Elora Manufacturing makes autoparts that it sells to automobile assemblers. Elora Manufacturing also makes its own branded autoparts that it sells in the automotive aftermarket. Each autopart is manufactured to the customer's specification.
The price that Elora Manufacturing charges customers is based on the cost of the autopart. These costs include the unit and batch-related costs of filling the order and a share of capacity-related costs.
At the moment Elora Manufacturing has four major customers: Giant Motors, Far East Motors, Tiger Motors, and Fargo Motors. The four customers, who are long-term, use, respectively, on average 10%,20%, 15%, and 15% of available capacity. Elora Manufacturing uses 30% of available capacity to make its own autoparts. On rare occasions, Elora Manufacturing receives an order from another source, and those are treated on a one-off basis.
Elora Manufacturing is organized into three divisions: manufacturing, assembler sales, and aftermarket sales.
The automobile parts aftermarket is very competitive and margins there are slim.
The price paid by the assembler to the assembler sales division is invariably a contract price. This contract price is negotiated between the assembler sales division and the assembler and is done with a full exchange of information. That is, the assembler has full access to all Elora Manufacturing's cost records. The assembler usually demands efficiency improvements and therefore, price reductions, during the life of the contract. Three of the four assemblers have consultants who regularly visit their suppliers' manufacturing facilities to suggest process improvements that will lower costs. Usually, the contract specifies a price that equals full manufacturing cost plus a markup to cover corporate-level capacity-related costs and a return on invested capital. The manufacturing cost base of the contract usually falls by 5% to 10% per year during the life of the contract.
Senior management is determined to provide the highest possible level on motivation to its three divisions. Therefore, the three divisions are treated as profit centers, and the company uses transfer prices to price transfers between the divisions. Problems have arisen relating to determining transfer prices under the different circumstances faced by the two sales divisions.
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