Case_15_1and15_5

Chapter 15

,:

Multina iont Or anizations 697

Case 15-1

AB ThorstenI

You will see from my report that the XL-4 project shows an e~cell nt rate of re-turn on the Skr 700,000investment an~ is also a logical ekte~sio of our productdevelopment and growth strategy here In Sweden. My mahag".me t and I stronglyrecommend this project. I :

-Anders Ekstrom, Managing DirectO}~ Th rsten, Stockholm(100 percent-owned ub idi ry of Roget S. A.)

Any extra XL-4'which Ekstrom might sell in Sweden can ~e P~OdUed in our exist-ing plant in Gent for no addi~ional investment. Ekstrom iSIno~onl very optimisticabout the sales potential, he IS also underestimating the man faot rmg problemsand costs he will face. I recommend that you inform Ekstrbm ~hat it is in Roget'sbest interest for him to import from Belgium any XL-4 he ban lell~n Sweden.

-Pierre Lambert, Vice President for Domektic and Export Sales andManufacturing, Industrial Products d ou~, R !getS. A. Brussels

Roget S. A. bI---Roget S. A.I was one of the largest industrial compani~s i9 Betium. The com-pany was incorporated in 1928 by merging three smalle~ fir s that all pro-duced industrial chemicals for sale in Belgium. By 19811Roget ad expanded toproduce 208 basic and specialty chemical products ih 2~ £ttories, for salethroughout Europe. / I

Until the mid-70s, Roget was organized with one large ma I ufacturing divi-sion and one large sales division in Belgium. A departrr1en~oft e sales divisionwas devoted to export sales. However, in the late 70s, ekpo.trts~,ew so fast, anddomestic markets became so complex, that the comp~ny;1ere ted three mainproduct divisions (Food, Industrial, and Textile), eac~ with i s own manufac-turing plants and sales organization. In addition, the qombanf created foreignsubsidiaries to take over the businesses in certain areas./ Fo~ example, in In-dustrial Chemicals the company had two subsidiarteSTon in the UnitedKingdom and one in Sweden (Thorsten), which served all ° Scandinavia. Atthe same time, the Domestic Department of the Industrial C emicals Divisionexported to the rest ofEurope. The United Kingdom aJd Swe en accounted for9 percent and 5 percent, respectively, of sales in that IDivikio .

lVIr.Gillot (see Exhibit 1) was responsible for pr~fit~ fr m all industrialchemicals; lVIr.Lambert was responsible for profits f 'omldo restic operations(manufacturing and sales of industrial chemicals) and exPlortfales to countrieswhere the company did not have subsidiaries or factories; rnd lVIr.Ekstromwas responsible for profits in Scandinavia. The coipahy tilized a ratherliberal bonus system to reward executives at each level, ~ase on the profits oftheir divisions. IThis case is adapted from AB Thorsten (A), (B), and (C) cases, which 1ere prep red by ProfessorsC. E. Summer and G. Shillinglaw and are copyrighted by the Institute or ~ana ement Development,Lausanne, Switzerland. 'I.l"AB" and "S,A." are abbreviations used in Sweden and Belgium that are sirl)ila to "Corp." or "Inc."

. in the United States,

698 Part Three Variations in Management Control

EXHIBIT 1 Roget S. A. Organizational Chart

Director GeneralAndre Juvet

Vice President .Finance

Eric BoIs

Senior Vice PresidentIndustrial

"Chemicals

Senior Vice PresidentTextile

Chemicals

Michael Gillot

Vice PresidentDomestic and Export

Operations

Anders Ekstrom

Managing Director·Roget Ltd. (U.K.) :

Managing DirectorAD Thorsten(Scandinavia)

Pierre Lambert

This, together with a policy of promotion from with n, helped stimulatemanagers in Roget to a degree not enjoyed by some of it competitors. It alsohelped the company to retain key people in an industry here experience wasof great importance. Many of the company's executives h d been in the starchchemicals business all of their business lives. It w~s J qo plex business, and ittook many years to learn it. I I

