Dissertation transfer pricing

A GROUP DECISION SUPPORT SYSTEM FOR TRANSFER PRICING

IN THE PHARMACEUTICAL INDUSTRY





PROEFSCHRIFT

ter verkrijging van de graad van doctor aan de Technische Universiteit Delft, op gezag van de Rector Magnificus,

Prof. Drs. P.A. Schenck, in het openbaar te verdedigen

ten overstaan van een commissie door het College van Dekanen daartoe aangewezen,

op dinsdag 12 september 1989 te 16.00 uur

door

MICHAEL BARTHOLOMEUS MARIA VAN DER VEN

geboren te Goirle

TR diss 1749

Dit proefschrift is goedgekeurd door de promotor: Prof. Dr. H.G. Sol

Promotiecommissie

Prof. Dr. H.G. Sol, Technische Universiteit Delft, promotor Prof. Dr. A. Bosman, Rijksuniversiteit Groningen Prof. Drs. B.K. Brussaard, Technische Universiteit Delft Prof. Dr. H. Koppelaar, Technische Universiteit Delft Prof. Dr. F.A. Lootsma, Technische Universiteit Delft Prof. Dr. Ir. CA.Th. Takkenberg, Rijksuniversiteit Utrecht Dr. H.C. Verlage, Raad van Bestuur Grasso's Koninklijke Machinefabrieken NV

"Transfer pricing in pharmaceuticals is more of an art than a science"

Otto Nowotny

The writing of this thesis is in gratitude dedicated to my wife Eugenie, my parents and my parents-in-law.

Published and distributed by:

Michael van der Ven p.o. Mosheuvel Molenbochtstraat 76 5014 ER Tilburg The Netherlands Tel. +31(13)365309 or +31(13)359429

Cover: Piet van Zwieten

Print: Gianotten BV, Tilburg

The following names are registered trade marks: Comshare IBM Lotus 1-2-3 MAUD MS-DOS Personal Wizard System W

The author was supported by a grant under the Ministry of Education "National Facility for Informatics" programme (project NFI-1).

CIP-DATA, Koninklijke Bibliotheek, The Hague Ven, Michael Bartholomeus Maria van der A group decision support system for transfer pricing in the pharmaceutical industry / Michael Bartholomeus Maria van der Ven. - [S.l. : s.n.]. - 111. Thesis Delft. - With index, ref. - With summary in Dutch. ISBN 90-9002887-0 SISO 385.9 UDC 681.3:[338.5:334.71:615.2](043.3) Subject heading: group decision support systems / transfer prices / pharmaceutical industry

ISBN: 90-9002887-0

© 1989 by M.B.M. van der Ven

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without written permission of the author.

Contents

1 BACKGROUND AND RESEARCH QUESTIONS 1 1.1 Introduction 1 1.2 Research questions and research approach 4 1.3 Outline of the thesis 9

2 THE EUROPEAN PHARMACEUTICAL INDUSTRY 11 2.1 Introduction 11 2.2 Some characteristics of the European pharmaceutical industry 12 2.3 Relationship with national health organizations 15 2.4 The approach of the British National Health Service 16 2.5 Conclusion 21

3 TRANSFER PRICING: A COMPLEX ISSUE 23 3.1 Introduction 23 3.2 Management-control transfer pricing 23 3.3 International transfer pricing 29 3.4 Transfer pricing in the pharmaceutical industry 38 3.5 A framework to describe transfer pricing 40 3.6 Conclusion 43

4 GROUP DECISION SUPPORT SYSTEMS 45 4.1 Introduction 45 4.2 Structuring decision processes 47 4.3 Multi-criteria decision making 54 4.4 Approaches to group decision support systems 56 4.5 Four aspects of developing group decision support systems 61 4.6 Conclusion 64

5 TRANSFER PRICING AT EUROPHAR: THE PROBLEM 67 5.1 Introduction 67 5.2 Europhar: the company 69 5.3 Decision process before system introduction 73 5.4 Descriptive empirical model 78 5.5 Descriptive conceptual model 81 5.6 Conclusion 85

6 TRANSFER PRICING AT EUROPHAR: A SOLUTION 87 6.1 Introduction 87 6.2 Prescriptive conceptual model 87 6.3 Prescriptive empirical model 107 6.4 Decision process after system introduction 116 6.5 Conclusion 135

vu

7 EVALUATION 137 7.1 Introduction 137 7.2 Questionnaire and answers 141 7.3 Overall evaluation 147 7.4 Conclusion 151

8 SUMMARY AND CONCLUSIONS 153 8.1 Summary of findings 153 8.2 Future research 155

REFERENCES 157

List of exhibits 165

Samenvatting in het Nederlands 167

Acknowledgements 171

List of contributing institutions 172

About the author 172

Index 173

viii

1

BACKGROUND AND RESEARCH QUESTIONS

1.1 Introduction

As a result of the post-war expansion of foreign direct investments, trade is increasingly dominated by multinational companies, so called "multinationals". An increasing part of this trade is intra-firm trade in the sense that the seller and buyer belong to the same multinational group of companies.

According to Murray [1981, p. 2] around 40% of the exports of multinationals based in the major Western industrialized countries were intra-group transfers and these figures are rising. According to the report of the Independent Commission on International Development Issues, intra-firm trade makes up over 30% of all world trade, see Brandt et al. [1980, p. 188]. Although these figures should be handled with care, they give a good indication. Besides the internal sales of goods, other transactions take place extensively between the different parts of these enterprises, for example the granting of loans, the licensing of technology and the provision of services. The price which is set for the transfer of goods and services between two companies belonging to the same group, is called "transfer price". For the purpose of this project, a more specific definition will be introduced in chapter 3. "Transfer pricing" is defined as the process of deterrnining transfer prices. It is related to decision making.

Within large multinational companies, decentralization is necessary as centralization of decisions at headquarters would become counterproductive: it would overtax the time and energy of top management. The background of transfer pricing can be found in this decentralization principle in decision making, see chapter 3. Sheer size and the resulting complexity of multinationals argue against centralized management. Secondly, vesting the decision-making responsibility with the local manager allows for a more flexible response to local circumstances which can vary enormously, see Plasschaert [1979, pp. 23-24].

Decisions concerning transfer prices may reflect legitimate business concerns of a company, but they are also capable of being used in order to shift profits from high to low tax countries or to get around exchange or price-control regulations. Such practices; although pursued in the best business interest of a company, may conflict with the interest of host countries. This is not to suggest, according to Brandt et al. [1980, p. 189], that as a class, multinationals have been using such practices. Plasschaert [1985, p. 263] states that, with regard to over- and underpricing the evidence is meager and he points to the dangers of undue generalizations. He protests against the connotation that multinationals "are the villains" and points to the sometimes negative effects of government measures concerning transfer prices.

Nevertheless, caused by the increased size of intra-company trade of multinationals and the negative publicity on the subject in the seventies, see for example Vaitos [1974],

1

BACKGROUND AND RESEARCH QUESTIONS Ch. 1

government interference has increased. So the multinational has to operate in an increasingly strict legal framework which has remained national. It has therefore to conform with the varied and sometimes conflicting national laws in countries in which it operates, see OECD [1979, p. 7]. The increased governmental interference in its turn causes a growing interest in the various aspects of transfer pricing from business as well as from governmental side.

In order to demonstrate the complexity of the issue, literature on international transfer pricing often presents examples from the pharmaceutical industry, see for instance Verlage [1975] and Plasschaert [1979]. According to Nowotny [1987] and Von Grebmer [1987a], transfer-pricing problems are especially poignant for the pharmaceutical industry. This is caused, amongst others, by their relatively high degree of internationalization in combination with centralized production and research facilities. In other words: high centralized costs need to be covered by international intra-company sales. The position of the pharmaceutical industry will be explained in more detail in chapter 2.

In all phases of the decision process, the problem of international transfer pricing, especially in the pharmaceutical industry, is considered to be highly ill-structured. Sol [1982, p. 5], discusses various definitions of ill-structuredness. One of these definitions is taken from Uhr [1973, p. 274]: "Ill-formedness in problems seems to be closely related to issues of vagueness, ambiguity, flexibility, and creativity about all of which little is known." With Sol, Takkenberg [1983a, p. 10] notes that many the existing definitions of ill-structuredness are vague. To avoid ambiguity, we use the definition of Sol [1982, p. 5]. Sol starts with the definition of a well-structured problem: "A problem is well-structured if the following conditions are met: 1. the set of alternative courses of actions or solutions is finite and limited, 2. the solutions are consistently derived from a model system that shows a good

correspondence, 3. the effectiveness and efficiency of the courses of action can be numerically evaluated" Problems that do not fulfil these requirements are defined as ill-structured.

In literature on decision support, many authors have stressed the importance of supporting decision making with regard to ill-structured problems. Attempts at supporting decision making in ill-structured problem situations have focused on the development of so called "decision support systems". The aim of these systems is the use of computers to aid decision makers, see Sol [1985b] and Bosman [1987a].

During the last decade, decision support systems have gained dramatically in popularity. Research on decision-making and decision support systems has increased likewise, see McLean and Sol [1986]. According to Sol [1987b, p. 203], experiences with decision support systems are not always positive: "... [We] observe that empirical evidence on the effectiveness of decision support systems is not overwhelmingly positive, and often conflicting", see also Sol [1987a]. On the basis of laboratory experiments, Van Schaik [1988, p. 127] concludes that "teams using a decision support system do not perform better than those without."

2

Sec. 1.1 INTRODUCTION

With reference to DeSanctis and Gallupe [1985] we define a decision support system as an interactive computer-based system which facilitates solution of ill-structured problems. Not that this definition does limit itself to computer support only: other elements of the organization, like data, procedures and organizational members can also be included, see also Bots and Sol [1988].

Confining ourselves to the pharmaceutical industry, we see the following: on the one hand, we have an ill-structured problem of increasing importance to the pharmaceutical company, namely international transfer pricing. On the other hand we have a relatively new research area, namely decision support systems. We expect that decision support systems are useful for determining international transfer prices within the pharmaceutical industry.

As will be explained in more detail in chapter 2, the environment of the pharmaceutical industry is complex, hostile and turbulent, especially with regard to transfer pricing.

The environment is complex as many actors are involved: consumer groups, various governmental bodies from many countries, supra-national organizations like the World Health Organization and the European Community, health insurance companies and last but not least the competition. The high degree of internationalization and the division between prescribing, using and paying for drugs are amongst the causes of the complexity of the environment.

Hostility of the environment is not only caused by the competition but also by the groups that oppose current price levels and international price differences. According to De Jong [1981] "the industry, which earlier contributed to the conquest of many diseases, is no longer in favor with the general public", see also Breuk [1985]. It is under scrutiny from health-care authorities and consumer groups. Books with titles like "Corporate crime in the pharmaceutical industry", see Braithwaite [1984], give an impression of the hostilities the industry has to face. In the book we just mentioned, a special section is dedicated to transfer pricing.

The environment is turbulent as constantly new regulations are issued by the authorities involved. The developments with regard to the common market and changing measures with the aim to contain health care costs are examples, see Scrip [1988]. Moves of competitors also need to be monitored closely.

According to Huber and McDaniel [1986, p. 577], complexity, hostility and turbulence are the three main characteristics of the organizational environment in the post-industrial society. For this kind of environment, Huber and McDaniel propose the "decision-making paradigm". Like Simon [1973, pp. 269-270], Huber and McDaniel consider decision making as the organization's central activity. In view of this, improving decision making in organizations should be the focus of attention of the organizational sciences. According to Huber [1984a, 1984b], one of the elements that can contribute to improved decision making of post-industrial organizations are so-

3


called "group decision support systems". These are decision support systems explicitly designed to be used by groups of decision makers.

With regard to transfer pricing, pharmaceutical companies find themselves in a complex, hostile and turbulent post-industrial environment. Following Huber, group decision support systems should be useful in such a setting. In other words, transfer pricing in the pharmaceutical industry seems a "perfect" example to test the concept of group decision support.

To put it more formally: it is our hypothesis that group decision support systems are helpful for improving decision making with regard to the determination of transfer prices in the pharmaceutical industry.

1.2 Research questions and research approach

In this section, we cover some issues that are related to our research approach. According to Fitzgerald et al. [1985, p. 5], information technology is still so new, that not one adequate research approach for scientific progress exists but that pluralism needs to be accepted. Our basic presumption is that these fundamental issues must be answered within the context of a particular research setting. That is to say, a research approach is neither appropriate nor inappropriate until it is applied to a specific research problem, see Downey and Ireland [1979, p. 630]. This holds also for the two research questions which we try to answer. These research questions are:

A: What are the characteristics of a group decision support system designed to support and improve organizational decision making with regard to transfer prices within the pharmaceutical industry?

B: What are the effects of the use of this designed group decision support system on decision making within the organization?

Following Huber and McDaniel [1986], we consider decision making as the organization's central activity. In the literature, various approaches towards decision making exist. One of these approaches is based upon "bounded rationality", see Sol [1982, p. 7].

In our research approach we take the paradigm of bounded rationality as point of departure. This implies that we do not presume that decision makers have all relevant information and an unlimited capacity to process this information. Our point of departure is that decision makers operate "in their own environment with own definitions and limited scopes on accessible data", see Sol [1982, p. 7]. Simon [1976, pp. 65-86] considers behavior bounded rational "when it is the outcome of appropriate deliberation. [Bounded rationality] depends on the process that generated it." Discussing bounded rationality, Takkenberg [1983a] states that "it is impossible to define unambiguously what is rational. ... Rational is now also determined by the multitude of circumstances that influence the decision maker".

4

Sec 1.2 RESEARCH QUESTIONS AND RESEARCH APPROACH

In order to determine the multitude of circumstances that influence a decision maker, we need to analyze the existing situation, see Bosman [1986, p. 315] and Takkenberg [1983b, p. 258]. On the basis of this analysis, we make a description of the decision process, as it takes place. We define this description of the "as-is" situation as the descriptive empirical model, see also Sol and Van der Ven [1989]. This model is descriptive in the sense that the actual ("as-is") situation is described. No normative elements are included. This first model is empirical in the sense that it describes an actual situation which exists within one specific organizational group. Names of organizational members, financial figures and other specific details will be included. On the basis of one or more descriptive empirical models, a descriptive conceptual model is constructed. This descriptive conceptual model is "data void", see Bosman and Sol [1985, p. 82]. This model is still a description of the "as-is" situation, but now at a higher level of abstraction: the essential characteristics of the various empirical models are transformed into a possibly more generic description which provides global insight in the existing situation. The level of abstraction is such, that this model can be used for other organizations which are in a similar position.

On the basis of this latter descriptive model, literature research and other explorations, a third model comes into existence: the prescriptive conceptual model. The prescriptive conceptual is a combination of "description and design principles", see Bosman [1987b, p. 32]. It is prescriptive in the sense that it contains normative elements, see Takkenberg [1983a]: using this model for decision making should lead to an improved decision process.

When elaborating on our first research question, we will determine three of the four model categories as presented in exhibit 1-1. In this exhibit, the numbers 1-4 indicate the order of the activities that we follow. These four activities precede the construction of the corresponding model.

empirical model

conceptual model

descriptive model 1: data collection concerning the existing situation

2: abstraction

prescriptive model 4: implementation of the improved model

3: analyses and improvement of the model

Exhibit 1-1. Categories of models.

The prescriptive conceptual model is our answer to the first research question.

In order to elaborate on the second research question, we need to perform a test in the form of experimental use of the system. Experimental use of the system requires

5


the set up of one or more empirical models on the basis of the prescriptive model that we designed. This latter model is defined as the prescriptive empirical model. The use of this empirical model in the daily practice of a pharmaceutical company provides the desired insight on the effect of the group decision support system on decision making. By means of analysis of the effect of the prescriptive empirical model, we evaluate our prescriptive conceptual model.

Now we explained various categories of models, we can rephrase our two research questions:

A': What are the characteristics of the prescriptive conceptual model?

B': What are the effects of the use of the prescriptive empirical model on organizational decision making?

With regard to organizational decision making, Mintzberg [1979, p. 584] states the following: "...It seems that the more deeply we probe into this field of organizations, the more complex we can find it to be, and the more we need to fall back on so called exploratory, as opposed to 'rigorous' research methodologies." To obtain a prescriptive conceptual model, Mintzberg [1979, p. 587] proposes research within one organization, sometimes even for years, as: "We need to be 'in touch'. Increasingly in our research we are impressed by the importance of phenomena that cannot be measured: by the impact of an organization's history and its ideology on its current strategy, by the role that personality and intuition play in decision making. To miss this in research is to miss the very lifeblood of the organization. And missed it is in research what by its very design, precludes the collection of anecdotal information." DeSanctis and Gallupe [1987, p. 593] propose longitudinal research specifically for research in the area of group decision support systems. Our research activities should be regarded as one of the "pilot testing" activities, see DeSanctis and Gallupe [1985, p. 8], that are required to progress in the area of group decision support.

We explicitly choose to answer these questions by means of a real-life case study, see Sol and Van der Ven [1988a]. This choice is based upon the following considerations, see Benbasat et al. [1987]: - little research exists which integrates all aspects of international transfer pricing, - the project has a revelatory character, see Yin [1984, p. 47] as not much is known

about the way transfer-price decisions are taken in practice, - as improvement of "real-life" decision making is one of the aims, close cooperation

with the industry is imperative.

It should be realized that "case study" as used above does not mean that the researcher is watching the organization from the sideline. He is actively involved in the design of the prescriptive conceptual model and should be regarded as a member of the organization.

In order to analyze the existing situation with regard to transfer pricing and to test a pilot system, we decide to cooperate with a large pharmaceutical company for a period

6


of five years. For the definition of "large pharmaceutical company" in this respect, see Van der Ven [1989a]. In this thesis we name this company "Europhar". In research terms, five years is a relatively long period of "on-site" analysis. Our research is of an explicit exploratory nature.

On the basis of this on-site research, the descriptive empirical model and the descriptive conceptual model will be created. In general, decision makers do not know how they reach a decision. Usually, they only know the outcome, the decision itself. Therefore the descriptive conceptual model will be based on long "on-site" observations, direct involvement in organizational activities, open interviews and video-taped meetings.

The exploratory approach that we choose to follow is described by Conklin [1968, p. 172] as involving "a long period of intimate study and residence in a well-defined community employing a wide range of observational techniques including prolonged face-to-face contact with members of local groups, direct participation in some of the groups activities, and a greater emphasis on intensive work with informants than on the use of documentary or survey data".

Strong involvement in an organization, however, will not be sufficient for the development of a prescriptive conceptual model. It is necessary to observe the organization from a (mental) distance as it "would hardly be a fish who discovers the existence of water", see Wolcott [1975, p. 115]. For us, the involvement in literature research will provide this distance. Literature research will be concerned with the areas of transfer pricing and decision support. Information on the pharmaceutical industry will be gathered.

On the basis of literature research and the descriptive conceptual model, we will design a prescriptive conceptual model. Based on this latter model, a prescriptive empirical model for one subsidiary company of Europhar will be made.

This prescriptive empirical model should be regarded as an experimental system and not as a full system, see Keen [1986, p. 51]. Our explicit aim is to demonstrate the feasibility of the group decision support approach for international transfer pricing. The development of the experimental system is regarded by Europhar as a low-risk research and development venture, especially as a substantial part of the costs are borne by various Dutch research institutions. Such an experimental "version 0" is defined by Keen [1986, p. 50] as "an initial small system which is complete in itself, but may include limited functional capability". The aim of the system, in our case the prescriptive empirical model, is to establish the value of the proposed concept.

For this experimental system, we need to select one subsidiary of Europhar International. For reasons discussed in chapter 5, Europhar UK Ltd in London will be selected. In the research project decision making concerning Europhar UK plays a dominant role and will be described in detail, see exhibit 1-2.

7


information on the

pharmaceutical industry

transfer-pricing

literature decision-support

literature

description decision process

Europhar UK (before)

descriptive empirical model

Europhar UK

descriptive conceptual

model

prescriptive conceptual

model

question A': what are the characteristics of the prescriptive conceptual model?

question B1: what is the impact of the prescriptive empirical model on organizational decision making?

information on

Europhar UK ' '

prescriptive empirical model

Europhar UK

' ' description decision process

Europhar UK (after)

comparison

Exhibit 1-2. Overview of the research approach.

8


It should be realized that the analysis of various other decision situations, for European as well as for third-world countries, will contribute to the construction of the descriptive conceptual model, although they will not be described in detail.

The "real-life" use of the experimental system (after implementation for the UK), together with the description of the already existing decision-process (before implementation for the UK) will form the basis for the evaluation.

1.3 Outline of the thesis

This thesis can basically be divided into two parts: the chapters 1 to 4 provide a theoretical background. In the chapters 5 to 8, the Europhar case study is discussed. The outline of the thesis is as follows:

In chapter 2 we discuss the pharmaceutical industry. It is explained why we limit ourselves to the European pharmaceutical industry.

In chapter 3, we explain the research limitation to international transfer pricing. We will introduce a framework for analyzing financing and transfer-pricing issues.

In chapter 4, backgrounds, possibilities and recent developments in the area of group decision support systems are discussed. The possibilities are related to transfer-pricing problems and lead to the design guidelines of the prescriptive conceptual model.

In chapter 5, we present the Europhar company and describe the descriptive empirical and conceptual model.

In chapter 6, we discuss the design of the prescriptive conceptual and empirical model. In this chapter, the use of the experimental system during six months is discussed.

In chapter 7, various approaches to the evaluation of information systems are discussed. Interviews are the main basis of the evaluation of the pilot system. Outcome of the interviews and anecdotal evidence are discussed.

Chapter 8 presents the conclusions and possible areas for future research.

The pharmaceutical industry, transfer pricing and group decision support are in itself complex issues. In the chapters 5, 6 and 7, these three areas come together in the descriptive models, the prescriptive models and the evaluation. For a proper understanding of what is presented in these chapters, the background knowledge as presented in chapters 1 to 4 of the thesis is essential.

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10

2

THE EUROPEAN PHARMACEUTICAL INDUSTRY

2.1 Introduction

As stated in the previous chapter, we limit ourselves to transfer-pricing problems for the following category of multinationals:

The European-based innovative pharmaceutical industry which develops, produces and sells human ethical drugs.

All aspects, of this limitation are now described below. We shall explain the rationale behind this limitation.

"Human ethical drugs" are drugs intended for human use. Use by the patient is only allowed upon a prescription by a medical practitioner. This in contrast with so called "over the counter" drugs like Paracetamol. For over the counter drugs, no prescription is needed. By this limitation, veterinary products are also excluded. We limit ourselves to this part of the pharmaceutical industry, as interference by governmental healthcare organizations is especially intense for these kinds of products. As will be explained in this chapter, governmental interference in this area influences transfer-price decisions.

With "Europe" in this respect, we mean all countries that participate in the European federation of pharmaceutical industry associations "EFPIA". Besides the current member countries of the European Community (except Luxembourg), Austria, Finland, Norway, Sweden and Switzerland participate in this organization, see EFPIA [1987]. By "European-based" companies we mean those companies which have their headquarters in Europe. As far as the pharmaceutical industry is concerned, outside Europe, only Japan and the United States need to be considered, see IMS [1988]. We exclude these non-European based pharmaceutical companies as decision making may be different due to sharply different circumstances on the home market. This holds for both Japan and the United States, see Burstall [1985, pp. 125-127] and Reinshagen [1988]. In general, it can be said, that the Japanese and American firms have another approach to decision making than European firms. This is due to cultural differences, see Nath [1988]. It is possible that these cultural differences influence vital presumptions of our approach, like team setting. (Team setting will be discussed in more detail in the next chapter).

That we decided to include all European countries is because of the information we received from the European-based industry. Like Burstall [1985, p. 2], we noted that European companies are more "notable for their degree of uniformity than divergence". Partially, information on the industry was systematically gathered, see Van der Ven [1989a]. For another part, we received feed-back in informal contacts with industry representatives during company visits, conferences and alike. It is interesting to note

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THE EUROPEAN PHARMACEUTICAL INDUSTRY Ch. 2

that Nath [1988] treats European firms as one class. This in spite of the differences that exist within Europe.

The limitation to innovative companies excludes those companies which only produce and sell so-called "generics". Generics are drugs which are usually sold under a chemical name instead of under a brand name. They are copies of good selling human ethical drugs developed by innovative pharmaceutical companies. These copies are brought on the market after the patent period is expired. As for the generic producers the product and the market are already developed, marketing and research expenditure are much less than for the research-based industry. In this chapter we shall explain how high fixed marketing and research costs influence organizational decision making. The exclusion of generic producers, however, does not imply that innovative companies never produce and sell generics. The difference with non-innovative companies is that generics only form a minor part of their sales. Within innovative companies sales of generics contributes to research cost.

To give a global impression of the size of the pharmaceutical industry in EFPIA countries, the following figures for 1986 are presented, see EFPIA [1987]: - production: 43,000 million ECU, - employment: 450,000 people. (In the beginning of 1986, the value of the ECU was 2.46 Dutch guilders.)

When in the remaining part of this thesis we discuss "the European pharmaceutical industry", we mean those companies as indicated by the description above.

2.2 Some characteristics of the European pharmaceutical industry

Lorsch and Lawrence [1970] demonstrated the interaction that exists between organization and environment leading to the contingency (or situational) approach to organizational design. As environmental characteristics may influence the organizational structure of a company, market structure, governmental interference and cost structure will now be discussed.

Market structure: separate therapeutic areas The pharmaceutical market is in itself subdivided into many self contained therapeutic areas, see Burstall [1985, p. 5]. For instance, in 1985 the Dutch market was divided in 24 submarkets which each contained between 2% and 7% of the market, see Nefarma [1985, p. 18]. Examples of these submarkets are the market for psychotropics and the market for anti-asthmatics. Diversification within the industry is low as a company needs to concentrate on one or a few of these therapeutic areas. Following Eccles [1985, p. 272] we use the term diversification to refer to the number of different businesses in which the company competes and how different these businesses are from each other. Costs of finding and developing a new drug are extremely large, according to Von Grebmer [1987b] about 100 Million ECU for every newly-introduced medicament. According to Von Grebmer [1987b], there are technical and economic limits to decentralization of these research activities. This centralized research

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Sec. 2.2 SOME CHARACTERISTICS OF THE PHARMACEUTICAL INDUSTRY

expenditure is directed to one or a few therapeutic areas and this expenditure can only be recovered by sales on this small part of the total pharmaceutical market. This implies that the submarket needs to be covered worldwide to recover research costs. Hence, strong internationalization is a common characteristic of these pharmaceutical companies. It should be realized that size and other characteristics of a certain part of the market may vary widely depending on the country and the therapeutic area that are serviced. In 1982, for example, over 40% of sales from the pharmaceutical industry of the European Community was realized outside the common market, see Burstall [1985, p. 115].

Governmental interference Due to the involvement of governmental authorities in health-care matters, sales of pharmaceuticals is subject to an "unusual degree of government regulations", see Burstall [1985, p. 14]. Despite a general tendency towards deregulation, recent trends do not point to any significant reduction in the stringency of drug regulations, see Hansen [1987].

Pharmaceuticals are closely linked to the issue of human health care, which is considered to be one of the prime governmental responsibilities. Many of these regulations are related to the drug safety and efficacy issues. Human health care is very sensitive as far as public opinion is concerned. The issues at stake require careful distribution and monitoring. This implies that the distribution of pharmaceutical products cannot be delegated to a third party with the instruction to "just get the product sold". Should something go wrong, hostile publicity and legal pursuits would force the company involved in a difficult position. Therefore strict control on quality and logistics is needed. Secondly, training and instruction of representatives is of vital importance to assure proper use of new and existing products. Well trained representatives are important to assure two way communication between the industry and prescribing doctors, which is necessary from a marketing as well as from a medical point of view, see ABPI [1985, p. 32]. Regulations require, for example, that the company that develops, produces and sells a drug keeps closely in touch with the market in order to pick up any adverse drug reactions (post-marketing surveillance).

To assure this proper two way flow of information between the parts of the company that are in touch with the local market, and the head office, a strong "vertical integration" is needed. Following Eccles [1985, p. 272] we use the term vertical integration to refer to the inclusion of activities within the firm that could be obtained externally, such as raw materials, distribution channels and staff services. So within the pharmaceutical industry one finds that fundamental research in search for a new product as well as the final instruction of medical professionals in a remote country is done by people of the same multinational company within a framework of strict control to the board of management, see also Von Grebmer [1987a]. This strict control reinforces centralization.

Regulations do not only pertain to registration of new products or quality control matters. Price regulations are involved as well. This will be discussed in the next section.

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Cost structure: high fixed costs According to Von Grebmer [1987b, p. 233 and 234], "knowledge of the specific cost structure of the research-based companies is the key to understanding their market behavior when considering their pricing strategies ... On average, not more than 30 percent of the cost can be allocated directly to individual products, the remaining costs and the profit margin have to be covered by contributions from total sale of the whole product range." In other words, judgement of profitability of a pharmaceutical company should take place at the aggregate, total company, level and not on the disaggregate, individual product, level. Selling prices at the disaggregate level are unavoidably based upon a more or less arbitrary allocation of fixed costs.

