C.S. Technology Company has two divisions, the Semiconductor Division and the PC

Question

C.S. Technology Company has two divisions, the Semiconductor

Division and the PC Division. The PC Division may purchase semiconductors

from the Semiconductor Division or from outside suppliers. The

Semiconductor Division sells semiconductor products both internally and

externally. The market price for semiconductors is $100 per 100

semiconductors. Frank Hoffman is the controller of the PC Division, and

Lisa Henderson is the controller of the Semiconductor Division. The

following conversation took place between Frank and Lisa:

Frank: I hear you are having problems selling semiconductors out of your

division. Maybe I can help.

Lisa: You've got that right. We're producing and selling at about

90% of our capacity to outsiders. Last year we were selling 100% of

capacity. Would it be possible for your division to pick up some of our

excess capacity? After all, we are part of the same company.

Frank: What kind of price could you give me?

Lisa: Well, you know as well as I that we are under strict profit

responsibility in our divisions, so I would expect to get market price, $100

for 100 semiconductors.

Frank: I'm not so sure we can swing that. I was expecting a price

break from a "sister" division.

Lisa: Hey, I can only take this "sister" stuff so far. If

I give you a price break, our profits will fall from last year's levels.

I don't think I could explain that. I'm sorry, but I must remain

firm---market price. After all, it's only fair --that's what you would

have to pay from an external supplier.

Frank: Fair or not, I think we'll pass. Sorry we couldn't have

helped.

Was Frank behaving ethically by trying to force

the Semiconductor Division into a price break? Comment on Lisa's

reactions.

Explanation / Answer

This scenario is a negotiation between two divisions. Frank is not behaving
unethically by attempting to get a good price from the Semiconductor Division. He is not behaving unethically because he refuses market price. This may not seem %u201Cfair,%u201D but price negotiation is a very typical business activity and is part of Frank%u2019s job. It would be unethical only if the PC Division refused to deal with the Semiconductor Division to purposefully hurt the Semiconductor Division%u2019s performance, so that PC could look good in comparison. This claim could only be supported if the PC Division%u2019s refusal to purchase from the Semiconductor Division was economically unsound. For example, maybe there are no transportation costs because the Semiconductor Division plant is on site. In this case, the total cost to the PC Division would be less by purchasing from the Semiconductor Division. Refusing to do so could be the basis for claiming an ethical breach.

The PC Division has overall profit responsibility and authority. This means that the PC Division has the choice of purchasing from the inside or the outside. The PC Division should have incentives to purchase from the inside in order to maximize overall corporate income. This means that the transfer price should be set below market price in order to give Frank an incentive to purchase from the Semi-conductor Division. Lisa%u2019s refusal to budge on market price will likely hurt the Semiconductor Division and the company as a whole. If there are no alternative buyers, the Semiconductor Division should negotiate with the PC Division and accept a price lower than market price. This produces a win-win for both divisions. Thus, although neither party appears to be behaving unethically, Lisa%u2019s price position appears to be the weakest.

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