Certain policies-rules of the game-governed relati nships with the sub-sidiary companies. These policies were intended 0 mai tain the efficiency ofthe whole Roget complex, while at the same time giving subsidiary managers

Iautonomy to run their own businesses. For exaF,ple, 1 subsidiary managercould determine what existing Roget products to sell in th~ local market. Exportsales would quote the same price as they quote agel ts in I countries. Ofcourse,all prices were subject to bargaining on both sides. Second subsidiaries were en-couraged to propose to division management in Brudse s the development ofnew products. If these were judged feasible, new p oduJts were manufactured in

II

Nine Plant Managers Director MarketingResearch

Director PaperIndustry Sales

Director By-ProductSales

Di rector ExportMarkets

DirectorApplications Labs

ManagerAppl.

Laboratory

I!

'.. .'.

Chapter 15 MUUi~ti,t It, rganizations 699Belgium for supply to world markets. Third, the subsidiar[ m naging directorcould build manufacturing plants if the investment in tile 10al market wereadequately justified. I

IAB Thorsten

ABThorsten was purchased by Roget S.A. in 1972. Since Ja time, Thorsten'sboard of directors had consisted of four persons: Mr. Mich 11 illot, senior vicepresident in charge of Roget's industrial chemicals ~ivi ion; Mr. IngveNorgren, a Swedish banker; Mr. Ove Svensen, a Stockho} i]' dustrialist; andthe managing director. Swedish law required any com~~n incorporated inSweden to have at least two outside directors, and the Rdgkt anagement feltfortunate in finding two men as prominent as Norgren ani: ~v nsen to serve onthe Thorsten board. I I

During the first four years of Roget's ownership, Thorsl1n' sales fluctuated

between Skr. 5 and 7 million, but hit a low in 1976.2 The .'~a d decided at thattime that the company was in serious trouble, and that ti1 0 ly alternative toselling the company was to hire a totally different managrm nt group to over-haul and streamline company operations. J

On the advice of the Swedish directors, Mr. Anders EIt trom, a 38-year-oldgraduate of the Royal Ins~itute of Technol0fS!"was ~jred 4~111anagingdirector.He had 16 years of expenence as a production engmeer for large paper ma-chinery company and as division manager responsible for rofits in a largepaper company. I I

Ekstrom joined AB Thorsten in January of 1977. Since h t time, sales hadincreased to Skr. 20 million and profits had reached level~ at Roget's man-agerrient found highly satisfactory.

Ekstrom said that at the time he joined Thorsten, he kne it was a risk:

I liked the challenge of building a company. If!did a goodjoplhe e I would havethe confidence ofNorgren and Svensen as well as of the Rog management inBrussels. I felt that succeeding in this situation would teach le~bhingSthatwould make me more competent as a top executive. So I chll t is job eventhough I had at the time (and still have) offers from other c 1/ ip nies.

Initial Proposal for Manufacture ofXl~In September of 1980, Ekstrom h.a~ ~nformed the ~hors Efnfoar.d or-directors

the manufacture of XL-4, a starch-based adhesive cherrhc 1 used in dryingpaper. He explained that he and his customer enginebts had discovered anew way of helping paper mills adapt the dryer sectio Islo their huge papermachines at very low cost so that they could use XL-4 i ste d of competitors'products. Large paper mills would realize dramatic ~a\[ings in materialhandling and storage costs and also shorten drying time kubstantially. Short-ened drying time increases the effective capacity of a J~e machine. It wasEkstrom's judgment that his innovation would allow him to develop a market

/

2Most monetary amounts in this case are stated in Swedish kronor (Skr). I


in Sweden almost as big as Roget's present worldwide mproduct was currently being produced in Roget's Domestil

rate of 600 tons per year, with none going to Sweden. Eks 0 stated:

