Birch Paper Company Case Analysis Transfer Pricing Help

Birch Paper Company Case Analysis – Transfer Pricing Help

Introduction

The Birch Paper Company case is one of the most widely discussed cases in managerial accounting and transfer pricing. It presents a real-world dilemma faced by a manufacturing company regarding internal transactions among its divisions. see postnext The case highlights how transfer pricing policies can influence managerial decisions, divisional autonomy, corporate profits, and overall organizational harmony.

At its core, the Birch Paper case is not only about determining the best price for a transfer but also about balancing divisional independence with the company’s long-term interests. This analysis will explore the company’s background, the problem faced by Northern Division, the transfer pricing conflict among divisions, and the best course of action for management. Additionally, it will examine key concepts in transfer pricing and lessons that can be applied by organizations facing similar challenges.

Company Background

Birch Paper Company is a medium-sized, integrated paper company. It operates across various product lines with several divisions:

  1. Northern Division – Produces corrugated boxes.
  2. Southern Division – Manufactures paperboard.
  3. Thompson Division – Produces printing and tissue papers.
  4. Linerboard and Other Divisions – Produce raw materials for packaging and paper products.

The company encourages each division to operate as an independent profit center. Division managers are responsible for their own profitability, making them accountable for costs, revenues, and decisions. While this system motivates autonomy and accountability, it also creates potential conflicts when inter-divisional transactions occur.

The Problem

The Northern Division of Birch Paper received a special order for 50,000 corrugated boxes from an outside customer. To produce these boxes, it required certain materials. Northern Division had two options:

  1. Purchase materials internally from Southern Division and Thompson Division at transfer prices quoted by them.
  2. Purchase externally from West Paper Company, an outside supplier that offered a competitive price.

The issue arose because the transfer prices quoted internally by Southern and Thompson Divisions were higher than the external price offered by West Paper Company. Northern Division, seeking to minimize its own costs, preferred the external supplier. However, from a corporate perspective, using internal suppliers would keep profits within the company as a whole.

Transfer Pricing Conflict

Transfer pricing is the price charged for goods or services exchanged between divisions within the same company. Ideally, the transfer price should align divisional incentives with corporate profitability. However, in Birch Paper’s case, transfer pricing became a source of conflict.

  • Northern Division’s View: It wanted to minimize its costs and maximize divisional profit. The external offer was cheaper, so from its perspective, it made sense to purchase outside.
  • Southern Division’s View: It wanted to sell its products at a high price to maximize its own profit. Its quoted price was not competitive compared to the external market.
  • Thompson Division’s View: Similarly, it wanted to sell at favorable prices, not at cost.
  • Corporate View: From the company’s standpoint, it would be more beneficial if the order were kept internal, even if Northern Division’s short-term profits were lower.

This situation illustrates a common managerial accounting challenge: what is best for the division is not always best for the company as a whole.

Financial Analysis

To evaluate the options, let’s break down the financial implications:

  1. External Purchase from West Paper:
    • Northern Division saves on costs compared to internal quotes.
    • However, corporate profit is lower because internal divisions lose potential revenue.
  2. Internal Purchase from Southern and Thompson Divisions:
    • Northern Division’s costs appear higher, reducing its divisional profit.
    • At the corporate level, the profit is retained within Birch Paper Company, making it the more profitable option overall.

Thus, from a corporate perspective, the internal transfer is better. From a divisional perspective, the external purchase is more attractive.

Lessons on Transfer Pricing

The Birch Paper case provides several insights into transfer pricing and divisional autonomy:

1. Misalignment of Goals

When divisions act as independent profit centers, their goals may conflict with the overall company’s profitability. Transfer pricing policies must be designed to align divisional incentives with corporate objectives.

2. Market-Based vs. Cost-Based Pricing

  • Market-based transfer pricing allows divisions to sell internally at prevailing market prices. This is fair but may harm overall profitability if the external market price is higher than internal cost structures.
  • Cost-based transfer pricing allows divisions to sell at cost plus a markup. This ensures internal competitiveness but may discourage efficiency.

In Birch Paper’s case, the market-based transfer price was unfavorable compared to the external supplier.

3. Autonomy vs. Corporate Control

Too much divisional autonomy can lead to decisions that harm the company as a whole. At the same time, excessive central control can demotivate managers and reduce accountability. Birch Paper’s situation reflects the delicate balance required between divisional independence and corporate oversight.

4. Long-Term Relationships

By choosing external suppliers over internal ones, divisions may harm long-term inter-divisional relationships. While short-term cost savings look attractive, they can weaken internal collaboration and trust.

5. Role of Top Management

Ultimately, top management must intervene in such cases to ensure decisions are made in the company’s best interest. While divisional autonomy is important, look at this site exceptions should be made when corporate profitability is at stake.

Recommended Solution

For Birch Paper Company, the best course of action would be:

  1. Accept the Internal Supply Option – Even though it increases Northern Division’s costs, it maximizes corporate profit. Keeping the order within the company benefits shareholders in the long run.
  2. Revise Transfer Pricing Policy – Birch Paper should develop a clearer policy to avoid such conflicts. A dual-rate transfer pricing system could be introduced:
    • Charge divisions at variable cost for internal transfers.
    • Allow them to earn profits on external sales.
      This ensures that divisions are not penalized for using internal suppliers while still motivating them to compete in external markets.
  3. Strengthen Performance Evaluation – Instead of evaluating managers solely on divisional profits, performance metrics should also include contribution to overall corporate profit. This way, managers have incentives to align their decisions with company goals.
  4. Encourage Internal Negotiation – Divisions should be encouraged to negotiate fair prices that are competitive with external suppliers while still benefiting the company as a whole.

Broader Implications

The Birch Paper case is not unique. Many organizations with decentralized structures face similar challenges in transfer pricing. For example:

  • Multinational corporations must set transfer prices between subsidiaries in different countries, which also has tax implications.
  • Conglomerates with diverse product lines must decide whether to source internally or externally.

The fundamental lesson is that transfer pricing is not merely an accounting mechanism—it is a strategic tool that influences behavior, collaboration, and long-term competitiveness.

Conclusion

The Birch Paper Company case highlights the complexities of transfer pricing in a decentralized organization. While Northern Division’s preference to buy externally made sense for its own profitability, it was not aligned with the overall company’s best interest. This conflict underscores the need for a well-designed transfer pricing policy that balances divisional autonomy with corporate profitability.

The case also emphasizes the role of top management in guiding decisions that affect the entire company. Without intervention, divisions may act in ways that optimize their short-term gains but damage corporate performance.

Ultimately, the Birch Paper Company case serves as a valuable learning tool for managers, accountants, and business students. view it now It shows that effective transfer pricing policies, combined with fair performance evaluation systems, can help organizations avoid conflicts, encourage collaboration, and ensure sustainable growth.