Siemens Electric Motor Works(B):

Pricing Interdivisional Sales

By
Prabhanshu Agrawal(91)
Rahul Singh(109)
Ojasvee Khanna(89)
Sravan Kumar(184)

Case study Introduction

Siemens AG was one of the largest producers of electrical and

electronics products.
The largest group under it was Energy Automation group, under it
manufacturing industries under which EMW is operate
EMW produces Low voltage motors.
In 1970s custom motors comprises of 20% and standard motors
comprises 80% of overall production
Huge competition to standard motors from Eastern Bloc
competitors which have a cost advantage of low labor rates.
To improvise they changed the strategy to 10% standard motors
and 90% custom motors.
For successful implementation of new strategy they followed the
following changes such as replacing old machines with
sophisticated machines for customization and vertical integration.

 Large Volume Components were manufactured using

automated equipment
Low Volume Components might be made by hand
The Production facilities of the Manufacturing Industries
Group were organized around production technologies
The sales division was organized around customer market
segments
The orders are evaluated based on data provided by
EMW Representative on cost of production.
Sales Representative on customer information.

Cost of Producing an Order :

Total Cost = Direct Material cost + Direct Labor Cost + Overhead Cost
Calculating Overhead Cost :

Overhead

Cost driver

Material related Overhead

Materials consumed

Production related Overhead

Direct labor/ Direct Machine hours

Support related Overhead

Direct materials + Direct Labor +

Manufacturing Overhead + Production
Overhead

Order Processing Overhead

Number of Orders (constant per order)

Special Component handling

Overhead

Number of special components

(constant per component)

Factory Cost Schedule for Low Wattage A/C Motors:

Number of
Discount Factor
pieces per order

1.00

2-4

.70

5-19

.57

20-99

.48

>100

.42

Factory Cost = Standard Cost * Discount Factor. For example motors from
an order of 12 with a standard 1 unit cost of 250 cost at 142.5 per
unit(250*0.57=142.5)
Factory Cost is an approximation to Process-Oriented Costing and both
are not the same

EVALUATING THE ORDERS:

The profitability of the customers total business with Siemens

corporation was analyzed.

A below cost price is accepted if the loss could be made up in

other transactions with the customer.

For all unprofitable orders, a price floor is set at 25% above the
variable cost of production.

The low volume orders are most profitable to the firm.

COMPUTING THE TRANSFER PRICE:

Transfer price is calculated based on the analysis of profit of the order for
the EMW to break even.

For profitable orders,

Transfer price=factory cost +(1/3*profit earned)

For unprofitable orders,

Transfer price=variable cost +(3/4*contribution earned)

The two transfer pricing rules were established by analyzing the cost structure
of low wattage A/C motor business at average capacity utilization over the
business cycle.

For unprofitable orders , 3/4th of contribution goes to EMW and 1/4th of the
contribution goes sales.

2. Outline the transfer pricing rules. What is the relation between

the cost of a product as generated by the product costing
system, the factory cost, and its transfer price?

Transfer Pricing
The price at which EMW transfers motors to the sales division is
called transfer pricing.

It calculated based on whether a motor is profitable or not.

Profitable order:
Transfer price = Factory cost + (1/3) *Profit

Unprofitable order:
Transfer Price = variable cost + (3/4) *contribution margin

Product costing system

1. Direct material cost
2. Direct labour cost
3. Overhead cost
i. Material related overhead (cost of direct materials)
ii. Production related overhead (Machine hours or labour
hours)
iii. Support related overhead (% of sum of direct material,
direct
labour, material related overhead, production related
overhead)
iv. Order processing cost (No. of orders)
v. Costs of handling custom components (No. of types of
special
components)

Factory cost
. Approximates the Process cost system based on the number
of motors per order. It is given by
Factory cost = Standard cost of one unit of one motor *
discount factor
based on no. of motors

1.

Do you agree with Siemenss decision to set up both Sales and EMW as
profit Centres? What are some of the costs and benefits associated with
this decision?
A: No.
. When there are two profit centers, the actual potential
profit of EMW is not revealed as a part of the profit goes to
sales.
.

When there is only one profit center the actual profit to

EMW can be shown.

If there is only one profit center , shipping and marketing

costs increases.

Administrative costs are lower when there is one profit

center.

3. If Herr Lottes asked for your analysis of his situation and a

recommended course of action, how would you respond?
Processing and special components handling overhead allocation is
done on lot produced
Maximum of the sales are with lot size 20 - 99
Increasing the discount factor for this lot size while calculating the
factory cost will increase the contribution margin and in turn
increase the overall contribution
This will bring contribution margin to 40% which will be breakeven
for EMW