Dindal is a manufacturer of air conditioners for the North American market. It sells the Dindal brand through independent agents and produces units with the brand names of various retailers. Although largely an assembler of purchased parts at this time, Dindal does produce its own condensers. It also sells con- densers to other manufacturers of air conditioners. Consequently, it has two operating divisions: condenser manufacturing and air conditioner assembly. At one time Dindal 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 condenser. The switching to purchased parts was done gradually. Dindal wanted to make only those parts for which it had distinct competitive and strategic advantages. The Dindal condensers and air conditioners are durable, efficient, and competitively priced. These product characteristics have been crucial for success, and they require efficient labour, competitively priced and high-quality parts, mistake-free assembly, minimal inventories, and on-time deliveries. Also, to remain successful the condenser division has an active research and product development team that is responsible for improving the products and manufac- turing 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 achieving improved results. At this year's meeting, the directors were again unhappy with the per- formance 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 for regularly produced non-financial information on the performance of both divisions. 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 Dindal and its divisions has been positive and, over the last few years, largely comparable to the attached finan- cial statements (shown in Exhibit 1) for the recent year. Each division reports as an investment centre, and the condenser division is clearly superior. Perhaps because of this unevenness of profitability, there is a dispute between the gen- eral managers of the two divisions. The condenser 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 mar- ket price for long-term contracts to other assemblers of air conditioners. For the latest year, Dindal sold 110,000 condensers to outside customers, while the assembly division purchased 90,000 condensers. The assembly division sold 50,000 Dindal air conditioners, and 40,000 under other brand names. The bonus set by the directors last year was equal to 30 percent of a general man- ager's salary if their division's ROI exceeded 18 percent. The ROI is operating income divided by divisional investment. It was 35 percent for the condenser division for the latest year, but only 9.5 percent for the assembly division. Required As the president, use the case approach and prepare a report to the board of directors that addresses and resolves their concerns. Exhibit 1 DINDAL AIR CONDITIONERS CONDENSER DIVISION Operating Statement For the Year Ending December 31 (in thousands of dollars) REVENUE Outside sales Assembly division $27,500 22.500 50,000 21,000 3,000 3,000 27,000 VARIABLE EXPENSES Manufacturing Administration Selling FIXED EXPENSES Manufacturing Selling, administration Research and development OPERATING INCOME 7,000 3,000 2,500 12,500 $10.500 Division Balance Sheet Working capital Net fixed assets Investment $ 4,000 26.000 $30,000 DINDAL AIR CONDITIONERS ASSEMBLY DIVISION Operating Statement For the Year Ending December 31 (in thousands of dollars) REVENUE Dindal brand Other brands $30,000 22.000 52,000 31.000 21,000 COST OF GOODS SOLD GROSS MARGIN ADMINISTRATIVE EXPENSES SELLING EXPENSES OPERATING INCOME Division Balance Sheet Working capital Net fixed assets Investment 7,000 10,000 $ 4,000 $ 6,000 36,000 $42.000 Dindal is a manufacturer of air conditioners for the North American market. It sells the Dindal brand through independent agents and produces units with the brand names of various retailers. Although largely an assembler of purchased parts at this time, Dindal does produce its own condensers. It also sells con- densers to other manufacturers of air conditioners. Consequently, it has two operating divisions: condenser manufacturing and air conditioner assembly. At one time Dindal 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 condenser. The switching to purchased parts was done gradually. Dindal wanted to make only those parts for which it had distinct competitive and strategic advantages. The Dindal condensers and air conditioners are durable, efficient, and competitively priced. These product characteristics have been crucial for success, and they require efficient labour, competitively priced and high-quality parts, mistake-free assembly, minimal inventories, and on-time deliveries. Also, to remain successful the condenser division has an active research and product development team that is responsible for improving the products and manufac- turing 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 achieving improved results. At this year's meeting, the directors were again unhappy with the per- formance 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 for regularly produced non-financial information on the performance of both divisions. 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 Dindal and its divisions has been positive and, over the last few years, largely comparable to the attached finan- cial statements (shown in Exhibit 1) for the recent year. Each division reports as an investment centre, and the condenser division is clearly superior. Perhaps because of this unevenness of profitability, there is a dispute between the gen- eral managers of the two divisions. The condenser 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 mar- ket price for long-term contracts to other assemblers of air conditioners. For the latest year, Dindal sold 110,000 condensers to outside customers, while the assembly division purchased 90,000 condensers. The assembly division sold 50,000 Dindal air conditioners, and 40,000 under other brand names. The bonus set by the directors last year was equal to 30 percent of a general man- ager's salary if their division's ROI exceeded 18 percent. The ROI is operating income divided by divisional investment. It was 35 percent for the condenser division for the latest year, but only 9.5 percent for the assembly division. Required As the president, use the case approach and prepare a report to the board of directors that addresses and resolves their concerns. Exhibit 1 DINDAL AIR CONDITIONERS CONDENSER DIVISION Operating Statement For the Year Ending December 31 (in thousands of dollars) REVENUE Outside sales Assembly division $27,500 22.500 50,000 21,000 3,000 3,000 27,000 VARIABLE EXPENSES Manufacturing Administration Selling FIXED EXPENSES Manufacturing Selling, administration Research and development OPERATING INCOME 7,000 3,000 2,500 12,500 $10.500 Division Balance Sheet Working capital Net fixed assets Investment $ 4,000 26.000 $30,000 DINDAL AIR CONDITIONERS ASSEMBLY DIVISION Operating Statement For the Year Ending December 31 (in thousands of dollars) REVENUE Dindal brand Other brands $30,000 22.000 52,000 31.000 21,000 COST OF GOODS SOLD GROSS MARGIN ADMINISTRATIVE EXPENSES SELLING EXPENSES OPERATING INCOME Division Balance Sheet Working capital Net fixed assets Investment 7,000 10,000 $ 4,000 $ 6,000 36,000 $42.000