Transfer Pricing; Strategy Better Life Products (BLP), Inc., is a large U.S.-based manufacturer of health-care products; it specializes in cushions, braces, and other remedies for a variety of health problems experienced by elderly and disabled persons. BLP knows that its industry is price-competitive and hopes to compete through rapid growth, primarily within the United States, where it has a well- established brand image. Because of the competitive industry conditions, BLF is focusing on cost and price reductions as a principal way to attract customers. Because of rising domestic production costs, lower production costs in other countries, and a modest increase in global demand for its prod- ucts, BLP manufactures some of these products outside the United States. Much of the materials for use by foreign manufacturers is shipped from the United States to the foreign manufacturer, which assembles the final product. In this way, BLP takes advantage of the foreign country's lower labor costs. For this purpose, BLP has formed three divisions, one in the United States to purchase and perform limited assembly of the raw materials; one a foreign division to complete the manufactur- ing, especially of the labor-intensive components of manufacturing; and one a marketing and sales division in the United States. Sales of BLP's products are approximately 80 percent in the United States, 10 percent in Canada, and 10 percent worldwide. The foreign divisions tend to focus only on manufacturing because of the specialized nature of the products and because of BLP's desire to have the U.S. sales division coordinate all sales activities. BLP now has 18 U.S. divisions and 23 foreign divisions operating in this manner.
Foreign divisions' shipments to the United States are subject to customs duties according to the U.S. Tariff Code, which adds to BLP's cost of the foreign-based manufacturing. However, the code requires U.S. companies to pay duty on only the value added in foreign countries. For example, a prod- uct imported from an Argentine company to BLP pays customs on only the amount of the product's cost resulting from labor incurred in Argentina. To illustrate, a product with $10 of materials shipped from the United States to Argentina that incurs $10 of labor costs in Argentina is charged a tariff based on the $10 of labor costs, not the $20 of total product cost. Thus, for tariff purposes, having as small a portion of total product cost from the foreign country as possible is advantageous to BLP.
BLP division managers, including those of the foreign manufacturing facilities, are evaluated on the basis of profit. Jorge Martinez is the manager of the manufacturing plant in Argentina; his compensation from BLP is based on meeting profit targets.
BLP uses a transfer-pricing approach common in the industry to allow each of the company's divisions to determine the transfer pricing autonomously through interdivision negotiations. In recent years, however, top management has played an increased role in such negotiations. In particu- lar, when the divisions determine a transfer price that can lead to increased taxes, foreign exchange exposure, or tariffs, the corporate financial function becomes involved. This has meant that the transfer prices charged by foreign divisions to U.S. sales divisions have fallen to reduce the value added by the foreign country and thereby reduce the tariffs. To avoid problems with U.S. and Argen- tine government agencies, the transfer prices have been reduced slowly over time.
One effect of this transfer-pricing strategy has been the continued decline of the foreign divi- sions' profitability. Jorge and others have difficulty meeting their profit targets and personal com- pensation goals because of the continually declining transfer prices.
Required
1. Assess BLP's manufacturing and marketing strategies. Are they consistent with each other and with what you consider to be the firm's overall business strategy?
2. Assess BLP's performance-measurement system. What changes would you suggest and why?