Entwhistle Electric makes compact batteries for a variety of mobile applications. It was recently purchased by Razor Holdings, which also owns Green Lawn Care, maker of low emission lawn mowers. The reason for Razor’s purchase of Entwhistle was to give Green an assured supply of batteries for Green’s new line of all electric lawn mowers. Razor’s corporate planning staff mandates that Entwhistle set a transfer price for batteries shipped to Green that equals its cost, and also requires that Entwhistle fulfill all of Green’s needs before it can sell to any other customers. Green’s orders are highly seasonal, so Entwhistle finds that it cannot fulfill orders from its other customers at all during the high point of Green’s production season. Also, because the transfer price is set at cost, Entwhistle’s management finds that it no longer has a reason to drive down its costs, and so its production efficiencies stagnate.
After a year, Razor’s corporate staff realizes that Entwhistle has lost 80% of its previous customer base, and is now essential ly relying upon its sales to Green to stay operational. Entwhistle’s profit margin has vanished, since it can only sell at cost, and its original management team, faced with a contracting business, have all left to work for competitors.