Assignment Case Study: Bright White Paper Company
Bright White Paper Company manufactures various types of paper for stationery, crafts, boxes, etc. The firm operates as several independent divisions.
- The Eastern Division manufactures several types of industrial paper
- The Southern Division fabricates corrugated cardboard boxes to customers' specifications
- The Northern Division makes various kinds of craft paper
The corrugated cardboard is composed of three layers:
- The paperboard outer layer can be colored or printed to suit the customer's needs
- The middle corrugated layer gives the cardboard its dimension and structural integrity
- The lower linerboard layer helps to hold the middle layer in place
Each division at Bright White is treated as a profit center. Managers are rewarded based on divisional profits and ROI. Each manager has the option to buy material from another division or from an external supplier, and so sell internally or to an external customer. Divisions selling to other divisions within Bright White are expected to charge the prevailing market price.
This year, the Northern Division created an unusual new design for corrugated cardboard display boxes to showcase its craft papers. When the design was complete, the Northern Division asked for production bids from the Southern Division and two outside suppliers, Alpha and Beta.
If the Southern Division gets the bid, it plans to buy the materials from the Eastern Division and then print, cut, and shape the materials into the display boxes. Therefore, the Southern Division asked the Eastern Division for a price quote on the materials.
The Eastern Division is not operating at full capacity and has excess inventory. Nevertheless, it quoted the prevailing market price of $280 per thousand boxes for the materials. About 60% of that amount represents the Eastern Division's out-of-pocket costs for the materials. The rest covers overhead and profit.
Based on the quote from the Eastern Division, the Southern Division estimated that 70% of its total out-of-pocket cost of $400 per thousand boxes would come from Eastern. The other 30% would come from other out-of-pocket costs to fabricate the display boxes. With its normal markup of 20% on cost to cover overhead and profit, that brought the Southern Division's bid to $480 per thousand boxes.
The Northern Division received the following bids:
- $480 per thousand boxes from the Southern Division
- $430 per thousand boxes from Alpha Paper Products
- $432 per thousand boxes from Beta Paper Products
If Beta gets the bid, it plans to supply its own corrugated material and linerboard, but would buy the paperboard outer layer from the Eastern Division for $90 per thousand boxes, and have it printed by the Southern Division for $30 per thousand boxes. The Southern Division's out-of-pocket cost to do the printing would be $25 per thousand boxes.
Arty Crafter, the manager of the Northern Division, was concerned about the significant discrepancy in the bids, and discussed the matter with Ima Boss, the commercial vice-president at Bright White. The Southern Division was operating at less than full capacity, so it seemed odd to Ms. Boss that the Southern Division manager, R. U. Smart, would add the full 20% markup to his out-of-pocket costs to fabricate the boxes. When she asked Mr. Smart about this, he pointed out that the bid followed firm policy, and that his division could not show a profit if it made bids that failed to cover full cost. Ms. Boss decided to explore the cost structure at Bright White. She knew that costs that were variable for one division could be fixed for the firm as a whole.
In addition, she recognized that Mr. Crafter, the manager of the Northern Division, would accept Alpha's bid of $430 per thousand boxes unless she issued specific orders to accept a different bid. Alternatively, she could require the Southern Division to make a lower bid. In addition, she was aware that, although this order represents less than 5% of the volume for any division, future transactions might raise similar issues.
What should Ima Boss do?