Bakery Products International,1 a family-owned company headquartered in Belgium, develops and produces a wide range of innovative high-quality bakery ingredients for artisanal bakeries, industrial bakeries, and supermarkets around the world. At the outset, the company worked with external distributors to sell its products. However, over the years, Bakery Products International has built a strong global presence and established 40 company-owned subsidiaries around the world responsible for selling the company's products.

Since its foundation after World War II, the company has developed and launched several innovative bread improvers that offered bakeries the opportunity to give their bread and pastries an authentic taste. Bread improvers are enzymes and emulsifiers that provide specific handling, baking and taste characteristics to the bakery product (e.g., dough- strengthening properties, gluten reduction, minimizing the risk of sticky dough, enhanced handling of the dough, and improved volume and crumb structure of the end product). In an attempt to escape the risk of future commoditization of the bread improvers market, Bakery Products International also offers special bakery mixes (also called pre-mixes) to its customers These are commercially-prepared mixtures of ingredients, ready to produce a certain quantity of a certain end product. Bakery mixes are obtained by adding additional ingredients (e.g., salt, specific types of flour, and vitamins) to the bread improvers in order to create extra value for the customer in terms of more convenience and assured quality and consistency of the end product. When baking, bakers can use these bakery mixes rather than creating bread and pastries from scratch. The company's wide offering of bakery mixes allows bakeries to make and sell a wider range of bread products, enabling them to better respond to changing customer demands (such as the increasing demand for healthier products), with an optimal use of flour, shorter production times, and less laborious material handling and storage. As such, the offered bakery mixes enable Bakery Products International to further differentiate the added value delivered to their customers, which creates an enhanced customer experience and a higher product and customer loyalty in the mature bread improvers market.

In the bread improvers market, Bakery Products International faces two types of competitors: on the one hand, the ''local heroes" (i.e., country-specific producers and distributors) and, on the other hand, ''major multinationals" (i.e., bigger indus- trial conglomerates) that operate in multiple countries. Some of these ''major multinationals" are niche players like Bakery Products International (e.g., Hollandia, a Dutch family-owned rival), while others are big food conglomerates that do not limit their operations to the bakery market.

The company's dual goal is to create shareholder value and to be the worldwide market leader in bread improvers. A differentiated quality focus based on patented bread improvers and adaptation to local taste has proven to be a very successful strategy in achieving this goal, especially in the artisanal market. In this segment of the market, the company gained a leading market position in different countries thanks to its product leadership strategy. The bread improvers helped artisanal bakeries to differentiate the quality and the taste of their bread and pastries. Till now, the bakers have been willing to pay a high price premium for the products and the price sensitivity in the market has been low. However, during the last five years, the market of artisanal bakeries in some countries has started to decline. To ensure future profitable growth, the company still has an opportunity to build market share in the growing segment of industrial customers, i.e., industrial bakeries and supermarkets. In this segment, till now, the company could only gain a limited market share. The industrial market has a limited number of large customers, buying large volumes of bread improvers at price levels much lower than in the artisanal market. In this market, price sensitivity is very high and ''good enough" quality is the standard.

1.2. Responsibility center structure and transfer pricing system

The parent company takes care of manufacturing, R&D and corporate overhead services, and is responsible for sales in Belgium. It also owns 40 subsidiaries, who are responsible for selling and marketing the company's products in their own countries. The subsidiaries are organized as separate legal entities and managed as profit centers. Subsidiaries are divisions led by country general managers, who are responsible for the EBIT (Earnings Before Interest and Taxes) of their division. The country general managers' yearly bonus depends on the achievement of their EBIT objective.

The products (e.g., bread improvers and bakery mixes) sold by the subsidiaries in the different countries are produced by the parent company in Belgium. All internal product deliveries to the subsidiaries are invoiced by the parent company based on a standard manufacturing cost plus transfer price. In determining the selling price charged to the end customer, the sub- sidiaries can add a local profit margin to the transfer price, taking into account their subsidiary-specific costs for freight and duties.

The transfer price is determined as follows: standard manufacturing cost + a profit margin of 40%. The standard manu- facturing cost is a full cost and includes production costs and corporate manufacturing overhead costs. The level of the profit margin (40%) was set at the time of the introduction of the profit center structure. At that time, the company was positioned in the market as first mover and quality leader, and price sensitivity of its products was very low. For example, Crusty, the most innovative bread improver product, was in high demand in the market and bakeries were willing to pay a high price for it. Given the current standard cost of 1.00 EUR per kilogram, the internal transfer price for this product was 1.40 EUR per kilogram.

In determining the internal transfer price, the company's top management felt it was appropriate and fair to apply such a high profit mark-up, because they were convinced that the profitability of their bread improver business was mainly deter- mined by the powerful innovation and R&D capability of the parent company and was less due to the sales efforts of the sales divisions. They also believed that applying high internal transfer prices would stimulate the sales representatives and divi- sion managers in the countries to ask high prices from their customers and to minimize discounts. This pricing strategy was believed to be consistent with their differentiated market positioning.

1.3. Changing competitive landscape

A few years ago, the competitive landscape gradually changed. New competitors entered the market and rivalry among competitors also increased, which resulted in an enhanced pressure on prices. These new entrants focused on the growing segment of industrial customers, i.e., industrial bakeries and supermarkets. In contrast to artisanal bakeries, these customers had a professional procurement department, which exercised strong negotiation power on their suppliers, applied uncompromising price negotiations and issued large tenders. Consequently, price levels of industrial customers were significantly lower than the prices paid by artisanal bakeries. In many countries, general managers were facing market prices in the indus- trial market that were even below the internal transfer price. For example, many industrial bakeries negotiated the selling price of the Crusty product down to 1.15 EUR, which was lower than the transfer price of 1.40 EUR, charged by the parent company. As a reaction to the unattractive market prices in the industrial market, country general managers mainly concen- trated their sales efforts on the artisanal market, because this segment was the most profitable for them. Thanks to these sales efforts, the company had maintained market leadership in the artisanal market segment. However, owing to the low price levels in the industrial market, country managers were reluctant to invest sales efforts in this market and missed large-volume orders because of uncompetitive pricing. Consequently, the overall market share in the industrial market remained very low.