As the relatively high fixed costs are made anyway, the total financial contribution that a local marketing subsidiary brings in, is of greater importance than its local net profit. So it is vital that the energy of the sales force is spent on the sales of in-house developed products and not on the sales of other products which might produce, in the short run, better results for one local subsidiary of the company. This cost structure contributes to a high vertical integration and centralization of decision making. In other words, within the industry, the delegation of power and responsibility to lower organizational levels (decentralization) is relatively limited.

The various items discussed above, make up the organizational environment for the European pharmaceutical industry and determine the main characteristics of the industry: strong internationalization and centralization, strong vertical integration and low horizontal integration, see also Von Grebmer [1987b, p. 240]. In exhibit 2-1, we present the structure of a typical pharmaceutical company. The arrows indicate the flow of goods.

national border

<

parent company

' subsidiary company

'

management center shareholder supplier research center

' subsidiary company

< ...other subs companies

marketing company

Exhibit 2-1. Organizational structure of a typical pharmaceutical company.

The parent company takes care of research, production, financing and marketing support. The parent company is the shareholder of the local subsidiary. The main task of the subsidiary company is to market the drugs, which are developed and

14

Sec. 2.2 SOME CHARACTERISTICS OF THE PHARMACEUTICAL INDUSTRY

produced by the parent company, on the local market. (Other words for subsidiary company are "local company" or "daughter company").

2.3 Relationship with national health organizations

Governmental interference in the supply of pharmaceuticals takes place in many countries all over the world, see for example Bouee [1987] and PBPA [1988]. In this section we will discuss the developments within Europe as an example. This is because Europe constitutes the home market of the industry.

In the European pharmaceutical market, a three-tier demand system exists: the physician prescribes the product, the patient uses it, and national health organizations pay the bill.

Background of the increasing interference in pricing of pharmaceuticals is the aim to contain health-care costs. Health-care costs are in most countries a part of collective expenditure, which in general suffer from large deficits. This pressure from public health services is a matter of great concern to the industry as "control over aspects of pharmaceutical company operations do not in general result from a considered view of the industry as a whole", see Burstall [1985, p. 14]. Governments and the European-Community authorities are under pressure of consumer groups to force down prices, see for example BEUC [1984]. In the annual report of the Netherlands-based multinational Akzo [1985], this concern is expressed as follows:

"The need for constructive talks between authorities and innovative pharmaceutical companies is growing. As we have argued on previous occasions, there is an ever-present danger that, in their understandable desire to control expenditures, the authorities will accept the prices charged by the producers of generics (drugs not protected by patents and trademark registration) as the bench mark for national health insurance payments. Were they to do so, there would be little or no margin left to conduct time- and money- consuming research for the new, better drugs so urgently needed. Such research, after all, is funded out of the revenues generated by the sale of established products. While this issue especially concerns the industry, it is also a significant public health matter. We are prepared to join with the authorities in looking for ways to reconcile these divergent objectives".

Within Europe, various ways to control prices exist. A basic difference between these price-regulation schemes is their approach to the issue of aggregation and disaggregation. Aggregate level price-regulation schemes control total-company profit of a specific subsidiary company. The disaggregate level pricing schemes control prices by fixing the selling price of individual pharmaceutical products. For an overview of the various approaches, see Van Cayseele [1987].

In view of the realization of the European common market, initial steps with regard to harmonization of the pharmaceutical market are being made by the European Commission. First aim of the Commission is to clarify the rules that are issued by

15


the various member states. As far as reimbursement systems are concerned, these attempts stress above all the importance of transparency in the operation of national systems so that importers can verify that objective criteria are genuinely being applied and all relevant factors are being taken into consideration by member states. Given the different medical traditions of the member states, however, the European Community authorities realize that it would appear unrealistic to seek to lay down a completely harmonized community price structure for pharmaceuticals, see Hankin [1988].

Besides the transparency in procedures followed by member states, a first step is made to increase transparency on prices themselves. By the European Commission, a database will be set up which, amongst others, contains ex-factory and retail prices, see EG [1989]. Although the registration of transfer prices was considered by the Commission, it was decided that these would not be included in the database as transfer-pricing information was considered to be of a confidential nature.

The involvement of a multi-state framework like the European Community in pharmaceutical pricing and reimbursement issues, poses additional problems for the industry. The directive concerning transparency represents only the start of a much wider debate on pricing, transfer pricing and reimbursement. The industry is, on the one hand, still faced with individual sovereign governmental policies. On the other hand it is confronted with a multi-state framework committed to the goal of a unified market, see Owen [1988].

2.4 The approach of the British National Health Service

In the previous section, governmental interference with (transfer) prices has been discussed globally. In this section, one price-regulation scheme is worked out in more detail to provide insight in the practical consequences of such a scheme for the companies involved. We choose the British scheme as, according to Burstall [1985, p. 152], "there is a general feeling among the major [European] drug companies that, if prices must be controlled, then the British system is the most acceptable. It also commands interest and respect in official circles elsewhere."

The scheme is limited to branded human ethical drugs paid for by the National Health Service (NHS). Generics are excluded. For further details see DHSS [1986]. The main purposes of the NHS scheme are to: - secure the provision of medicines for the National Health Service at reasonable

prices, - to promote a strong pharmaceutical industry capable of sustained research

expenditure. Note that "reasonable prices" are not the only aim of the scheme. The NHS authorities (the "Department of Health and Social Security") also act as sponsor for the industry, on behalf of the British government. Aspects that are relevant for the authorities as part of their "sponsor" responsibilities are the size and quality of employment in the United Kingdom and the size of exports. According to the Association of British

16

Sec. 2.4 THE APPROACH OF THE BRITISH NATIONAL HEALTH SERVICE

Pharmaceutical Industries, for example, recent changes in the regulations encourage the development of research and production facilities in Britain, see Scrip [1987a, p. 5].

The "Pharmaceutical Price Regulation Scheme" provides a set of regulations for the calculation of profit (the "Annual Financial Return"). This profit calculation forms a basis for negotiations between each individual pharmaceutical company and the NHS authorities. Focal point is the profit that the company makes on sales to the NHS. The NHS-profit calculation of each company needs to be completed annually and submitted to the NHS authorities. All costs claimed are examined critically by the health service. In principle most of the costs are allowed, but there are however some special constraints. If the health service considers that profits of a company are excessive under the terms of the price-regulation scheme, price reductions or cash repayments are sought to the extent necessary to reduce profit to an acceptable level. The negotiations between pharmaceutical companies and the authorities have been described as "tough but fair", see Scrip [1987b, p. 2]. The target profit on which price increases or repayments are based, are established by taking the average return on capital of British industries in other public sector business, like aircraft-building companies. This target profit is influenced by the state of the public finances and subject to negotiation with each individual company.

NHS sales -\- transfer prices (landed costs) -\- manufacturing costs -\- manufacturing overhead

gross margin -\- distribution costs -\- information costs -\- promotional costs

operating performance -\- royalties -\- general overheads

profit before interest and taxation

Exhibit 2-2. First part of the NHS-profit calculation.

Usually the target profit is expressed as a return on capital. This return on capital is the focal point during the negotiations between the authorities and the individual company. If the actual return on capital is greater than the target, defined as an "excess", a repayment to the NHS might be the consequence. In case the actual return on capital is smaller than the target, defined as a "shortfall", a price increase might be the consequence. The calculation basically exists of three parts: - calculation of the "profit before interest and taxation", starting from the NHS sales, - calculation of the "total adjusted profit", starting from the profit before interest and

taxation, - calculation of the "excess/shortfall on the target return on capital", starting from the

total adjusted profit.

17


The global outline of the first part of the NHS-profit calculation is presented in exhibit 2-2.

In exhibit 2-2, the sign "-\-" stands for "minus". The gross margin, for example, is calculated by subtracting transfer prices (or landed costs), manufacturing costs and manufacturing overhead from the NHS sales. We presume that lump-sum royalties are paid to the mother company and the mother company is the only supplier. All figures are expressed in British pounds sterling (GBP). This set of figures is made up for NHS sales as only these sales are controlled. Generic sales in Britain or exports are excluded in the profit calculation. When costs are directly related to activities (like distribution, information and promotional costs), there is no need for allocation. In cases that costs cannot be precisely apportioned between NHS sales, generic sales and exports, an artificial cost allocation has to be made. Possible bases for allocation are: - net sales, - local manufacturing costs (added value), - costs of goods (costs of goods equal the sum of landed costs and local

manufacturing costs). The first step of the NHS-profit calculation is to calculate the gross margin. The distribution, information and promotional costs are subtracted from the gross margin to obtain what is defined as the operating performance.

The scheme makes a strict distinction between allowable and non-allowable costs. Allowable information costs include for example expenses on samples for identification purposes and medical symposia. Allowable promotional costs include among others literature, representatives, administration and advertising. Gifts are not allowed as a promotional cost on the profit calculation.

Both royalties and general overheads are subtracted from the operating performance to obtain the profit before interest and taxation. The authorities are only interested in the profit before interest and taxation. The companies are not allowed to include taxation costs and interest costs in the profit calculation because the different financing structures of the companies would distort the comparison between companies.

Now follows the second part of the NHS calculation. The profit before interest and taxation, as calculated above, is the basis for the calculation of the "total adjusted profit" as presented in exhibit 2-3.

profit before interest and taxation + add-back injected costs + add-back promotional costs -\- export discouragement correction

total adjusted profit

Exhibit 2-3. Second part of the NHS-profit calculation.

18

Sec. 2.4 THE APPROACH OF THE BRITISH NATIONAL HEALTH SERVICE

An add-back for royalties and transfer pricing (defined as add-back injected costs) is added to the profit before interest and taxation, when the sum of transfer prices and royalties exceeds a certain percentage, considered acceptable by the NHS, say x%. In this case the NHS authorities consider the "injected costs" (cost transferred from the mother company) too high and demand a correction on profit before interest and taxation. So the formula for the add-back is as follows:

add-back injected cost = (allocated royalty + NHS transfer price) -\- x% of NHS sales

Here we can clearly see how transfer pricing decisions and regulations of health-care authorities interfere: the value of the add-back on injected cost equals the difference between transfer prices added to royalties and x% of the total net sales. This x% is a negotiated figure and differs per company. It is important to note that there exists only an add-back for transfer prices and royalties. Where the local picture does not satisfy the authorities, they then consider the consolidated picture. If, however, the sum of transfer price and royalties is lower than the negotiated percentage, no action is taken. In other words, there is no symmetry in the approach of the authorities in this respect. They only adjust the figures where this is to their advantage.

Say, for example, that a British subsidiary of a multinational company has liquidity problems and that a transfer-price decrease is considered. In case this company should decide to lower the sum of transfer prices and royalties to a percentage lower than the agreed x%, it artificially increases its profits. This high profit could ultimately result in a repayment to the national health service. This example clearly illustrates the interference of transfer-price decisions with health care regulations.

The NHS sets a maximal sales-promotion allowance. Not only are some costs unacceptable, when a company spends more then this allowance, the amount overspent (add-back promotional costs) has to be added to the profit before interest and taxation. Also a cash repayment of the amount overspent is requested. For more details on the background of this punishment for overspent promotional costs, see Haayer-Ruskamp and Dukes [1986].

A strict apportionment of capital and costs between home and export markets may in some circumstances produce an unfair result. High export sales may result in a smaller part of capital allocated to the NHS. This is called the export discouragement (or "disincentive"). As on the other hand, the authorities are concerned with balance of payments and employment effects, a correction mechanism is applied. So an export-discouragement correction is deducted from the profit before interest and taxation. A special set of rules exists for the calculation of the correction.

19


The concepts used in the third and final part of the NHS-profit calculation are: - negotiated target return on capital, percentage, - average capital employed (NHS sales), in GBP, - average capital employed (total), in GBP, - actual return on capital, percentage, - excess/shortfall on target, in GBP. The first step is to calculate the actual return on capital. The size of the acceptable return on capital earned by individual companies on NHS sales is a matter of negotiation with the NHS authorities. The negotiated target return on capital depends on the nature and scale of the company's relevant investment and activities and the associated long-term risk. Eventually the negotiated target return on capital is assessed by the authorities.

In order to obtain the actual return on capital first the average capital employed for NHS sales has to be calculated. The sum of the net-capital employed on the opening and the closing balance sheet is divided by 2 to obtain the total average capital employed. The average capital employed for NHS sales is calculated by allocating the total average capital employed according to one of the allocation methods mentioned earlier in this section. The actual return on capital (ROC, sometimes also called "return on investment") is a division of the total adjusted profit by the average capital employed for NHS sales multiplied by 100. In formula:

total adjusted profit actual ROC = * 100%

average capital employed (NHS sales)

The excess or shortfall on target can now be calculated by subtracting the negotiated return on capital multiplied by the average capital employed for NHS sales from the total adjusted profit. In formula:

excess/shortfall = total adjusted profit -\- [negotiated ROC * average capital employed (NHS sales)]

This final excess/shortfall calculation is not only influenced by the levels of transfer prices. Changes in royalty payments, changes in intracompany payment terms and intracompany cost charges also influence the excess/shortfall. This implies that of all these financing instruments, the impact on the profit calculation needs to be determined.

In this section we explained the British price-regulation scheme. Their approach to pharmaceutical pricing is one amongst many, both within Europe and worldwide. In most countries, Eke in Britain, interaction exists between transfer pricing and reimbursement. By means of the example given above, we demonstrated what such a relationship might look Eke. All transfer-pricing issues that relate to the relationship with the health-care authorities, wiU be referred to as the commercial aspects of transfer pricing.

20

Sec. 2.5 CONCLUSION

2.5 Conclusion

Three conclusions can be drawn from this chapter.

In chapter 1, we stated that the pharmaceutical industry finds itself in a complex, hostile and turbulent environment, see Huber [1984b], certainly as far as pricing and transfer-pricing issues are concerned. In this chapter we elaborated on this statement.

Secondly, great similarities exist in the way European pharmaceutical companies operate. As the environment of the industry is for an important part determined by governmental regulations and interest groups, the environment is alike for most companies. As a consequence, many European pharmaceutical companies are structured in a similar manner. This similarity is confirmed by the research of Burstall [1985] and by our own experience, see Van der Ven [1989a]. This conclusion is of relevance when possibilities for a more general use of the prescriptive conceptual model will be discussed in chapter 8.

Thirdly, the European pharmaceutical industry can be described by the following characteristics: a high degree of internationalization and centralization, a high degree of vertical integration and a low degree of diversification. These characteristics are relevant for our discussion of the various approaches to transfer pricing in the next chapter.

21


22

3

TRANSFER PRICING: A COMPLEX ISSUE

3.1 Introduction

Transfer pricing is a subject that seems favorite amongst economists, as an abundance of literature can be found, see for example Eden [1985], Kassicieh [1985] and Hirschleifer [1956]. Not only scientists like the subject. Transfer pricing appears to be a rather preferred choice of masters-degree students in economics, see for example Mostermans [1982] and Van der Plas [1983]. It struck us that so many of these publications seem irrelevant for the problem at hand. Although a profound ability in mathematical modeling is demonstrated, practical relevance for our analysis is small. As will be discussed in section 3.2, the publication of Rasch [1980] is a notable exception. In general, scientists are aware of this limitation, see for example Meijboom [1986].

Transfer-pricing studies that provide a picture of most aspects involved are for example Verlage [1975], Plasschaert [1979] and Krens [1979]. The relevant aspects can be divided into two categories. The first category deals with what is defined as "management-control" issues, see Krens [1979]. Planning of corporate resources and performance measurement are the two main aspects of management-control transfer pricing. These will be discussed in the next section. The second category is of importance in the case of international transfers and is concerned with international financing, tax issues, duties, foreign-exchange controls and alike. These will be discussed in section 3.3. Pharmaceutical price-regulation schemes as discussed in chapter 2 are related to this "international" aspect. In section 3.4 we will apply the various concepts to the situation in the pharmaceutical industry.

In the remaining part of the thesis we decide to concentrate on transfer prices for goods. Transfer prices for services are excluded. As will be explained in section 3.3, this is not to say that payments for services, like management fees and royalty payments, do not relate to the transfer-pricing problem, see also OECD [1979].

3.2 Management-control transfer pricing For a better understanding of management-control transfer pricing, we should go back to micro-economic theory. According to Adam Smith, individuals should pursue then-own interest and by doing so, they promote the interest of society, see Landreth [1976, p. 39]. Presuming competitive markets, individuals are led by an invisible hand when pursuing their own interest, according to Adam Smith. This invisible hand leads individuals by means of prices for goods, services, capital and labor. As stated in section 3.1, we concentrate on the prices of goods.

23

TRANSFER PRICING: A COMPLEX ISSUE Ch. 3

A relatively high price for a good that an individual produces and sells, leads to a relatively high income and hence to relatively high spending power. In other words, the individual is rewarded by society for offering goods that are relatively scares. Below, we will relate this aspect to "performance measurement".

This rewarding mechanism influences the decision that the individual makes: he will plan the use of his resources in such a way that he is able to offer those goods on the market that are relatively scares. Below we will relate this aspect to "planning".

It should be realized that above, we only discussed external prices. External prices that are set between independent parties operating on their own behalf on a competitive market. We now discuss the use of a price-mechanism for use within large organizations.

According to Chandler [1977, p. 1], modern business enterprises partially "took the place of market mechanisms in coordinating the activities of the economy... In many sectors of the economy the visible hand of management replaced what Adam Smith referred to as the invisible hand of market forces". Cause of this replacement, according to Chandler [1977, pp. 6-7], is that modern companies "... continued to grow by setting up or purchasing business units that were theoretically able to operate as independent enterprises - in other words, by internalizing the activities that had been or could be carried on by several business units..." From the point of view of the organization, a side-effect of this growth is an increase in management problems.

Allocating limited resources to alternative uses can be expressed as a mathematical problem for which various formulations and solutions exist. In case of linear constraints and a linear target function that expresses company objectives, linear programming can be used, see Lee and Shim [1986]. As Bosman [1977] and Verlage [1975] explain, detailed knowledge on all units which constitute the organization is required for successful use of this technique. All technical parameters, for example, should be known. If this approach is followed, an optimal solution is presented allocating the resources to the final products. Given this solution, so called "shadow prices" of the resources can be calculated. Both Bosman [1977, p. 241] and Verlage [1975, p. 185] reject the use of shadow prices as a coordination mechanism for large complex organizations.

An alternative approach to the problem of allocation of resources is divisionalization, combined with the "right" transfer prices. Divisionalization can be defined as decentralization plus delegation of divisional profit responsibility to lower organizational levels at which decision making also exists, see Verlage [1975, p. 5]. Splitting up in divisions is an attempt to combine many of the advantages of a big company with many advantages of a small one. Such a system replaces detailed planning and evaluation decisions by top management. Another possibility which will be discussed later in this section, is to split up an enterprise into smaller units without strictly adhering to the profit-center concept. Transfer pricing that is related to divisionalization issues is defined as "management-control transfer pricing", see Krens [1979].

24

Sec. 3.2 MANAGEMENT-CONTROL TRANSFER PRICING

Transfer-price decisions have great influence on the distribution of profit of the divisions involved. Take for example a multinational A. X and Y are two divisions of A, each with own profit responsibility. The intermediate product z is produced by X and then sold to Y. When the transfer price of product z is increased, the divisional profit of X will increase, to the expense of Y's divisional profit. Divisional management considers the maximization of its own divisional profit as its main target. The divisions "compete" with each other to obtain the highest divisional profit. As the divisional management is judged (and compared) on the basis of this divisional profit, a shift of cost is of great importance to divisional management. So a correct approach to transfer pricing is a prerequisite to make the profit-center concept work.

According to Verlage [1975], a transfer-pricing policy should serve the same two roles that are performed by external prices: performance measurement and planning. From a point of view of profit measurement (ex post), transfer prices must ensure that divisional profit, as it is measured, is the same as the controllable profit for all divisions involved. So divisional profit should not be influenced by decisions taken by other divisions and reflect only the impact of decisions made by the own division. A transfer price which possesses this quality is defined as "neutral". From a planning point of view (ex ante), transfer prices must ensure that, when divisional management bases its decisions on these prices to maximize its own divisional profit, the profit of the enterprise as a whole is maximized. A transfer price which possesses this quality is denned as "optimal". Verlage [1975] concludes that a transfer-pricing policy based on market prices is the only system that meets both requirements. A prerequisite for such a system, however, is that a competitive market for intermediate products exists.

The concept discussed above deals with a really divisionalized enterprise. We now turn to another approach. It is possible that decision making in the organization takes place by means of teams and that no internal competition between divisions exists. This approach of decision making in groups relates to the "behavioral theory of the firm", see Verlage [1975, p. 19]. According to the behavioral theory of the firm, company goals are the result of interaction between organizational members. Rasch [1980, p. 65] defines a team as a group of people with a common goal. People at different positions within the organization may have different information and hence may take different decisions based on that information, but there is no incentive problem. There is no conflict of interest between team members. Under the condition of team setting, the transfer-pricing policy does not have an impact on company goals. Rasch's proof of this statement is of a mathematical nature. Under the premise that the individual decision maker has knowledge of the impact of his decision on the organization as a whole, the transfer price is an internal mechanism for the firm and as such it has no impact on the overall objectives. This result can be anticipated by the realization that the decision makers are attempting to achieve corporate objectives which are derived from an overall perspective based on external (market) conditions. The internal transfer price is merely a means for liquidity transfer and does not affect the performance of the organization as a whole. The decentralized team-decision policy is independent of transfer pricing and the determination of a transfer-pricing policy should not be based on its effect on the decentralized decision-maker's actions, according to Rasch.

25


Rasch [1980, pp. 100-103] even states that, given team setting, the expenses involved in working out a transfer-pricing policy may be avoided and an increase in efficiency might be realized.

Several approaches to planning and performance measurement exist. The "divisionalization" approach discussed above takes divisional profit as the central item and a guideline for divisional decision making and performance measurement. The "team setting" approach as described by Rasch [1980], takes the concept of teamwork as the central means to achieve company goals.

On the basis of empirical research, Eccles [1985, p. 274] relates these two approaches to company and market characteristics, see also Lorsch and Lawrence [1970]. According to Eccles, the transfer-pricing policy depends on the type of organization and, consequently, the environmental setting in which the organization finds itself. The two main factors which determine the transfer-pricing policy according to Eccles, are vertical integration and diversification.

The term vertical integration refers to the inclusion of activities within the firm that could be obtained externally, such as production of raw materials, distribution channels and staff services. Vertical integration creates mutual dependencies between the various units like divisions, corporate line management and staff functions of the enterprise.

The term diversification refers to the number of different businesses (or markets) in which the company competes and how different these businesses are from each other. The larger the number of products and markets in which a company competes, the greater the diversification, according to Eccles. In exhibit 3-1 three types of company are shown.

A high x

(cooperative)

degree of vertical integration

low x (competitive)

I ^. low degree of high

diversification Exhibit 3-1. Eccles' contingency approach to management control.

Of these three types, two are relevant for our research: the cooperative and the competitive type. These will now be discussed in more detail. The following descriptions are based upon Eccles [1985, pp. 276-277].

X (collaborative)

26


The cooperative organization The cooperative organization is high on vertical integration and low on diversification and has its focus on a small line of products. This organizational type is often found in capital-intensive industries. The term cooperative is used to indicate that decision making within this firm is focused on cooperation among all managers to "maximize" total company performance. The strategy for this type of company is a strategy for the company as a whole, with all decentralized strategies being expressed in terms of their contribution to it. The narrow product focus results in the company being organized as one single profit center. Management-control systems distinguish functional responsibilities in terms of costs, revenues, and physical units. Great emphasis is placed on using internal standards and historical results in evaluating performance. The high interdependence across the various units (for example, manufacturing and sales) requires substantially subjective judgment on the part of general management in evaluating performance, since high interdependence makes divisional profit an imperfect measure. The processes between superiors and subordinates are very much top-down because of the focus on a narrow range of products and the interdependence across units. Horizontal processes for conflict resolution aim at expertise sharing and finding common interests. In other words, units seek to find a solution that is in the best interest of the company as a whole. Top management exercises control on the actions of lower-level managers primarily through the organizational structure. Control over actions is necessitated by the high degree of interdependence caused by vertical integration. It is possible to have such control because of top management's experience in and detailed familiarity with the narrow range of businesses in which the company is engaged. Because of the high degree of interdependence, lower-level managers are rewarded in terms of their contribution to the performance of the company as a whole.

The competitive organization The opposite of the cooperative organization is the competitive organization. The competitive type is high on diversification and low on vertical integration. Its structure is based on many different businesses that do little sharing of such resources as manufacturing facilities and sales forces. This organizational type is exemplified by conglomerates or holding companies. The term competitive is used to indicate that the subunits of this organization are profit centers and compete with each other for capital and other resources on the basis of performance. Performance is comparable across all subunits, unlike the case of the cooperative organization. Corporate strategy in the competitive firm is largely an aggregation of subunit strategies, such as those of divisions. Although broad strategic guidelines might exist for the company as a whole, they are not nearly as important in developing subunit strategies as they are in the cooperative organization. Competitive firms employ a multi-divisional structure, supplemented by systems that measure the profitability and return on investment of the divisions. As a result of the high degree of decentralization of authority and responsibility, vertical processes are bottom-up - initiated by lower-level profit-center managers when they want assistance from top management or corporate staff. The horizontal processes of conflict resolution are characterized by negotiation, in which each party attempts to maximize his own share in the context of fixed-sum payoffs. In other words, profit centers seek to maximize their own results even at the expense of

27


other profit centers. The emphasis is on using financial measures, like divisional profit, to evaluate performance. Top management must exert control primarily through the measures of financial outcomes, since it cannot know each of the company's many businesses in sufficient detail to deal more directly with operating concerns. The lower-level general managers are rewarded in terms of the performance of their divisions.

The empirical research undertaken by Eccles [1985] shows that depending on the type of company (competitive or cooperative) a different approach to transfer pricing exists:

The cooperative type of company often uses full-cost transfer prices. A full cost price includes both variable and fixed-cost elements. An example is provided by means of the following formula for the transfer price of intermediate product z:

transfer price = variable cost + x% of fixed cost

The x percent serves to allocate fixed overheads. The percentage of x is determined by means of dividing the budgeted fixed cost for the coming period by the "normal size" of the production, see Van der Schroeff and Groeneveld [1980] and Bosman [1977]. Following Bosman [1977, p. 258], the term "allocation" should in this respect be interpreted as "a more or less arbitrary apportionment of cost, which results from planning activities". Transfer prices determined by means of full costing are not very useful instruments in the area of management-control transfer pricing. Therefore, little effort is made to identify responsibility for variances. The performance of each. profit center affects, and is affected by, the performance of others. A full-cost transfer-pricing approach is neither "neutral" nor "optimal" as defined earlier in this section.

The distinctive characteristic of cooperative kind of companies is the low level of conflict that exists. This is because of the high level of cooperation among the managers involved. All are focusing on objectives at a level higher than their own unit. In all cases, subjective judgment is important in evaluating and rewarding the performance of these managers, since divisional profit is an imperfect indication of their contribution to the company as a whole.

For this type of company, Verlage [1975, p. 188] proposes consolidated, and not divisional, profit measurement to determine the performance of divisional management. Detailed budgets should be used for planning purposes. This means, in practice, that profit responsibility is replaced by responsibility for much more detailed budgets, which are stated in terms of volumes, cost, etc. According to Bosman [1977, pp. 241-242], these budgets are determined by means of negotiations between top management and lower management levels. A good management information system is a prerequisite for detailed budgeting procedures and consolidated performance measurement.

According to Eccles [1985], the competitive type of company uses transfer prices based upon market prices of the intermediate product that is sold between the divisions. Inter-divisional transactions only occur when they are agreed upon by managers in both

28


the buying and selling division. The distinctive characteristic of the competitive type of company is that there are discouragements to trade internally. This problem results from the pressures placed on profit-center managers to achieve financial objectives and from their awareness of the difficulties internal transfers could create for them in inhibiting their ability and authority to achieve these objectives. Because they are evaluated and rewarded primarily in terms of divisional profit, they have little incentive to cooperate with other divisions.

The distinction between the cooperative- and the competitive type companies, as developed by Eccles, is useful for our research. However, as Eccles [1985, p. 273] states, any actual organization can be composed of several of these types. Relations between divisions, for example, could be identified as competitive as a high degree of diversification and a low degree of vertical integration exists. One of the divisions, say division X, might consist of various decentralized units. Relations between the decentralized units within division X could be identified as cooperative as a low degree of diversification and a high degree of vertical integration exists. Consequently, the transfer-pricing policy should be set in accordance with the different structures in the different parts of the company. In chapter 6, the Europhar case will illustrate this issue.

3.3 International transfer pricing

In the previous section the management-control aspects of transfer pricing have been discussed. In a multinational enterprise, however, another aspect is also of great importance.

As the transfer price is the price for which the product crosses the national border, the height of the transfer price has, among other things, consequences for the international distribution of funds and profits, corporate taxes paid in various countries and import duties. We define transfer pricing based on these considerations as "international transfer pricing" to distinguish it from transfer pricing for management-control purposes. Note that this definition has a wider scope than the term "fiscal transfer pricing".