At that meeting, Mr. Gillot and the other directors seemed e It i iastic. Duringthe next six months, we did the analysis. My marketing dire' t ~ sed modernmarket research techniques to estimate the total potential inl I den at 800 tons .-ofXL-4 per year, using the custom engineered approach we re proposing. Weinterviewed important customers and conducted trials in th~ ~ls of three bigcompanies which proved that with the introduction of our m! i e designs, thelarge cost savings and capacity expansion would indeed mat' .Jl ze. We deter-mined that if we could sell the product for Skr. 1,850 per tod ~ could captureat least one-half of the market within a three-year period, 0' o! tons a year.At the same time, I called the head of the corporate enginee . g ivision inBelgium and asked for his help in designing a plant to prod' 00 tons ofXL-4per year and in estimating the cost of the investment. This i a outine thing.The central staff divisions are advisory and always comply I . 1 equests forhel~. He assigned a project.manager and f~ur other engineer 1 work o.nthedesign of factory and machinery and to estimate the cost. Al hf same time Iassigned three men from my staff to work on the project. In t r e months thisjointtask group reported that the necessary plant could be ii for about Skr700,000. All of this we summarized in a pro forma calculati xhibit 2].This calculation, together with a complete written explanatt n as mailed toMr. Gillot in early April 1981. I felt rather excited, as didjt fmy staff. Weall know that introduction of new products is one ofthe ke s t? our continuedgrowth and profitability. The yield on this investment was II bove the mini-mum 8 percent established as a guideline for new investm p the Roget vicepresident of finance. We also knew that it was a good anal 'Iss! sing moderntools of management. In the cover letter, I asked that it be p ~ n the agendafor the next Thorsten board meeting. ~ IThe minutes of the next board meeting held in Stoc I, on April 28, 1981,

quoted Ekstrom's remarks as he explained the proposal 01 ther directors:

Youwill see from the summary table [Exhibit 2] that this W ~Iet is profitable.Gentlemen, it seems clear from these figures that we can jn ti this investment

'These working capital investment amounts are net of tax credits."Taxes are calculated after depreciating Skr. 700,000 over a 5-year period on straight-line basis.ISales value, net of appropriate taxes, assuming plant will be closed at end of seven years.

701

'j

in Sweden on the basis of sales to the Swedish market. The gror p .ce presidentfor finance has laid down the policy that any new investment s 'd yield atleast an 8 percent return. This particular proposal exceeds that, sjh stantially,using a very conservative seven-year, life. My management and s ,rongly recom-mend this project. I I iEkstrom later recalled Gillot's reactions III his role a I c of the

Thorsten board: II 1/

IIGillot said that it seemed to him to be a clear case. He askedtions, mainly about the longer-term likelihood that we couldls400 tons a year, and about how we would finance any further x ansion. Iexplained that we in Sweden were very firm in our judgment h t we wouldreach 400 tons a year even before one year, but felt constraindd 0 show a con-servative estimate of a three-year transition period. We alsol sro ed him howwe could finance any further expansion by borrowing in swedtn. That is, ifRoget would furnish the, initial capital, and if the 400 tons go' 11 ere reachedquickly, any further expansion would easily be financed by 10 11 anks. Thetwo Swedish directors confirmed this, The board voted unan~ 'd sly toconstruct the plant. II I

Ihave been through some additional discussions with the prod ctl,ionandmarketing people here in the Domestic Department. They thin the engineeringdesign and plant cost is accurate, but that you are too optimist c] n your salesforecast. It looks like you will have to justify this more. 1111

Ekstrom said:

Disagreement about the XL-4 Proposal,

dI

About a week later, Gillot telephoned Ekstrom:

