Butler Inc. is a manufacturer of commercial appliances for the North American market. It sells the Butler Inc. brand through independent agents and produces units with the brand names of various retailers. Although largely an assembler of purchased parts at this time, Butler Inc. does produce its own motors. It also sells motors to other manufacturers of appliances. Consequently, it has two oper­ating divisions, motor manufacturing and assembly.

Once Butler Inc. produced nearly all of its own components. However, over the last 20 years, it has gradually switched from making components to buying them. Now it makes only a single compo­nent, the motor. The switching to purchased parts was done gradually. They wanted to make only those parts for which it had distinct competi­tive and strategic advantages.

The Butler Inc. motors and appliances are durable, efficient, and competitively priced. These product characteristics have been crucial for success, and they require efficient labor, competi­tively priced and high-quality parts, mistake-free assembly, minimal inventories, and on-time deliveries. Also, to remain successful the motor division has an active research and product devel­opment team that is responsible for improving the products and manufacturing processes.

Once a year, the board of directors reviews divisional performance and assesses the company's future opportunities and threats. This is an infor­mal occasion, but the directors — especially those with significant share holdings — are very serious about understanding the operations and obtaining improved results. At this year's meeting, the dir­ectors were again unhappy with the performance of the assembly division. That division's general manager explained the poor performance as a consequence of the transfer price. The directors asked for a justification of the transfer price method and recommendations for a balanced scorecard for the company. You, as the president to whom the general managers report, have taken it upon yourself to resolve the board's concerns.

You first recognize that profitability of Butler Inc. and its divisions has been positive and, over the last few years, largely comparable to the attached financial statements (shown in Exhibit 1 on next page) for the recent year. Each division reports as an investment centre, and the motor division is clearly superior. Perhaps because of the difference in profitability, there is a dispute between the general managers of the two divisions. The motor general manager wants a market-based transfer price. The assembly general manager wants it to be actual cost of goods sold plus 50 percent.

In reviewing the transfer price, you note that it is set at the average market price for long-term contracts to other assemblers of appliances. For the latest year, Butler Inc. sold 110,000 motors to outside customers, while the assem­bly division purchased 90,000 motors. The motor division did not incur any selling expenses on units sold to the assembly division. The motor division manager believes they will only be able to sell 110,000 units externally each year for the next three years. The assembly division sold 50,000 Butler Inc. appliances, and 40,000 under other brand names. The bonus set by the directors last year was equal to 30 percent of a general manager's salary if their division's ROI exceeded 18 percent. The ROI is operating income divided by divisional investment.

Required:

For the president, use the case approach and prepare a report to the board of directors, which addresses and resolves their concerns. Be as detailed and precise as possible. Full explanation is required.

Exhibit 1

Motor Division Operating Statement For the year ended December 31 (in thousands of dollars)			Assembly Division Operating Statement For the year ended December 31 (in thousands of dollars)
Revenue			Revenue
Outside sales		$34,375	Butler Inc. brand	37,500
Assembly division		28,125	Other brands	27,500
		62,500		65,000
Variable expenses
Manufacturing	26,250		Cost of goods sold	38,750
Administration	3,750		Gross Margin	26,250
Selling	3,750	33,750
Fixed Expenses			Administrative expenses	8,750
Manufacturing	8,750		Selling expenses	12,500
Selling, Administration	3,750		Operating Income	5,000
Research and development	3,125	15,625
Operating Income		13,125
Division Balance Sheet			Division Balance Sheet
Working capital		5,000	Working capital	7,500
Net fixed assets		32,500	Net fixed assets	45,000
Investment		37,500	Investment	52,500