Management Control Systems

Birch Paper Company

Arun Kumar
Ayush Vardhan Singhania
Jaiveer Singh Bajwa
Leandro Sol Morell
Varun Tyagi

International Master in Business Management (IMBA)

Management Control Systems: The Birch Paper Company Case

Table of Contents
THE BIRCH PAPER COMPANY..............................................................................................2
ECONOMIC IMPACT TO THE COMPANY OF SOURCING THE PRODUCT TO WEST PAPER, EIRE, OR
THOMPSON....................................................................................................................................3
BID THAT IS IN THE BEST INTERESTS OF THE COMPANY, WEST, EIRE OR THOMPSON.................4
IF YOU WERE KENTON, WOULD YOU SOURCE IT TO THOMPSON AT $480? WHY OR WHY NOT. . .4
IF YOU WERE BRUNNER, WOULD YOU REDUCE YOUR PRICE BELOW $480? WHY OR WHY NOT? 5
ADDITIONAL COMMENTS:.............................................................................................................6
Exhibit 1: Job is done by the Thompson Division per thousand boxes...................................7
Exhibit 2: Job is done by Eire Papers per thousand boxes....................................................8
Exhibit 3.................................................................................................................................9

The Birch Paper Company

Management Control Systems: The Birch Paper Company Case

Owing to a laymans propensity to always go for the lowest bidder, sometimes companies
loose in the process. Only after careful vetting do the companies realize the merits of
transfer pricing and sourcing in-house. Birch Paper company case is an illustration of the
conundrum usually faced by managers at responsibility centres whether to outsource or to
insource. Birch Paper has four different divisions that are adept at varied processes. The
rub brews when one of the divisions, Northern, solicits a bid from one of the other
divisions, Thompson, and two external suppliers. Thompson bids exceeded that of the
other two parties by a considerable amount. For instance Thomsons bid was $480, Eire
Companys was $432 and West Companys was $430. This bid created a furore in the
company where the divisional manger of Northern Division is whining about the bid put
forward by Thomson in excess of the market prices. We are going to analyse the case
using management control systems tool.

Economic impact to the Company of sourcing the product to

West Paper, Eire, or Thompson
Thompson Companys processing cost is $120 (See Appendix 1), and if we add Southern
divisions costs i.e. $168 (See Appendix 1), the total out-of-pocket costs incurred by the
whole company would be $288. Whereas, if the job is outsourced to the Eire Company,
the company will buy the linear board and corrugating medium from the Thompson
Division at a price of $120 per thousand boxes and Thompson division would buy the
required unprocessed material from Southern Division for $90 per thousand boxes and
would further process it at $25, hence the overall out-of-pocket costs incurred by the
company will be $391 (See Appendix 2). Considering the above two marginal costs, the
price quoted by the West Company seems to be humongous and would mean an out-of3

Management Control Systems: The Birch Paper Company Case

pocket costs of $430 to the company as a whole. This compels us to believe that if the
Birch Paper Company is able to resolve its endogenous issues, the company can bid
competitively. The company will be better off by $103 per thousand boxes, if the
Thompson division wins the bid.

Bid that is in the best interests of the Company, West, Eire or

Thompson
It is the duty of the central management to support the various divisions of the company
from the strategy as well as the management control point of view. It is evident from the
calculations that the lowest out-of-pocket costs incurred by the company are when
Thompson wins the bid. Hence, it is in the best interests of the company if the Thompson
division secures the bid and the work remains in-house. The only considering factor
would be the distribution of $103 among the various divisions. It is prudent for the
Northern division to go for the West Company because of its lowest bid. However, the
company as a whole and each division would loose since the Thompson and the Southern
divisions will loose the opportunity to amass marginal revenues. The idea here would be
to involve the upper management to intervene and convince Kenton to reduce the bid
price to match that of the West Company. The appropriate transfer prices must be
determined in order for the work to remain within the Birch Paper Company.

If you were Kenton, would you source it to Thompson at $480?

Why or why not
If I were Kenton, I would not source from Thompson at $480 and would rather choose
West Company to execute the work, as the bid quoted by the Thompson Company is at

Management Control Systems: The Birch Paper Company Case

least 10% higher than the market rate. If Kenton approves the bid of the Thompson
division, despite having the highest bid-price, it would have negative repercussions on the
overall profitability and Return on investment of the Northern division, which are the
KPIs of each division. This move would also germinate the risks of not receiving
competitive bids from the external companies in the future. However if Kenton rejects the
bid from Brunner, It runs the risk of internal rivalry, resentment and animosity to breed.
Come what may, it is imprudent for Kenton to approve Brunners bid at such a high
price. The problem seems to put Kenton on the back foot and has compelled him to refer
the matter to the Central management.