I

Ipushed him to set up a meeting the following week. This was at ended bymyself and my marketing and production directors from Swed n, and fourpeople from Belgium-Gillot, Lavanchy (director ofmanufactu-inr), Gachoud(director of sales), and Lambert (vice president for domestic a d xport). Thatwas one of the worst meetings of my life. It lasted all daY'Gac~o d said thatthey had sales experience from other countries and that in his 'u1gment themarket potential and our share were too optimistic. I told him oVfr and overhow we arrived at this figure based on our custom engineeref ~ roach, but hejust kept repeating the over-optimistic argument. Then Lav11P' said that theproduction of this product is complicated, and that he had dif cUties producingit in Belgium, even with trained workers who had long experi ncl .I told him Ionly needed five trained production workers and that he could send me two menfor two months if he liked, to train Swedes to do the job. I impres ed on him thatthey could oversee manufacturing for us in Sweden until we 1 ar ,if they didnot have confidence in Swedish technology. He repeated that t e difficulties inmanufacturing were enormous.

Lavanchy then said that since the whole world market ~of I get was only600 tons a year, it was inconceivable that Sweden alone co~llki:rake 400 tons.Gillot ended the meeti~g withou~ a decision, and said t?at.,~i ~oped all con-cerned would do more investigation of this subject. He mdlc'j'te that hewould think about it himself and let us know when another, I eting wouldbe held.

702 Part Three

I

/11

Ekstrom returned to Stockholm and reported the m et ng to his own staff,and to the two Swedish members of his board: /1 I

They, like I, were really disgusted. Here we were, operati g with initiativeand with excellent financial techniques. Roget managem t had often madespeeches in which they emphasized the necessity for del tfalized profitresponsibility, and for authority and initiative on the p b foreign sub-sidiaries. One of my men said that they seem to talk delc nt alization and actlike tin gods at the same time. Mr. Norgren, the Swedish b~nker on Thorsten'sboard, expressed surprise. I considered this carefully. IJ i s und business forAB Thorsten, and XL-4 will help to build one more groJ, I ompany in theSwedish economy. Somehow, the management in Brussel h s failed to under-stand this. I dictated a letter to Mr. Gillot telling him that I didn't know whythe project was rejected, that Roget has a right to its 0f~r asons, but that Iwas prepared to resign as a director. It is not that I am 4n/fY, or that I havea right to dictate decisions for the whole worldwide Roge organization. It issimply that if I spend my time studying policy decisions, ws ich are notappreciated by parent company management, then it id I aste of my timeto continue.

While I certainly wouldn't bring these matters out in a p lif meeting, I thinkthose Belgian production and sales people simply want to bUJildtheir empire andmake the money in Belgium. They don't care about Thors e9 and Sweden. Wehave the ideas and initiative, and they take them and gkt th payoff.

I

Variations in Mtinagement Control

Finally, Ekstrom stated:

Further StudyII I

Mr. Gillot received Norgren's letter in late May 1981. H t~en contacted Messrs.Lavanchy, Gachoud, and Bols (VP. finance, Roget) fildl. told them that theSwedish XL-4 project had become a matter of key imporiaiice for the whole RogetGroup, because of its implications for company profijj~ ah.d for the morale andautonomy of subsidiary management. He asked them 0 ktudy the matter verycarefully and report their recommendations in one mo th Meanwhile, he wroteEkstrom, "Various members of the Corporate Head& ~~ters are studying theproposal very seriously. You will hear from me within aboit six weeks regardingmy final decision."

Lavanchy's Response

A month after he was asked to study the XL-4 projJc ore closely, Lavanchygave Gillot a memorandum explaining his reasons fi r I pposing the proposal:

At your request, I have reexamined thoroughly all of t~ IcJt figures that bearon the XL-4 proposal. I find that manufacture of this pr dt ct in Sweden wouldbe highly uneconomical, for two reasons: (1) overhead co t would be higher, and(2) variable costs would be greater.