In the following months, general managers from all over the world discussed these changing market conditions in several meetings. In October, a corporate strategy review meeting was organized. Next, there was also a performance review meet- ing in April of the following year.

1.4. The October strategy review meeting

Given the changing market environment, the company's top management decided to organize a corporate strategy review meeting in October. All country general managers attended this meeting. During the strategy review meeting, they discussed in detail all the emerging market opportunities and threats and their consequences for the corporate strategy. The recently hired VP Sales, who came from a large branded company, confirmed the company's ambition to become the undisputed mar- ket leader in all market segments, through sustainable profitable growth. Key strategic objectives were not only to defend market leadership in the artisanal market, but also to significantly increase market share in the industrial market and become an important player in this segment. To achieve this objective in the industrial market, country general managers were asked to invest in intensified sales efforts focused on targeted prospects, build long-term relationships with large accounts, increase the number of different products sold per customer, deliver excellent customer service, respond quickly to individual customer demands, and market more strongly the company's differentiated quality advantage.

1.5. The April performance review meeting

In April, all country general managers were again invited to a performance review meeting, during which they had to report on the progress they had made regarding the achievement of the strategic objectives discussed in October of the pre- vious year. During the meeting, the CEO noticed that most of the country general managers had not initiated any strategic initiatives to build market share in the industrial market and execute the sales strategies. He was furious about this and sta- ted that this lack of initiative was unacceptable. Some country general managers explained that expanding market share in the industrial market segment conflicted with their divisional profitability objectives because the internal transfer prices were too high and unfair, due to the high upstream profit taking. The CEO replied that the transfer price system had to stay unchanged, because it was the backbone of the corporate profitability control system and the transfer prices were part of the corporate tax policies, which could not be adapted because they had been accepted by the local tax authorities. He once more argued that high upstream profit taking was appropriate and fair because the R&D efforts of the parent company were the key driver of corporate profitability.

During this performance review meeting, there was a lot of agitation and discussion among the country general man- agers. Several country general managers had a strong voice during this meeting, especially the Brazilian general manager and the Spanish general manager.

1.5.1. Brazilian entrepreneurship

Fabio Ferreira, the Brazilian general manager, found the internal transfer price discussions to be a non-issue. He fully sup- ported the corporate strategy and had worked out with his local management team a new breakthrough strategic initiative. His objective for next year was to increase market share in the industrial sector by 15%. Besides this objective, he also aimed to increase his EBIT by 10%. In order to meet these challenging performance targets, Fabio planned to source his bread impro- vers with local and cheaper suppliers. At the same time, he decided to no longer buy some of the bakery mixes internally and proposed to invest in a local production line of bakery mixes. The new sourcing policy would enable him to obtain the Crusty product at a standard full cost of 1.05 EUR per kilogram. With costs of freight and duties of 0.10 EUR per kilogram, this would mean a cost reduction of 0.45 EUR per kilogram for his division. The lower purchase price of the bread improvers and the local production line of bakery mixes would lead to a significant reduction of the cost of goods sold of the Brazilian division and a significant increase of its EBIT. During an informal meeting with the CEO, Fabio explained his ambitious plans and got the CEO's full support. The CEO praised him for his entrepreneurship and promised to finance his investment project.

1.5.2. The loyal Spanish division manager

Fernando Martinez, manager of the Spanish sales division, could also not understand why managers felt so badly about the internal transfer pricing system. Fernando was a very loyal person. He had already been working for the company for 20 years and was in fact also a minor shareholder. He strongly believed that good managers always act in the interest of the company overall. His point of view was: ''When you, as a division manager, have the opportunity to sell a large volume of Crusty at a selling price of 1.15 EUR per kilogram, you have to go for it. You know that the company as a whole still makes a profit." When the CEO asked his advice about the transfer pricing discussion, Fernando proposed to stop discussing these types of bureaucratic issues. He said: ''In this company we definitely have to strengthen our culture. We must act as ONE company. We need to make stronger sense of 'us' and stop the 'we versus them' thinking. Many managers in our organi- zation think too much in terms of 'my margin versus your margin' and should be urged to better work together on improving 'OUR margin', the total margin in the internal value chain."

During the different discussions, the CFO observed that the transfer pricing system caused serious internal tensions and a lack of strategic alignment in the organization. He proposed to call in a specialized consultant to investigate how the dys- functions could be resolved.

QUESTIONS:

1. Outline the current strategy and business model, competitive landscape and structure of Bakery Products International; and describe the current responsibility center structure and transfer pricing system in place.

2. Identify and explain the dysfunctions and tensions relating to the existing responsibility center structure and transfer pricing system.

3. What changes would you recommend to the responsibility center structure, key performance metrics and/or transfer pricing system to overcome the dysfunctions and tensions identified in question 2. Explain how your suggestions will overcome the dysfunctions and tensions.

4. The management team at Bakery Products International are interested in your thoughts in general about the key components of a robust managerial control system. They have asked that you make a short presentation (restricted to three PowerPoint slides or equivalent) regarding your views and the contemporary thinking in this area. Provide the three slides that would guide your presentation. Note: Just listing dot points on each of the tree slides would be regarded as insufficient.