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Hi.
The answer to Q1b regarding transfer pricing, I am having trouble understanding why costs such as labour, materials and overheads are being deducted from the external quote of $200 per warranty service?
Surely JHK would not be incurring these costs if it were to outsource the work??All they are doing is working out the contribution and profit that would be made by the service division if it were to charge the manufacturing division $200 (the market price) instead of the current price that generates revenue of $10,000. The current transfer price looks high and ‘feather-beds’ the service division ie they find it easy to make goods profits even if inefficient. Reducing the transfer price to $200, so that they have to compete with external suppliers keeps them on their toes.
Thanks for that.
I was just confused because the answer then goes on to discuss the dangers of outsourcing such as loss of control over quality etc. If I’m not mistaken, then the reason the answer mentions this is to show that the service division may be able to justify charging in excess of the market price of $200 as doing the work in-house will overcome these issues?That’s correct. The in house provision might be better (eg better coordination and service, better quality and more influence over that department) and this might justify a premium over the $200. Pay $200 to the outsourcer for an adequate service, or $220 (say) for an excellent service. At least the final price is being benchmarked to a market price.
Hello,
could you kindly explain the ‘Cost plus pricing’ part to me?
To maintain current contribution levels $10m/39600 = $252.53
To cover variable costs = $5.346m/39600 = $135
For division to breakeven = 10m – 2.674m/39600 = 185
I shall be grateful to you.
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