As to the first we can produce XL-4 in Gent in our e iS1ng plant with less, . . I' Ioverhead cost. Suppose that Thorsten does sell 400 tons a ear so that our totalworldwide sales rise to 1,000 tons. We can produce the ih le 1,000 tons mBelgium with essentially the same capital investment II II ave now. Ifwe

II I

Chapter l S Multinational. J I izations 703

produce 1,000 tons, our fixed eo," will decrease by Skr, 120 a tan.' ! ~ mean,Skr. 72,000 in savings on production for domestic and export to co n n s otherthan Sweden (600 tons a year), and Skr. 120,000 for worldwide pro~ Ic'ton includ-ing Sweden (1,000 tons). Second we could also save on variable cos s I~we were toproduce the extra 400 tons in Belgium, the total production of 1,00~0 s a yearwould give us longer production runs, lower average setup costs, at I~ger rawmaterial purchases, thus allowing mass purchasing and material ! fa ing andlower purchase prices. My accounting department has studied thi nl concludesthat our average variable costs will decrease from Skr. 950 a ton td It 930. ThisSkr. 20 per ton difference means a savings of Skr. 12,000 in Belgia 1 estic pro-duction and a saving of Skr. 20,000 for total worldwide production I ~ ing thatSweden takes 400 tons a year. Taxes on these added profits are abd ,t e same inBelgium and Sweden-about 50 percent of taxable income. In cone i n, a newplant should not be built. Ekstrom is a bright young man, but he d:. slot knowthe adhesives business. He would be caught up in costly productio I I. takes fromthe very beginning. I recommend that you inform the Thorsten mJ, Ig ment thatit is in the Company's interest that they must buy from Belgium.

BoIs's Response

The same week, Gillot received the following memoranduJ t~Roget's financial vice president: III

I am sending you herewith estimates ofthe working capital requir m nts ifRoget increases its production ofXL-4 in our Belgian plant from 6:0 I ~ 1,000 tonsa year [Exhibit 3]. Initially, we will need Skr. 54,000, for additionil in entoriesand accounts receivable. By the end of the second year, this will hi I ncreased toSkr. 74,000. The working capital amounts shown in this exhibit a~ Jsed on the

'Working capital amounts are net of tax credits.tvariable cost per ton SKr. 1,380Manufacturing 930Shipping from Belgium to Sweden = 50Swedish import duty 400Total variable cost 1,380

3Total fixed cost in the Gent factory was the equivalent of Skr. 180,000 a year. [)i idf.d by 600, thisequals Skr. 300 a ton. If it were spread over 1,000 tons, the average fixed cost II II be Skr. 180.

t'J.~;!


applicable law which permits businesses to deduct 6°fPley --inventory costs from taxable income. I have also lookedIa vahchy's calcula-tions for the fixed and variable manufacturing costs, afj r- in ~ull agreementwith them. In conclusion, I see no reason to spend Skr .. o/~,o to build a factoryin Sweden when we have excess capacity in our Belgia ~k t 1hich can producethe incremental tons at lower cost and with lower man I f dt ririg risk.

Gillot's Response IIII

In early July 1981, Gillot sent a letter to Ekstrom in ,I i I~inJ that the XL-4pro-posal was turning out to be more of a problem than I • ad ~nticipated. He in-cluded copies ofthe memos from Lavanchy and Bolsi :~ sa* he was not yet ina position to give final approval. He said he would 1 f' strom know his deci-sion as soon as possible. I 1

Ekstrom's Thoughts

Ekstrom expressed some impatience with the way tt, i I·· were going:

ihave other projects that need developing for ThorsteJ 1 this kind oflong-range planning takes much time and energy. Also,just ing on top of thenormal operating problems of the business we already ~l Ii takes up a lot of mytime. Sometimes I feel like telling them to go and sell Xi 1 hemselves.

Questions IIII

1. Using the numbers from Exhibit 2, what is you I J

1mateof the NPV (at

8 percent) for the Swedish proposal. Also, what is t IRIl?2. What is the NPV (at 8 percent) and IRR ofthe Bel . ipro~osal in Exhibit 3?3. What are the key arguments for and against the 1 tl e natives presented by

the contending parties from Belgium and Sweden I4. Is everything that is being expressed by Ekstrom d the Belgium manage-

ment above board? What are the respective hiddel endas that can be an-ticipated for each party, and in what way do they i ,idJ? In what way canthey be expected to diverge? 1 I

5. If you were in Gillot's shoes, would you support tf $ edish or the Belgianproposal? Why? I

6. Ignoring your answer to question 5, if the plant W·· ot built and the prod-ucts were shipped from Belgium to Sweden, wh I tr nsfer price would be~~~~ I

7. What are the competitive advantages of Roget S. .?Iegy in the industrial chemicals business? Are the II aterns designed to support this strategy?

