1. National Children's Museum

"I'm outraged," said Melissa Ray, director of the Urban Life Program of the National Children's Museum.

A few weeks ago, I asked D&E (Design and Engineering Department) for a bid to build the Central Artery Exhibit of my Cities and Streets Project. The D&E bid was $7,000 more than a bid I received from a local construction firm, yet it seems Alan (the museum's director) is encouraging me to use D&E anyway. It doesn't make sense!

Background

The National Children's Museum was a medium-sized nonprofit museum. Its charter stipulated that it was to orient its activities and exhibits toward the environment, and it had been very successful in attracting a wide following of regular visitors as well as tourists to the area.

Recently, under the leadership of Alan, the new director, the museum had been organized into profit centers and Ms Ray's program had been designated as one of the programmatic profit centers. As such, she was encouraged, but not required, to "purchase" all design and construction services for her program from the museum's Design and Engineering Department, a service profit center. Both managers, as well as other profit center managers, had the possibility of earning annual bonuses based upon the profits of their profit centers.

The services of the D&D Department ranged from the construction of relatively simple display cases to the design and manufacture of rather complex exhibits. Because of the complexity of the demands made upon it, and the resulting need for a wide variety of technical skills, the D&D Department needed a rather large staff. Since the museum was too small to fully utilize its staff, the Department also sold its services to other organizations including several smaller museums in the area. At the moment, the Department's staff was not fully utilized. This was not an unusual situation.

The Central Artery Exhibit

In planning her Cities and Streets project, Ms Ray knew she needed several exhibits designed and built to rather exacting specifications. One was the Central Artery exhibit, a large-scale illustration of the environmental impact of planning an expressway underground. Her plans called for four phases of construction, showing how the environment would be affected by each phase. The exhibits had to be large enough to allow children to explore them from the inside, letting them experience as well as learn about the impact of the project.

Data

Because the exhibit was a large one, Ms. Ray had asked John Hutton, the D&D Department director, to assist her in putting together the design and engineering specifications. The two had spent several days discussing the exhibit's objectives and constraints, and Mr. Hutton had prepared some architectural and engineering drawings.

At that point Ms Ray had asked him for an estimate of the cost, and after a few days of gathering the necessary information he had provided her with a figure of $27,000. His calculations are show here:

Budget Information Prepared by the Design and Engineering Department

Materials $ 7,000

Direct Labour (1) 10,000

Variable Overhead (2) 2,000

Fixed Overhead (3) 5,000

Total costs $24,000

Markup 3,000

Total bid $27,000

Notes:

1. Carpenters, plumbers, electricians, painters and gofers. All currently are on staff, i.e. no one would be hired especially for this project.
2. Miscellaneous cleaning solvents, sandpaper, and other minor materials that will not be purchased specifically for this project, but that would not be used without the project. Also includes the cost of supervision.
3. Allocated portion of the cost of the department head, administrative assistant, and secretary, as well as several other administrative costs, such as the rent charged the department by the museum's central administration.

Shocked at the amount, Ms Ray had called Mr Hutton to complain. At his suggestion, she had taken the drawings to a local construction firm and asked them for a bid. Using the drawings plus the design and engineering specifications prepared by Mr Hutton, the local firm had given Ms Ray a figure of $20,000. The firm had indicated that the figure was all-inclusive and was firm, i.e. it included all supplies, materials, labour and profit. Ms Ray would be charged $20,000 regardless of the actual costs the firm incurred in constructing the exhibit.

The Decision

When he heard of the situation, Alan Bourne, the museum's new director immediately called the two managers into his office, and asked for an explanation, Mr. Hutton was the first to speak:

I simply can't do the job for less. I've been working for several months now to establish a fair pricing structure, not only for people inside the museum, but for my external customers. This is a price I would use for our neighboring museums, and it's the one I feel I must use for Melissa as well. Besides, I spent all that time helping her design the project and preparing the drawings - that must be worth something.

Ms. Ray responded:

When I was in school, we were taught the transfer price should be the market price. I think I've pretty well established what the market price is, and I should not be asked to pay any more than that. If I did, my profits would fall, and you've been asking us to worry about our bottom lines. This $7,000 difference would make a big difference at the end of the year, particularly in terms of my bonus.

Mr Bourne's main concern at this point was with the overall surplus of the Museum. It was clear that if Ms Ray used the local construction firm to build her exhibit, the cost to her department would be less. But, he felt quite certain that the impact on the museum's surplus would be worse than if she used Mr Hutton's department. He was not sure if he should intervene in the decision or not, and if he did, what his intervention should be.

Questions your analysis should answer:

1. What are some of the advantages and disadvantages of organizing the museum departments into profit centers? (4 marks)
2. What is the impact on the Museum's surplus of each of the options? (6 marks)
3. Should Mr Bourne intervene in this decision? Why or why not? (6 marks)
4. If Mr Bourn intervenes, what should he do? Be specific: for example, should he tell Ms Ray to purchase the work for the exhibit form Mr Hutton? If so, at what price? (4 marks)
5. If Mr Bourne does not intervene, what do you think will happen? Is this good or bad for the museum in the short term? In the long term? (6 marks)
6. What other advice would you give Mr Hutton, Ms Ray, Mr Bourne? (3 marks)
7. Is there anything else you wish to add? (1 mark)