While discussing multinationals, the OECD report on transfer pricing [1979, p. 7] states: "... Such an international economic entity generally operates in a legal framework which has remained national; it has therefore to conform with the varied and sometimes conflicting national laws [and other regulations] of the countries in which it operates." A group of Dutch transfer-price experts concludes that fiscal and other authorities should be reticent in their requirements towards the multinational because in the area of transfer pricing it is difficult to qualify prices as "right" or "wrong", see Vereniging van Belasting Wetenschappen [1987, p. 65]. As an illustration, we now present some of the issues that may be at stake, see also Vereniging van Belasting Wetenschappen [1987], OECD [1984], Verlage [1980] and Plasschaert [1979]:

29


- A company in country A bought from its subsidiary in country B at a price which was too low, according to the customs authorities of country A, and therefore the price was increased. This increase, however, was not accepted by the corporation-tax authorities in country A. The company took this decision to court, but the court decided that the decision of the customs authorities was not relevant to tax on profit.

- In dealing with the customs authorities of various countries, multinationals may adapt price setting to the customs regulations. This can, however, lead to different transfer prices for different countries which in itself can be a source of criticism for fiscal or other authorities.

- Minority shareholders and/or profit-sharing personnel may require a low transfer-price level with the aim to maximize own income.

- In countries where, as a result of government interference, loans and other financial means are hard to obtain, transfer prices might be changed to increase the cash flow of the division in need. This in order to satisfy already existing local money suppliers.

- Constraining foreign exchange control regulations may influence transfer prices as sales and/or purchase of goods might be the single method allowed to transfer money from one country to another.

- Governments usually try to capture the largest possible slice of the taxable cake. All in all, the fiscal authorities tend to look critically at business practices which reduce their portion of taxable revenue but show no interest in questioning the payments that increase their revenues. Their attitude is asymmetrical which may result in double taxation.

- In some industries, governments use data about transfer pricing to reduce, say, the final prices to the consumers and may induce other countries to take similar action (so called "domino effect") although the market circumstances may widely diverge. In this process the least favored position for the industry tends to spread amongst countries.

- Government interference on transfer prices sometimes imposes an inordinate amount of reporting and red tape on the multinational. Data produced are occasionally used by civil service bureaucrats without proper understanding of business mechanics.

The different approaches to transfer pricing from various types of authorities (for example tax and customs) may cause conflicting requirements for the multinational. As the first example given above showed, problems concerning these regulations may be difficult, or nearly impossible, to resolve. In the requirements that are to be met by the multinational, an important distinction can be made: some requirements are set at the aggregate level and other at the disaggregate level, see also Sol [1985a].

30

Sec. 3.3 INTERNATIONAL TRANSFER PRICING

Corporation-tax authorities might judge a company on total company figures (aggregate level). Custom authorities might judge prices for individual articles (disaggregate level).

The situation concerning transfer pricing is not only complex for a multinational. Interpretation of the situation is also difficult for the authorities as "it is an essential feature of the problem that it is always necessary to have regard for the particular facts in each case", see OECD [1979, p. 18]. This might be the reason that most disputes between authorities and multinationals concerning transfer prices are settled before they reach court. This in itself can be regarded as a proof that transfer pricing in practice is very difficult, see Verlage [1975, p. 194].

According to Plasschaert [1979, p. 34], it may well turn out that the most acceptable system is one that minimizes conflicts with external groups, such as governments. Also Verlage [1975, p. 194] underlines the importance of international transfer pricing. He states that the situation around transfer pricing creates room for manoeuvering not only for the multinational, but for fiscal authorities as well. Since in practice, the authorities will try to use this room for their own benefit, it is necessary for the company to analyze ways and means of defending its interest.

It will be clear that the problems around international transfer pricing are completely different from the management-control problems as discussed in the previous chapter. Transfer prices established for management-control purposes are intended to produce internal goal congruence between the different parts of the company. International transfer pricing aims at fitting the transfer-pricing policy within an external framework of rules and constraints established by legislation and administration, see Quirin [1985, pp. 132-133].

Over the last two decades, the awareness has increased that an international and well-defined approach to international transfer pricing is needed. The "arm's length principle" is one of the concepts which resulted from this approach. The arm's length concept has originally been developed for fiscal purposes. It will now be discussed briefly below.

The OECD committee on fiscal affairs [1979, p. 7] developed the arm's length concept for fiscal purposes. The arm's length price is in their report defined as the price "which would have been agreed upon between unrelated parties engaged in the same or similar transactions under the same or similar conditions in the open market". Note that the definition states: "which would have been". In other words, the concept is in fact based upon a fiction. The Vereniging van Belasting Wetenschappen [1987, p. 65] states that "it is more realistic ... to approach transfer-price problems from the point of view of the multinational as a whole, in which each part has its proper business function".

In order to assess whether prices are at arm's length or not, the following four approaches have been established, see Verdoner [1988] and IBFD [1987]: r

31


Comparable uncontrolled price method The comparable uncontrolled price method offers the most direct way of determining an arm's length price. The transfer price is set by reference to comparable transactions under the same or similar conditions between a buyer and a seller which are not associated.

Resale-price method There will be many cases where no useful evidence of uncontrolled transactions will be available, because, for example, the goods which are supplied are so special to the group that there is no open market for them. This is the case for patented drugs. In such circumstances it will often be necessary, in order to establish an arm's length price, to use the resale method. The resale (or sales-minus) method starts from the fined selling price and subtracts the cost and profit mark-up of the last division involved. The resale method is useful where it is applied to marketing operations of finished or semi-finished products, like for a local marketing subsidiary of an international pharmaceutical company.

Cost-plus method In cases where neither the comparable uncontrolled price method, nor the resale method are applicable, the cost-plus method can be used. The cost plus method starts from the direct cost of providing the goods or services and adds whatever costs and profit mark-up that are appropriate.

Other methods The complexity of real-life business situations may put many conceptual and practical difficulties to the application of the methods referred to above. A mixture of these methods may sometimes therefore have to be used, sometimes in combination with other methods. Another such method might be to look at the yield on capital involved or to determine the contribution of the various units involved ("functional method").

Above, we limited ourselves to prices concerning the transfers of goods. Such transfer prices, however, are only one of the instruments used for the international transfer of funds within a company, see Krens [1979]. We explicitly consider international transfer pricing only one aspect of the problem of international financing. As explained in the previous chapter, pharmaceutical multinationals are in general highly centralized. Hence various other means for transferring funds between parent and subsidiary exist. These are now briefly described below, see Ammer and Ammer [1977].

Transfer prices Transfer-price payments are the payments from the local subsidiary to the parent company for goods bought from the parent company by the subsidiary. (As stated in section 3.1, we limit ourselves to the prices of goods.) These payments are related to the parent company's role of production center and supplier. (In section 3.5, a distinction will be made between transfer prices and internal selling prices.)

32


Royalty Royalty payments are payments from the local company to the parent company in exchange for the right to use proprietary trade marks, patents or other intangible assets from the parent company. These payments are related to the parent company's role of research center and patent holder.

Dividend/share capital Dividend is the part of a local company's profit that is distributed among the shareholders in proportion to their share of ownership. In our example, it is a payment from the local company to the parent company. Share capital is also related to the ownership of a local subsidiary. It is a payment from the parent company to the subsidiary company. Payments of share capital and dividend are related to the parent company's role of shareholder.

Current account Another financial tie is the so called "current account". The current account is the ongoing trading-debt position of the subsidiary company due to the purchase of goods. It is possible to change payment terms for intracompany sales. By decreasing the creditor's payment term from the parent company, debts have to be paid off earlier and the creditors account will decrease. Hence the local company's liquidity decreases. Increasing the payment term would have the opposite effect. Transfers due to changes in the current account are related to the parent company's role of supplier.

Intracompany loan A loan is a sum of money, borrowed at interest, for a period of time. The local company can lend out to the parent company and vice versa. Payments are related to the parent company's role of internal bank for the multinational group as a whole.

Cost transfer A cost transfer is a payment from the parent company to the local company or vice versa. It is based on a specific agreement between the two. An example is a promotional allowance to compensate for the extra marketing effort of the local company related to the introduction of a new product. Payment of allowances are usually related to the parent company's role of management center. In exceptional cases, the parent company may decide to compensate the legally existing loss of the subsidiary company. So it is a payment from the parent company to the local subsidiary. We classify these payments also as cost transfers. They are related to the parent company's role of shareholder.

Like transfer prices, the size and conditions of the other financing instruments described above, should be at arm's length, see IBFD [1984]. In the decision process on local company financing, arm's length considerations play an important role.

The direction of the transfer of funds depends mainly upon the liquidity situation of the local company. A liquidity surplus is defined as an excess of funds resulting from operations. A liquidity shortage is defined as a shortage of funds resulting from

33


operations. Some of the alternatives discussed above have an impact only on the liquidity position of the local company (for example an intracompany loan or capital increase) and others have an impact on the liquidity position ay well as on the profitability of the local company (royalty or transfer-price increase).

From the point of view of the subsidiary company, a change in liquidity position can be due to changes in the profit and loss account or it can be due to changes in balance-sheet items. As transfer prices are the subject of our research, we shall focus on those problems for which transfer-price changes are considered a possible solution. In general these are the situations in which liquidity problems (shortage or surplus) are caused by changes in the profit and loss account. So we focus on two problem areas: - a combination of profit and liquidity surplus, - a combination of loss and liquidity shortage. When we discuss a liquidity surplus in the remainder of this thesis, a profit is usually implied. When we discuss a liquidity shortage, in general, a loss is implied. By means of this limitation, financing of investment programs, for example, is excluded.

Costs of the various ways to transfer funds are of importance. Tax and duty rates may have a significant impact on costs. To compare the cost of various ways to transfer funds, a small standard scheme is used. Point of departure of this scheme is a fixed sum of liquidity that needs to be transferred. This transfer can be either to or from the subsidiary company. The scheme that we use is quite simple. It is also used by others with the aim to compute the total net effect of the various tax savings and tax costs, see for example Comptax [1987].

To illustrate this scheme, we use the example of the company that will be described in chapter 5. A parent company in the Netherlands, called Europhar International BV owns a subsidiary company in the United Kingdom (abbreviated as "UK"), called Europhar UK Ltd. Let us presume a liquidity shortage for the British company.

In setting up these schemes, the central question is: In order to increase the liquidity position of the UK subsidiary with GBP 100.-, what is the amount in NLG that needs to be transferred by the parent company ("NLG" stands for Dutch guilder, "GBP" stands for the British pound sterling)? So we calculate the marginal effect of a net liquidity increase of GBP 100.--. We presume a fiscal profit or adequate fiscal compensation possibilities for all companies involved. We define this marginal effect as the "financial impact" of the financing alternative under consideration. Calculations are rounded off at two decimals. In exhibit 3-2, the calculation of the financial impact of a transfer-price decrease is shown ("NL" stands for Netherlands).

34


GBP + GBP

GBP NLG

-\- NLG NLG

100.00 53.85 153.85 563.08 236.50 326.58

transfer-price decrease - supplying company is Europhar Int BV: input parameters: corporate tax rate UK: 35 X corporate tax rate NL: 42 I exchange rate: 3.66 NLG/GBP calculation of the marginal effect of a net liquidity increase of GBP 100. liquidity increase: UK corporate tax: transfer-price decrease in GBP: transfer-price decrease in NLG: NL corporate tax: net decrease of NL liquidity:

Exhibit 3-2. Financial impact of a transfer-price decrease.

In order to obtain a liquidity increase of GBP 100.--, it is necessary to decrease transfer prices with GBP 153.85 as lower costs increase profit and hence corporate tax in the UK. Given an exchange rate of, say, 3.66 NLG/GBP, transfer prices need to be lowered with NLG 563.08. Due to lower revenues of the parent company, corporate tax decreases. The net effect is NLG 326.58. This is less than the GBP 100.-- required as GBP 100.-- equals NLG 366.-.

In exhibit 3-3, the financial impact of an increase in payment term is presented as a second example.

increase of the credit current-account position with supplier Europhar Int BV: (payment term is increased) input parameter: exchange rate: 3.66 NLG/GBP calculation of the marginal effect of a net liquidity increase of GBP 100. — : liquidity increase: GBP 100.00 amount of current-account increase: GBP 100.00 net decrease of NL liquidity : NLG 366.00

Exhibit 3-3. Financial impact of an increase in current account.

As the simple scheme shows, no tax effects exists. A third example that we want to present is the intracompany loan, see exhibit 3-4.

35


intracompany loan from Europhar Int BV: input parameters: corporate tax rate UK: corporate tax rate NL: interest rate intracompany loan: exchange rate:

liquidity increase: interest paid: tax on interest: amount of intracompany loan (GBP): amount of intracompany loan (NLG): interest received: tax on interest: net decrease of NL liquidity:

of

+ -\-

-\-+

35 42

10.3 3.66

a net GBP GBP GBP GBP NLG NLG NLG NLG

% Z I NLG/GBP

liquidity in 100.00 11.04 3.86

107.18 392.26 40.40 16.97

368.83

Exhibit 3-4. Financial impact of an intracompany loan.

In this example, the amount of the intracompany loan needs to be such that the interest and tax effects for the first year of the loan are included. In the UK, the payment of interest causes lower corporate tax. In the Netherlands, the interest payments cause higher corporate tax. Note that the loan is slightly disadvantageous as NLG 368.83 needs to be paid to obtain the counter value of NLG 366.--. In this example, interest payment of one year is included, as within Europhar financing decisions are reviewed every year. It is possible, of course, to include interest payments for a longer or shorter period. The interest to be paid by the subsidiary is calculated by means of the formulas shown in exhibit 3-5.

i - i * (too + i - \ - T)

T - t * i

1: interest payment T: tax on interest i: interest rate t: tax rate

i * 100 1 -\- i * (1 -\- t)

Exhibit 3-5. Calculation of the interest payments for an intracompany loan.

The tax effects influence the liquidity position with a considerable time lag. This causes second-order interest effects which alter the financial impact. Also the time of interest payment causes a second-order interest effect. Under normal circumstances (no hyper inflation, for example), these net second order effects are relatively small. So for the determination of the financial impact, we decided to exclude these effects: we presume

36


that all payments of a certain calendar year take place on the first of January of that calendar year. For the liquidity planning, these delays should be included, of course. Exhibit 3-6 presents a summary of the results.

summary of financial impact results in case of a liquidity shortage input parameters: corporate tax rate UK: 35 X corporate tax rate NL: 42 X interest rate intracompany loan: 10.3 % exchange rate: 3.66 NLG/GBP alternative : net decrease in NLG : transfer-price decrease Europhar Int BV : NLG 326.58 current account : NLG 366.00 intracompany loan : NLG 368.83

Exhibit 3-6. Summary of the financial-impact results.

This example shows that of the three alternatives, the transfer-price decrease causes the lowest liquidity decrease at Europhar International BV. The financial impact is one of the elements which are relevant to select a financing alternative. The three examples are relatively simple. The only intention is to demonstrate the principle of the financial impact calculation. For an explanation of other more complex alternatives like dividend payment, see Van der Ven [1988b].

The financing alternatives described above, all relate to intracompany transfers. One other alternative, however, is usually evaluated simultaneously with intracompany transfers. This is the local borrowing/lending alternative:

Local borrowing/lending Like the intracompany loan, the external loan is a sum of money, borrowed at interest, for a period of time. This financing alternative is not an internal transfer of funds like the other alternatives but results from an agreement with an external local bank.

In case of Uquidity shortage in the UK, for example, it might be better to borrow locally instead of transferring funds from the parent company. The net interest differences between the Netherlands and the UK need to be added to the schemes presented above in order to make them comparable with the local borrowing alternative. By means of the intracompany transfer a real flow of funds takes place. At the end of a period, the financial impact can be measured exactly at the parent company as the amount of money has actually decreased (or increased) with a certain amount of guilders. In the case of using the local borrowing alternative, however, no real transfer takes place. In other words, a comparison needs to be made by means of an accounting exchange rate. Although important, we consider a discussion of this matter outside the scope of this thesis. For more details we refer to Van der Ven [1988b].

37


Above we discussed various financing alternatives. It should be realized, however, that a decrease in cost or an increase in sales by means of a temporary rebate can solve an existing problem in the financing area. All alternatives which primarily have an external impact, like the two mentioned above, are defined as operational alternatives. It will be clear that making decisions with regard to these operational alternatives is the core of the business.

Financing alternatives can be defined as those alternatives which only cause an internal flow of funds. Local borrowing/lending is also considered a financing alternative. No flow of goods or operational activities result from implementing a financing alternative. Financing is a secondary activity within the multinational. The focus is on the operational activities.

Besides operational and financing alternatives a third category exists: relocation alternatives. Relocation alternatives cause a shift in activities within the multinational. So their primary focus is internal. An example of a relocation alternative is the shift of production or packaging activities from one group company to another. Like financing activities, relocation activities should support the smooth running of the business. Hence it is a secondary activity. It will be clear that activities in the relocation area, like the operational activities, influence the financing situation. We discuss this distinction between operational, relocation and financing alternatives to clearly define our "problem space": financing problems only.

On the basis of literature study we categorized the financing alternatives into eight categories, see Ammer and Ammer [1977]. It should be realized that the number of existing financing alternatives for a subsidiary company is much larger. From a theoretical point of view, the number is near infinite. The cost transfer alternative alone, for example, offers already an extremely large number of possibilities as in theory each cost item or combination of cost items can be considered for transfer to or from the parent company.

In this section, we globally described the issues at stake in international transfer pricing. The main conclusion is that international transfer pricing is a part of the problem of international financing, so it cannot be considered in isolation.

3.4 Transfer pricing in the pharmaceutical industry

In chapter 2, we concluded that high vertical integration and low diversification are dominating characteristics of the pharmaceutical industry. As explained in section 3.2, this indicates that we deal with a cooperative type of company in which decision makers act as a team with a common goal, see exhibit 3-7.

38

Sec. 3.4 TRANSFER PRICING IN THE PHARMACEUTICAL INDUSTRY

A high x

pharmaceutical companies: cooperative type

degree of vertical integration

low

low degree of high diversification

Exhibit 3-7. The place of pharmaceutical companies in Eccles' contingency approach to management control.

Consequently, no transfer-pricing policy is needed from a management-control point of view. Other mechanisms, like detailed budgets and consolidated performance measurement are used as a steering mechanism (ex ante) and for performance measurement (ex post).

According to Rasch [1980], team setting implies that a transfer-pricing policy, whatever the kind, does not influence corporate performance as decisions are in line with company goals anyway on the bases of other steering and control mechanisms. As explained, a transfer-pricing policy is not useful and even inefficient in this case, according to Rasch.

Although many, if not all, pharmaceutical companies belong to the cooperative type, the conclusion of Rasch would be completely false. As explained in the previous section, the international aspects result in high "compliance costs" of all kinds of regulations, see Quirin [1985, p. 148]. The interference of health-care authorities only adds to this point. Although there is no need for transfer pricing for management-control purposes, there is a great need for a transfer-pricing policy to respond to sometimes contrasting and continually changing regulations. Not only regulations from fiscal and customs authorities, but also regulations from central banks, health-care authorities and other institutions are involved. In his analysis of a large Swiss-based pharmaceutical company, Von Grebmer [1987a], reaches the same conclusion. He stresses the problems resulting from cost containment measures as described in the previous chapter. As stated in chapter 2, all aspects relating to pharmaceutical-pricing and cost-containment issues will be referred to as the "commercial aspects". International transfer pricing deals with the financing, fiscal and commercial aspects of transfer pricing.

In summary the position of the pharmaceutical industry can be presented in exhibit 3-8. Other branches of industry might find themselves in other positions of the scheme, as the example of "company A" illustrates.

39


Let us take a competitive type of company, named "company A", whose divisions are located in various countries. Company A might score very high on the "management-control axis" as the company is of the competitive type. It might also score high on the "international axis" as the internal transfers between divisions cross national borders. That company A scores less on the "international axis" than a typical pharmaceutical company, might be caused by the absence of commercial aspects.

A very important x

pharmaceutical companies

i n t e r n a t i o n a l x t rans fer company A pr ic ing

not important

I ». not management-control very important transfer pricing important

Exhibit 3-8. The importance of various kinds of transfer pricing for the pharmaceutical industry.

So far we reached this conclusion by studying the existing transfer-pricing literature and publications concerning the pharmaceutical industry. In addition to this we conducted a survey among 12 transfer-pricing experts within the European pharmaceutical industry itself, see Van der Ven [1989a]. The outcome of this survey was as follows: - management-control aspects of transfer pricing are not of main importance to

pharmaceutical companies, - international aspects of transfer pricing are of great importance to the industry and

they are an area of major concern. Our point of departure is supported by the point of view of these experts. Based on these findings, we will now concentrate on international transfer pricing.

3.5 A framework to describe transfer pricing

In order to facilitate fast communication and better understanding of the problem, we developed the following framework to describe a multinational:

Our point of departure is the so-called object company. The analysis of the financial ties between the parent company and one of its subsidiary companies is the focus of attention. This subsidiary company is defined as the object company. Besides the financing area, these financial relationships have, among others, an impact in the fiscal and commercial area. Various categories of financing instruments, like transfer prices, royalties and loans, need to be considered simultaneously. Decision making requires the

40

Sec. 3.5 A FRAMEWORK TO DESCRIBE TRANSFER PRICING

involvement of local and central management and fiscal and financial experts. In the decision process, we try to solve the financing problems (liquidity surplus or liquidity shortage) of the object company.

This object company purchases its products from a source company. By definition, a source company is a company which belongs to the same multinational and which sells goods to the object company. As shown in exhibit 3-9, the parent company is a supplier of the goods and hence a source company. The sales of these goods are defined as "transfers".

tran

external .

parent company

sfers '

subsidiary company

sales '

local wholesaler

source company

object company

destination

Exhibit 3-9. The basic pattern between source company, object company and destination.

Destinations are all companies that purchase from the object companies. Usually the destinations are wholesalers from the country in which the object company is situated. In most cases, the wholesalers are taking care of further distribution of the articles and assist in the local marketing activities.

As shown in the exhibits 2-1 and 3-7, strong vertical integration between parent and subsidiary is our point of departure. Conceptually, this remains so. In practice, however, the parent company may not be the only source company. In addition it is possible that the object company sells to destinations belonging to the same multinational. Although amounts sold and purchased may be of minor importance, say 10% of the amount bought from the parent and sold in the local market, these additional ties may seriously complicate the situation. The relationships within the multinational are shown in exhibit 3-10.

41


source company

transfer of source article (transfer price)

reference article reference price)

object company

reference

external sale of destination article

(external selling price)

internal sale of destination article

(internal selling price)

destination third

destination

destination company

Exhibit 3-10. Relationships within a multinational.

The price that the object company must pay for a source article purchased from a source company is defined as a transfer price. The object company can resell the articles to a destination within the multinational or to a destination outside the multinational group (a "third party"). A destination within the multinational group is defined as a destination company. The price a destination company has to pay for a destination article is called an internal selling price. When the destination is a third party, a destination third, this price is defined as an external selling price. Note the distinction we make between transfer prices and internal selling prices. Usually, these two words are synonymous. Within our conceptual framework, however, the transfer price is the price that the object company pays to the source company and the internal selling price is the price that the object company receives from a destination company.

Although we concentrate on one object company, its financing problems cannot be considered in isolation. The authorities of the country of the object company determine regulations with regard to transfer prices. These authorities influence, or are influenced by, authorities of other countries. These countries are defined as reference countries. Related companies situated in the reference countries are defined as reference companies. Articles sold to these companies are defined as reference articles. Transfer prices for these reference articles are defined as reference prices. All issues which relate to these cross-border impacts of transfer prices, are referred to as reference effects.

Decision making with regard to international financing is a secondary activity. It has to react to actions that take place in the operational and relocation area. Therefore the time span cannot be too long: frequently the international-financing situation needs to be adjusted to changes which take place in the operational or relocation area. In

42

Sec. 3.5 A FRAMEWORK TO DESCRIBE TRANSFER PRICING

international transfer pricing, chief specialists and general management, just under the top level, are usually involved. Following the three levels of organizational decision making as discerned by Bosman [1983], transfer pricing is not classified as a strategic top-level problem but as an issue that is handled at the administrative - intermediate -level.

Solving the financing problems of an object company is a multi-disciplinary process as, amongst others, financial, fiscal and commercial aspects are relevant. Reference effects are of importance as well. Within the multinational, various organizational members need to be involved to provide the necessary expertise. In many companies we find that the following units are represented: local management, central management, price coordination, fiscal affairs and financial affairs. As within this industry no management-control aspects are involved in decision making, no transfer-price negotiations need to take place. Given the strong outside pressure and the hostility of the environment, we presume that this group acts as a team. This point of departure of team setting is supported by the small survey that we held within the industry, see Van der Ven [1989a].

3.6 Conclusion

Based on the previous sections, we conclude the following:

Transfer pricing in the pharmaceutical industry focusses very much on international aspects. Management-control aspects are of minor importance as other instruments, like budgets and consolidated profit measurement, are used for planning and performance measurement.

International transfer pricing is an integrated part of the financing activities of the multinational. Financing of one subsidiary company, the object company, is focus of our attention. From a theoretical point of view the number of financing alternatives is infinite. These financing alternatives can be classified into the following eight categories: - transfer prices, - internal selling prices, - royalty payments, - cost transfers, - capital/dividend payments, - intracompany loans, - current account changes, - local borrowing/lending. These instruments have different characteristics. Consolidated cost, for example, may differ per alternative due to different tax effects. The consolidated cost are defined as the "financial impact". Usually a combination of various instruments from the eight categories mentioned above is used to solve the financing problems of a local subsidiary company.

43


Like relocation activities, financing is a secondary activity within the multinational. Operational activities are the core of the business.

Selection of the financing instruments is based on fiscal, commercial and financing considerations both on the aggregate and disaggregate level. The arm's length concept plays a dominant role in the decision process. In the multi-disciplinary decision process, the following organizational groups are represented: local management, central management, price coordination, fiscal affairs and financial affairs. It is realistic to presume that this group of decision makers acts as a team.

Before turning to the next chapter, we discuss the contribution of our approach to transfer-price research.

Verlage [1975] is one of the first authors who defines transfer pricing explicitly as a multi-disciplinary problem. Even though we concentrate on the international aspects alone we are still confronted with the multi-disciplinary character of transfer pricing: a transfer price should be acceptable from a commercial, fiscal and financial point of view. The rapport of Vereniging van Belasting Wetenschappen [1987, pp. 16 and 20] states that "the enterprise should choose a pragmatic approach" and "transfer prices used in reality need to be a compromise" of all aspects involved. In the final chapter of his dissertation, Verlage proposes the set up of a headquarters staff department which concentrates on integration of the aspects mentioned above. This department should managed by a so-called "price coordinator". Concerning this department, Verlage [1975, p. 197] states the following: "It is obvious that this department cannot operate without an adequate knowledge of the following subjects: - the accounting system of the enterprise ... - customs regulations and fiscal law ... - financial policy - commercial policy ... It is clear that this knowledge is most likely to be found in financial management and transfer pricing should be a part of the authority of the financial director."

In his proposal, Verlage states that the integration of the various aspects and the search for a "pragmatic compromise" is the responsibility of the price coordinator. He does not work out, however, how the integration of these aspects should take place. It is in this area that we intend to contribute to transfer-price research: on the basis of developments in the realm of decision support, as will be discussed in the next chapter, we will propose a systematic integration of all aspects involved.

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4

GROUP DECISION SUPPORT SYSTEMS

4.1 Introduction

As explained in the two previous chapters, the pharmaceutical industry operates in a hostile, complex, and turbulent environment, especially as far as transfer pricing is concerned. In chapter 1, we explained that the decision-making paradigm is appropriate when studying and designing organizations which operate under such "post-industrial" conditions. Huber [1984b, pp. 934-939] reviews various aspects of the decision-making paradigm. The requirement that decision making in post-industrial organizations needs to be more frequent, faster, and more complex creates decision-tasks which are qualitatively greater than those of the past. Awareness of this fact provokes and promotes developments both within organizations themselves and within the organizational-science community. Huber expects these efforts to be successful and that, in order to enhance their decision processes, post-industrial organizations will adopt on a widespread basis three design features: advanced computing technologies, improved decision-group technologies and decision-process management.

Advanced computing and communication technologies Huber expects that communication technologies, electronic mail systems and other devices will become extremely user friendly. The consequent increased accessibility to people, increased efficiency of communication, and increased timeliness of communication (all much more important in the faster-paced environment of post-industrial organizations) will cause post-industrial communications to be adopted on a scale not greatly different from that of the telephone today, according to Huber [1984b].

With regard to computerized aids in decision making, Sol [1987a] and Koppelaar [1988] expect the addition of artificial intelligence techniques to decision support systems and office automation. According to Boot and Koppelaar [1982], artificial intelligence can enable computers to process natural language. Sprague and McNurlih [1986, pp. 363-385] expect extreme user friendliness to become a common characteristic of computerized systems. They mention the extensive use of graphics, speech recognition and pull down-menus.

Improved decision-group technologies Increased environmental complexity leads to the need for more information exchange, see Galbraith [1977]. Often this exchange takes place at meetings between staff experts and line management. An important point to note is that the organizational members meeting may not make the ultimate decision. They may be creating and/or reviewing alternatives to be submitted as a short list to the next level in the organizational hierarchy, see Gray [1986, p. 158]. Given higher levels of environmental complexity, there will be pressure for the number of meetings in post-industrial organizations to be greater. This pressure will be resisted strongly, however, since the managerial time

45

GROUP DECISION SUPPORT SYSTEMS Ch. 4

available for meetings may be approaching its limits and because meetings are widely regarded as less than optimal uses of time. What is to be the resolution of this situation?