8. What changes in the management control systemGillot?

at is Roget's strat-agrment control sys-

ld (Yourecommend to

Chapter 15/11 I

MUltinatlo IOr,anizations 725

Case 15-5

Xerox Corporation (B)There is no real process difference between our internation 1 •n domestictransfer pricing systems. The breadth of the issues, howevet ~5ar greater for theinternationaL Transfer pricing and currency translation ar1 t a problem for us.I manage the process and resolve potential conflicts veryt aslwe operateunder clear and simple guidelines. I

-Raghunandan "Sach" Sacli'd, corporate controller

Sach was explaining the process by which Xerox takes I ting and frustra-tion out of two very volatile topics for many global corpor s+multinationaltransfer pricing and currency trading. He further ill I ted the specificsof the system.

Transfer Pricing

As Sach described the transfer pricing policy, purely ~lllstic transfers uti-lized a full standard cost price method while foreign trI'~.·ir rs fUsed an arm's-length market price method. This was the general rull, ~ t the system wasquite flexible, which enabled a quick response to chand I arket conditions.The document processing industry was extremely compe:~~. e, and Xerox man-agement realized that they must respond to various glJ f' market pressuresand competitive challenges. A manager from the xer9f azilian operationasserted the following: "The transfer pricingjsystem ] esigned to attackthe marketplace. We drive the products in the marketP~'1 ~k and Xerox knowsthe source of the revenue is the customer." I I

The domestic transfer pricing was less complicated ' 1 the internationalsituation. The controller for the US customer operation,'!! lained.

We purchase copiers from one of the Webster, New York, fa~~1 s, part of theOfficeDocuments Products division. Normally, the transfe i ade on a fullstandard cost basis, which includes a small percentage for I nistration. If weneed to respond to a competitive pricing threat, we are una e renegotiate.The manufacturing unit cannot sell below cost as they are 4t~IIU1turedto, at aminimum, cover their costs. In this case, the respective un·i9 trollers woulddiscuss possibilities of cost savings and the volume imPlicali 1~1if Jricing erodesunit sales. The corporat~ cor:troller would step in, as appro~ ta e, tb help facili-tate a solution. The aggressive business targets and the fiet-~. Ie mpetition made

~ Ifor some very heated and hard meetings. We were both unde e same legal en-tity with the effects oftransfer pricing balanced at consolidr ~f' .The primaryconcern was the influence of transfer pricing on achieving 4 t erformancetargets. II I

In the past, this (t:a~s~er pricin~) would .hav~been a b~gIP ,o~~em.We were to-tally focused on our individual busmess units given the tIgr 1- It performancetargets. Today,we know the value of market share and thellI , to respond tocompetition. We learned that the performance comes from. ff~ to externalcustomers. Besides with TQL [total quality leadership] the f ~try has becomevery sensitive to their costs.

Prepared by Lawrence P. Carr, Associate Professor, Babson College. Cop ld Ht by Jawrence P. Carr.

I

iII.--r-0

I,,I

L.


