The Firm as a Production Function Objective: Maximize Profit Labor Firms Output Capital This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

The Firm as a Contractual Focal Point Employees Suppliers Labor Unions Insurance Providers The Firm Stockholders Bondholders Banks Customers This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

Conflicts within the firm Owners vs. Managers Top Managers vs. underlings Creditors and stockholders Managers and labor unions Buyer-supplier conflicts Partner-owners may free ride on each other’s effort This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

Divisional Performance Evaluation Cost Centers Expense Centers Revenue Centers Profit Centers Investment Centers This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

Cost Centers Objectives – Are these equivalent? Decision Rights Minimize Costs for a given output Maximize Output for a given budget Minimize Average costs Decision Rights Input mix Requirements When would a cost center be appropriate? This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

Marginal, Not Average Price MC AC Output This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

Marginal, Not Average Price MC AC Demand Output MR This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

Expense Centers Maximize service given budget Problems Solutions If users aren’t charged for the service they will overuse it. Managers sometimes build empires Solutions Benchmark size against other firms Place under the control of the largest user Example: Accounting department This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

Revenue Center Maximize revenue given price and budget Problems Can’t let managers set prices Central management must set the product mix or sales will focus on expensive items. Example: Sales, distribution and service This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

Profit Center Objectives Decision Rights Requirements Actual profit Actual profit vs. Expected Profit Expected Present Value of current and future profit Decision Rights Input mix Product mix Selling prices Requirements This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

Investment Centers Objectives Decision Rights Requirements Maximize ROA = (Acct Net Income)/(Total Assets) Decision Rights Input mix Product mix Selling prices Capital invested Requirements Problems: This is not a measure of profit and may cause managers to avoid investments with lower ROA that would lower profitability. High ROA projects are frequently risky Near retirement executives may take high short term ROA that are poor in the long term This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

Investment Center Problems ROA may cause managers to avoid profitable projects with low ROA Risky projects often have high ROA Near retirement managers may adopt projects with high short term ROA This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

Transfer pricing Costless Information Rule: The most profitable transfer price is equal to opportunity cost. Retail in the US P = $15 Manufacturing MC = $5 AC =$20 European Retail P = $20 This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

Transfer Pricing: Who Can You Trust? Successive Monopoly / Double Monopoly Markup Price Manufacturing Price Retail D D 85 60 MC 10 MC MR MR 5 11 Quantity 5 11 22 Quantity MR This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

Transfer Pricing: Common Methods Market Based Transfer Price Competitive prices minimize long-run costs Beware of synergies There may be costs of writing and enforcing contracts with others Marginal Production Cost (MPC) MPC may not be MC May not be relevant near capacity This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

Transfer Pricing: Common Methods Full Cost Transfer Prices May work well when near capacity Doesn’t maximize profit Negotiated Transfer Prices The right people are at the meeting Time consuming Negotiating skills are critical This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

17-1 Auto-fit is a multidivisional firm that produces auto parts. It has the capacity for annual production of 100 units of a particular part. The marginal cost of producing each unit is $10. These units can be sold internally either to other divisions or to external customers. The external market price is $20. The allocated share of corporate overhead for each part produced is $5. Total corporate overhead expenditures do not vary with the production of the part. How many units of the part should the company produce? What is the theoretically correct transfer price (should the company decide to transfer the part internally)? This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

a. What is the likely reason for the under-forecasting? 17-4 The Xtrac Computer company is organized into regional sales offices and a manufacturing division. The sales offices forecast sales for the upcoming year in their territories. These figures are then used to set the manufacturing schedules for the year. Prices of the computers are determined by corporate headquarters and the sales people are paid a fixed wage and a commission based on sales. The regional sales offices are evaluated as revenue centers. The regional sales manager is paid a small wage (about 30% of pay) and a commission based on the sales of her territory that exceeds the budget (about 70% of pay). Xtrac has a notoriously bad track record for forecasting computer sales. Its budgets always under-forecast sales, and then, during the year, manufacturing scrambles to produce more units, authorizes labor overtime, and buys parts on rush orders. This drives up manufacturing costs. In fact, Xtrac even under-forcasts sales when the economy is slow. a. What is the likely reason for the under-forecasting? b. Propose solutions to the problem This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.