As one approach, Huber [1984b] expects behavioral scientists and individual organizations to develop and implement additional technologies for increasing the efficiency and effectiveness of decision-oriented meetings. Even though a good deal of development work has already been done, and some adoption of decision-group technology is emerging, in the post-industrial organizations the increased need to exchange information leads to much higher density of application of such technologies.

As a second approach, Huber expects that an increase in decision-group effectiveness will be achieved by integrating communication and computing technologies into decision-group technologies. This has already occurred in a rudimentary way in the form of teleconferencing and video-conferencing. Face-to-face groups are made more effective with marriages of communication and computing technologies and behavioral-based technologies. Huber presents the nominal group technique as an example: each participant writes his or her ideas on an electronic pad and then transfers them to a "public screen" with the touch of a "send" button. Ratings are forwarded and compiled electronically and displayed so that discussion can be directed in more fruitful channels, according to Huber.

Huber concentrates on the cognitive processes and information exchange within decision-making groups. This includes collecting and evaluation of information, forging alternative courses of action and selecting one as preferred. Huber's focus is not on the social-psychological dynamics of group behavior, see also Guzzo [1982, p. 4] and Cook and Hammond [1982, pp. 13-39].

In summary, given the apparent need for more decision-group meetings and at the same time a considerable resistance to them, we expect post-industrial organizations to seek and adapt on a widespread basis more sophisticated group technologies and that, as a result, the effectiveness of decision groups will increase.

Decision-process management According to Huber, the demand for faster decisions will cause logistically-related delays in decision processes to be considerably less tolerable in post-industrial organizations. In addition, the need to make more complex decisions will require organizations to ensure participation from a wider variety of experts and managers. Together these needs will motivate post-industrial organizations to adopt more structured approaches to "decision-process management".

Although the implementation of more formal decision processes is new, it is so similar to the concepts of project management, that Huber [1984b] expects it to be readily in operation. Both Bosman [1987a] and Sol [1985b] consider decision-process structuring a prerequisite for providing effective decision support. According to Huber, it is likely that as decision making receives more explicit recognition, decisions will increasingly be viewed as ad-hoc "projects". This can be explained as follows: As situations change

46


rapidly, it is impossible to install fixed bureaucratic procedures to react to stimuli from outside the organization. On the other hand, to assure the quality of the decision process, the involvement of several organizational members, like managers and experts, is required. The timeliness of the decision process requires this involvement to be without delay. This will lead to the adoption of project-management technologies for managing the production of lower-level decisions. For example, at the planning stage the use of planning networks would facilitate identification of: - needed activities such as obtaining particular information, - needed resources such as experts, computer programs, authorizations from top

managers, etc., - precedence and temporal relationships among these activities, thereby contributing

to the scheduling of meetings, people and tasks. According to Huber, it appears that process-management technologies such as these could be readily transferred to the organizational-decision context. Future demands could lead to the development and use of technologies specifically designed for decision-process management. This does not mean, however, that decision making should take place in a more formal atmosphere: in some situations, the decision process may be managed and structured to create an informal, adaptable and flexible way of decision making, see Huber and McDaniel [1986, p. 583].

To summarize, we can state that post-industrial organizations should include, among other design features, advanced communication and computing technologies, improved decision-group facilities and decision-process management as responses to the post-industrial environment's demand for more frequent, faster, and more complex decisions.

We agree with Huber however, that we do not expect any one particular feature, any one particular technology, structure, or process, to be lasting. Opportunities and problems, and means for dealing with them, will change. The appropriateness of any particular organizational-design feature will change, often quickly. So innovation in organizational design and organizational decision support is, and will be, called for.

And innovation is the aim of our research. In this section we developed the following broad design guidelines, related to the decision-making paradigm: - the use of advanced communication and computing technologies, - improved decision-group technologies, - decision-process management. These three features form the basis for designing the prescriptive conceptual model. The issue of decision-process management is closely related to structuring decision processes. This will be discussed in the next section.

4.2 Structuring decision processes

According to Ginzberg and Stohr [1982, p. 20] "a good decision support system brings as much structure as possible to the problem". Bosman underlines the importance of

47


structuring decision processes. When discussing the design of information systems, Bosman [1986, p. 315] states that the distinction into "phases of the decision process is for both the description and the design of vital importance". If we are to support a decision process, it is essential to structure it in terms of tasks, decisions and information needs. Hence the need for an approach that accommodates for the apparent paradox of structuring an ill-structured problem.

In this context, the approach suggested by Bots and Sol [1987] is very promising. Their method of task analysis provides both the structure and the flexibility required for the modeling of our problem. Its basic concept is task. The actual structurmg of the decision process is accomplished using tasks. A task consists either of decisions only or of decisions and other more detailed tasks (subtasks). In the latter case, the decisions have a coordinating function in the sense that their outcome determines whether a specific subtask has to be performed or repeated. Hence the term "coordinating decision". At the most detailed level, tasks are specified in terms of decisions and information, where each decision requires information (input) and generates information when it is made (output).

According to Simon [1977, p. 41], problem solving comprises four principle phases: intelligence, design, choice and review. These four phases are defined as follows: 1. intelligence: searching the environment for conditions calling for decision, 2. design: inventing, developing, and analyzing possible courses of action, 3. choice: selecting a particular course of action from those available, 4. review: assessing past choices.

Huber and McDaniel [1986, p. 576] discern the following phases in problem solving. (A set of related problems is regarded as one problem): 1. sensing the problem, 2. exploration of the problem, 3. definition of the problem, 4. generation of alternative solutions, 5. evaluation of alternative solutions, 6. selection of alternative solutions.

Various other approaches exist. For a more detailed review of decision-making literature, see Van Schaik [1988]. In this section, we limit ourselves to the approaches of Simon and Huber and McDaniel as presented above. For the most recent developments, see Simon et al. [1987]. We will use the word "alternative" in the meaning of "alternative solutions" and "particular course of action".

Neither Simon nor Huber make a distinction between "problem solving" and "decision making". Both activities are aimed at removing the decision maker's dissatisfaction with his present state, the problem, see Sol [1982], where he can identify: - one or more outcomes he desires, - two or more different courses of action, - an environment containing factors that affect the outcomes. Note that opportunities are included in this definition of a problem.

48

Sec. 4.2 STRUCTURING DECISION PROCESSES

Before the problem is solved, however, the solution needs to be implemented. According to Simon [1977, p. 43] executing decisions is again a decision-making activity, but now at a more detailed level. In order to make a distinction between these two levels of detail, we define "problem solving" as encompassing the following tasks: 1. scan task, 2. decision-making task, 3. authorization task, 4. implementation task. Following Bots and Sol [1987], we prefer the term "task" instead of the word "phase" as the research of Witte [1972] shows that although decision processes can be delineated in distinct phases, no simple sequential relationship exists between them. Simon [1977, p. 43] puts it as follows: "The cycle of phases is, however, far more complex than this sequence suggests".

The relationship between these tasks and the phases as defined by Simon and Huber will now be explained.

Scan task We define the scan task as the ongoing search for occasions for making a decision. It is similar to the intelligence phase of Simon and the sensing of problems of Huber. During this task, problems are noticed and identified.

Decision-making task The decision-making task comprises all steps between identification of the problem and making a decision. In the previous section, a distinction was made between making a decision and authorizing a decision. We now define a decision as a, yet unauthorized, concrete plan for action with the aim to remove the problem. The decision-making task comprises all phases as described by Huber, except sensing the problem. Included are: exploring the problem, definition of the problem and generation, evaluation and selection of alternative solutions. Below we will come back on the tasks that constitute decision making.

Authorization task We define the authorization task as the formal acceptance of the decision by the organizational members who are ultimately responsible for finding and implementing a solution.

Background of the inclusion of a separate authorization task, is our focus on group decision support. An individual who takes the responsibility for his own decisions, does not discern a separate authorization task. In the case of an individual, making a decision implies at the same time authorizing that decision. In case of organizational decision making, however, it is possible that a group of experts and managers decides, in the sense as defined above, but that only one of the group, the general manager for example, has the power to authorize. The position of the authorizer might also be at a higher level in the organization.

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We would put the authorization task after the last phase (selection of solutions) of Huber. So authorization is not included in Huber's definition of problem solving, see also Huber [1984a, p. 196]. Following the example of Simon [1977, p. 42] on the decision to introduce computers in an organization, we would conclude that according to Simon, authorization is a part of the choice phase.

Implementation task We define the implementation task as the execution of the authorized decision with the aim to remove the problem. Like authorization, implementation is not included in Huber's definition of problem solving. As said above, Simon considers implementation as a new decision-making task, so it is not included in his definition of problem solving and/or decision making.

Above, the four tasks which constitute problem solving have been briefly discussed. According to Huber [1984a], the decision-making task should be the focusx of attention as this is the main element of the problem-solving task. If we consider the problem of transfer pricing as discussed in the previous chapter, we note that the scan, authorization and implementation tasks do not give rise to substantial problems. This is in contrast to the decision-making task. Following Huber, we will mainly concentrate on the decision-making task, see also Bui and Jarke [1986, p. 84]. Within the decision-making task, the following tasks are defined: 1. preparatory design, 2. integrative design, 3. choice. These tasks are now described in more detail.

Preparatory-design task The preparatory-design task resembles the scan task as the main aim is to gather information. The distinction between the preparatory-design task and the scan task is that preparatory design is focussed on a specific problem. During a limited period of time, detailed information is obtained on the specific problem at hand and on the solutions available. This specific problem may still lack accurate description. In contrast to the scan task, the preparatory design task is not an ongoing process aimed at spotting relevant problems. We define the preparatory design task as the analysis of the relevant aspects of a specific problem and solutions related to this problem during a limited period of time.

This task can be regarded as a part of the design phase as defined by Simon. Following Huber and McDaniel, this task encompasses the exploration and definition of the problem and generation of alternatives. Focus during this task is on exploration of the problem. Definition of the problem takes place as far as required in order to determine the focus of the preparatory design.

The limited period of time set apart for the preparatory design may be a number of weeks. Time spent depends mainly on the urgency of the problem at hand and the capacity available. As explained in chapter 3, from a theoretical point of view, the

50


number of alternative solutions is near infinite. In chapter 1 we explained that decision makers do not possess unlimited cognitive abilities. Therefore the restricted period of time available limits the number of alternatives generated.

Integrative-design task On the basis of the information gathered during the preparatory design task, integrative design takes place. It encompasses the same tasks as defined by Simon and Huber: exploration and definition of the problem and generation of alternatives. Focus is on the definition of the problem and generation of alternatives. We define the integrative design task as: - definition of the problem and the integration of all aspects as determined during

the preparatory analyses, - generation of alternatives on the basis of the preparatory analyses. Note that this definition of design is more limited than the definition of Simon. Simon's definition of the design phase includes the preparatory design as described above. The background of splitting up the design phase as defined by Simon in two different tasks is our focus on group decision support: it might be more efficient to perform the preparatory design task individually. Integrative design, however, requires the involvement of all decision makers. For the integrative design task we can use the term "integral decision making" as all decision makers consider the relevant aspects simultaneously.

Choice task Following Huber and McDaniel, we define the choice task as the evaluation and selection of alternatives. Note that our definition of choice is more limited than Simon's definition, as he includes the authorization task. Ways to structure the choice task, like multi-criteria techniques, are discussed later on in this chapter.

Above we described the various tasks. Using the technique of Bots and Sol [1987] we now present the visualization of this task structure. As explained above, a task consists either of decisions alone or of decisions and other tasks. In the latter case, the decisions have a coordinating function in the sense that their outcome determines whether a specific more detailed task has to be performed or repeated. Hence their definition: "coordinating decision". At the most detailed level, tasks are specified in terms of decisions and information (input and output). Note the distinction with regular flow diagrams. In this thesis, we do not present task-structures at the most detailed level. Our research served as a case study in testing the method of task analyses. This study is reported in detail by Bots [1989], who presents task structures at the most detailed level.

In the exhibits presented below, coordinating decisions are depicted as small circles and tasks as rectangles. The arrows indicate the order of the tasks. In case tasks of a detailed level (subtasks) are depicted, the "path" is indicated. The path shows the hierarchy of tasks. As an example we take task A. Task A is an element of task B and in it's turn, task B is an element of task C. The path of task A is indicated as follows: "path: C \ B \ A" (Personal computer users will note that the path indication

51


resembles the directory-path indication of MS-DOS). A task finishes whenever one of its subtasks finishes that has no outgoing arrows, or when one of its coordinating decisions is made in such a way that none of its outgoing arrows can be followed. Unlike regular flow diagrams, task structures have no explicit stop symbols. When a task is finished, one has to look at its parent task to determine what should be done next. The name of the parent task can be derived from the path of the subtask.

O problem worth analyzing?

yes v

decision making

authorization

O alternative authorized?

yes ,,

implementation

path: problem solving

Exhibit 4-1. Proposed structure of the problem-solving task.

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The technique is used to describe both the decision-making task as well as the problem-solving task. As explained above, we focus on the decision-making task. The problem-solving task provides a reference for the decision-making task. Using this technique, the problem-solving task looks as presented in exhibit 4-1.

.preparatory design

yes f O further

analysis required?

Integrative design

yes f O further

analysis required?

choice

path: problem solving \ decision making

Exhibit 4-2. Proposed structure of the decision-making task.

Note the two coordinating decisions in exhibit 4-1. The first one determines whether it is justified to start the decision-making task. The decision-making task requires a lot of time of the participants. Often, many problems which all require decision making will come up simultaneously. During this coordinating decision, priorities are set. The second coordinating decision checks whether the higher management levels indeed authorized the decision, as requested. If not, a new iteration of (a part of) the decision-making task needs to take place.

53


For the task structure of the decision-making task, see exhibit 4-2. As the decision-making task constitutes a part of the problem-solving task, the path is indicated. The two coordinating decisions check whether all necessary information is available.

4.3 Multi-criteria decision making

Another issue related to structuring decision processes is "multi-criteria decision making". These techniques contribute to structuring the choice task. In cases of expertise sharing, like in the case of international transfer pricing, these techniques may especially be useful, see Bui and Jarke [1984]. Aim of these multi-criteria techniques is to combine the following two elements, see Lootsma [1988]: - an objective evaluation of the alternatives with regard to the relevant criteria, - a subjective assessment of the importance of the criteria used in the evaluation. It will be clear that the evaluation of alternatives can only be completely objective in some exceptional cases. The main aim of the multi-criteria techniques is to improve the decision-process structure. Many different approaches, simple and sophisticated, exist, see Roy [1985], and Zeleny [1982].

In the introduction of the previous chapter, we discussed the gap that exists between sophisticated mathematical models and every-day practice in the area of transfer pricing. Like in the area of transfer pricing, also in the area of multi-criteria techniques, such a gap exists. Fortuin and Lootsma [1985] define this as the "practicality gap". To avoid this practicality gap, we set the following three criteria for selecting a technique for the choice task: - The complete technique should be understandable for all decision makers, even if

they are non-mathematicians. This implies, for example, that logarithmic scales may be considered undesirable.

- The technique should be simple to use. This is in order to avoid long cumbersome procedures during the meetings.

- The technique should offer a good point of departure for discussion within a group, see Lootsma et al. [1986].

By setting these requirements, we will avoid the choice task being choked by the technique. The three criteria presented above determine some aspects of the design guidelines that will be used to construct the prescriptive conceptual model.

The technique that we have selected is now described below by means of an example. It is a simple approach based on some elements as used in "Maud". Maud is a computer package for multi-criteria decision making as designed by the University of London, see DAU [1986a; 1986b].

Let us presume that we need to choose one out of three financing alternatives. These financing alternatives are: a transfer-price increase, a loan and a dividend payment. The criteria that we consider relevant are "fiscal effect", "financial impact" (cost) and "flexibility". We define the "score" of an alternative on a specific criterion as the degree that this criterion is met by the alternative. These scores are expressed by means of figures in the range from one to seven. The meaning of these figures ranges from "very

54

Sec. 4.3 MULTI-CRITERIA DECISION MAKING

unfavorable" via "indifferent" to "very favorable". So the higher the score, the better the alternative.

The second part of our multi-criteria technique is the determination of the weights. For the three criteria, the relative importance of each criterion needs to be determmed. This is done by attaching a number to each of the criteria. For convenience sake, these weights are normalized, see exhibit 4-3.

weight (C(i)) normalized weight (C(i)) - * 100%

n £ weight (C(i)) 1-1

n - number of criteria C(i) E criteria, 1 s i s .n

Exhibit 4-3. Formula for normalized weight.

Say that we weigh "fiscal effect" with 15, "financial impact" with 5 and "flexibility" also with 15. The next step is to integrate the weights and scores into one total score per alternative. The total score per alternative is defined by means of the formula as presented in exhibit 4-4.

total score A - £ {score (A, C(i)) * normalized weight (C(i))} i-1

n - number of criteria A 6 alternatives C(i) E criteria, 1 s i s n

Exhibit 4-4. Formula for total score.

This formula calculates the weighted average score of the alternative on each criterion. For the complete table with weights and scores, see exhibit 4-5.

alternatives: weight normalized transfer loan dividend

criteria: weight price fiscal effect 15 43% 1 6 A financial impact 5 14% 6 4 5 flexibility 15 43% 7 3 5

35 100% 4.3 4.4 4.6

Exhibit 4-5. Table with total scores.

55


In exhibit 4-5, the total scores are rounded off at one decimal. As we can see, the dividend has the highest total score and hence the dividend alternative is selected. However, the method should be used with the utmost care as marginal differences can cause a different outcome. A score on "flexibility" for the dividend of 4 instead of 5, would make the loan the favorite alternative. For more details on the effect of the technique on the choice of the best solution, see Claessens and Vogt [1988]. In then-comparison of various multi-criteria techniques, they used real-life scores from our research project in order to demonstrate the differences.

We realize that the multi-criteria technique that we decide to use is very simple indeed. Other techniques that we studied, like the method of Israels and Keller, see Albers [1987], however, would not contribute to communication within the group due to their complexity. It is our impression that decision makers without a mathematical background will be put off by "dominance matrices" and "s-scores". These technicalities would distract the attention from the problem at hand and the intragroup communication. We realize that these complex approaches may be considered more "elegant" and theoretically superior to the technique that we use. In our case, however, we consider a simple technique the most appropriate.

The use of multi-criteria techniques has a significant impact on the way that decisions are made. For one thing, evaluating and choosing alternatives becomes much more explicit. All combinations of criteria and alternatives get a visible score. In case of group decision making, such an approach leaves little room for so called "hidden agendas" (or "hyper games") of the participants, see Lootsma [1988]. In case these techniques are included in a decision support system, such a system changes the way decisions are made. So it does more than "supporting" decisions. In fact, the decision process changes. For this reason, Lootsma [1988] proposes the term "decision reform systems" instead of decision support systems.

4.4 Approaches to group decision support systems

As explained in the previous section, international transfer pricing is a group decision process. Davis [1969, p. 2] defines small groups as groups with a dozen or fewer people. As less than twelve organizational members are involved in international transfer pricing, we now discuss group decision support for small groups. Like Cook and Hammond [1982] and DeSanctis and Gallupe [1987, p. 591] we abstract from psychological interaction within the group and concentrate on information exchange and problem understanding. This point of departure is related to the presumption of team setting as discussed in the previous chapter. We focus on "expertise sharing groups" We exclude negotiation support systems, see for example Jarke et al. [1987] and Jarke and Jelassi [1986]. Expertise sharing involves the resolution of conflicting viewpoints, so called cognitive conflict tasks, see DeSanctis and Gallupe [1987]. Resolution of conflicting motives or interests, however, is excluded.

We focus on information exchange and decision making within the group. In other words, the focus is very much on the problem. This problem-oriented approach of

56

Sec. 4.4 APPROACHES TO GROUP DECISION SUPPORT SYSTEMS

participants is best helped by means of an informal atmosphere, see Schnelle [1977]. It is our impression that this informal atmosphere is more important than the "executive feel" with "plush carpeting" and "quality furnishings" that decision rooms should have, according to Gray [1986]. For more details on motivational aspects of decision making, see March and Simon [1958] or Davis and Olson [1985].

Following DeSanctis and Gallupe [1985] we define group decision support systems as follows:

An interactive computer-based system which facilitates solution of ill-structured problems by a set of decision makers, working together as a team.

To facilitate the communications and the exchange of information between members, a group decision support system might be a useful tool. Jarke [1986] and DeSanctis and Gallupe [1985; 1987] discern four kinds of group decision support systems, see exhibit 4-6.

place close

proximity

dispersed

duration limited

decision room

teleconferencing facilities

ongoing

local decision network.

remote decision network

Exhibit 4-6. A basic taxonomy of group decision support systems.

These four categories will now be described in more detail:

Decision room Huber [1984a] describes a decision room as follows: - a personal screen and input device, for example a keyboard, for each group

member, - a public display screen large enough to be seen by all participants, - computing and communication capabilities that: (a) allow each participant to link

his input device to its respective personal screen, to the group leader's personal screen or to the public screen and (b) allows any participant to retrieve from predetermined databases,

- software that provides (a) state-of-the-art word-processing capabilities to each terminal; (b) computing capabilities with a particular focus on drawing simultaneously on data from several or all terminals or the predetermined data bases; (c) state-of-the-art graphics capabilities for example capabilities for constructing and altering work sheets, bar graphs, decision trees and the like and (d) anonymity of the individual participants when this is desired.

57


We define a computer supported meeting held in a decision room as a group session. According to DeSanctis and Gallupe [1985], the combination of one input/output device, one computer processor and one public screen constitutes a less sophisticated example of a decision room. A computer for each group member is not imperative.

Teleconferencing facilities For teleconferencing mainly telecommunications are involved. By transmitting images and voice of the participants of the meeting to the locations involved, an artificial meeting room is created. This meeting room could be extended with the facilities described above to become a decision room.

Local decision network ' Office automation offers the possibility to communicate "memos" by means of a local-area network. In case one of the participants addressed by a memo is not at his desk, these memos can be stored in order to be retrieved after his return. Reactions of people, involved in the decision process can be sent to all involved who, at a convenient time for them, can voice their opinion via the system. Participants can access common and private databases or decision-support software as required and view a distant "public screen" on their personal screen as needed. Decision makers are engaged in their day to day work and set up distant "group meetings" or conferences as needed. This approach offers greater flexibility than the decision room, but there is the important disadvantage of removing the face to face communication.

Remote decision network A remote decision network offers the same facilities as a local decision network, only extended to "far-away" locations.

The four approaches to group decision support, as presented above, will now be discussed with the problem of international transfer pricing in mind.

A decision room could be very helpful in providing support as the various experts and managers involved need to integrate the different aspects of the problem: commercial, financing and fiscal. These aspects need to be considered from both a local as well as a central point of view. The decision room will be discussed in more detail later on.

Local management will only occasionally be able to participate in decision-room meetings due to geographical distance. This makes another option of the exhibit 4-6 interesting: teleconferencing. Teleconferencing, however, is not something to start with as the experimental situation is relatively complicated. In comparison to the decision room, for example, teleconferencing requires more hardware facilities. During a teleconferencing session, it will be harder to create the informal task-oriented atmosphere that we are aiming at. Teleconferencing might be an enhancement of the decision room when the latter is properly developed.

58


A local decision network for transfer pricing can be installed in the head office. As transfer pricing is explicitly an ongoing process and not a problem that can be solved during one group session, a local decision network needs our attention. Such a network has the disadvantage, however, of removing face to face contact and therefore communication becomes less efficient, according to the research as described by DeSanctis and Gallupe [1987, p. 598]. As with regard to transfer-pricing decision making communication is the focal point, we consider the local decision network an enhancement when the decision room is properly developed.

As in their very essence, transfer prices cross borders, remote decision networks can be used to involve local management when time differences prohibit direct communication. We agree with Desanctis and Gallupe [1985], however, that remote decision making is not a form of decision support to start with as it is very complicated.

In their "foundation for the study of group decision support systems", DeSanctis and Gallupe [1987, p. 602] propose the concentration on one category only as "the most appropriate tactic for researchers" as the issue of group decision support is very complicated. On the basis of the comments made above, it will be clear that we consider the decision room the most appropriate approach to start with.

As we are designing a system for "real-life" situations and not for a laboratory setting, we have to accept the constraint that, at the current time, not all decision makers know how to work with a computer. This is described as "end-user technophobia", see Suchan et al. [1987, p. 441]. It should be accepted that some decision makers, from now on defined as "participants", are "computer illiterate" and wish to remain that way. Therefore not every participant should be expected to provide (some) of the input for the meeting via a terminal. This implies that the participants need to be supported during the group session by one or more "analysts" who take care of handling the computer.

Besides the role of the analyst, a second role is of great importance: the role of facilitator, see Huber [1984a, p. 198]. As explained in the previous chapter, decision-process structuring is one of the dominant issues in providing decision support. This implies that one of the members of the support staff needs to take care of structuring the meeting. He should help the participants to put their point of view forward when appropriate and not just as it comes to mind. In his role of facilitator, the support-staff member who takes this role should not so much concentrate on the outcome of the meeting, but more on the structure of the decision process itself, see also Phillips [1985].

In designing group-decision support, the problem of "minimum frequency of use" should be addressed: each system needs a minimum frequency of use to avoid that it is totally abandoned, due to lack of experience of its users. This issue is usually approached by means of widening the scope of the system: the design should be such that group decision making related to various organizational areas can be supported. Consequently, the group decision support system should be of a general nature, see Huber [1984a] and Suchan et al. [1987, p. 443].

59


We think, however, that another approach is also possible, see Sol and Van der Ven [1988b]. We decide to focus on integration of group decision support in the organization. This approach can be regarded as one of the main elements of our design.

By using a facile decision support system generator, see Sprague and Carlson [1982], frequency of use should be guaranteed by employment of the developed application domain support by individual decision makers, see Bosman and Sol [1985, p. 90]. So in our case, for example, computerized support should be available for all those who are concerned with determining transfer prices, whether working individually or in a group. It should be easy to adapt the application to future needs as knowledge on how to operate the generator is already available within the organization. When using this approach, careful attention should be paid to the choice of the decision support generator. Frequency of use of this generator should be guaranteed by its use for other applications as well. In case the application domain is the focus of attention and not group support itself, we get a group decision support system that differs from the ones described by Gray [1986] and Huber [1984a].

Huber [1984a] stresses the usefulness of general group decision support especially for strategic top-level decisions. As explained in chapter 3, transfer pricing is a problem of translating this top-level policy into financing decisions for the coming one or two years. It is hence an administrative-based problem. We consider the approach of integration of group decision support in the organization especially applicable for problems on this administrative level. The reason is that "hard" company data are more relevant on this intermediate level than in the case of strategic top-level decisions.

In the case of application-domain support, we would not so much concentrate on computerized voting tools, agendas, decision trees and alike, see DeSanctis and Gallupe [1987]. The focus is much more on "what-if" tools on the basis of spreadsheets and databases. Both the "what-if1 tools and the' databases are specific for the application domain. Our application-domain support can be considered to be a specific decision support system existing of databases, various models and a user interface, see Sprague and Carlson [1982]. Application-domain support facilitates the integration of group decision support in the organization. Usually, computer-supported group meetings take place in an isolated setting, see for example Phillips [1986] and Vogel et al. [1988]. The group meets in a decision room outside their normal working environment. In these cases, company databases and company specific models are not available during the group session. In the case of application-domain support, however, preparation of the group meeting and the meeting itself take place on-site.

In Gray [1986], some examples of existing decision rooms are presented. On the basis of the design characteristics discussed in this chapter, exhibit 4-7 shows a possible layout of an ad-hoc "decision room" which focusses on application-domain support and integration in the organization.

60


personal computer

T public screen

□ printer

ll public screen

facilitator

□ table with

participants

II personal

□

□ □ Exhibit 4-7. Possible set up of an ad-hoc decision room.

The group session should be held in a normal company meeting room and not in a specially-designed sophisticated decision room. Hardware used can be two ordinary personal computers. These might be used by two analysts, for example. Such a simple set-up implies that for a group session, no special hardware is required. The only hardware specifically needed for this ad-hoc meeting room is two public screens, attached to the two personal computers. Various possibilities for such a public screen exist: a video gun, a liquid crystal display or a large monitor could be used. The two computers should be connected to a low-noise printer (like a laser printer) in order to provide hard copies when required. Besides the two computers other means like flip chart or white board can be used for intra-group communication. In comparison with a sophisticated decision room, this ad-hoc set up is very cheap.

4.5 Four aspects of developing group decision support systems

Developing group decision support systems should be guided by paying attention to the following four aspects: - problem specification, - decision-process structure, - roles of organizational members, - computerized support. The use of these four aspects can be regarded as the basic design guideline for the prescriptive conceptual model.

PROBLEM SPECIFICATION

Most decision-room sessions described in the literature start with problem specification during the group session itself, see for example Phillips [1986] and Vogel et al. [1988]. As explained in the previous section, we propose integration of the system in the

61


organization. The aim of our decision support system is to support decision making with regard to a specific problem domain, transfer pricing, inside as well as outside the group session. This requires that the system is designed for "a specific category of ill-structured problems". In order to be able to offer permanent support, a clear delimitation of the problem is required. Without a problem specification, for example, it is unknown which databases and "what-if' tools are required. Aspects of the problem specification that are relevant are: - time perspective (long or short term), - level of decision making (strategic level, administrative level), - kind of decision (operational, relocation or financing), - categories of possible solutions (like transfer prices or cost transfers) A clear problem specification requires an important deal of application-domain knowledge. So a clear problem specification is not only a prerequisite for the system, it is a part of the support as it forms the basis for a structured approach to decision making. Or as Larichev [1983] puts it: "It is an art to set a problem correctly 'in a solvable manner"1. Application-domain knowledge is conveyed to the user by means of the problem specification. Structuring the decision process is facilitated by offering a clear problem specification. In this sense, the problem specification and the decision-process structure are related.