Transfer pricing between foreign units was a litN ore complicated due toa greater breadth of issues. There were different If~a entities, two differentsets of regulatory authorities (for tax, duty, etc.), aid t 0 different currencies.In this situation Xerox used a market-based trans~ Irl ric/k(market price lessa discount). This method conformed to the US tax l~ s and to the rules ofmost of the other taxing authorities. In addition,ilma "ket price followed theOEeD guidelines. The transfer price denominatioi (cur}ency) varied basedon the product value added (explained in the next]1 Cll.on?,.The market-basedtransfer price provided a margin to the selling un~t 1 wEfllas sufficient mar-gin to the buying unit. This enabled the buying ul1 be[competitive in theirlocal market. I

The buying unit was responsible for duty and r g1latory compliance. Thegeographic sales offices cooperated with the facto+ s nd kept them well ap-prised of their country regulations and routinely e m unicated changing re-quirements to the factories. They also ensured tha p oduction facilities wereaware of the competitive pressures. Xerox sales Jnit constantly encouragedquality and price improvements (part of the TQL JJp ant).

The new Xerox culture enhanced the awarenesJ91ft e customer. The sellingunit knew that they must respond to their interna au tomer (the buying unit).At the same time, they understood that the source f uccessful business wasthe satisfaction of the outside customer. I

The financial impact of transfer pricing on perro~mance plans concernedmanagers from both the buying and selling unitJI ~fJqternalfactors such as achange in duty rates or country regulations (i.e.11q'llbtak, etc.) may have anadverse effect on performance. The pressure easeh s ewhat with the recentincorporation of more operating statistics to evalh t unit and manager per-formance. Sach points out: I

Weknowwhat is goingon and do not just manage py tpe financial numbers.Our regular controllerconversationspermit an open di~cussionofpotentialprob~emsand offera vehicle to expl~realternative IF' lu ions. This is wherethe financialmanager can help the line manager unfe stand the full rangeofthe business implicationsof their decisions.We 1 0 void surprises atcorporate.

The arm's-length market price preserved the intlependence of the legal en-tity, ?ut, a~the same ~ime, required managers to fbre cl?sely consid~r the eco-nomic variables. Aunit manager from South AmeTiClll1sa1d the followmg:

The financialmeasures are fair. Sometimes,howe le~,I here are events beyondour control,like a devaluation or unanticipated loda~i ,flation or an uncertainregulatory environment,which can alter our perfo}ra ceoI feel it is unfairthat management sometimesdoes not take this int9 a~count.Weneed finan-cial measures whichhave a longer time horizon [greatr than one year].

As with the domestic transfer pricing, mUlti~lti, nal transfer prices werenegotiated if there were changes in the curre1tl competitive situation orchanges in the economic variables such as curin ,tax, duty, and countryregulations. In this case, they employed a market- ased transfer price as areference point for negotiation. The corporate C0 t oller resolved conflicts orimpasses between entities.

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Chapter 15 Multinati n.a Or anizations 727

Currency exposure can create major swings in .the I b 0 cs of transferpricing and was critical in the consolidation of foreig I p ra ions. Sach ex-plains the Xerox policy as follows:

All units are responsible for their transaction currency expos r . T ere are noexceptions. The managers must manage. For product sourc : It rou h our man-ufacturing units the rule is simple. If manufacturing adds I, re tha one-thirdof the product value, then the manufacturing unit is respon i 11 for managingthe currency hedging. Note that the transfer price uses the, Y 's urrency tocalculate the price. If the manufacturing units add less tha n -thi' d oftheproduct value, then the buying unit is responsible for the cu .~ Y ~edging.Note that the transfer price uses the seller's currency to cal! la e t~e price. Inthis case, the value passes through the marketing organizaf h or recovery. Inessence, we determine the denomination of the transfer priC\11y the value addedto the product based on the cost and the final selling price.

Xerox management used both local and US currencie iO fo~eign unit per-formance measures. The foreign manager, however, rea] r thft the consoli-dation currency was US dollars, and dollar reporting i as the basis of the

:J~~~~:;~~:'r!':~:~::~:~::~~:~mt:d~!~~i~{:;c' m t:~~t~~h:o~:::~sure to manage local currency changes was clearly on thd or igf manager.

