LeBlanc Inc. has always been the sole supplier of CAV, a raw material needed by Anderson Company. LeBlanc has steadily increased the price of CAV to $100 per pound. Badly in need of a second source, Anderson asked Magnussen to begin producing CAV and thus to compete with LeBlanc. Anderson and Magnussen are managed as investment centers, and both are divisions of the Clarkson Company.
Magnussen knew that if it constructed a new, specialized facility, it could make and sell CAV by incurring variable costs totaling $30 per pound and could be profitable in the long run by selling CAV at any price above $50 per pound. At a cost of $100,000,000, Magnussen constructed a facility to make CAV. The facility cannot be used for any other purpose and has no determinable resale value. The facility has been completed, and its entire $100,000,000 cost has been paid. It is the largest single investment ever made in any division of Clarkson Company.
Magnussen decided to delay production of CAV when all the orders from potential buyers of CAV were canceled in the week before the new facility was scheduled to begin production. The reason for all the cancellations was that LeBlanc announced a reduction of its price to $20 per pound effective immediately.
At the next executive meeting at Clarkson headquarters, the general manager of Anderson Division explained, "Of course we have to buy CAV at the lowest price available to us, or else we can't be competitive. That's because all our competitors are now getting CAV at $20 and are slashing the prices on their final products, so we'll be out of business if we have to pay more than $20 for CAV." Magnussen Division's general manager replied, "There's no way we can price CAV below $30 in the short run, nor below $50 in the long run."
Required:
(1) What is the short-run, per-pound advantage or disadvantage to Clarkson if Anderson Division buys CAV from the outside supplier, LeBlanc, for $20 per pound rather than from Magnussen Division for $50 per pound?
(2) If Anderson indicates it will buy CAV from LeBlanc at $20 per pound, does Clarkson's top management have any short-run incentive to intervene in the decision and direct Anderson Division to buy from Magnussen Division?
For the next two parts, suppose LeBlanc changes its per-pound price to $42 and Magnussen sets its per-pound price at $50.
(3) What is the per-pound advantage or disadvantage to Clarkson if Anderson buys CAV from LeBlanc for $42 rather than from Magnussen for $50?
(4) If Anderson indicates it will buy CAV from LeBlanc at $42, what short-run incentive is there for Clarkson's top management to intervene in the decision?
For the next two parts, suppose Clarkson's top management ended the meeting at headquarters by directing the management teams of Anderson and Magnussen Divisions to " . . . remain in this conference room until you have agreed in writing to some arrangement by which CAV will be produced by Magnussen and transferred to Anderson. The arrangement must be acceptable to both of you, and it must not change your divisions' status as investment centers. Catered meals, clean clothing, and anything else you need- except intervention or subsidy from us-will be provided to you as needed. And keep one thing clearly in mind: if necessary, all of you can be replaced."
(5) In what sense(s) has Clarkson's top management reduced the division's decision-making autonomy?
(6) In what sense(s) has Clarkson's top management preserved the divisions' decision making autonomy?