Although a problem specification aids the participants in finding alternative solutions, the quality and quantity of the solutions that are generated remains dependent upon the creativity of the participants.

DECISION-PROCESS STRUCTURE

As described in section 4.2, structuring of problem-solving tasks is a vital element in providing decision support, see also Van Schaik [1987]. The basic structure that we propose for problem-solving tasks is the following: 1. scan, 2. decision making, 3. authorization, 4. implementation. For the decision-making task we propose the following task structure: 1. preparatory design, 2. integrative design, 3. choice.

For the description of these tasks, we use the technique as developed by Bots and Sol [1987]. For the structuring of the choice task, we use a multi-criteria technique. The execution of the decision-making tasks in this structure take place both inside as well as outside the group session. As the definition states, the support system focusses on the support of the decision-making task only, see the previous section.

The tasks presented above constitute a basic approach for structuring group decision processes at the administrative level. This approach needs to be adapted to each

62

Sec. 4.5 FOUR ASPECTS' OF DEVELOPING GROUP DECISION SUPPORT

specific decision situation. The decision-process structure should facilitate decision making on both the aggregate and disaggregate level.

ROLES OF ORGANIZATIONAL MEMBERS

In the previous section, we have already discussed the roles of the support staff. We consider the services of the support staff an integrated part of the prescriptive conceptual model, see also Phillips [1984]. A description of the role of the system users is also presented as this clarifies the aim and use of the system.

Participant role The decision makers involved are defined as "participants". As a group the participants make the decisions. We presume that all participants work together as a team in the best interests of the company. Team setting implies that the participants feel free to submit any item they consider relevant. In other words, in the selection of criteria, no normative elements are included. We presume that the participants do not pursue "hidden agendas" and do not play "hyper games". Each participant possesses unique knowledge which is of importance for the decision. "Expertise sharing" is the most appropriate description of the interaction amongst participants. Besides bringing in know-how, all participants should be involved in evaluating alternatives during a group session. The decision support system is designed for their use. System design should be such that the system can be used by participants at any time, both inside and outside the group session.

Authorizer role The authorizer is one of the participants and performs all participant activities that are required. Besides this he has three additional tasks. Firstly he is official chairman of the meeting. This implies that he can aid and correct the facilitator when necessary. The facilitator is mainly concerned with the decision process. In those cases in which no common consent by the group is reached, it is the authorizer who cuts the Gordian knot. The second role of the authorizer is that he authorizes the final decisions made by the group, if he is allowed to do so. In cases in which higher organizational levels need to be involved, the authorizer submits the decision for authorization. The third task of the authorizer is to start the decision process. This is shown by the first coordinating decision in exhibit 4-1.

Facilitator role The facilitator's main task is to structure the decision process, both inside as well as outside the group session. The facilitator is explicitly a member of the support staff. He should be independent from the group. He is not and cannot be a participant as he might otherwise mix up the two responsibihties: that of facilitator and that of participant. Another facilitator task is to be an intermediary between the participants and the analysts, when necessary. He should know when the various software modules can be used. A third task for the facilitator is to stimulate an informal, problem-focussed atmosphere within the group, both inside and outside the group session.

63


Analyst role The analyst operates the computer both inside and outside the group session. The analyst should also be able to adapt the software when requested by the participants. During the preparatory-design task, the analyst is actively involved in assisting the participants.

COMPUTERIZED SUPPORT

As Van Schaik [1988] demonstrated, computer support alone does not guarantee better decisions. In combination with the three aspects defined earlier, however, we consider fast "what-if' tools, databases and a computerized multi-criteria technique extremely useful. As decision support is only used when needed, we should guarantee a minimal frequency of use in order to avoid disuse of the system. Therefore, an easy to use software tool should be used as a "decision support system generator", see Sprague and Carlson [1982]. This generator can be used for other applications as well. No fixed links between the various modules exists. The decision-process structure provides guidelines for software use but ultimately the user decides upon the way the various modules interact.

With regard to the development of group decision support systems, Von Winterfeldt [1983] comments that participants, not being experts in decision analysis, do not want "overly complex modeling [or] too extensive use of incomprehensible or inaccessible machinery". Phillips [1985] described the necessary characteristic of the software as "simple but not simplistic". Little [1971, p. 483] puts it as follows: "...The biggest bottleneck in the managerial use of models is not their development but getting them used. I claim that the model builder should try to design his models to be given away."

4.6 Conclusion

In this chapter, we developed possible design characteristics of decision support systems for small face-to-face groups. In summary, the main design characteristics are:

- Our group decision support system can be described by means of the following four aspects: problem specification, decision-process structuring, roles of organizational members and computerized support. Decision support is considered to be much more than computerized support alone.

- Our system is designed to aid participants cooperating in small expertise-sharing groups. A specific "application domain" is the focus of attention and the support can be used both inside as well as outside group sessions. In other words, individual use is supported.

- The decision-making task and not the entire problem-solving task is supported. During the choice task, a multi-criteria technique is used.

- For group sessions, an ad-hoc decision room is set up. The "simple and sufficient" approach which is followed in the selection of the hardware is followed in the other

64

Sec. 4.6 CONCLUSION

areas of the design as well. Participants are not forced to operate the computer themselves, neither inside nor outside the group sessions.

- Frequency of use of the computerized support should be guaranteed by means of the use of a facile decision support system generator.

Aiming at improving decision making, we would like to describe our approach to group decision support as simple and sufficient. In this phrase, "simple" is the opposite of "complex". "Sufficient" is the opposite of "perfect" in the sense that a better decision process, and not perfection is the aim of the prescriptive conceptual model, see also Keen and Scott Morton [1978, p. 74].

65


66

5

TRANSFER PRICING AT EUROPHAR: THE PROBLEM

5.1 Introduction

In the previous four chapters, we provided a theoretical background for our research. In the remaining part of the book implementation and experimental use of a group decision support system are the focus of attention.

As explained in chapter 1, we decided to cooperate with one of the large, innovative, European-based, pharmaceutical companies for the period of five years. Analysis and experimental use of the system took place at this company. At the request of the company, figures, names, and some minor details have been changed. In this chapter we concentrate on the description of an existing situation within this particular pharmaceutical company. The name of the company we cooperated with is "Europhar International BV". Below the decision process at Europhar International BV (abbreviated as "Europhar Int BV" ór "Europhar Int") is described.

The five years of longitudinal research which took place at Europhar Int are indicated as "Year 1" to "Year 5". In the period Year 1-Year 2 the author worked as a financial analyst in the fiscal & financial department of Europhar Int BV. One of his responsibilities was to analyze the financing effects of transfer-price decisions. It will be clear that this part of the author's job contributed to the insight in the decision process before the introduction of the system that we designed. It also contributed to the choice of Europhar Int BV as the experimental company.

The sheer size and complexity of the transfer-pricing problem requires that a detailed description of the existing situation and the implementation of the experimental system are to be limited to transfers between the parent company and one subsidiary company only. The subsidiary that is chosen is Europhar UK Ltd which is situated in London.

One of the reasons for this choice is that, with regard to the financing situation of this subsidiary, the same people are involved in decision making since Year 1. The eight people involved are the two top managers who are ultimately responsible, and the six participants. It is our impression that it is rather unique to have a group of eight organizational members in a dynamic organization like a multinational company who have worked in the same positions on the same problems for five years. This offers the possibility for a better comparison of the situation "before" and "after" introduction. Another reason for the choice of the British subsidiary of Europhar is the nonexistence of language, time and distance problems. The main reason however, is the following:

Within Europhar, problems exist with regard to the British situation for a number of years. As explained in chapter 2, the situation with regard to the United Kingdom (UK) is difficult for many companies, not only for Europhar. But for Europhar, however, the situation is even more complicated because of the rather intricate

67

TRANSFER PRICING AT EUROPHAR: THE PROBLEM Ch. 5

relationship with the various source and destination companies. It is the opinion of top management that if the experimental system can aid decision makers in the UK case, then, as far as Europhar is concerned, it has proved its feasibility. For a good insight in the research project, we now describe the organizational set up.

In the beginning of Year 3, the start of the project is authorized by means of an agreement between Europhar and the research institutions involved. A joint steering committee is formed. In this joint steering committee, the following people participate: - Prof. Dr. H.G. Sol, Delft University of Technology, chairman, - Mr. R. Marcus, financial' director, Europhar Int BV, - Mr. D. Pieterse, head information management department, Europhar Int BV, - Mr. F. Terwolde, head price coordination department, Europhar Int BV, - Dr. H.C. Verlage, transfer-pricing expert. For an organizational chart of Europhar and its holding company Eurochem, see exhibit 5-1. The six progress meetings of this committee take place in June Year 3, November Year 3, July Year 4, December Year 4, March Year 5 and June Year 5.

For system design, a working group is formed. In this working group, the following people participate: - Mr. H. Berkers, head fiscal & financial department, Europhar Int BV, - Mr. N. Katwijk, manager European region, Europhar Int BV, - Mr. K. Nijboer, staff member, fiscal & financial department, Europhar Int BV, - Mr. F. Terwolde, see above, - the author. On ad-hoc basis, T. Derecks, financial controller of Europhar UK Ltd and J. Oostbeek, staff member of the fiscal & financial department of Eurochem Holding NV participate in working-group meetings. Working group meetings take place about once every fortnight during the whole of Year 4. Regularly, discussion drafts of the software, as developed by the author, are presented at these meetings.

After the design, development of the experimental system is done by Derecks, Nijboer and the author. This takes place in the period January-March Year 5. Various students from Delft University of Technology, two programmers from a software house and two software experts from Europhar assist in the development activities.

The time table for the research project appears as follows: - Year 1-Year 2 (two years): same participants and top management, no transfer-

pricing support system. Until the end of Year 2, the author is Europhar employee. - Year 3-Year 4 (two years): same participants and top management, analysis of the

existing situation, design of the system. - January-March Year 5 (3 months): same participants and top management,

development of the system. - April-September Year 5 (6 months): same participants and top management,

experimental system use. - October Year 5 (1 month): same participants and top management, evaluation of

system use.

68

Sec. 5.2 EUROPHAR: THE COMPANY

5.2 Europhar: the company

We start with the description of the Eurochem group. Then the two divisions which are relevant for our research (Europhar and Eurobitec) are described. We also describe Europhar's financial management information system and its information-system policy.

THE EUROCHEM GROUP OF COMPANIES

Eurochem is the overall holding company of all group companies and divisions. The Eurochem (EUROpean CHEMical) group is a multinational chemical company of Dutch origin. Its turnover in Year 5 is about NLG 25 billion. Eurochem Holding shares are traded on the Amsterdam stock exchange and other main financial centers all over the world. The Eurochem head office is situated in Rotterdam, the Netherlands.

Eurochem produces various kinds of chemical products such as plastics, fibers and human-ethical drugs. Special divisions exist for these mam classes of products. Each division has its own profit responsibility. All Eurochem activities are as much decentralized as possible. This is necessary, because of the variety of markets serviced and the great differences in products sold. So each division is responsible for and carries out its own research, production and marketing activities.

Centralized activities relate to strategic policy, personnel management, management development and finance and administration. Finance and administration, among others, sets detailed guidelines for the financial MIS (management information system) and consolidation of figures for external reporting purposes. Monthly reporting of the complete profit and loss account, balance sheet and source and application of funds per division is required at the Eurochem head office within twelve working days after the end of the month. To make this possible, figures from the local subsidiary companies have to arrive at the divisional head office within ten working days after the end of the month. Two working days are used for divisional consolidation of these figures before they are sent to Eurochem Holding.

There is a separate fiscal unit in most countries in which Eurochem daughters are situated. All Eurochem daughters from all divisions in, for example the UK, form one fiscal unit. A similar fiscal unit exists in the Netherlands.

The information-system policy for the finance and administration area is a completely centralized activity. Within all divisions Comshare's System W modeling and database software is used for MIS and external reporting activities. For quick ad-hoc financial modeling, Lotus 1-2-3 spreadsheets are used throughout the company. For word processing, however, no standards exist within Eurochem. The hardware standard for personal computers is IBM. Standard operating system for these computers is MS-DOS.

69


Decentralized fiscal and financial activities are coordinated by the central fiscal & financial department of the group. This Eurochem headquarter department cooperates closely with the fiscal & financial departments within each division.

THE EUROBITEC DIVISION

Eurobitec (EUROptan BIoTEChnology) is a newly established division of Eurochem. It's operations started in Year 1. All biotechnological products are produced at Eurobitec. Although Eurobitec is still small, it is growing fast. Turnover in Year 5 is about 500 million Dutch guilders (NLG 500 mln). One subsidiary company of Eurobitec International BV is located in Oxford (Eurobitec UK Ltd). This company has its own production facilities. Biosulfine is one the main products that is manufactured at the Oxford production plant. The marketing of Biosulfine under the name of Sofanaat is done by Europhar, the pharmaceutical division of Eurochem. The price of Biosulfine (or Sofanaat) influences the profit for both Europhar and Eurobitec. As both divisions have their own profit responsibility, see chapter 3, inter-divisional transfer prices may be subject of dispute between the two divisions. Transfer pricing between Europhar and Eurobitec should be categorized as "management-control transfer pricing". Because of this some tension exists between Eurobitec and Europhar, see chapter 3.

THE EUROPHAR DIVISION

The pharmaceutical division is called Europhar (EUROpean P/£4i?maceutical). Europhar has over fifty daughter companies in countries all over the world, see the description of a typical pharmaceutical company in chapter 2. Europhar's marketing activities are divided into five regions. Only two of them are important in view of our research project: Europe and Far East. Europhar's turnover in Year 5 is about NLG 3 billion. The head office of Europhar is situated in Amsterdam, Netherlands where the main production facility and research center are located. Some new laboratories have been built to comply with "good laboratory practice" regulations. Of course, these laboratories cause an extra need for liquidity.

As explained in chapter 3, budgets and consoUdated profit measurement are used for planning and control purposes. This requires extensive budgeting procedures. The budget comprises sales in units per destination per article, expected prices, detailed cost breakdown, detailed opening balance sheet, detailed closing balance sheet and a source and application of funds. Each autumn, regional management and the general manager of the local company make a budget proposal for the coming calendar year. This usually takes a number of meetings. Discussions during these meetings may be tough. Once the budget figures are determined, however, they are accepted within the complete Europhar organization. This holds also for exchange rates and other external financial parameters that are included. Budgets are only made for one year. In the final determination of budget figures, the financial director and the marketing director are involved. The expected external financial parameters, like exchange and interest rates, are determined by the Eurochem fiscal & financial department.

70


Europhar UK Ltd in London is one of Europhar's subsidiary companies. Europhar UK Ltd buys from both Europhar Int BV (the Dutch parent company) and Eurobitec UK Ltd (mainly Biosulfine) and it sells mainly to British National Health Service (NHS), but to Europhar Australia and Taiwan as well. Europhar UK exports to non-group customers and, in total, sales are approximately 50 million British pounds sterling (GBP 50 mln) in Year 5.

With regard to the UK, all other European countries are treated as reference countries. One of the main products of Europhar is Biosulfme/Sofanaat (produced by Eurobitec). Because Biosulfine is a new product, extra promotional costs to market this drug are allowed by the NHS authorities.

EUR0CHEM HOLDING NV (Rotterdam)

executive board fiscal & financial

department ■— [Oostbeek]

other

financial director [Marcus]

price coordination department [Terwolde]

information management department [Pieterse] [France»]

fiscal & financial department [Berkers] [Nijboer]

other

Europhar Int BV (Amsterdam)

board of directors

Eurobitec Int BV (Rotterdam) I board of directors

-other | Eurobitec UK Ltd |

marketing director (Oxford) other [Gisbers]

other European region

regional manager [Katwijk]

Far East region

regional manager

other

Europhar Australia Pty Ltd

Europhar UK Ltd (London)

I general manager

[0'Brian]

financial controller [Derecks]

marketing manager

other

other

Europhar Taiwan Ltd

Europhar Belgium NV Europhar France SARL Europhar Germany GmbH Europhar Italy SRL Europhar Netherlands BV Europhar Sweden AB Europhar Switzerland GmbH

Exhibit 5-1. Organizational scheme of the Eurochem group.

71


The organizational structure of Eurochem, as far as relevant for our case, is displayed in exhibit 5-1. The links between the various companies express 100% ownership. The dotted line between the two fiscal & financial departments indicates a functional relationship. Names of the people involved are indicated by square brackets.

The group of decision makers with regard to financing of Europhar UK Ltd consists of the following organizational members: - Berkers, head fiscal & financial department Europhar Int BV, Amsterdam, - Derecks, financial controller Europhar UK Ltd, London, - Katwijk, regional manager Europe (authorizer of the decision process), - O'Brian, general manager Europhar UK Ltd, London, - Oostbeek, fiscal & financial department, Eurochem Holding NV, Rotterdam, - Terwolde, head price coordination department Europhar Int BV, Amsterdam. This group is supported by Nijboer who is staff member of the fiscal & financial department of Europhar Int BV, Amsterdam. Nijboer takes the role of analyst. When Katwijk is not allowed to authorize certain decisions, normally the involvement of the Europhar directors Gisbers and Marcus is sufficient. In exceptional cases (for example in case of a capital increase, see chapter 3), the involvement of the Eurochem executive board is required. The six participants and two top managers mentioned above are working in their current position since Year 1 or earlier.

We are now able to discuss the companies and their relations within the Europhar case. In chapter 3, we displayed a conceptual framework to categorize different kinds of companies that exist. Now, we fill in the Europhar companies for those definitions. We distinguish the following classes of companies: - object company:

- Europhar UK Ltd, London. - source companies:

- Europhar Int BV, Amsterdam, - Eurobitec UK Ltd, Oxford.

- destination companies: - Europhar Australia Pty Ltd, Sidney, - Europhar Taiwan Ltd, Taipei.

- destinations third: - Generic sales (UK), - NHS human-ethical sales (UK), - Export third parties China, - Export third parties Nigeria.

- reference companies: - Europhar Belgium NV, Brussels, - Europhar France SARL, Paris, - Europhar Germany GmbH, Munich, - Europhar Italy SRL, Milan, - Europhar Netherlands BV, Utrecht, - Europhar Sweden AB, Stockholm, - Europhar Switzerland GmbH, Basel.

72


In chapter 3, we explained the relationship between these different kinds of companies. Filling in the names of the Eurochem companies gives a scheme like exhibit 5-2.

Eurobitec UK Ltd

Europhar Int BV

transfer of source article (transfer price)

reference article (reference price)

external sale of destination article

(external selling price)

export third parties China export third parties Nigeria generic sales (UK) NHS human-ethical sales (UK)

destination

Europhar UK Ltd

internal sale of destination article

(internal selling price)

Europhar Australia Pty Ltd Europhar Taiwan Ltd

Europhar Belgium NV Europhar France SARL Europhar Germany GmbH Europhar Italy SRL Europhar Netherlands BV Europhar Sweden AB Europhar Switzerland GmbH

Exhibit 5-2. Relationships of object company Europhar UK Ltd.

5.3 Decision process before system introduction

In Year 1 and Year 2, before the start of our research project, the first attempts are made to come to a systematic approach with regard to financing and transfer pricing. It is felt that the transfer-price policy is too much based on ad-hoc decisions and that a consistent policy for the short term (the budget year) is lacking. Long-term commercial, fiscal and financing policy is relatively well worked out, but the translation of the long-term policy into a short-term financing and transfer-price policy is lacking. In view of external pressure from mainly fiscal and health-care authorities such a policy is required. The initiative to improve the situation is taken by marketing director Gisbers. A small working group is formed. The following people participate in this working group: - Berkers, head fiscal & financial department, Europhar Int BV, - Oostbeek, fiscal & financial department, Eurochem holding NV, - Terwolde, head price coordination, Europhar Int BV,

73


- the author, at that time working at the fiscal & financial department of Europhar Int BV.

The set up of this working group is rather informal. The main aim is twofold: firstly to interpret the long-term fiscal and commercial policy and translate the Europhar policy into practical guidelines to determine transfer prices and secondly to set up computerized support to aid decision makers.

With regard to the first aim, the long-term transfer-pricing policy is translated in a gross margin of the local company on a sales-minus basis. Let us say that an overall local gross margin of 45% is considered to be the long-term aim. In case of changes which disturb this gross margin, transfer prices might be reviewed to bring the gross margin back on target. Signals of a changing gross margin are picked up by the Europhar fiscal & financial department . from the monthly MIS reports. The computerized support that is set up by the working group provides an overview of the current situation on the basis of MIS profit and loss figures over the past three years. The package used is Lotus 1-2-3. Specific details concerning the financing situation and regulations are entered in text mode, in the same Lotus file.

In January Year 3, the research project starts with an analysis of the existing situation in order to construct a descriptive empirical model. As the interviews with the participants do not reveal much more than that "the situation is very complex" and that "everything relates to everything", it is decided that the analysis of the existing situation will concentrate on the situation with regard to one local company: Europhar UK Ltd (Europhar UK Ltd is sometimes referred to as "London". Europhar Int BV is sometimes referred to as "Amsterdam").

All documents with regard to London from the beginning of Year 2 onwards are closely examined. These documents include telex messages between Amsterdam and London, internal memos (memo is an abbreviation for "memorandum"), internal reports, minutes of meetings in Amsterdam as well as in London, correspondence with the NHS, fiscal authorities and external consultants.

The analysis of the documents reveals the decisions that are taken, but not the decision process itself. It again makes clear that "everything relates to everything". As this approach does not reveal much of the way decisions are taken, the meetings during which transfer-price and financing decisions concerning the UK and other companies are made, are analyzed. As explained in the previous section, we now concentrate on the UK situation. One of the meetings concerning the UK is video taped. In this meeting which takes place on July 14th Year 4, Katwijk, Terwolde and Derecks participate. The meeting takes three hours.

The problem at hand is a liquidity surplus that comes up due to the unexpected success of Biosulfine. The budget for Year 4 is made in the autumn of Year 3. Biosulfine is launched in January Year 4. Biosulfine sales are above budget which results in a an expected extra gross margin of about GBP 1.4 mln for Year 4. The expected liquidity surplus is also GBP 1.4 mln. In Year 4, new research laboratories

74

Sec. 5.3 DECISION PROCESS BEFORE SYSTEM INTRODUCTION

are planned to be built in Amsterdam. This is one of the reasons why a transfer of funds to Amsterdam needs to be considered.

The MIS figures for May Year 4 indicate clearly the liquidity surplus. Problems are for the first time discussed in June Year 4. As regional manager Katwijk is heavily involved in solving problems concerning the marketing approach for Briconcyl, one of the Europhar products, he decides that decision making should be postponed to July. Organizational members involved are Berkers, Terwolde, Derecks, Katwijk, Oostbeek and O'Brian. Katwijk asks financial controller Derecks to prepare figures for the meeting that will take place in July. Analyst Nijboer works out a consolidated profit statement per article.

Katwijk, Derecks, price coordinator Terwolde and analyst Nijboer participate in the meeting. O'Brian and Berkers are on holiday and Oostbeek is tied up with fiscal problems of another division. The agenda for the meeting is as follows: 1. discussion of input papers, 2. conclusion with regard to commercial and fiscal aspects, 3. action steps.

In chapter 4 we stressed the importance of an informal, task-oriented attitude within the group. The atmosphere during this meeting is also task oriented, informal and open. Relief of tension takes place by means of a relaxed and humorous yet businesslike approach.

The meeting is chaired by regional manager Katwijk. As input the following papers are served: - Revised profit and loss budget figures, as estimated by financial controller Derecks,

for Year 4. Per month detailed figures are provided and not only a statement of annual figures. Comments on the estimated results, as made by Derecks, are included.

- Estimated NHS-profit calculation for Year 4, provided by Derecks. - Summary of the expected source and application of funds, expected balance sheet

and expected profit and loss account for the years Year 5-Year 9. Exchange rates, sales developments, etc. are based upon Derecks' personal expectations.

- Correspondence with the various authorities, internal memos, etc.

Total number of input pages is 42. These 42 pages are provided as loose sheets of paper in different sizes without clear headings. Most reports are computer printouts of Lotus 1-2-3. Each participant of the meeting has a copy of these 42 pages. Input papers are sent to the participants a few days in advance of the meeting.

Besides the items mentioned above, analyst Nijboer has brought with him detailed information on sales in units, selling prices, transfer prices, local added value and consolidated financial contribution per article. This information consists also of computer printouts produced by means of Lotus 1-2-3. The number of pages is about 30. Analyst Nijboer is in possession of the only copy available during the meeting.

75


Now the first part of this meeting is discussed: Katwijk opens the meeting and sets the agenda. Discussion of the input papers is the first item. Derecks proposes not to transfer all the surplus to Amsterdam, but to use GBP 240,000 in order to set up a marketing conference for the general practitioners in Britain. This conference was already planned a long time ago. The plans have been discussed with O'Brian before Derecks left London for the meeting.

Katwijk proposes to increase royalties. For eight years Europhar UK Ltd has been paying a lump-sum royalty payment to Amsterdam. Sales have increased significantly in that period. Also inflation has occurred. Therefore it would be reasonable to ask a larger contribution from London. This could also be considered to be at arm's length (see chapter 3). Current royalties are NLG 11 mln annually. Katwijk proposes to change the annual royalty payment to GBP 4 mln. Using an exchange rate of 3.30 NLG/GBP, the original amount of NLG 11 mln is GBP 3,330,000 so a royalty payment of GBP 4 mln would be an increase of GBP 670,000. According to Katwijk, the change in currency is an advantage for London. The consequences of exchange rate fluctuations do no longer have an impact on the Europhar UK figures, as Amsterdam now takes the complete exchange risk, explains Katwijk.

Terwolde puts forward, that as royalty is a lump-sum payment, it needs to be allocated for NHS purposes. Allocation is currently done on the basis of sales. According to Terwolde, it would also be reasonable to allocate on the basis of cost of goods (cost of goods equals the transfer price plus the local added value). By means of some calculations, using a pocket calculator and a piece of paper, Derecks determines that an allocation on the basis of cost of goods would not make too much difference. The exact calculations are not shared with the group, but the conclusion is accepted.

A second option, proposed by Terwolde, is a cost transfer of transportation cost from Amsterdam to London. As part of a Europhar Int contract with "Channel Transport Company", a part of the Europhar UK transportation costs are borne by Amsterdam. The distribution for the south part of the UK is cared for by "Channel Transport". This is a part of an experimental contract for the entire Eurochem group. It would be reasonable to transfer these cost, which are now paid by Amsterdam, to London. Given budget sales for Year 4, these costs would be GBP 200,000, according to Terwolde. Katwijk, however, does not agree. Biosulfine, the product that causes the liquidity surplus, is not the only product that deviates from budget. Katwijk expects also higher Colcipar sales as he recently has spoken to one of the marketing people of London. As sales of Colcipar are up, extra transportation cost should be expected. This is because of the requirement that Colcipar ampules should be stored at low temperatures during transportation. On a piece of paper the estimated impact of extra Colcipar sales on transportation costs is calculated. These are GBP 50,000.

This meeting continues in a similar manner. For a detailed account, see Van der Ven [1989b]. At the end of the meeting it is decided that the total amount of the liquidity surplus will be spent as presented in exhibit 5-3.

76

Sec. 5.3 DECISION PROCESS BEFORE SYSTEM INTRODUCTION

royalty increase: GBP 670,000 marketing conference.' GBP 240,000 transportation cost: GBP 200,000 transportation Colcipar: GBP 50,000 Retravir transfer price increase: GBP 240,000 total: GBP 1.4 mln

Exhibit 5-3. Summary of financing alternatives decided upon at the end of the meeting in July Year 4.

Katwijk thanks all participants and closes the meeting.

After the meeting Derecks flies back to London and discusses the options with general manager O'Brian. O'Brian agrees on all points. When working out the transportation cost option, however, Derecks notes that a calculation mistake has been made during the meeting in July. Colcipar transportation cost are GBP 140,000 instead of the calculated GBP 50,000. This is communicated to Katwijk and Terwolde by means of telex. They agree with a new total transfer for transportation cost of GBP 340,000 (GBP 200,000 + GBP 140,000) instead of the expected GBP 250,000 (GBP 200,000 + GBP 50,000). Katwijk authorizes the transfer of transportation cost and the transfer-price increase for Retravir. This is done by means of an internal memorandum.

In August, marketing director Gisbers is informed by Katwijk about the plans to hold the marketing conference and to transfer the remaining amount to Amsterdam. As Gisbers does not agree with the marketing conference, this option is disregarded. He proposes that the entire amount will be transferred to Amsterdam. So additional means to transfer funds need to be found. Gisbers authorizes the creation of a new royalty contract by means of an internal memorandum.

In the meantime, the actual MIS figures of July show that the expected liquidity surplus by the end of the year will be GBP 1.5 mln instead of GBP 1.4 mln.