Sach explains the tra [ation exposure currency policj Is ollows:

Normal changes in the foreicy, from 3 to 5 percent, Ie he lesponsibil-ity of the foreign unit management to cover. We consolidate a d eport the com-pany's results in dollars, and we expect the managers to deliiflr heir plan. It isup to the local managers to oversee their translation curreno ex os+re. If thecurrency swings vis-a-vis the dollar is [sic] greater than 3 to I ~e cent, then thetranslation exposure becomes a corporate issue. We will peg I t e sbandard(PDR) and coordinate and share the managing of the exposur th the foreignoperation. We regularly discuss the currency topic during ou'l e kl~11informalcontroller talks. , I ISach indicated that if the currency goes in a favor a e irection for the

foreign operation, then corporate discounts the boosted 1 h nc~~l results forunit performance measurement purposes. In this inst

le, corporate man-

agement may authorize the foreign operation to investlt e cutrency-drivenportion of their profits back into their unit, depending 01 It e ~ttractivenessof the proposals. ..\

Sach said, 'We regularly discuss the currency and tra I fep~icing topic atthe FEC and on the telephone between controllers. We trus e ch other and arecomfortable discussing the topics. This is how we prevedt ea -end surprises."

A subunit manager said the following: [ [

In the Americas Customer Operations [Central and South ,ri a], the USdollar is our functional currency.! We make all our trades in; la s ahd ouraccounting based performance measures are in dollars. We Jb k ff alPDR

. (plan development rate), which is our reference point for all t'i ns ations .. We update the transfer prices on a quarterly basis. [

lThe local currency is the functional currency for all other parts of the wor! .


EXHIBIT 1Venray PlantReportingOrganization

II

Direct Report

PerformanceMeasurement rOperational

Reporting

Venray Plant

G~ I.

Controller

An example of the complexity of the transfer pricing, c}c/lJ translation,and performance measurement system is the following.

The Venray, Netherlands, facility regularly sold or transfr~re copiers to theUS marketing unit. The Venray plant was legally part of ~an Xerox, but forperformance purposes the general manager reported to M~n facturing Sup-port (MS), a central corporate function. Corporate manage" e t explained thefollowing:

The Venray site director currently reports to MS through the Ran Xerox Manu-facturing Operations organization. We are currently working bJ r commenda-tions on how to align and transition focus factories to report to h businessteams/business divisions. The Venray product array does, ho eve, support morethan one business division. There will be areas that are not in u ed in the focusfactories and that will remain reporfirig to MS. 1/

Note that within the Venray site (Exhibit 1) there were funeti ns that reportedto the Venray site director as well as to organizations 0t i e ManufacturingSupport. . j . .

Performance measures were driven by the Manufact~1n: Support orgam-zation with Supplies and the Materials and Supply fun~ro s being driven bythe respective organizations managing them as indicated 0 the organizationchart. This responsibility will transition to the divisionis i line with the re-porting structure referenced above with ongoing suppor f om MS, Supplies,Integrated Supply Chain, and Customer Operations orJani ation. In essence,central support organizations provided services for the I ~si ess divisions andsustained the performance measures as appropriate.

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Questions

Chapter 15 Multinational Organizatio 729

1. You are the Western regional sales controller, and the sales manJJer hasasked for your help. A major California bank with over 200 brandhles haschosen to cancel the Xerox copier contract (annual lease revenu~1 bf ver$1 million per year) due to pricing. The competition with a West 9o!as as-sembly plant has made an offer 27 percent less than yours. You cLl. akeup 5-7 percent of the difference without materially affecting YOU~I*u get.If the customer is to be preserved, you need pricing help from the fa ory.You call the US Customer Operations controller because the loss/IJf alesrevenue will significantly affect your budget. What are the options f?rJIX rox,and how will Sach resolve the issue? II

2. The Venray plant transfers copiers to the US Customer Operati~ s or aFOB EC port price. If the US customer price is 100 percent and th~ nraytransfer price is 60 percent, answer the following:a. What currency is used to value the trade?b. Who is responsible for hedging?c. As the Venray controller, what is your currency exposure?d. How does this influence your performance measures?e. Does this system seem fair to you? What, if anything, would YON

change?