 39500. It is comparatively less in comparison to the total contribution of Zumwald’s division €102600 and same would be foregone in case Heidelberg does not attain the order. The difference between both the options is €63100. Financially Zumwald is more appropriate option in case ISD sources displays internally. The same can be assessed in the following manner:

Cash Outflow in case option of Display Technologies is availed                               €100500

Cash Outflow in case it is being sourced internally

Variable cost of Heidelberg excluding ECD- suppliers: €28400

ECD variable cost                                                                   : €9000               €37400

Difference between the above two options                                                                €63100

The specified division provided components to Heidelberg for € 21600 and around € 9000 variable cost. Thus the contribution margin of ECD will be €12600 in case of the ISD purchases from it. However, as it is operating at 90% capacity, it might not be feasible for ECD to attain the present project. Further, in case, it accepts the project it might not be feasible to attain the project as it is operating at 90%. Thus in case, it does not accept the project a trade-off might be needed in order to ascertain the more appropriate project.

The manager of Zumwald, Paul Bauer assesses that he has been requesting with the sales person who hasn’t reduced prices and he required full margin business in order to attain his plan successfully. Thus this decision refer that Mr Bauer wanted to acknowledge the price competition in the present segment of the market. The same might also lead to ignorance of marginal cost and contribution concept.

The same can be understood with hypothetical figures:

Policy of price             Price                Volume           Contribution / Unit     Total Contribution

Importance of considering organization goals

Full Price                     140                  70                                90                                6300

Cut Price                     100                  100                              50                                5000

In present case due to market conditions and customer price sensitivity, the manager should give up some business in order to attain higher margins; even though they are working in below capacity. It is the responsibility of a manager to assess the prospect of its own division along with the prospect of whole organization (Merchant and Van der Stede, 2007). In case the decision is to be take in to be taken in favour of a part of an organization or in favour of the whole organization then priority should be provided to a profit of the organization. Managers are believed to be one of the main variants behind the success of the organization. As, they are liable for their own performance along with the performance of other employees or whole management. They are required to think twice before taking any decision as the same have a significant impact on the other employees as well as the whole organization. In any situation, if the inappropriate decision is to take than it is possible that whole organization might suffer loss due to same. Giving priority to one department or a division and neglecting the main goal of organization for same might lead to increase in issues and conflicts within management (Merchant and Van der Stede, 2007). The main goal of the organization should never be underrated in front of individual unit goal. The reason behind same is it is not possible to attain the main goal of the organization through giving more priority to individual unit goals in case the same is contradict each other. An efficient manager is the one who considers both the prospects, i.e. from individual unit basis and overall organization basis. In case he neglects any of the perspectives he will not be able to accomplish its objective in an appropriate manner. The same prospects should be considered by the manager of Zumwald in order to make the appropriate decision.

Mr Fettinger required analyzing the whole situation in detail manner as managing director and then attempting to take a decision in the interest of Zumwald. The reason behind same is that in case transfer pricing leads to enhancement in the existing level of profit within the company than same should be considered and the decision should be taken to move for same. In the present case, the manager is not working as an effective leader of whole organization as he is concerned only with the profits relating to his division. Thus Mr Fettinger should assess the scenario and provide guidance with the manager of ISD to source internally as the same is more profitable for the whole organization.

It can be assessed in the present case that managers are making rational arguments and not emphasizing on the overall organization rather than focus is made on individual department. Thus, Mr Fettinger requires operating highly decentralized fashion in order to discontinue the present manner of working as well as decision making. In case Mr Fettinger gets involved in the case than he will have to consider all the perspectives and resolve other relating issues too. Decentralization leads to the risk of sub-optimization. Further transfer policy can be developed in present case so that better transfer pricing decision could be made (Merchant and Van der Stede, 2007). The policy should cover internal transfer in order to ascertain best outside market price as well as cost and normal mark up. Developing of policies could not be said as assurance of resolving issues of succeeding. The reason behind same is it only provides the manner of working or the way one should follow to attain the objectives. In same manner, Mr Fettinger will require developing the policy relating to transfer price, but the same would not assure that it will resolve the issue. All the perspectives are required to be assessed in detail by Mr Fettinger so that he could be able to take an appropriate decision regarding sourcing of X73

References

Merchant, K. A., & Van der Stede, W. A. (2007). Management control systems: performance measurement, evaluation and incentives. Pearson Education.