In August, Katwijk and Terwolde decide to increase the transfer price of Ogmentin from NLG 112,-- per unit to NLG 148,- per unit. This will result, according to budget Year 4, in an extra transfer of GBP 250,000. This is the amount that is needed. For the new picture, see exhibit 5-4.

77


royalty increase: GBP 670,000 transportation cost: GBP 200,000 transportation Colcipar: GBP 140,000 Retravir transfer-price increase: GBP 240,000 Ogmentin transfer-price increase: GBP 250,000 total: GBP 1.5 mln

Exhibit 5-4. Summary of financing alternatives decided upon in August Year 4.

Terwolde informs Oostbeek by telephone about the decisions made. Oostbeek does not object against any of the measures that are proposed. This especially as the entire liquidity surplus is transferred to the Netherlands. Oostbeek considers this a good thing in view of the demands made by the Dutch fiscal authorities. Berkers is informed by Terwolde and does not object. So Katwijk authorizes the transfer-price increase for Ogmentin in his role of regional manager. The end of August, financial director Marcus authorizes the transportation-cost transfer by means of an internal memorandum.

The decision process of which some parts are described above will be used for construction of the descriptive empirical model.

5.4 Descriptive empirical model

To describe the decision situation we use the four aspects for describing decision situations as presented in chapter 4: problem specification, decision-process structure, roles of organizational members and computerized support. The descriptive empirical model as presented in this section is based upon a systematic analysis of the entire meeting which took place on July 14th Year 4, see Van der Ven [1989b]. In the previous section, a part of this meeting has been described.


The problem at hand is a liquidity surplus. Not only financing alternatives are considered during the meeting. Besides the four categories of financing alternatives (dividend payment, cost transfer, royalty increase and transfer-price increase), operational and relocation alternatives are also discussed. The operational alternatives discussed are: the marketing congress for general practitioners and the withdrawal of Prefanid and Apticram from the market. The relocation alternative discussed is: the transfer of the packing activities for Cotergenine to Amsterdam.

Two different time perspectives are considered simultaneously. The Year 4 situation is discussed on the basis of budget figures. When this is considered relevant, figures are adapted during the meeting. Long-term plans are merely based upon the expectations of the individual that makes up the figures, in our case Derecks. During

78

Sec. 5.4 DESCRIPTIVE EMPIRICAL MODEL

the meeting, two time perspectives (budget year and long term) are considered simultaneously. No distinction is made between the relatively "hard" budget figures and the much "softer" long-term expectations.

Not all eight categories of financing alternatives, as discussed in chapter 3, are considered. The four options that are not discussed during this round of decision making are: local lending, internal selling-price decrease, current account change, intracompany loan. It does not become clear why these alternatives are not considered.

The meeting does show that transfer-price problems are closely linked with other financing alternatives. It also becomes clear that fiscal, commercial and financing problems are considered simultaneously.


Not all decision makers are directly involved in the decision process. Instead, decisions are made in subgroups and by means of the use of telecommunications (telex, telephone and telefax). The meeting that we partially described above is a subgroup meeting. Some decision makers are put into a position similar to the position of the higher management levels that finally authorize the decision. Their only contribution is their "yes" or "no" with regard to the solution proposed. Their expertise is not used in the decision process itself. This is illustrated in the analysis of the dividend alternative, see Van der Ven [1989b]. No single argument pro or contra is provided. Merely the opinion of Oostbeek is put forward. Just before the final decisions, not concerning dividend, are authorized, the opinion of Oostbeek is asked.

No clear distinction is made between the aggregate and the disaggregate-level aspects of the problem. This is illustrated as only a transfer-price increase of Retravir is considered. On an ad-hoc basis, a lot of information at disaggregate level is provided by analyst Nijboer, but this information is not accessible for the participants, and therefore it is not used. In total this happens four times. After the meeting, when marketing director Gisbers objects to holding the marketing conference, Katwijk and Terwolde decide to increase the transfer price for Ogmentin. This decision is taken without any systematic search at the disaggregate level.

When the decision process is analyzed, various actions can be discerned, both during the main meeting in July Year 4 and during the entire period of decision making (June-August Year 4). The frequency of relevant actions taking place during the meeting is presented in exhibit 5-5.

During the entire period (June-August Year 4), four times partial decision making (in subgroups) takes place.

The meeting is not very well-structured: nine times a change of subject takes place without a proper conclusion. This is realized by the participants. During three occasions, problems arise as the budget is not properly actualized. The use of computerized support is not very well organized. Two times, it takes the participants

79


a long time to find the relevant sheet amongst the 42 sheets of computer output. As the input papers are related to action steps and the approach vis-a-vis the authorities, the agenda for the meeting cannot be pursued. No structure is detected in the meeting, except that all items discussed relate in one way or another to financing problems. Excluding the break, the meeting takes three hours. No systematic analyses of all alternatives (on aggregate or disaggregate level) takes place. Systematic evaluation of possible options is lacking completely. When the participants get a transcript of the meeting, they feel uncomfortable about the lack of structure. One of the participants remarks that he "did not realize that it was that bad".

relevant actions with frequency information available but not shared with other participants considerable loss of time due to search for information number of times that participants are missing need for properly actualized budget information on alternatives lacking number of operational or relocation alternatives evaluated number of alternatives evaluated (at aggregate level) general complaints about the complexity of the issue disaggregation without systematic selection of articles quantitative insight in the consequences of actions impossible when needed sensitivity analyses with regard to external parameters impossible when needed no proper introduction or résumé when relevant change of subject without proper conclusion manual calculation error choice task mixed with the integrative-design task

Exhibit 5-5. Frequency distribution of actions taking place during the meeting of July Year 4.

A last point that we make is that the decision of August Year 4 to increase the Ogmentin price is a good example of a "partial" decision: only one alternative is considered and decided upon by a small subgroup (Terwolde and Katwijk).


Derecks does not defend a specific local interest in view of the transfers of funds under consideration. All participants who are involved, share their expertise in order to find the best solution available.

Katwijk takes the authorizer role and chairs the meeting. He initiates the decision process and authorizes the outcome of the meeting. In the case described above, no lasting disagreement between group members occurs. When this might happen, Katwijk takes the final decision. From analyses of other meetings and the interviews, we would like to put forward, however, that these cases are extremely rare.

Nijboer takes the role of analyst in the sense that he prepares the reports for the meeting.

80

Sec. 5.4 DESCRIPTIVE EMPIRICAL MODEL


Computer output is provided by Derecks and analyst Nijboer. Nijboer provides information on the financial contribution per article (disaggregate level, see chapter 2). Derecks provides information on the long-term expectancies for the Europhar UK situation.

Information is provided in the form of reports. Neither the layout, nor the contents of the reports are discussed in advance with the participants. The relevance of Nijboer's input is not properly understood by the participants and the discussion of Derecks long-term planning gets stuck as the participants do not agree on the premises. As no on-line computer faculties are available, it is impossible to perform "what-if" calculations during the meeting. Calculations are made by hand, which in the Colcipar case causes a substantial calculation error.

Layout of the reports is not explained to the participants before the meeting. This causes irritation and loss of time during the meeting itself.

5.5 Descriptive conceptual model

In this section, a descriptive conceptual model is presented. The aim of this model is to describe the basic pattern of this, and other decision situations concerning transfer pricing. The model is not only based upon the empirical model as presented in the previous section but it is also based upon other decision situations that we encountered at Europhar in the period Year 1-Year 3. These decision situations included both European and third-world countries. For the description of the conceptual model, we again use the four aspects as presented in chapter 4: problem specification, decision-process structuring, roles of organizational members and computerized support.


The problem specification is vague. The only thing that is clear is that a financing problem exists: This problem is defined as a liquidity surplus or a liquidity shortage. Management-control issues are not considered to be a part of the problem.

The myriad of problems addressed in the decision process includes the following aspects: - short and long-term consequences, - strategic and administrative-level decisions, - operational, relocation and financing alternatives, - various categories of financing alternatives. Financing, commercial and fiscal consequences are considered simultaneously.

81


i 1

no

"

scan

yes w

analyzing?

decision making

alternatives for which authorization at higher level is required

submission for

authorization at higher

level

formal agreement

by authorizer

-o-Ó determine authorization

level required

alternatives authorized?

yes alternatives for which authorizer involvement is sufficient

implementation


Exhibit 5-6. Structure of the problem-solving task in the descriptive conceptual model.

In chapter 3, we discerned eight categories of financing alternatives. All these eight categories are known and used in various decision situations. Not all eight categories of financing alternatives, however, are explicitly considered as possible solutions for one

82

Sec. 5.5 DESCRIPTIVE CONCEPTUAL MODEL

specific liquidity problem which requests a solution. Only the alternatives that come to mind are discussed.


Using the process structure for problem solving as described in chapter 4, we get the picture as presented in exhibit 5-6. The authorize task as presented in this exhibit differs from the authorize task as presented in the previous chapter. The authorize task is split into two different tasks. Within the decision-making group, one participant takes the role of authorizer. His involvement is shown by the task formal agreement by authorizer. It is possible that the authorizer's formal agreement is sufficient for implementation of the group decision. This depends upon the authorization regulations that exist within the company. In case a higher level within the organization needs to be involved, the authorizer asks permission for implementation at the higher level. This is shown by the coordinating decision determine authorization level required and the task submission for authorization at higher level. Note that in general, relocation and operational alternatives are also considered in the decision process and therefore also need to be authorized.

The environment is constantly scanned by all participants for signals which might require the start of the decision process. Whether the decision process will really be started depends on the importance of the other problems at hand and the time available. It might be that more urgent matters require the attention of the participants. In exhibit 5-7, the scan task is shown in more detail.

1

no

< ' global analysis of the

environment

} J changet

yes ,r policy required?

priority evaluation

path: problem solving \ scan

Exhibit 5-7. Structure of the scan task.

83


The global analysis of the environment is performed by all participants. On the basis of MIS-reporting, "hearsay" and any other possible information source, participants decide whether further analyses of the financing situation is desirable.

The decision makers determine whether changes in financing policy are required during the coordinating decision changes in financing policy required?. In case the difference between the expected commercial, fiscal figures and the desired figures is considered to be unacceptably high, priorities are evaluated.

Where the priority evaluation task needs to be performed, it is necessary to determine whether there is any other business which needs attention. Time available from both support staff and participants is considered. On the basis of this information the priority of the various projects is determined by the authorizer. The output of this task is the input of the coordinating decision problem worth analyzing?, see exhibit 5-6.

Decision making can explicitly be described as "negative selection": any solution that is acceptable for all participants is selected. A decision-process structure which stimulates generation of alternatives or a systematic choice amongst the available options, lacks completely. The decision-making task is performed by means of a negative selection process. Any solution that might contribute to solving the problem is decided upon under the condition that none of the participants opposes. The decision-making task, which is the focus of our attention, in shown in exhibit 5-8.

i

no

' '

propose partial solution

1 ' all participants?

path: problem solving \ decision making

Exhibit 5-8. Structure of the decision-making task in the descriptive conceptual model.

During the task propose partial solution, a solution is proposed. During the coordinating decision acceptable to all participants? is determined whether any participant objects. If not, the alternative is selected. The analysis does not disclose more detail of the decision-making task.

Only a very limited set of options is discussed. In chapter 4, the decision-making task was divided into preparatory design, integrative design and choice. Within the descriptive conceptual model, none of these tasks can be discerned. Activities which should constitute the preparatory design task, for example, are performed as a last

84

Sec. 5.5 DESCRIPTIVE CONCEPTUAL MODEL

check before the proposed solution is implemented. Integrative design and choice are lacking completely.

"Partial decision making" constitutes the decision-making task: a part of a problem is solved by one isolated solution and not considered in relation to other causes of financing problems or other solutions. Between the various partial decisions, a considerable amount of time elapses. Partial decision making is defined as the opposite of "integral decision making", see chapter 4. "Partial" is this respect can be interpreted in two ways: not all participants are involved in the decision process simultaneously and not all aspects of the problem are considered simultaneously.

Aggregation and disaggregation are not explicitly separated. Participants may put forward arguments on the aggregate and the disaggregate level simultaneously.


No management-control issues are addressed. The meeting is in line with our point of departure of team setting. The participants work together as a team in the best interest of the company. Expertise sharing is the dominant characteristic of the interaction between the participants. All participants are involved in selecting alternatives. The authorizer starts the decision process, chairs the meetings and authorizes the decisions made. Where he is not allowed to authorize the decisions made, he submits the decision for authorization at higher management levels. Support staff provides input in the form of computerized reports.


Computerized support is provided in the form of reports and not via the telephone during the meetings itself. These reports are made by means of ad-hoc modeling using two-dimensional spreadsheets. Layout and contents is not discussed in advance with the participants. "What-if" analysis during the meeting itself is impossible.

5.6 Conclusion

From the description of the descriptive conceptual model it is clear that the situation with regard to transfer pricing is unsatisfactory when compared to the guidelines as described in the previous chapter. This feeling of dissatisfaction is also encountered when discussing the situation with the organizational members involved.

Main points calling for improvement concern problem specification, decision-process structure and computerized support. Support should be provided for both inside as well as outside group sessions.

Except for the facilitator role, the roles of organizational members are already similar to those described in the previous chapter. The point of departure of group-decision making and team setting proves to be realistic.

85


A last point to make is that the problem-solving task described in this chapter is similar to the problem-solving task described in the previous chapter. In both cases the following four tasks are discerned: scan, decision making, authorization and implementation. In other words, as the design guidelines as presented in chapter 3 already match the existing situation, we do not see much room for improvement. This in contrast to the decision-making task.

The decision making-task described in this chapter lacks structure and is based upon negative selection. According to the design guidelines as presented in the previous chapter, however, decision making should constitute preparatory design, integrative design and choice. This implies that the decision-making task is an area that explicitly calls for improvement.

86

6

TRANSFER PRICING AT EUROPHAR: A SOLUTION

6.1 Introduction

In chapter 1 our research approach has been explained: when analyzing the existing situation (the descriptive models) we go from the empirical model to the conceptual model. In this chapter the prescriptive models are described.

In section 6.2, a prescriptive conceptual model is described. This model forms the answer on our first research question (A') defined in chapter 1:

What are the characteristics of the prescriptive conceptual model?

As explained in chapter 1, this model is based upon information on the pharmaceutical industry (chapter 2), transfer-pricing literature (chapter 3), group decision support literature (chapter 4) and the descriptive conceptual model (chapter 5). The concepts used in the current chapter are explained in these earlier parts of the book. Without these explanations, this chapter will be difficult to read.

Although the design of the descriptive conceptual model is based upon various decision situations, the existing situation has been described in detail for only one local company of the Europhar group. The implementation of the concept is done for the same local company: Europhar UK Ltd. The prescriptive empirical model is presented in section 6.3. Decision making on the basis of this model during a period of six months is presented in section 6.4.

6.2 Prescriptive conceptual model

In chapter 4 we defined four aspects to describe decision situations and group decision support systems: problem specification, decision-process structure, roles of organizational members and computerized support. These four aspects will now be used to describe our prescriptive models in this chapter. This in order to facilitate the comparison between the old and the new situation. The prescriptive conceptual model combines the "description" as presented in the previous chapter and the "design guidelines" as presented in chapter 4. For a better understanding of the prescriptive conceptual model, the areas of change are indicated in exhibit 6-1. It should be realized that the classification into one of the three categories is sometimes arbitrary. The main aim of exhibit 6-1 is to indicate the major difference between the prescriptive conceptual model and the descriptive conceptual model: the structure of the decision-making task.

87

TRANSFER PRICING AT EUROPHAR: A SOLUTION Ch. 6

the prescriptive conceptual model compared to the descriptive conceptual model problem specification distinction between liquidity shortage and liquidity surplus distinction between short and long term distinction between operational, relocation and financing problems explicit consideration of the eight categories of financing instruments decision-process structure scan task authorization task implementation task preparatory-design task: actualize and review integrative-design task: feasible-solution search / disaggregation choice task: preference ordering group session roles of organizational members authorizer role participant role analyst role facilitator role

computerized support accounting module (component 1) regulation database (component 1) preference-ordering module (component 2) financial-impact module (component 2) disaggregation module (component 3) reference database (component 3)

legend: -: no change c: change *: completely new

Exhibit 6-1. The prescriptive conceptual model compared to the descriptive conceptual model.


Once a financing problem arises, it needs to be defined as a liquidity-shortage or as a liquidity-surplus problem, see chapter 3. This is determined directly after the start of the decision process. With regard to this aspect, no difference with the old situation exists.

Although operational and relocation problems are of great importance to a company, they should be excluded from the financing-decision process, see chapter 3. Including operational and relocation aspects in the financing decision process creates a myriad of related problems, see the descriptive conceptual model. Decision making should take place in clear iterations. Firstly, it is determined what is going to happen in the operational and relocation area. Once that has been determined, the financing problems are reviewed.

It can happen that financing problems cannot be solved. This implies that a solution must be found in the operational or relocation area. The fact that these areas are related, however, does not imply that decision making should take place simultaneously. Among other things operational and relocation problems require other organizational

Sec. 6.2 PRESCRIPTIVE CONCEPTUAL MODEL

members to be involved. After feedback from the operational and relocation area, financing decision making takes place.

Related to the limitation of the problem to the financing area is the distinction of two time perspectives: short term and long term. Financing decisions should be made for the period for which a detailed forecast is available: the short term. These figures are usually available for the next one or two years. With regard to the long term, the setup of forecasts for financing problems alone is not a viable approach. The reason is that, in order to create reliable figures, many organizational members need to be involved, usually of a high organizational level. It is unrealistic to expect that the heavy procedures, which are necessary to produce these figures, will be set up in the organization, only to solve the problems in the financing area. In other words, financing decision making should take the "infrastructure" which already exists into account. If no general accepted forecasts exist for the long term, financing decision making should do without. This is not to say that the expectations of the participants should not be taken into account. But it should not be tried, for example, to perform sophisticated "what-if' analysis for the long term.

All eight categories of financing alternatives, (for instance transfer price, royalty, and current account, see chapter 3) should be considered explicitly. It will be clear that not all categories are relevant in each case, but none of the alternatives should be disregarded in advance. In other words, the preparatory-design task should include the analysis of all eight categories of financing instruments.

With regard to the criteria against which the alternatives should be judged, we follow the two points of departure as explained in chapter 4: all criteria are welcomed and a checklist of possible criteria is made in advance. That we welcome all criteria implies that no criteria will be considered unacceptable in advance: during the selecting of the criteria, any criterion can be brought up. The use of the checklist should avoid that some of the criteria are forgotten, see chapter 4.


Structuring the problem-solving task is the core of the prescriptive conceptual model. As explained in chapter 4, we use the following general process structure for problem solving: 1. scan task 2. decision-making task 3. authorization task 4. implementation task With regard to the structure of problem solving, see exhibit 6-2, the prescriptive conceptual model is similar to both the descriptive conceptual model as presented in the previous chapter and the design guidelines as presented in chapter 4. As the existing situation already matches the desired situation as included in the design guidelines, there is no need for change.

89


<j problem worth analyzing?

yes f

decision making

alternatives for which authorization at higher level is required

submission for

authorization at higher

level

determine ♦ solved I O-unsolved pare

problem part for which a solution is found

formal agreement

by authorizer

problem pare for which no solution is found

solution search in the operational

or relocation

area

V -o-

Ó determine authorization level required

alternatives authorized?

yes alternatives for which authorizer involvement is sufficient

implementation


Exhibit 6-2. Structure of the problem-solving task in the prescriptive conceptual model.

The scan task is identical to the situation as described in the previous chapter: the global analysis of the environment is performed by all participants. On the basis of MIS reporting, "hearsay" and other possible information sources, participants decide

90


whether further analysis of the financing situation is desirable. MIS reporting is one of the main sources of information as it provides profit and loss figures, balance sheet and the source and application of funds on a monthly basis.

If the problem is considered to be worth analyzing, the decision-making task is started. If there is no need to start this task, the scan process continues. With regard to the coordinating decision problem worth analyzing?, the situation is identical to the situation as described in the previous chapter. (For the explanation of the term "coordinating decision", see chapter 4.) The priority evaluation is the input for this decision.

It is important to note that the coordinating decision determine solved/unsolved part differs from the one described in the previous chapter. One of our design guidelines is that a distinction needs to be made between decision making with regard to the financing, relocation and operational area. For the unsolved part of the problem, by definition a solution needs to be found in the operational or relocation area. Other organizational members, usually of a higher hierarchial level, need to be involved. On the basis of the outcome of decision making in the operational and relocation area, a new iteration of financing decision making might be initiated via the scan task. Input and output of the task solution search in the operational or relocation area is the unsolved part of the financing problem, which consists of the target financing, commercial and fiscal figures in combination with expected figures (after implementation of the financing alternatives). Solutions which are found on the basis of this search may influence, in their turn, financing decisions via the scan process. As described in chapter 5, in the descriptive conceptual model, no explicit distinction was made between operational, relocation and financing decisions.

Note that, with regard to authorization and implementation procedures, (represented by three tasks and two coordinating decisions) the prescriptive conceptual model is similar to the descriptive conceptual model as presented in chapter 5 as the situation does not call for improvement.

The decision-making task is our focus of attention. In chapter 4, we discerned the following three tasks within decision making as our design guidelines: 1. preparatory-design task, 2. integrative-design task, 3. choice task. As explained in chapter 4, these three tasks do not yet describe the decide tasks in detail. They are merely the application of existing decision-process structures to group decision processes. Detail description depends on the class of problems at hand. We now apply this task structure to financing problems, see exhibit 6-3.

The main differences in process structure between the prescriptive and descriptive model takes place within the decision-making task. The reader will notice the big difference: in the descriptive model, as described in the previous chapter, the decision-making task is based upon "negative selection" whereas in exhibit 6-3 a distinct sequence of steps is shown. The explicit breakdown of the decision process in various steps brings structure to the "myriad of problems" as described in chapter 5.

91


preparatory design

actualize and

review

integrative design

(re)set financing commercial

and fiscal targets

target rese required but proved I

choice

to be impossible? no \

no

'

analyze and alter

*

feasible-solution search

<

yes ,

) prefer orderii requir

preference ordering

' '

budget recalculation

budget ' latives ( b *—

id?

i

budget I target and not all alternatives considered

budget # target and alternatives exhausted

# means: does not equal; path: problem solving \ decision making

Exhibit 6-3. Structure of the decision-making task in the prescriptive conceptual model.

92


In the preparatory-design task the review of financing alternatives and the actualization of budget figures takes place. Hence the name we choose for this task: actualize and review. We name the primary integrative-design task feasible-solution search as the main aim of this task is to determine the solutions that are feasible in view of the regulations that are issued by the various authorities. The main choice task is named preference ordering as the choice between the alternatives is based upon their order of preference. In theory, each task should be performed during each iteration of the decision process. As exhibit 6-3 shows, a new iteration takes place after the budget recalculation except in case the budget figures equal the target. In practice, however, tasks can be skipped when the outcome of an earlier iteration can still be applied.

During the actualize and review task the actualization of budget figures and a detailed review of all eight categories of financing alternatives takes place. The input of the actualize task is the existing budget. The output is the actualized budget, which can be regarded as a short term forecast. All participants are involved in the actualize task. Usually, this preparatory task is performed individually or in small groups. The participants from the marketing discipline, for instance, take care of determining the expected sales and the financing people within the group of participants review, for example, expected inventories and the credit side of the balance sheet. People from outside the group, like support staff, are usually involved.

When the actualization of the budget has been performed, all eight categories of financing alternatives, see chapter 3, come under review. Participants contact other organizational members and external consultants for relevant information. The fiscal expert, for instance, might contact the fiscal consultant to obtain necessary information with regard to the fiscal unit of which the object company is a part. If transfer-price changes of various source companies are to be considered, these source companies need to be contacted. The review of the alternatives "transfer-price change" or "internal selling-price change" takes place on both the aggregate and the disaggregate level. As explained in chapter 4, the number of alternatives generated during this task depends upon time available and the creativity of the participants. In summary, input of the review activity is any information from any possible source. Output is a piece of integrated and updated background information per reviewed alternative. This output serves as input for the group session.

The second task in exhibit 6-3 is the determination of the financing, commercial and fiscal targets. This task should take place during a group session. We define this first part of the integrative-design task as: (re)set financing, commercial and fiscal targets. Output of this task is the (adapted) financing, commercial and fiscal targets. Input is the actualized budget figures, the long term financing, fiscal and commercial policy, regulations and any other relevant consideration (like the position of other parts of the fiscal unit).

When a reset of targets is required because the targets cannot be reached by using the financing alternatives, it may be possible that a target reset is considered undesirable in view of the long term financial, commercial and fiscal policy. In this

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case, a solution needs to be found outside the financing area. This is described by the coordinating decision: target reset required but proved to be impossible?

The third task in exhibit 6-3 is feasible-solution search. Various iterations of this task take place. To start with, a part of the problem is focussed on. For this part of the problem, all categories of alternatives are considered. For each alternative, the maximal amount of funds that may be transferred is determined (the maximal remittance). Constraints are the long-term financial, commercial and fiscal company policy. Regulations on both aggregate and disaggregate level are interpreted. Depending on the specific problem at hand, it is determined which gross margin range is acceptable. On the disaggregate level, reference prices are considered. For all financing instruments under consideration, the limits are determined. In summary, input for this task is the targets, regulations, the budget, the reference prices and background information per alternative. Output of this task for each iteration is the total remittance which should be obtained and the maximal remittance per financing alternative.

We now turn to the various parts of the choice task. When all feasible options together provide more possibilities than are needed for the transfer of funds, preference ordering of these feasible solutions is required. This is indicated by the coordinating decision: preference ordering required?. If no preference ordering is required, the budget recalculation can take place directly.

During the preference-ordering task, all financing alternatives of the current iteration are considered simultaneously. Only one of the aspects that is considered in detail now, is the cost of the various alternatives on a consolidated basis (the "financial impact", see chapter 3). Once these costs have been determined, a choice is made by means of a multi-criteria technique. Criteria concerning the alternatives, on the basis of which a selection is made, can be taken from a criteria checklist, if available. Input for this task is the total remittance which should be obtained during the current iteration, the maximal remittance per alternative, regulations, financial parameters and the criteria checklist. Output of this task is the actual remittance per financing alternative for this iteration.

With the chosen alternatives included in the budget, the task budget recalculation is performed. This recalculation offers the possibility to determine interaction effects between the alternatives. The input of this task is the financing alternatives and the budget. The budget (after recalculation) is also the output.

In case the target has been reached, the decision-making task is finished. (As explained in chapter 4, in the representation technique that we use, this exit of a task is not indicated by an arrow.) In exhibit 6-3 this is shown by the coordinating decision analyze budget and alternatives. For a new iteration two possibilities exist: - The target has not been reached yet and not all reviewed alternatives are

considered. The next iteration starts with feasible-solution search concerning a new set of reviewed alternatives.

- The target is not reached and the feasible alternatives are already exhausted. In this case a reset of the targets is required.

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Before turning to the roles of the organizational members, two tasks are worked out in more detail: feasible-solution search and preference ordering.

select subset of

alternatives and set total

remittance

disaggregation

select alternative and determine

maximal remittance at aggregate

level

yes O transfer prices/ internal selling prices considered and and disaggregation still to be done F

all alternatives of Q subset considered?

yes X

summarize information on subset of alternatives

path: problem solving \ decision making \ feasible-solution search

Exhibit 6-4. Structure of the feasible-solution search task.

The feasible-solution search task, see exhibit 6-4, starts with the task select subset of alternatives and set total remittance. These alternatives focus on a part of the problem. It is possible to make a distinction between the financing instruments that have a direct impact on profit before interest and taxation (like transfer pricing and cost transfers) and the financing instruments that are mainly capital transfers (like a capital increase or a change in the current account position). Another possibility is to focus on one of the targets at the time. When financial problems are urgent (for instance in case of a large liquidity shortage), the group might start with solving the financing problem. In a second and third iteration, the group might then try to find compensation for undesired commercial and fiscal effect that may be caused by solving the financing problem. During the select subset of alternatives task, regulations and background

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information on the various financing alternatives are considered. This background information is gathered during the actualize and review task. Input for the select subset of alternatives task is background information on the alternatives of the subset, regulations and the financing, commercial and fiscal target. Output is the subset of alternatives and the total remittance for the subset. It will be clear that after the last iteration of decision making, the target variables as calculated during the budget recalculation should be equal to the target as determined during the task (re)set financing, commercial and fiscal targets.

Once the total remittance has been set, the task select alternative and determine maximal remittance at aggregate level is performed. For each alternative the maximal remittance (output) is determined on the basis of the following input: budget, regulations, background information per alternative and the targets. In case the answer on the coordinating decision transfer prices or internal selling prices considered and disaggregation still to be done? is "yes", the disaggregation task has to take place.

During the disaggregation task, the aggregate-level alternative, reference prices and regulations (input) are considered in order to translate the aggregate-level alternative into one or more price changes of individual articles (output). The aggregate and disaggregate level cannot be strictly separated. As is shown in exhibit 6-4, effects are considered on both the aggregate and the disaggregate level. In a systematic way the effect of price changes on (aggregate-level) financial, commercial and fiscal figures is determined. To obtain a desired aggregate-level effect, disaggregation takes place in a systematic way. As computerized support is indispensable to perform the disaggregation task, this subject is covered in more detail later on.