If you were Brunner, would you reduce your price below $480?
Why or why not?
If I were Brunner, I would not reduce the bid price below $480. Primarily, The Northern
division only reimbursed out-of-pocket costs of the Thompson division while using its
services to design the package. Brunner forewent the profit in that stage and is hoping to
reap premium in the bid. Brunner calculated the price of $480 using Cost ($400) plus a
margin for profit ($80). Secondly, Brunner justifies it by saying that any price below
$480 would not cover the overhead costs and reaping the profits would be a lost cause.
Thirdly, He issued instructions to his sales team to refrain from shaving the bids. Now, if
he reneges on his advisory, it will be detrimental for his credibility and the overall quality
of the business. He is hell bent on receiving profits in this bid by basing its rationale on
the fact that he did not make any profits on the package design, which he was entitled for.

Management Control Systems: The Birch Paper Company Case

Additional Comments:
It is intriguing to understand as to why Brunner is so fixated to not lower the prices. One
of the reasons has already been highlighted above. The other explanation can be that
Brunner believes that with the cost plus margin policy, he might be able to secure the
deal outside in which case he would be able to double his contribution margin (from $32
to $80). This marketing strategy may prove beneficial for the division but may not be in
the best interests of the whole company. On the flipside, we observed that the company
offered design and development consulting services to the Northern division and if they
continue to do so, they can charge premium on these services to recoup costs and reap
profits. Northern Division should have valued this service and it seems that this division
tried to take advantage of the fact that the Thompson division was a division inside the
company and Kenton could arm-twist Brunner into reducing the bid price. Had Northern
outsourced the work to external suppliers in the design phase, the division would have
incurred massive costs.
Given the fact that the Thompson and Southern divisions are running under capacity, If
Brunner is able to negotiate with the Southern division to lower its prices then he can bid
competitively by lowering his price. The role of the central management should be
prescriptive and should let Brunner decide after ensuring that Brunner evaluates all the
options. They should understand that despite being a small percentage (5%) of the
divisions volume, the problem could snowball into a serious issue, which will have
negative consequences for the company. Hence the management should be involved
keeping in mind not to disrespect the autonomy of the divisional managers aka delegation
of decision rights.

Management Control Systems: The Birch Paper Company Case

They should also institute mechanisms to ensure the optimum transfer price without
affecting the decentralized structure adopted and established for so many years. In order
for the company to sustain in the future, the company should establish performance-based
tools that factor in the efficiency of maintaining the inventory, production and capacity
instead of considering only profits. Presently, every division is acting as a Profit centre
hence it is vital for every divisional manager to focus on the profit of their respective
profit centre and not think about the company as a whole. Therefore, transfer pricing
becomes dysfunctional here because every division is motivated to maximize profits.
In the decentralized corporate structure, profit maximization only benefits each division
whereas it results in sub-optimal results for the whole company.

Exhibit 1: Job is done by the Thompson Division per thousand boxes

Linerboard & Corrugating medium cost bought from
Southern = 70% x $400
Thompson Divisions Costs
Total quoted Out of Pocket Cost

$280
$120
$400

Marginal Cost Calculation

Southern Divisions Costs = 60% x $280
Thompson Divisions Costs
Total Marginal Cost

$168
$120
$288

Management Control Systems: The Birch Paper Company Case

Southern Divisions Contribution ($280- $168)

Thompson Divisions Contribution (considering Eire
Paper's quoted price) = $432 - $400
Total Contribution to fixed costs and profit

$112
$32
$144

Exhibit 2: Job is done by Eire Papers per thousand boxes

Amount quoted by Eire to Northern Division

$432
Charge by Southern to Thompson Division for
unprocessed linerboard
Cost for Eire Papers = 60% x $90
Total contribution of Southern Division to fixed costs
& profit ($90-$54)
Charge by Thompson Division to Eire for colored &

$90
$54
$36

Management Control Systems: The Birch Paper Company Case

printed linerboard
Costs from Southern Division
Costs from Thompson Division
Total contribution of Northern to fixed costs & profit
($120-$90-$25)
Total Cost ($432-$36-$5)

$120
$90
$25
$5
$391

Total Contribution to fixed costs and profit = $36 + $5

$41
Difference in contribution to fixed cost & profit calculation
1. Thompson Divisions contribution ($32 - $5)
2. Southern Divisions contribution ($112 - $36)
Difference in contribution to fixed costs & profit

Exhibit 3

$27
$76
$103