Problem: Transfer Pricing and Breakeven Profitability
International Consulting Services Group (ICS) consists of the following four independent groups (a) Management Consulting (b) Risk Assessment Consulting (c) Securities Trading and (d) insurance and Liability Underwriting. The company’s consulting revenues comes mainly from small businesses with annual revenues in the $10 - $20 million range.
The groups develop their own clientele but often require services from groups within the company to fulfill the needs of their clients. For example, the Management Consulting group might discover that some of its clients need risk assessment analysis followed by recommendations on appropriate levels of insurance and liability coverage. Instead of going outside ICS to secure these services, the management Consulting group would first attempt to have its sister groups bid for the service. The corporate policy allows each group to operate as a profit center with full autonomy over its operational decisions.
The following is representative of the pricing and the cost information for each group:
Per Consulting Hour
Group Billing Variable Total Fixed
Rate Cost Cost
Management Consulting $130 $37.70 $106,145
Risk Assessment Consulting $175 $56.00 $168,000
Securities Trading $100 $25.00 $67,500
Insurance and Liability Underwriting $190 $76.00 $182,400
Required
(Question 1) Determine the net profit that each group makes annually if each bills on the average 10,000 consulting hours per year. What is the breakeven point in consulting hours for each group?
(Question 2) The Insurance and Liability Underwriting Group (ILUG) is fully occupied with its own outside clientele. If the Management Consulting Group wants to secure services from ILUG, at what price per hour should ILUG bill the Management Consulting Group? Provide reasons) for your answer.
(Question 3) Are there any conditions under which the ILUG should bill the Management Consulting Group at less than this price?
(Question 4) The Management Consulting Group has used about 1,000 hours per quarter of the Risk Assessment Consulting Group’s time (RACG)at $175 per hour. If the manager of RACG wants to raise the rate by 15%, should the corporate management force the Management Consulting Group to pay the increased rate to keep the business in house? Support your answer with reasons.
(Question 5) If the RACG is operating at 80% capacity i.e. 8,000 hours per year, and receives a proposal from the Securities Trading Group to purchase 1,200 hours of its excess capacity at $75 per hour, should RACG accept the offer? Support your answer with reasons and calculations.