In case there is no need to perform the disaggregation task, or in case this task is already performed, the decision process continues with the coordinating decision all alternatives of the subset considered?. In case the answer is "no", the next alternative is taken. In case the answer is "yes", the task summarize information on subset of alternatives follows. During this small task, the maximal remittances per alternative of the subset (input) are summarized. The summarized information constitutes the output. During the feasible-solution task, all participants are involved in group discussion.

Another task that is discussed in more detail is the preference-ordering task, see exhibit 6-5. This task starts with the task select relevant criteria. The criteria which determine the preference ordering are the output of this task. One of the criteria which is discussed here is the financial impact, see chapter 3. On the basis of the criteria checklist, a first selection of criteria is made. On the basis of regulations and background information, new criteria, which were not yet included in the checklist, may be added. Regulations, background information on the alternatives, the criteria checklist and the financial impact is the input of this task. Output is a list with relevant criteria.

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select relevant criteria

determine actual remittance

per participant

outcome for each participant identical?

discuss differences and make group

decision

path: problem solving \ decision making \ preference ordering

Exhibit 6-5. Structure of the preference-ordering task.

The second task in exhibit 6-5 is determine actual remittances per participant. This is the only group-session task that is performed individually. For the performance of this task, a multi-criteria technique is used, see chapter 4. The participants determine a weight for each criterion that is considered relevant. Per alternative/criterion combination, each participant determines a score. On the basis of weights and scores, the preference order of the alternatives is calculated. This preference order in combination with the maximal remittances, determine the selected actual remittances per participant. Input for this task is the background information per alternative, regulations and the hst with relevant criteria. The output is a list of actual remittances per participant.

In case differences in actual remittances exist, a discussion amongst participants needs to take place. During the coordinating decision outcome for each participant identical? it is decided whether this group discussion needs to take place.

When the outcome on this coordinating decision is "no", the next task of preference ordering is discuss differences and make a decision. Differences in weights and scores are spotted and discussed. On the basis of a group discussion, a group decision is made. Input for this task is the actual remittances, weights and scores per participant. The output is the group decision, including the actual remittances for the subset.

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So far, we have mainly discussed the task structure of the decision process. A second aspect which needs attention is how decision making takes place. In the chapters 4 and 5, we explained the difference between partial and integral decision making. As far as feasible-solution search and preference ordering are concerned, integral decision making should take place. In other words, these tasks should be performed during a group session. The actualize and review task can be performed individually or in subgroups.


As explained in chapter 4, we take team setting and expertise sharing as our point of departure.

Most roles of organizational members do not differ from those of the descriptive conceptual model: the authorizer, the participants and the analysts perform similar tasks. For the analysts only one task is added: to provide on-line computer support during the group session.

What is new with regard to the existing roles, is that decision making should not only take place during sub-group meetings, but that a group session should also take place. As explained in chapter 4, all participants are explicitly defined as members of this decision-making group and in this group, integral decision making is of importance. During such a group session all participants are actively involved in the decision process.

With regard to most roles, no great distinction exists between the descriptive and the prescriptive situation as the existing pattern is considered to be already in accordance with transfer-pricing theory and decision-support theory. The difference is that all participants are defined as group members. The decision-process structure makes clear what is expected from the participants.

In the prescriptive conceptual model, however, one role is completely new. This is the role of the facilitator. As explained in chapter 4, the facilitator is a member of the support staff. He is the actual leader of the decision process, gives a short conclusion of the different points of view and integrates propositions of possible solutions. The decision process is structured by the facilitator, who is a sort of interface between the decision group and the analysts. He asks the analysts for specific output and can explain, if desirable, the outcomes achieved. We choose to include this role in our prescriptive conceptual design as this role, when properly performed, will guarantee that the participants stick to the designed decision-process structure. It contributes to proper use of the designed software. For the set-up of the ad-hoc decision room we follow the design guidelines as developed earlier. Two personal computers, two public screens and a printer form the main elements, see chapter 4.


The fourth and last aspect of the prescriptive conceptual model is the specification of the designed computer support. For the following three tasks, three specific decision

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support components, see chapter 4, are designed: feasible-solution search, preference ordering and disaggregation. This is not to say, however, that the use of the support is limited to these tasks only, but for the system design, one of these tasks is kept in mind. Each support component should exist of two modules: a "what-if' tool and a database (When we mention "what-if' spreadsheet software, target seeking is included). Menus and a help facility are part of the human interface. Per component, the design is described below. In this description, we limit ourselves to the functional specifications. Menu layouts will be used to illustrate these specifications. Using the approach as described in chapter 4, the computerized support is presented in exhibit 6-6.

databases models -

database

8-8

f E

nil

i

module

36

k

component 1

component 2

component 3

user interface menus help facility

module

ordering module

module

1 i

logging

Exhibit 6-6. Global outline of the computerized support.

Note the inclusion of a logging facility in the design. The logging facility is not a part of the computerized support. It is designed and used for research purposes only. Together with audio tapes, it will be used to describe the steps of the decision process and the use of the various modules.

Regulation database (component 1) As explained above, the regulations are of vital importance in the decision process. The regulation database should offer detailed information on regulations concerning financing alternatives. This information is generally filed per authority by means of legal textbooks, correspondence, etc. When considering all aspects (financing, commercial and fiscal) it is not easy to find the right piece of information. A second problem is that legal texts are very hard to read for non experts. In these texts, concrete interpretations are lacking. For the regulation database, two design characteristics are of importance: - The regulations should be stored per alternative and not per authority. This means

that all regulations concerning one financing instrument should be stored under the same heading. A distinction is made between the use of a certain instrument in a

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liquidity-shortage or in a liquidity-surplus situation as the approach of the various authorities is influenced by their financial interest. So the direction of the cash flow is considered, see chapter 3.

- Interpretations of the regulations, as made by participants, other organizational members and external consultants should be included. The text should be understandable for anyone involved in intracompany money transfers. Following the approach taken by the International Bureau of Fiscal Documentation, see IBFD [1986], information is stored in text mode.

Accounting module (component 1) The accounting module is designed to perform "what-if calculations at the aggregate level. Various sets of figures should be related to each other. The first set represents the MIS (management information system) figures. On the basis of these figures, the local company activities are judged by local and central management. As explained in chapter 3, the MIS is an internal reporting system. These figures should be translated into the statutory figures. These statutory figures form the basis for all external reporting. Various kinds of external reporting may exist. Fiscal reporting is usually one of them. Another kind of external reporting may be for health-care authorities (pharmaceutical price control), central banks (foreign-exchange control), or capital-base requirements (avoidance of capital export).

The accounting module offers the possibility to gain insight in financing, commercial and fiscal consequences, see chapter 3, when MIS figures are changed. It offers extensive facilities for "scenario analysis" and "sensitivity analysis". The sensitivity analysis is mainly concerned with determining the impact of financial parameters like exchange interest and inflation rates. Changes in sales volume and inventory period can be considered. The scenario-analysis option offers the possibility to determine the impact of the various (combinations of) financing alternatives on key figures. These key figures may reflect the financing, commercial, fiscal or currency situation.

We divide the variables of this module into four categories, see exhibit 6-7.

variable

instrument variable exogenous variable •

parameter

endogenous variable

Exhibit 6-7. Four types of variables.

The most important endogenous variables are the key figures which reflect, amongst others, the financing and fiscal situation. These key figures are defined as "target variables". The exogenous variables can be categorized into "instrument variables" and "parameters". All exogenous variables of which the size is decided upon by the decision-making group are defined as "instrument variables". These instrument variables

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(the financing alternatives) are related to the scenario analysis. The exogenous variables that are not determined by the decision-making group are defined as "parameters". Note that according to this definition the interest rate for an intracompany loan, for example, is an instrument variable. The interest rate for an external bank loan, however, is a parameter.

In exhibit 6-8, the main menu of the accounting module is presented.

accounting module (component 1)

main menu:

1) MIS profit and loss account 2) MIS balance start, January 1st 3) MIS balance close, December 31st A) MIS source and application of funds 5) fiscal profit calculation 6) other calculations required 7) summary key figures 8) data entry financing alternatives, liquidity shortage 9) data entry financing alternatives, liquidity surplus 10) data entry sensitivity analysis 11) help message 12) exit

enter your choice (1-12) :

Exhibit 6-8. Main menu of the accounting module.

The options 1 through 4 of this menu should give extensive information on the local company's situation on the basis of MIS figures. The options 5 and 6 should give the fiscal-profit calculation and any other calculation that might be required. Option 7 (summary of key figures) requires special attention. By means of a simple set of key figures, an overall picture of the situation should be presented. For the screen behind option 7, see exhibit 6-9.


summary key figures: MIS profit/loss: liquidity surplus/shortage: fiscal profit/loss: other key figures:

Exhibit 6-9. Summary key-figures screen.

The screen as presented in exhibit 6-9 looks quite simple. Calculation rules, however, can be highly complex. One of the complexities that influences the calculation rules is that the impact of fiscal or other regulations may depend on the destination. Price-regulation schemes, for example, may treat home sales differently from export sales. The same might apply for currency-exchange regulations. Special tax rules may apply

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in case of inter-concern sales. The logical design of the module, should reflect these issues.

Financial-impact module (component 2) The database of this component is called "financial-impact module". It is called a module because it offers limited "what-if' possibilities with regard to parameters like tax and exchange rates. Its main use, however, is as a database. The aim of this database is to provide insight in the cost on a consolidated basis for each of the financing alternatives.

It is important that the financial impact of all financing alternatives are compared in a consistent way. We use the method of calculation that has been worked out in detail in chapter 3. For each financing alternative, a calculation similar to the calculation as presented in chapter 3 is made. As we explained, in case local borrowing or local lending is considered, interest effects should be incorporated in the calculation. The main menu of the financial-impact module is shown in exhibit 6-10.

financial-impact module (component 2)

main menu:

1) liquidity shortage without local borrowing 2) liquidity shortage with local borrowing 3) liquidity surplus without local lending 4) liquidity surplus with local lending 5) change financial parameters 6) help message 7) exit

enter your choice (1-7) : ■

Exhibit 6-10. Main menu of the financial-impact module.

As explained in chapter 3, eight categories of financing alternatives exist. Within each of these categories, differences in financial impact occur. A transfer-price change from a source company which is located in a different country has a different financial impact due to, for instance, different currency-exchange, fiscal and duty effects. The database reflects these differences.

Preference-ordering module (component 2) In chapter 4, one multi-criteria technique has been worked out in detail. On this technique the design of the preference-ordering module is based. In chapter 4, we explained our logical design by means of an example: a selection amongst financing alternatives. For the explanation of the terms "opinion", "weight" and "normalized weight", "score", "total score" and "preference order", we refer to chapter 4. In the preference-ordering module this multi-criteria technique should be combined with a few calculations which will now be explained.

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During the feasible-solution search task, the maximal remittance per alternative and the total remittance required for that iteration are determined. The module should calculate the actual remittance per alternative on the basis of the preference order. We will now illustrate this by means of an example:

Let us assume that we have two alternatives (1 and 2) and that the total remittance required is X. The maximal amount, determined during the feasible-solution search task for alternative 1 is Y. For alternative 2 it is Z. We presume that X > Y and that alternative 1 is preferred. Alternative 1 should be used to the maximum: an amount of Y. To obtain the total requirement of X, an additional amount of X -\- Y is needed. The second alternative (alternative 2) should be used for this amount. So on the basis of the scores and weights entered by the participants, the actual remittance per participant should directly be calculated.

The design as described above, however, presents decision support for one participant only: each participant has his own "preference-ordering worksheet" to perform his own multi-criteria calculations. The following design characteristics make it possible to cope with group decisions and stimulate effective communication. The preference-ordering module should be able to present an overall picture for all participants. Using the simple example from above and presuming 6 participants, we could get the screen as shown in exhibit 6-11.

preference-ordering module (component 2)

actual remittances per participant alternative 1 alternative 2

participant 1 Y X-\-Y participant 2 Y X-\-Y participant 3 Y X-\-Y participant 4 X-\-Z Z participant 5 X-\-Z Z participant 6 X-\-Z Z

Exhibit 6-11. Actual-remittances screen.

This screen forms a good basis for discussion. Participant 4, 5 and 6 have a different opinion than the others as they prefer alternative 2. Other overview screens should be possible, for example a screen that shows the weights for the various criteria per participant. Such a screen would help to focus the discussion on those aspects that cause the differences within the group, see exhibit 6-12.

Using the same example as in exhibit 6-11, the screen with weights shows a sharp difference in opinion within the group. With regard to the criteria C and D, the participants 4, 5 and 6 consider criterion D of much greater importance than criterion C. After consultation of this screen, the discussion would focus on the criteria C and D only as with regard to the criteria A and B, no large differences exist. The interface of the system should be such that it is easy to change the scores. Note that the group aspects of the tool as described above should facilitate effective communication. We

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do not consider it necessary to include a "voting tool" which calculates a kind of group average. Expertise sharing is the aim of the group. Communication within the group is presumed to be of such quality, that decisions can be made on the basis of consent. In the exceptional cases that no consent can be reached, the authorizer should cut the Gordian knot, see chapter 4. The use of a formal voting tool would disturb group interaction.


criteria: A B C D

1 15% 54% 16% 15%

nonnaliz

2 19% 50% 16% 15%

;ed weight per participant in percentages participants:

3 18% 52% 15% 15%

4 17% 52% 2% 29%

5 16% 52% 2% 30%

6 18? 51% 1%

30% 100% 100% 100% 100% 100% 100%

Exhibit 6-12. Screen with weights per participants.

Although a computer is used for performing fast multi-criteria calculations, participants do not key in their own scores, see chapter 4. Each participant puts his scores down on a multi-criteria worksheet. The analysts use these worksheets to key in the scores.

Reference database (component 3) As explained in chapter 3, prices of reference articles play a vital role in determining the transfer price to the object company. To have all reference information available when necessary, the reference database provides the following information per source article: - transfer price to the object company, - (adjusted) strategic minimum price and / or world market price, - (adjusted) reference prices, - article descriptions and article numbers of reference articles. This reference database is designed to give information on reference prices of directly comparable articles. The definition of "directly comparable" depends on company strategy and the kind of articles considered. Although prices of indirectly comparable articles are not stored in the database, in exceptional cases, these prices might be relevant. Therefore, information on the existence of indirectly comparable articles should be stored.

The concept of adjusted reference price needs some additional explanation. The adjusted reference price is, for example, the reference price adjusted for pack-size differences: in case a source article containing 20 tablets is transferred to the object company for the price of NLG 33.—, and a reference article containing 40 tablets is transferred to a reference company for the price of NLG 60.—, the adjusted reference price is NLG 60.-- * 0.5 = NLG 30.--. As will be clear, the adjustment factor of 0.5 is this case, is the ratio of the pack sizes (20/40).

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In case articles with a different dosage of active substance are considered to be directly comparable, the adjusted reference price should take these differences in dosage into account.

The reference database should facilitate insight in the minimum and the maximum of the adjusted reference prices per article. By providing these two figures, participants are able to judge reference effects of a proposed transfer price at one glance.

Disaggregation module (component 3) The disaggregation module is a calculation tool that is designed to link aggregate-level effects with price changes of individual articles. It can be used to determine the sensitivity of a chosen alternative for changes in parameters like exchange rate or sales volume. This module is closely related to the accounting module in which the aggregated figures are used. Both modules are used in the feasible-solution search task. The tool is designed for use in two directions: For aggregation ("up") and for disaggregation ("down").

The main use of the disaggregation module is to calculate the exact impact of a price change of one or more articles on the aggregate-level gross margin. Per destination, the set up of the module should be such that the effect of a change in one of the following external parameters or instrument variables can directly be determined: - transfer price per article, - sales volume per article / per destination, - selling price per article / per destination, - currency exchange rate, - duty rate.

Where not only sales, but also production takes place at the object company, it might happen that one or more source articles are transferred into one or more destination articles. Then also the conversion factor and the local added value determine the gross margin. The conversion factor needs some additional explanation. The conversion factor is defined as the number of source units needed to produce one unit destination article.

Taking a Swiss object company, for example, the input/output matrix which presents these conversion factors, might look as presented in exhibit 6-13 ("CHF' stands for Swiss franc).

output: destination article: A B input: source article X: 1 unit 2 units source article Y: 3 units 3 units local added value: CHF 5.— CHF 6.--

Exhibit 6-13. Example of an input/output matrix presenting conversion factors.

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This input/output matrix presents the input needed per unit output. We see that the production of one unit destination article A requires one unit source article X, three units source article Y and a local added value of CHF 5.--. One unit destination article B requires two units source article X, three units source article Y and a local added value of CHF 6.--. Where such interrelationships exist, the disaggregation module should be able to cope with the required calculations.

It should be possible to use the disaggregation module in the other direction ("down"): to search for source articles with some desired characteristic. The disaggregation module could be used, for example, to gain insight into the impact that transfer-price changes have on the gross margin for the various destinations. For this purpose, the "destination-ratio screen" is designed. Per source article, the impact that a transfer-price change would have, is indicated, see exhibit 6-14.

disaggregation module (component 3)

destination ratios for destination Y transfers total transfers ratio

destination Y source article A NLG 7,500 NLG 10,000 75* source article B NLG 100 NLG 5,000 2% total NLG 7,600 NLG 15,000 51X

Exhibit 6-14. Screen with destination ratios.

A destination article is sold to the various destinations in a certain proportion. Let us presume that destination article d is produced out of source article A. Article d is sold to the destinations X and Y. (X could be the home market and Y export third parties.) 25% of the volume of d is sold to destination X and 75% to destination Y. A transfer-price decrease increases the gross margin. In case the payments for article d are decreased with an amount of NLG 100, the gross margin on sales to destination Y would increase with the equivalent of NLG 75.

In case all transfer prices are changed with the same percentage, 51% of the total effect is caused by a change in the gross margin for destination Y. In view of regulations, however, this might be undesirable. It might be preferable to avoid an impact on the gross margin for destination Y. In that case, source article B would be a good choice as the destination ratio for destination Y for this article is only 2%.

Let us presume an exchange rate of 2 NLG/CHF. If we would increase the gross margin of the Swiss object company by CHF 100 by means of a transfer-price decrease for source article B of 4%, (4% * NLG 5000 = NLG 200 = CHF 100) the increase of the gross margin on destination Y sales, would only be CHF 2 (2%). The aim of the screen above is mainly to help in identifying appropriate source articles.

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Above, the four elements of the group decision support system have been described. It should be realized that for every financing problem a complete group session and the use of all modules is not always required. For every (part of) the decision process, the authorizer and the facilitator should determine which aspects are of importance and which tasks need to be executed. This should be done during the coordinating decision: "Problem worth analyzing?", which is part of the scan task.

6.3 Prescriptive empirical model

The prescriptive conceptual model, as described in the previous section, will now be applied to the Europhar situation. For a detailed explanation of the Europhar company, see chapter 5. As in chapter 5, names of the divisions of the Eurochem Holding NV are not always written in full. Usually only the place name is used. Europhar Int BV in Amsterdam is referred to only as "Amsterdam". Europhar UK Ltd in London and Eurochem Holding NV in Rotterdam are respectively referred to as "London" and "Rotterdam". Eurobitec UK Ltd is referred to as "Oxford". As the two destination companies of London are located in Taiwan and Australia, these country names are used.

As in the prescriptive conceptual model, the prescriptive empirical model is described below on the basis of the four aspects of decision support systems as explained in chapter 4: problem specification, decision-process structure, roles of organizational members and computerized support.


To start with, the problem at hand should be specified as either a liquidity-shortage or as a liquidity-surplus situation. (In Year 5, we are confronted with a liquidity shortage situation.)

Following the prescriptive conceptual model, only financing problems are addressed. At Europhar in London, packing for Biosulfine takes place. These production activities can be switched to Eurobitec. This would result in relocation of activities between Eurobitec and Europhar. For the UK, a sharp distinction between financing problems on the one hand, and relocation problems on the other hand is especially important. As the actual decision process will show, this is not to say that no interaction between the two areas takes place.

With regard to the time perspective, the situation is as follows: the financing situation for Year 5 is considered at the start of the decision process in April Year 5. (The budget for Year 6 is not made before autumn.) Decisions taken will have an impact on the figures of Year 5, hence the short term. Year 5, therefore, should be the focus of attention. Careful updating of all budget items should take place. This holds for the profit and loss account as well as for the year-end balance sheet.

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The prescriptive conceptual model requires that all eight categories of financing options are analyzed in advance and considered simultaneously. As explained above, each category exists of more than one option. On the basis of the description of Europhar UK Ltd and presuming a liquidity shortage, we know that the following options exist: - transfer-price decrease:

- source company Amsterdam, - source company Oxford.

- internal selling-price increase: - destination company Europhar Australia Pty Ltd, - destination company Europhar Taiwan Ltd.

- cost transfer away from Europhar UK Ltd: - Any cost item can in principle be subject to this cost transfer. This needs to be

worked out in the actualize and review task. The system is not a great help in this case. The only thing that can be said is that it is very likely that cost should be transferred to Amsterdam, as many ties exist between Amsterdam and London.

- royalty decrease: - The only royalty paid is an annual lump sum royalty to Amsterdam. A decrease

should be considered. - capital increase:

- A capital increase made by Amsterdam (only shareholder) should be considered. - intracompany loan to London:

- The only loan to be considered is a loan from Amsterdam. - current account:

- increase of the payment term from Amsterdam, - increase of the payment term from Oxford, - decrease of the payment term to Taiwan, - decrease of the payment term to Australia.

- local bank loan / overdraft facility: - The bank loan or overdraft facility should be provided under an Eurochem

guarantee.

As explained above, all kinds of criteria should be welcomed by the facilitator. A checklist of criteria should aid the participants when considering the preference order of the financing alternatives. This checklist is set up in advance by means of analysis (by the participants) of all Europhar financing problems in the period Year 1-Year 4. The 50 criteria that resulted from this analysis produced the following short checklist for the UK case: - financial impact, - flexibility, - UK fiscal effects, - other fiscal effects, - NHS effects, - reference effects.


Given the priority evaluation, the following tasks should take place:

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Sec. 6.3 PRESCRIPTIVE EMPIRICAL MODEL

1. actualization of the budget figures for Year 5 and review of all eight categories of financing alternatives,

2. feasible-solution search, 3. preference ordering, 4. authorization, 5. implementation.

The actualize and review task should take place during April Year 5. The feasible-solution search is planned for a two-day group session on 28 and 29 April Year 5. After the group session, authorization and implementation need to take place.

This decision process will be described in detail in the next section. As explained in chapter 4, we will concentrate on the decision-making tasks: actualize and review, feasible-solution search and preference ordering.


In the case of Europhar UK Ltd the following organizational members are involved in the decision process (for a "who is who", see chapter 5): - authorizer / participant:

- Katwijk. - participants:

- Berkers, - Derecks, - O'Brian, - Oostbeek, - Terwolde.

- analysts: - Francen, - Nijboer.

- facilitator: - the author.

As the list shows, the organizational members that are involved in the decision process are the same people as before the introduction of the system. As far as the support staff is considered, however, two new people are involved: Francen and the author.

Francen is a systems analyst working in the information-management department of Europhar Int BV. He reports to Pieterse (joint steering committee member, see chapter 5). The facilitator role is completely new. As described in chapter 4, this role is vital as the facilitator should guide the decision process and ensure that optimal use is made of the computerized support. Within Europhar, however, nobody is available in Year 5 to perform this role. This role is therefore taken by the author, who, being an ex-Europhar employee, is considered an insider. As developer of the system, he knows the system sufficiently well to perform this task. It should be realized that this is a second best solution, which needed to be taken due to the experimental character of the system.

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For development of the software as designed above, we need a modeling tool with at least three "dimensions". Three dimensions mean that a variable can be regarded as a vector with three indices. Another requirement is that the tool is self documenting in order to limit writing of system documentation to a minimum. It should be user friendly enough for development of the system by non-programmers and run on IBM-compatible personal computers as that is both the Delft University of Technology as well as the Eurochem standard. The tool should offer possibilities to include system documentation in each module, as documentation on paper is considered impractical, especially as no standard for a word-processing package existed, either within Eurochem, or at Delft University. The main aim is to find a practical solution. A last selection criterion is that besides the personal-computer version, a mainframe version should be available. This as a mainframe version is needed for large models or databases. (For the experimental system, however, no mainframe is used). One of the packages that meets these criteria is Personal Wizard from Comshare, see also Sprague and Watson [1986].

We decide to use Personal Wizard as the development tool as it is already used within Europhar. The product is known by Europhar employees, so we can use the in-house support as provided by, for example, Francen from the information-management department. Another reason for the choice of Personal Wizard is that Comshare products are already used for decision support in the financing area by 6 of the top 20 European pharmaceutical companies, see Van der Ven [1989a].

For a detailed description of the modules in the Europhar case, see Van der Ven [1988a; 1988b; 1988c]. In this subsection we concentrate on the global structure of the various modules and on the user interface. As all six modules are set up in Personal Wizard, we use the package as a two-dimensional spreadsheet, a three-dimensional spreadsheet, a database and a word processor. When convenient, tailor-made menus are set up. In other cases we use the interface facilities that are offered by the package itself. Our approach to set up tailor-made menus is a good example of how we interpret "simple" in the "simple and sufficient" approach.

Menu building in Personal Wizard requires the use of separate DOS files which do not form an integral part of the module to which the menu screens belong. This is highly impractical, especially for the non-technical user. Therefore an automatically start-up routine is developed which creates the necessary DOS files automatically when the module is retrieved. This approach has been published by the software house involved, see Comshare [1989]. In this example, "simple" is interpreted from the users and not from the builders point of view. This same approach is followed when designing the financial-impact module or the regulation database.

For this experimental system we decide not to build interfaces with already existing computerized systems, for example the MIS system. It is considered that design and implementation of interfaces goes beyond the aim of the research project: developing an initial "0 version", see chapter 1. As figures are entered in the experimental system

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manually, they need to be checked carefully. Various checking procedures are used. Firstly, checking variables are included in the software. Debit and credit side of the balance sheet, for example, need to be identical. Secondly, in order to check total figures, the original budget is used. Budget figures are entered in the software modules. The totals included in the budget need to be identical to the totals included in the software modules. A third and last check is at the detailed level by various people who check whether the input is correct.

The modules in the Europhar-UK situation are now briefly described below:

Regulation database (component 1) The categories of rules that are stored in the database are: - rules from the UK National Health Service (NHS), - fiscal rules from the UK Inland Revenue, - Dutch fiscal rules, - rules as laid down in the UK Companies Act, - rules concerning duties and value-added tax from the UK customs and excise

authorities, - Eurochem internal authorization rules. These rules are considered for each of the eight categories of financing alternatives. A distinction is made between a liquidity-shortage and a liquidity-surplus situation. For the problem at hand, only the part concerning a liquidity-shortage situation need to be used.

An example illustrates the approach. Below we provide the information that is presented when the UK fiscal aspects of an intracompany loan are considered (liquidity shortage):

"The interest rate should be at arm's length (not too high) and the interest payment should be on an annual basis. Arm's length interest rate is related to the currency of the loan. The amount of the loan should be acceptable in view of the arm's length equity/debt ratio of Europhar UK Ltd ('Thin capitalization rules'). The arm's length interest rate in case of a loan in NLG could be determined on the following two bases: - Dutch 'promesse disconto' + 1.5% - LIBOR (London Inter-Bank Offered Rate) + 1% In case of a loan in GBP, the arm's length interest rate could be determined on the following two bases: - British base rate + 1% - LIBOR + 1%."

For this regulation database, we used the word processing capabilities of Personal Wizard.

Accounting module (component 1) This "what-if' tool exists of a three dimensional spreadsheet model with figures and calculation rules. This "cube" can be used for the manipulation of figures. On the

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horizontal axis, the various destinations (including total company) are shown, see exhibit 6-15. The following destinations are presented: - NHS, - generics, - Europhar Taiwan Ltd, - Europhar Australia Pty Ltd, - export third parties Nigeria, - export third parties China.

profit and loss account

balance-sheet opening

balance-sheet close

source and application of funds

-71 fiscal -* . NHS profit

-calculation

'NHS generics etc. total 'I I statutory

Exhibit 6-15. The accounting module.

On the vertical axis, all relevant sets of financial variables are indicated. Together these variables compose the profit and loss account, opening and closing balance sheet and the source and application of funds. Relationships between these variables are put in the module by means of calculation rules. An example of such a calculation rule is the relationship between inventories of finished goods on the end-year balance sheet and value of annual goods sold on the profit and loss account:

inventories in GBP = annual sales in GBP * (inventory period in days / 365).

By changing the inventory period or the annual sales, "what-if analysis can be performed.

On the third axis, the different internal and external reporting requirements are indicated. Each of the four vertical "slices" of the cube is used for a different set of figures. In the UK case, besides MIS, statutory and fiscal figures, the profit calculation for the NHS is important. Like the other calculations, this profit calculation is performed in one of the vertical slices. This may be illustrated by means of an example. The NHS limits promotional costs to a certain maximum. The statutory

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accounts, however, need to reflect all promotional costs. The calculation rule that translates statutory promotional costs into NHS promotional costs is now as follows: 1. add all relevant statutory promotional cost items together (this total is defined as

A), 2. calculate the maximal promotional costs as accepted by the NHS (defined as B), 3. take the minimum of A and B. The figure thus calculated represents the NHS promotional costs and is stored in the "cell of the cube" identified by the following three indices: - variable: total promotional cost (profit and loss account), - destination: NHS, - financial statement: NHS profit calculation.

