Arial Production makes movies and music videos. It has three divisions: Filming, Sound, and Editing. Sam Norwell, president and CEO of Arial Production, feels it is best to keep his divisions independent and lean, so he allows each division to go after its own business. Sound does not have to cooperate with Filming, nor Editing with Sound or Filming.

Each division is freestanding and held accountable for its ROI. Over the last year, the three divisions have worked together less and less. While Sam has okayed these choices, he is beginning to feel that he is losing some economies of scale by not having the divisions work together more closely.

The question is: How does he make this happen?

Sam decides to hold a meeting with the heads of the three divisions to see if they can come up with some way to make it in everyone’s best interest to work together on projects. Bruce Walker, head of Filming, is first to arrive. He immediately begins lobbying Sam to make Sound and Editing work with him. Filming is having to purchase these services from the outside and the market is tight right now—everyone is very busy so the prices for these services keep going up. Filming’s ROI is suffering as a consequence, leading Bruce to look toward his sister divisions to help shore up the filming part of the business.

Their conversation goes like this:

Bruce: Sam, nice to see you. I was wondering about something, if you have a few minutes to chat before the meeting begins. We in Filming are getting our clocks cleaned by having to buy our sound and editing services out side the corporation. Wouldn’t it be in everyone’s best interest to work together? We’d keep the costs on a film down and keep the profits inside!

Sam: I don’t know, Bruce. I think it would be great to see the divisions working together more, but I really don’t want to interfere too directly in decision making. I like seeing everyone strive to do the best with the assets I’ve entrusted to them. With the market as busy as it is, Sound and Editing are doing very well. They probably would want to be paid the going market price for any work they do for you.

Bruce: I don’t see why they need market . If they work with us in Filming, they don’t have the same costs. We can cooperate and make the work load lighter for them. And the profits would all stay in the corporation, so everyone wins.

Sam: I’m not sure they’ll see it that way, Bruce. They are doing very well selling at market prices. If I tell them they have to work with your group at reduced prices, it’s going to directly impact their ROI, and, hence, their performance evaluation.

Bruce: Well, Sam, what if you credited their income statement at market , but allowed us to be charged only cost on internal transactions? Since the profit is a wash for the corporation, wouldn’t we be better of keeping more of the work internal?

Sam: That’s a novel idea, Bruce, but how would it be fair to the other division heads if you get the equivalent of an internal price break on basic services? You’ll look better than you would if you had to pay market .

Bruce: But we need to work together, Sam. It only makes sense to put our focus on making money on our movies and music videos, not on our basic services. Isn’t there some other way you can structure our incentive system so we still strive to do our best but we have the incentive to work together?

Sam: Let ’s see what we come up with during the meeting, Bruce. I’ll float a few ideas and we’ll see if there isn’t something that can be done to keep more of our internal services available for Filming. My guess is you’re going to have to pay close to market , though, perhaps with a discount for not having to pay commissions to salespeople and other marketing cost reductions. Let ’s see what can be done.

REQUIRED:

a. What do you think about Bruce’s plan to use market prices for the supplying divisions and cost for the using division (Filming)? What are the pros and cons of this approach?

b. Are there other incentives or measurements that might lead to more cooperation between the divisions? Please try to be specific.

c. Is the corporation better off as it is currently run or would it be better off if the divisions worked together? Please explain your answer.