Case Analysis: Zumwald AG

In August 2015, a pricing dispute arose between the managers of some of the divisions of Zumwald AG. Mr Rolf Fettinger, the company's managing director, had to decide whether to intervene in the dispute.

The Company

Zumwald AG, headquartered in Germany, produced and sold a variety of medical imaging systems. The company was organized into six operating divisions, with total revenues exceeding $3 billion.

Zumwald managers ran the company on a highly decentralized basis. The managers of each division were allowed considerable autonomy if their performances were at least on plan. Performance was evaluated, and management bonuses were assigned, based on each division's achievement of budgeted targets for return on invested capital (ROIC) and sales growth. Even though the company was partly vertically integrated, division managers were allowed to source their components from external suppliers if they so choose.

Involved in the dispute mentioned above were three of the company's divisions - the Imaging Systems Division (ISD), the Heidelberg Division (Heidelberg), and the Electronic Components Division (ECD).

ISD sold complex ultrasound and MRI systems. These systems were expensive, typically selling for $500,000 to $1,000,000.

Heidelberg sold high-resolution monitors, graphics controllers and display systems. Approximately half of its sales were made to outside customers. ISD was one of Heidelberg's major inside customers.

ECD sold application-specific integrated circuits and subassemblies. ECD was originally established as a captive supplier to other Zumwald divisions, but in the last decade its managers had found external markets for some of the division's products. Because of this, ECD's managers were given profit center responsibility.

The dispute

ISD had recently designed a new ultrasound imaging system called X73. Hopes were high for X73. The new system offered users advantages in processing speed and cost, and it took up less space. Heidelberg engineers participated in the design of X73 but Heidelberg was compensated for the full cost of the time its employees spent on the project.

After the specifications were set, ISD managers solicited bids for the materials needed to produce X73 components. Heidelberg was asked to bid to supply the displays needed for the production of the X73 system. So were two outside companies. One was Bogardus NV, a Dutch company with a reputation for producing high-quality products. Bogardus had been a long-time supplier to Zumwald, but it had never before supplied display units and systems to any Zumwald division. Display Technologies Plc, was a British company that had recently entered the market and was known to be pricing its products aggressively in order to buy market share. The quotes that ISD received were as follows:

Supplier	Cost per X73 system ($)
Heidelberg Division	140,000
Bogardus NV	120,500
Display Technologies	100,500

After discussing the bids with his management team, Conrad Bauer, ISD's managing director, announced that ISD would be buying its display systems from Display Technologies Plc. Paul Halperin, Heidelberg's general manager, was livid. He immediately complained to Mr. Bauer, but when he did not get his desired response, he took his complaint to Rolf Fettinger Zumwald's managing director. Mr. Fettinge agreed to look into the situation.

A meeting was called to try to resolve the dispute. Mr. Halperin asked Christina Schonberg, ECD's GM, to attend this meeting to support his case. If Heidelberg got this order from ISD, it would buy all its electronic components from ECD.

After this meeting, Mr.Bauer immediately showed his anger:

Paul wants to charge his standard markup for these displays. I can't afford to pay it. I'm trying to sell a new product (X73) in a very competitive market. How can I show a decent ROIC if I have to pay a price for a major component that is way above market? I can't pass on these costs to my customers. Paul should really want this business. I know things have been relatively slow for him. But all he does is quote list prices and then complain when I do what is best for my division.

We're wasting our time here. Let's stop fighting amongst ourselves and instead spend our time figuring out how to survive in these difficult business conditions.

Mr. Fettinger asked Mr. Halperin why he couldn't match Display Technologies' price. Paul replied as follows:

Conrad is asking me to shave my price down to below cost. If we start pricing our jobs this way, it won't be long before we're out of business. We need to price our products so that we earn a fair return on our investment. You demand that of us; our plan is put together on that basis; and I have been pleading with my sales staff not to offer deals that will kill our margins. Conrad is forgetting that my engineers helped him design X73, and we provided that help with no mark-up over our costs. Further, you can easily see that Zumwald is better off if we supply the display systems for this new product. The situation here is clear. If Conrad doesn't want to be a team player, then you must order him to source internally! That decision is in the best interest of all of us.

In the ensuing discussion, the following facts came out:

1. ISD's tentative target price for the X73 system was 340,000. ¹(see footnote below)
2. Heidelberg's standard manufacturing cost (material, labour, and overhead) for each display system was $105,000. When asked, Mr. Halpering estimated that the variable portion of his total cost was only $50,000. He treated Heidelberg's labor costs as fixed because German laws did not allow him to lay off employees without incurring expenses that were "prohibitively" high.
3. Because of the global business slowdown, the production lines at Heidelberg that would produce the systems in question were operating at approximately 70% capacity. In the preceding year, monthly production had ranged from 60% to 90% of total capacity.
4. Heidelberg's costs included $21,600 in electronic subassemblies to be supplied by ECD. ECD's full manufacturing costs for the components included in each system were approximately $18,000, of which approximately half were out-of-pocket costs. ECD's standard policy was to price its products internally at full manufacturing costs plus 20%. The markup was intended to give ECD an incentive to supply its product internally. ECD was currently operating at 90% capacity.

¹The cost of the other components that go into X73 is $72,000. ISD's conversion cost for the X73 is $144,000, of which $117,000 is fixed.

Near the end of the meeting, Mr. Bauer reminded everybody of the company's policy of freedom of sourcing. He pointed out that this was not such a big deal, as the volume of business derived form this new product was only a small fraction (less than 5%) of the total revenues for each of the divisions involved, at least for the first few years. And he also did not like the potential precedent of his being forced to source internally because it could adversely affect his ability to get thoughtful quotes from outside suppliers in the future.

The decision

As he adjourned the meeting, Mr. Fettinger promised to consider all the points of view that had been expressed and to provide a speedy judgement. He wondered if there was a viable compromise of it, instead, there were some management principles involved here that should be considered inviolate (intact or undamaged).

Questions: Students should provide both qualitative and quantitative analysis.

1. What sourcing decision for the X73 materials is in the best interest of: (15 marks)

a. The Imaging Systems Division?

b. The Heidelberg Division?

c. The Electronic Components Division?

d. Zumwald AG?

2. What should Mr. Fettinger do? (5 marks)