Volvo

Volvo

BACKGROUND OF THE CASE

Compagnie du Froid, S.A (referred here as Compagnie in short) was a company in the ice cream business with business in France, Italy and Spain. The company operated based on a decentralised decision making structure with each region having its own manufacturing, distribution and sales organisation. The central office was responsible for the finance and accounting of the business, development of new products and sharing of experiences and learning. The CEO, Jacques Trumen, maintained control of the regions through a profit planning and control system. Each regional manager would submit their profit plan in Nov/Dec prior to the fiscal year. Using the plan, Jacques would discuss and supervise the expansion strategy for each of the region, ensuring that there would be sufficient cash flow to support the plan. Subsequently, a top management meeting would be held to discuss the new growth opportunities. The profit plan would be used to monitor the performance of the region. The regional manager would then submit a profit statement fortnightly during the summer months for monitoring.

Traditionally, Jacques had been giving the 3 regional managers the same bonus, with each getting 2% of corporate profits. However, in 1996, the poor performance of the Spanish region caused the company’s profit to drop to its lowest in 10 years. This induced him to rethink the way he has been evaluating the performance of the regional managers.

HOW WOULD YOU ACCOUNT FOR THE ICE CREAM TRANSFER FROM FRANCE TO SPAIN?

Transfer Price for Products to Spain

There are two main approaches to determine the transfer price for the product, namely, market price approach and cost-based approach . The market price approach is commonly used. However, in this case, as the ice cream is only produced by the company and not available in the market, the market price approach cannot be adopted. Hence a cost-based approach is to be used. In the computation of the transfer price, Jacques has set it based on the full cost plus a 5% profit. The transfer price should be based on incremental cost incurred as a result of the production . In this case, the full cost has included fixed overheads which would have been incurred by the French region with or without the transfer. Since the French region had the spare capacity to support the additional production for the Spanish region, there was no additional incremental cost or other opportunity cost incurred besides the incurrence of the variable cost. As such, we proposed that the transfer price should not be based on the full cost, but rather the variable cost plus 5% profit margin. Incorporating a mark up as established by Jacques is reasonable because there is a need to compensate the French region for the additional work incurred. Therefore, the transfer price is proposed to be 5,602,830 FrF instead of 6,803,000 FrF (Please see Appendix 1 for the detailed computation). It is also fair for the Spanish region to bear the expenses of sending people to France to assist in the packaging since this cost are incurred as a result of the additional production for the Spanish region. To prevent future disputes on the transfer pricing, it is recommended that the central office established the transfer pricing computation methodology for transfer across the region.

HOW WOULD YOU EVALUATE THE PERFORMANCE OF THE 3 MANAGERS?

There is a need to differentiate between the evaluation of the managers and the performance of the regions and this could be done through the evaluation of the actual performance or comparing the actual performance with the profit plan. When comparing against the profit plan, there is a need to adjust the profit plan to discount the impact of factors that are beyond their control such as the effects of drop in temperature on the performance of the Spanish region. The actual performance should also only consider controllable costs, which are costs that are significantly influenced by the actions of someone within their respective regional business unit . Otherwise, the managers may not do their best to achieve or exceed the target subsequently. To start shaping the desired behaviour, the performance rewards system should gradually implement features to be included in the new performance evaluation system for the coming fiscal year. However, as the evaluation was based on the performance of the fiscal year that was already over, changes in the performance evaluation and reward system should not negatively affect the remunerations of the managers as compared to past arrangements. Nonetheless, if there is justification to send a strong signal for poor performance, it should be carried out.

Jacques expected 18% ROI before taxes for the shareholders’ and his