Zumwald AG Case Text

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Chapter 7 . Financial Responsibility Centers
In August 2002, a pricing dispute arose between the

managers of some of the divisions of Zumwald AG.
Mr. Rolf Fettinger, the company's managing director,
had to decide whether to intervene in the dispute.
ECD sold application-specific integrated circuits

and subassemblies. ECD was originally established
as a captive supplier to other Zumwald divisions.
but in the last decade its managers had found external markets for some of the division's vroducts.
Because of this, ECD's managers were given profit
center responsibility.
THE COMPANY
Zumwald AG, headquartered in Cologne,
Germany, produced and sold a range of medical
diagnostic imaging systems and biomedical test
was
equipment and instrumentation- The
organized into six operating divisions. Total annual
revenues were slightly more than 3 billion.
Zumwald managers ran the company On a
decentralized basis. The managers of each division
were allowed considerable autonomy if their
performances were at least On plan. Performance
was evaluated, and management bonuses were
assigned, based on each division's achievement
invested
of budgeted targets for retum
(RolC) and
growth. Even
the 'Ompany was partly
integrated,
managers were
to source their
from external suppliers if they so chose.
Involved in the
were
three of the
the Imaging
Systems Division (ISD), the Heidelberg Division
(Heidelberg), and the Electronic Components
Division (ECD).
THE DISPUTE
1, 2001, ISD designed a new ultrasound imaging

system, called the ~ 7 3H~~~~
.
were high for ~ 7 3 .
The new system offered users advantages in processing speed and cost, and it took up less space.
~ ~ i d engineers
~ l b participated
~ ~ ~ in the design
of ~ 7 3 but
,
~ ~ i d ~ was
l b e ~ ~
for
the full cost of the time its employees spent on this
pro,ect.
managers
~f~~~ the specifications were set,
solicited bids for the materials needed to produce
X73 components. Heidelberg was asked to bid to
supply the displays needed for production of the
X73 system. So were two outside companies. One
was Bogardus NV, a Dutch company with a reputation for producing high-quality products. Bogardus
had been a long-time supplier to Zumwald, but
it had never before supplied display units and
systems to any Zumwald division. Display
Technologies PIC was a British company that had
ISD sold complex ultrasound and magnetic reson- recently entered the n~arketand was known to be
ance imaging systems. These systems were expen- pricing its products aggressively in order to buy
market share. The quotes that ISD received were as
sive, typically selling for 500,000-1 million.
Heidelberg sold high-resolution monitors, graphics
controllers, and display subsystems. ApproximCost per X73 system ()
ately half of its sales were made to outside cus~ ~ i d ~ i ,~, i ~ il~ , , b ~ ~ ~
140,000
tomers. ISD was one of Heidelberg's major inside
120,500
Bogardus NV
100,500
customers.
Display Technologies PIC
,
This case was prepared by Professors Kenneth A. Merchant and Wim A. Van der Stede.
Copyright O 2003 by Kenneth A. Merchant and Wim A. Van der Stede.
304
Zumwald AG
After discussing the bids with his management

team, Conrad Bauer, ISD's managing director,
announced that ISD would be buying its display
systems from Display Technologies Plc. Paul
Halperin, Heidelberg's general manager was livid.
He immediately complained to Mr. Bauer, but
when he did not get the desired response, he took
his complaint to Rolf Fettinger, Zumwald's managing director. Mr. Fettinger agreed to look into the
situation.
A meeting was called for August 29, 2002.
Mr. Halperin asked Christian Schonberg, ECD's
GM, to attend this meeting to support his case. If
Heidelberg got this order from ISD, it would buy
all of its electronic components from ECD.
At this meeting, Mr. Bauer immediately showed
his anger:
1. ISD's tentative target price for the X73 system was

340,000.'
2. Heidelberg's standard manufacturing cost (material, labor and overhead) for each display system
was 105,000. When asked, Mr. Halperin estimated that the variable portion of this total cost was
only 50,000. He treated Heidelberg's labor costs
as fixed because Geman laws did not allow him to
lay off employees without incurring expenses that
were "prohibitively" high.
3. Because of the global business slowdown, the
production lines at Heidelberg that would produce
the systems in question were operating at approximately 70% of capacity. In the preceding year,
monthly production had ranged from 60-90% of
total capacity.
4. Heidelberg's costs included 21,600 in electronic
subassemblies to be supplied by ECD. ECD's full
manufacturing costs for the components included
in each system were approximately 18,000, of
which approximately half were out-of-pocket
costs. ECD's standard policy was to price its products internally at full manufacturing cost plus
20%. The mark-up was intended to give ECD an
incentive to supply its product internally. ECD was
currently operating at 90% capacity.
Paul wants to charge his standard mark-up for these

displays. I can't afford to pay it. I'm trying to sell a
new product (X73) in a very competitive market.
How can I show a decent ROIC if I have to pay a price
for a major component that is way above market?
I can't pass on those costs to my customers. Paul
should really want this business. I know things have
been relatively slow for him. But all he does is quote
list prices and then complain when I do what is best
for my division.
Near the end of the meeting, Mr. Bauer reminded
We're wasting our time here. Let's stop fighting
everybody
of the company's policy of freedom of
amongst ourselves and instead spend our time figuring
sourcing.
He
pointed out that this was not such a
out how to survive in these difficult business conditions.
big deal, as the volume of business to be derived
Mr. Fettinger asked Mr. Halperin why he from this new product was only a small fraction
could not match Display Technologies' price. Paul (less than 5%) of the revenues for each of the divireplied as follows:
sions involved, at least for the first few years. And
he
also did not like the potential precedent of his
Conrad is asking-meto shave my price down to below
being
forced to source internally because it could
cost. If we start pricing our jobs this way, it won't be
long before we're out of business. We need to price adversely affect his ability to get thoughtful quotes
our products so that we earn a fair return on our from outside suppliers in the future.
investment. You demand that of us; our plan is put
together on that basis; and I have been pleading with
my sales staff not to offer deals that will kill our mar- THE DECISION
gins. Conrad is forgetting that my engineers helped As he adjourned the meeting, Mr. Fettinger
him design X73, and we provided that help with no promised to consider all the points of view that had
mark-up over our costs. Further, you can easily see been expressed and to provide a speedy judgment.
that Zumwald is better off if we supply the display He wondered if there was a viable compromise or
systems for this new product. The situation here is
clear. If Conrad doesn't want to be a team player, then if, instead, there were some management principles
you must order him to source internally! That deci- involved here that should be considered inviolate.
sion is in the best interest of all of us.
In the ensuing discussion, the following facts
came out:
' The cost of the other components that go into X73 is 72,000.
ISD's conversion cost for the X73 system is 144,000, of which
1 17,700 is fixed.

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Chapter 7 . Financial Responsibility Centers

In August 2002, a pricing dispute arose between the

ECD sold application-specific integrated circuits

1, 2001, ISD designed a new ultrasound imaging

After discussing the bids with his management

1. ISD's tentative target price for the X73 system was

Paul wants to charge his standard mark-up for these

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