Financial-impact module (component 2) As far as possible, the financing alternatives are worked out in detail. For each source or destination company, the financial impact of pricing and current-account alternatives is calculated, see chapter 3. In case of a liquidity shortage with local borrowing as one of the alternatives, the menu screen in the Europhar case looks as shown in exhibit 6-16.

financial-impact module (component 2)

submenu 2 : liquidity shortage with local borrowing

the 14 reports are (1..14) : 1) local borrowing 2) share capital increase 3) cost charge to Europhar Int BV 4) debit current account, Europhar Australia Pty Ltd 5) debit current account, Europhar Taiwan Ltd 6) credit current account, Eurobitec UK Ltd 7) credit current account, Europhar Int BV 8) intracompany loan from Europhar Int BV 9) royalty decrease 10) internal selling-price increase Europhar Australia Pty Ltd 11) internal selling-price increase Europhar Taiwan Ltd 12) transfer-price decrease Eurobitec UK Ltd 13) transfer-price decrease Europhar Int BV 14) a summary of the results of the financing alternatives (1-13) 15) help message 16) exit to main menu

enter your choice (1-16) :

Exhibit 6-16. Submenu of the financial-impact module.

The financial-impact module is a small, but complex, two-dimensional spreadsheet.

Preference-ordering module (component 2) The preference-ordering module is a general tool which needs little adaptation to the Europhar UK situation, see exhibit 6-17. The individual multi-criteria worksheet of each participant is one vertical slice of the front of the cube. The summary tables that were discussed in the previous section, are "slices" of this cube. The actual-remittances screen, for example, is a horizontal slice of the bottom of the cube. For an explanation

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of the multi-criteria technique, see chapter 4. For details on the background of the calculations that are performed, see the previous section.

criteria: financial. impact flexibility

etc. total score preference order maximal remittance actual remittance

/ /

/ opinion

yes

yea

weight

6

10

... 25

normalized weight

24Z

40X

... 1001

transfer price increase

6

4

... 5.4

1

100

100

etc.

...

...

... 3.2

2

300

250

'etc i

/ \ 1

(total remittance required is 350)

Exhibit 6-17. The preference-ordering module.

Reference database (component 3) In the case of the UK, the following companies are considered to be the reference companies: - Europhar Belgium NV, - Europhar France SARL, - Europhar Germany GmbH, - Europhar Italy SRL, - Europhar Netherlands BV, - Europhar Sweden AB, - Europhar Switzerland GmbH. For these seven companies, all the prices of the directly comparable articles are included in the database. In the Europhar case, "directly comparable" is defined as follows: two articles are directly comparable when they contain per tablet (or ampoule) the identical active ingredients in an identical dosage.

Disaggregation module (component 3) In exhibit 6-18, the design of the module is shown. The variables on the horizontal axis are presented per article (as shown), and as total value per destination (for example: transfer value = units * transfer price). On the vertical axis the source and destination

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articles are shown. The third axis is used to indicate the destinations. Note that this third axis is identical to the horizontal axis of the accounting module.

In general, this module is the largest one in size. In case of 30 variables, 100 articles and 15 destinations, for example, total size of the module is already 45,000 cells.

Biosulfine/ Sofanaat Briconcyl etc. total

transfer price

local added value

local cost price

net selling price

gross margin

total

Exhibit 6-18. The disaggregation module.

From a calculation point of view, the production activities in London are uncomplicated. Packing activities take place and, as far as the Eurobitec articles are concerned, tablets are produced out of raw material. No complex input/output relationships exist. A destination article is always produced out of only one source article and a source article is used in only one destination article.

In the previous section, the concept of the destination ratio has been explained. In the case of the UK, the NHS-destination ratio is of great importance as the NHS has its own set of rules to judge the figures of Europhar UK Ltd. By means of the use of the destination ratio, the participants are able to determine accurately the effect of transfer-price changes on NHS figures.

Logging facility The logging facility is not a part of the system itself. In cooperation with the software house involved it is designed for research purposes, see Comshare [1988]. It is a keystroke logging facility with automatic replay possibilities. All key-strokes are interpreted as Personal-Wizard commands and stored in a command file (the logging file). In the replay mode, the group session or any other use can be replayed at a speed determined by the researcher. The time and date of the key strokes are recorded in the logging file. This facilitates analysis of the logging-file printouts.

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6.4 Decision process after system introduction

In this section, 6 months of system use of the pilot system is described. System use starts at the end of March Year 5, just after the pilot system is completed and presented to the joint steering committee.

All software modules are checked carefully and contain the figures that are derived from the original budget. In the databases, data concerning both a liquidity surplus as well as a liquidity shortage are included. The software is ready for use.

A preparatory meeting is held on the 1st of April Year 5. The following five people participate in this meeting: regional manager Katwijk, financial expert Berkers, price coordinator Terwolde, the facilitator and analyst Nijboer.

These organizational members plan a group session for 28th and 29th April Year 5. So the participants have 4 weeks to undertake the actualize and review task. Four more people have to participate in the group session. These are: UK manager O'Brian, UK controller Derecks, fiscal expert Oostbeek and analyst Francen.

After the group session, Eurobitec proposes changes in the relocation area due to problems with regard to the production of Biosulfine. These changes require new iterations of decision making in the period May-September Year 5.

In the following subsections the preparatory meeting, the preparations during the month of April, the two days of the group session on 28/29 April and the Eurobitec negotiations are described in detail as these are a good example of how decision making takes places with the help of the experimental system. The author is, as facilitator, involved in the decision process during this period. Besides logging files, audio tapes and internal memos are used to obtain a detailed picture of the decision process.

In the subsections below, bold headings are used to indicate the tasks. Of the path, see chapter 4, only the task that is one level higher in the hierarchy, is indicated. Where the outcome of a coordinating decision is obvious, this coordinating decision is not explicitly mentioned.

THE PREPARATORY MEETING

Katwijk, Berkers, Terwolde, the facilitator and analyst Nijboer are present at the preparatory meeting on the 1st of April Year 5.

Task: scan \ priority evaluation Katwijk arranged this meeting and he explains why he did so. He expects problems with sales of the product Retravir. Retravir, one of the current leading Europhar products, is attacked by a new competitive product which has recently been introduced in the UK and Australia: Denal from Smits Pharma. It has some advantages over the Europhar product. On top of this, Smits Pharma's marketing approach seems to be

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Sec. 6.4 DECISION PROCESS AFTER SYSTEM INTRODUCTION

more effective. Although sales of Retravir are still on target, they are expected to be 20% below budget at the end of Year 5. Budgeted sales for Retravir are GBP 20 mln. With a gross margin of about 50%, this results in an expected decrease of gross margin of:

20% * (50% * GBP 20 mln) = GBP 2 mln

The total budgeted sales for Europhar UK (for all products) are GBP 54 mln. As the entire liquidity surplus of the previous year is already transferred to Amsterdam, this shortfall on budgeted sales will result in serious financial problems for Europhar UK. As Retravir is sold not only on the home market, but also in Australia, there will probably be problems in Australia too.

After explaining this problem, Katwijk inquires whether there are currently other urgent matters, which need to be worked out first. According to Berkers and Terwolde there are no other problems which require priority. Then Katwijk authorizes the start of the decision process.

Task: decision making \ actualize and review There are eight categories of financing alternatives which should be reviewed and discussed in order to find a suitable solution for the problem. Furthermore the year-end balance sheet and the sales budget should be actualized, because the original budget does no longer represent the financial situation of Europhar UK. The facilitator puts all eight categories on the flip chart. The options are (see chapter 3): - internal selling-price increase, to Taiwan and/or Australia, - transfer-price decrease, from Oxford and/or Amsterdam, - cost transfers to Amsterdam, - decrease of royalty payments to Amsterdam, - local borrowing (bank loan), - intracompany loan from Amsterdam, - capital increase, - changing the current-account trading position. There are four possibilities: increasing

the creditors payment term from Amsterdam and/or Oxford and decreasing the debtors payment term to Australia and/or Taiwan.

The alternatives will be worked out in April by the participants with the help of analyst Nijboer.

Terwolde, as price coordinator, will review the alternatives dealing with prices. These are internal selling-price increases and transfer-price decreases. Katwijk will contact his colleague O'Brian and together they will gather data on the cost-transfer alternative and the royalty decrease. Berkers will contact Derecks and together they will work out the possibilities in the financing area. These are local borrowing, capital increase and intracompany loan.

Remaining tasks are actualization of the profit and loss account and actualization of the year-end balance sheet. The first task is performed by Katwijk and O'Brian and

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the second by Berkers and Derecks. Oostbeek will be contacted by the other participants to provide fiscal background information where needed.

Berkers opposes the current-account alternatives, because the Eurochem rule is one month payment term. It is his view that the group should stick to this Eurochem rule of 30 days settlement. So there is no need to consider these alternatives, according to Berkers. The facilitator explains that each alternative should be worked out, even if it seems to be against the company policy. All alternatives should be studied according to the "rules of the game". The process structure is designed for this purpose. Berkers accepts this point of view. He and Derecks will analyze the current-account alternatives. As all actualize and review tasks are now assigned, Katwijk closes the preparatory meeting.

PREPARATIONS

During April Year 5, the participants review the different financing options and actualize the sales budget and the balance sheet. Analyst Nijboer is heavily involved with the preparations. He performs data input of the actualized budget in the disaggregation and accounting module. He retrieves the necessary information from the reference database, regulation database and the financial-impact module when requested.

Katwijk telephones UK manager O'Brian and they make an appointment for working out the cost-transfer alternative and the royalty-decrease alternative. They actualize the sales and cost budget. In the actualized budget all changes in the forecast year-end balance sheet are included. Part is the information is obtained from Katwijk and O'Brian. These have been worked out by Berkers and Derecks. By using the disaggregation module and the accounting module, analyst Nijboer obtains the financial, commercial and fiscal key figures based on this actualized budget.

Price coordinator Terwolde studies the transfer-price alternatives and the internal selling-price alternatives. He phones Oostbeek, when he needs some additional fiscal information. He contacts analyst Nijboer to obtain information from the reference database, the regulation database and the disaggregation module. As explained in chapter 4, the participants prefer not to use the computer personally.

Terwolde contacts the management of Eurobitec in Rotterdam and Oxford. He explains the situation London is in at the moment and asks them to consider a transfer-price decrease. It is not always easy to get a transfer-price decrease, because the divisions of the Eurochem company are profit centers and each division is judged on its own profit. This sometimes creates friction between the divisions.

Terwolde contacts analyst Nijbocr and together they use the reference database in order to obtain information about European reference prices. It appears that prices to the UK are relatively low compared to other destinations. However this does not apply to all products. The transfer price of the generics might be decreased.

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Terwolde telexes the management of Taiwan and Australia in order to make inquiries about a possible internal selling-price increase. Apparently an internal selling-price increase to Australia is not possible, as Australia has the same problems with Retravir as the UK. However an internal selling-price increase to Taiwan seems a feasible alternative as Taiwan is in a strong financial position at the moment. However, using the financial-impact module, Terwolde notices that it is very expensive to transfer money from Taiwan to London, because of the high import duties.

Terwolde and analyst Nijboer use the disaggregation module in order to compare prices to Taiwan with prices to other destinations. It appears that prices to Taiwan are relatively low. Terwolde thinks a price increase of about 20% is feasible. The regional manager Far East and the local Taiwan management do not object to such an increase.

UK controller Derecks visits financial expert Berkers in Amsterdam and, together with analyst Nijboer, they actualize the local borrowing alternative, the intracompany loan alternative and the capital-increase alternative. When fiscal problems arise during their meeting, they telephone Oostbeek for fiscal background information. They ask analyst Nijboer to consult the regulation database to find out who is to authorize an intracompany loan. This appears to be the Eurochem fiscal & financial department. Oostbeek discusses the intracompany loan with this department, but they do not approve.

Note that until now all aspects of the problem are studied in isolation. Studying the alternatives in isolation should be interpreted in two ways. The financing alternatives are not considered simultaneously. Moreover the participants analyze these alternatives individually or with a subgroup.

Before the group session, the facilitator studies the alternatives that are worked out by the participants and analyst Nijboer. The facilitator visits all participants to explain the new approach that will be followed. The multi-criteria technique is explained and used in a small exercise.

FIRST DAY OF THE GROUP SESSION

The first day of the group session takes place on the 28th of April Year 5. The six participants, including the authorizer, meet together with the two analysts and the facilitator in one of the meeting rooms of the Europhar head office in Amsterdam. This same meeting room has been used for the meeting in July Year 4 which has been described in chapter 5. The layout of this meeting room is shown in chapter 4.

Before presenting a detailed account of this two day session we like to describe the atmosphere of the meeting. Like in the meeting described in chapter 5, the atmosphere is task oriented, informal and open. Relief of tension within the group takes place by means of a relaxed and humorous yet businesslike approach.

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As authorizer, Katwijk opens the meeting and asks the facilitator to structure the decision process in the coming two days. The facilitator takes over and gives a brief review of the decision support system that will be used. Special attention is paid to distinction between the authorizer and facilitator role, see chapter 4. After this introduction, the decision process starts.

Résumé of the actualize and review task First the results of the actualization of the sales budget and the balance sheet are discussed together with the eight financing options. The actualization of the sales budget by Katwijk and O'Brian resulted in a slightly less unfavorable picture due to better sales of a few small products: GBP 1.5 mm below budgeted sales (In the preparatory meeting the shortfall on budgeted sales was estimated at GBP 2 mln).

When actualizing the balance sheet, Berkers and Derecks explain that currently an extension to the factory is built. The costs exceed the budget by GBP 1 mln due to additional "good manufacturing practice" regulations. The special bank loan of GBP 5 mln that was arranged originally, will not be sufficient to cover the expenditure. Total liquidity shortage for the coming year will be GBP 1.5 mln + GBP 1.0 mln = GBP 2.5 mln.

The key figures based on the reviewed budget represent the starting point and are shown on one of the public screens, see exhibit 6-19.


summary key figures MIS profit/loss: -\- 771 liquidity surplus/shortage: -\- 2,504 NHS excess/shortfall: -\- 3,338 fiscal profit/loss: -\- 2,351

(amounts in GBP * 1,000)

Exhibit 6-19. Summary key-figures screen (at start of the group session).

After the acceptation of this budget as starting point, all possible financing alternatives are discussed. Terwolde presents the options he reviewed with analyst Nijboer and, in a few cases, with Oostbeek. - Internal selling-price increase to Taiwan. This seems feasible as Taiwan is doing well

as expected. - Internal selling-price increase to Australia. This is not feasible as Australia has the

same difficulties with Retravir as the UK. Increasing the internal selling price would lead to serious financing trouble due to a trading loss. Besides, the fiscal loss in Australia would become unacceptably high.

- Transfer-price decrease from Oxford. This seems feasible although the idea is not welcomed by Eurobitec. They suggest Europhar to solve its own problems, but with the intervention of marketing director Gisbers this option seems feasible. The only transfer price that can be discussed, is a price decrease of Biosulfine. As has been explained earlier in this section, it is not always easy to get a transfer-price

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decrease, because the divisions of the Eurochem company are profit centers and each division is judged on its own profit.

- Transfer-price decrease from Amsterdam. Since the cost price for the generic articles is relatively low compared to the transfer price, this is a feasible option. For other articles, no possibilities exist in view of the reference prices to other European countries.

Katwijk, O'Brian and Oostbeek have worked out two financing alternatives, together with analyst Nijboer. Occasionally Oostbeek has been involved. These are the results: - Cost transfers. This is not feasible since it would constitute a deviation from the

long-term fiscal policy. This would probably not be accepted by the Dutch fiscal authorities.

- Royalty contract. As the royalty contract was changed last year in order to bring royalty payments in line with sales of Europhar UK, a change in the opposite direction would not be logical and probably not accepted by the Dutch fiscal authorities.

Berkers, Derecks and analyst Nijboer have worked out the remaining financing alternatives. Again Oostbeek has sometimes been involved. Results are as follows: - Local borrowing. This looks feasible, although interest payments are a drawback as

they decrease liquidity. The absolute maximum is set on GBP 1 mln after discussing the option with the Eurochem fiscal & financial department. This maximum is set in view of the Eurochem contracts with banks in the UK. In cooperation with the Eurochem fiscal & financial department, a bank is selected: the Northampton West Bank. Interest rate for the loan (annual interest) would be 6.7% under an Eurochem guarantee.

- Capital increase. This is feasible and there are no fiscal problems and no problems with NHS regulations. The maximum as set by the Eurochem fiscal & financial department is GBP 1 mln.

- Intracompany loan from Amsterdam. This is considered unfeasible after discussions within the Eurochem fiscal & financial department due to arrangements made between the Dutch fiscal authorities and Eurochem holding. These arrangements cover financing of Eurochem's foreign subsidiaries.

- Current account Amsterdam. This is feasible, but 50 days payment term is the maximum in view of the arm's length principle according to Oostbeek. At the moment the payment term is 30 days, so increasing the payment term to 50 days would result in:

20/365 * GBP 19.6 mln (being anticipated purchases during year) = GBP 1.1 mln

- Current account Oxford. Eurobitec's financial position is good. So the option seems feasible, but Eurobitec is not very willing to help Europhar. "Let Europhar solve its own problems". In view of NHS regulations, the maximal payment term would be 40 days (within the UK). At the moment the payment term is 30 days, so an increase would result in:

10/365 * GBP 2 mln (being anticipated annual purchases) = GBP 55,000

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Sbce the remittance is not that large, it is not worth trying to achieve a current-account increase. Besides, it is certainly not worth the hassle, when London wants a transfer-price decrease from Eurobitec.

- Current account Australia and Taiwan. Decrease of payment term is not possible as the invoice would need to be paid before the goods would arrive, which is not allowed by the custom authorities.

The facilitator summarizes the results and writes the remaining options on a flip chart. These are: - internal selling-price increase Taiwan, - transfer-price decrease Oxford, - transfer-price decrease Amsterdam, - local borrowing, - capital increase, - current-account increase Amsterdam.

Task: decision making \ set financing, commercial and fiscal targets Berkers puts forward that the financing target should be to avoid any liquidity shortage. A surplus, however, is not necessary. Oostbeek puts forward that the fiscal loss should preferably be less than about GBP 900,000. As far as the NHS is concerned, O'Brian explains that the solution for the liquidity problem should not interfere with the NHS calculations or alter the result. Negotiations with the NHS authorities start in the autumn. O'Brian considers the current actualized figures for Year 5 a realistic point of departure. Katwijk puts forward that a MIS profit target does not need to be included as a separate target as decisions are made on the basis of Europhar's consolidated performance. O'Brian agrees in principle, but if possible, he would like to have a small MIS profit.

The facilitator summarizes the targets on the flip chart, see exhibit 6-20.

MIS profit/loss: small profit liquidity surplus/shortage: zero NHS excess/shortfall: shortfall of GBP 3.3 mln fiscal profit/loss: loss of GBP 900,000

Exhibit 6-20. Summary of financing, commercial and fiscal targets.

Task: feasible-solution search \ select subset of alternatives and set total remittance Katwijk proposes to split up the problem into two different iterations. First a "profit and loss iteration" to generate extra cash flow of GBP 1.5 mln, and then a "balance-sheet iteration" of GBP 1.0 mln. The participants and the facilitator agree with the proposal. The profit and loss iteration considers three alternatives: - transfer-price decrease Oxford, - transfer-price decrease Amsterdam, - internal selling-price increase Taiwan.

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In this iteration the total remittance should equal GBP 1.5 mln. The balance-sheet iteration also considers three alternatives: - capital increase, - current-account increase Amsterdam, - local borrowing. In this iteration the total remittance should equal GBP 1.0 mln.

The facilitator proposes that in the first day's meeting (April 28th) the profit and loss iteration will be held. The balance-sheet iteration is planned for the second day (April 29th). In the remaining of the subsection, the profit and loss iteration will be described.

Tasks: feasible-solution search \ select alternative and determine maximal remittance at aggregate level & disaggregation The three options of this iteration are discussed thoroughly. For each of these options the tasks mentioned above take place.

- Transfer-price decrease Amsterdam. Terwolde explains the situation. From the reference point of view none of these transfer prices can be decreased except for generic products. The only possibility is to lower the prices of some products which are also sold by generic houses. Taking their prices as a reference, a price decrease of 20% would be possible.

The facilitator asks analyst Nijboer to display the landed costs per destination (accounting module, component 1) on the public screen. On this screen it can be seen that the landed cost for generics are GBP 1,515,000. So a decrease would result in an extra gross margin of:

20% * GBP 1.515 mln = GBP 303,000.

- Transfer-price decrease Oxford. This alternative involves a highly complex issue, see chapter 2 for more details on NHS regulations. The facilitator explains NHS regulations at the request of Oostbeek as these regulations only apply to UK pharmaceutical companies. The facilitator's explanation is supported by the NHS-profit calculation of the accounting module, which is shown on one of the public screens, see exhibit 6-21.

Under the current NHS regulations, royalties together with imported cost of goods sold equal 48.3% of NHS sales. The NHS norm, however, is 47.3%. Therefore, the NHS adds back 1% of the NHS sales to company profit. The destination-ratio screen is shown on one of the public screens. The NHS destination ratio for Biosulfine, the main product from Eurobitec, is 81%. If the transfer-price decrease results in a transfer-price decrease for NHS sales of more than 1% of sales, there is no add-back anymore as 47.3% is the NHS norm. Any additional transfer-price decrease on NHS sales (above 1%), however, would further reduce NHS costs and increase profitability of NHS sales. Eventually, this increased profitability could go to a level which might result in a selling-price cut since the NHS authorities will

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not automatically make a corresponding correction for the decreased profitability of NHS sales. NHS sales are GBP 41 mln. 1% decrease is 1% * GBP 41 mln = GBP 410,000. Total acceptable decrease from NHS point of view: GBP 410,000/81% = GBP 507,000 (rounded off).

disaggregation module (component 3)

destination ratios for NHS transfers total ratio for NHS transfers

source article: Biosulfine 823 1,022 811 Miconitraat 141 176 80X Phosphoramidorine 267 311 861 (amounts in GBP * 1,000, source company Eurobitec UK Ltd)

Exhibit 6-21. Screen with destination ratios (profit and loss iteration).

Biosulfine transfers are GBP 1,022,000. So a decrease in transfer price of about 50% is required to obtain the GBP 507,000 which are needed. Berkers puts forward that such a large decrease is not feasible, especially when the relationship with Eurobitec is concerned. According to Katwijk, however, this 50% decrease in transfer price is feasible and needed. The decrease is feasible because Eurobitec recently introduced a new technology which causes a substantial decrease in the cost price of Biosulfine. The decrease is needed because training of general practitioners is more expensive than originally expected. Compensation for the extra marketing cost made by Europhar should be granted by means of a lower transfer price, according to Katwijk. As Berkers agrees, the facilitator concludes that the maximal remittance of this option is GBP 507,000.

- Internal selling-price increase Taiwan. Terwolde explains that prices to Taiwan are relatively low when compared with prices for other destinations since the Taiwan prices have not been increased for a number of years. (This can be seen using the disaggregation module.) An increase of 20% seems acceptable and Oostbeek agrees. Oostbeek states that a price increase would still be at arm's length as the local gross margin would remain very good. Moreover there are few other ways to transfer money to Amsterdam. Berkers remarks that money is needed in Amsterdam for the new research program. Therefore no money should be left idle in Taiwan. As an overall price increase of 20% is acceptable, this will result in:

20% * GBP 3,963,000 = GBP 793,000.

Task: feasible-solution search \ summarize information on subset of alternatives For the profit and loss iteration, the facilitator summarizes the situation on the flip chart, see exhibit 6-22.

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total remittance: GBP 1.5 mln maximal remittances per alternative: - transfer-price decrease Amsterdam: GBP 507,000 - transfer-price decrease Oxford: GBP 303,000 - internal selling-price increase Taiwan: GBP 793,000

Exhibit 6-22. Maximal remittances per alternative (profit and loss iteration).

Task: preference ordering \ select relevant criteria This task is supported by the preference-ordering module. The facilitator asks analyst Francen to show the checklist of criteria (preference-ordering module, component 2) on his public screen. The following checklist is shown on one of the public screens: - financial impact, - flexibility, - UK fiscal effects, - other fiscal effects, - NHS effects, - reference effects. The alternatives have different financial consequences, so the criterium "financial impact" needs to be included in the checklist according to Katwijk. The "flexibility" criterion can be left out of the checklist, because the three alternatives can be considered inflexible according to Terwolde: after a transfer price or an internal selling price is changed, it should in principle not be changed again in the near future (The same argument applies for royalty contracts and cost transfers). Oostbeek thinks that the criteria "UK fiscal effects" and "other fiscal effects" can be left out, because in this case the alternatives do not differ as far as fiscal aspects are concerned. Derecks remarks that this does not apply for the "NHS effects", which differ significantly for the alternatives under consideration. Terwolde suggests to include "reference effects", because the alternatives differ in view of this criterion.

"Speed & trouble" is added on request of financial expert Berkers, aiming at the problems he expects with Eurobitec. So the following four criteria are selected: - financial impact, - NHS effects, - reference effect, - speed & trouble.

Task: preference ordering \ determine actual remittance per participant The participants each receive a preference-ordering worksheet on which they fill in their scores and weights for the three alternatives. The worksheets are then collected by the facilitator and entered into the computer by the two analysts. Using the preference-ordering module (component 2), a printout of the complete worksheet per participant is made. On this printout, the normalized weight, preference order and the actual remittance per alternative, as calculated by the computer, are presented. As an example, the printout of the worksheet of Derecks is presented in exhibit 6-23.

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financial impact NHS effects reference effects speed & trouble total score preference order maximal remittance actual remittance

opinion

yes

yes

no

yes

weight

9

11

-13

33

normalized weight

271

33*

-40Z

1002

transfer-price decrease Amsterdam

3

3

-5

3.8

1

303

303

transfer-price decrease Oxford

2

2

-2

2.0

3

507

404

internal selling-price increase Taiwan

4

2

-4

3.3

2

793

793

(total remittance required 1,500, amounts in GBP * 1,000)

Exhibit 6-23. Example of a preference-ordering worksheet (printout).

The facilitator asks the participants if the outcome of the computer matches their "gut feeling". All participants agree.

Task: preference ordering \ discuss differences and make group decision The results as shown in exhibit 6-24 are now presented on the public screen.


actual remittances per participant

Derecks Berkers Katwijk 0'Brian Oostbeek Terwolde

total remittance

1,500 1,500 1,500 1,500 1,500 1,500

transfer price decrease

Amsterdam 303 303 303 303 303 200

transfer price decrease Oxford 404 404 404 404 404 507

internal selling price increase Taiwan 793 793 793 793 793 793


Exhibit 6-24. Screen with actual remittances (profit and loss iteration).

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As can be seen above, the figures of Terwolde deviate as a transfer-price decrease from Amsterdam is his least preferred option and therefore not completely used. For all other participants apparently a transfer-price decrease from Eurobitec is the least preferred option. The facilitator puts forward that the difference in opinion is small as far as the final outcome is concerned. The only difference within the group is whether GBP 100,000 transfer-price decrease should come from Oxford or from Amsterdam. This is only 7% of the total amount of GBP 1.5 mln that needs to be transferred.

On proposal of the facilitator, the "normalized weight" table is shown on the public screen, see exhibit 6-25.


normalized weight per participant in percentages

Derecks Berkers Katwijk O'Brian Oostbeek Terwolde financial impact 27Z 381 20* 23% 28X 211 NHS effects 33X 19% 23% 321 31% 24% reference effect - 19% 23% - - 411 speed & trouble 40% 24% 341 45% 41% 14Z

100% 100% 1001 100% 100% 100*

Exhibit 6-25. Screen with normalized weights (profit and loss iteration).

Terwolde has a relatively high weight for "reference effect" and a relatively low weight for "speed & trouble". On request of the facilitator, he gives an explanation on this deviation. In 1992 he expects problems with prices in Europe. One open market makes it impossible to have different prices to the European countries, according to Terwolde. So his weight for the "reference effect" is higher. On the other hand he does not expect too much problems with Eurobitec and so his weight for "speed & trouble" is lower.

In spite of the difference in results among the participants, the "Amsterdam alternative" is easily accepted by Terwolde on proposal of Katwijk.

Since just GBP 1.5 mln is needed, this implies that the least preferred alternative (transfer-price decrease of Biosulfine from Eurobitec) is not fully used. The maximal transfer-price decrease is 50% (507/1,022). The actual transfer-price decrease for Biosulfine will now be 404/1,022 = 40%.

Task: decision making \ budget recalculation During the night, analyst Nijboer enters the new prices in the disaggregation module (component 3). Derecks and the facilitator are present. The new figures as calculated by the disaggregation module are entered into the accounting module (component 1) and a new set of key figures is produced.

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SECOND DAY OF THE GROUP SESSION

29th April Year 5 is the second day of the group session. As on the first day, the six participants, the two analysts and the facilitator are present.

Résumé of the profit and loss iteration The facilitator gives a brief résumé of the meeting of the first day. In exhibit 6-26 the result of the profit and loss iteration is presented.


summary key figures MIS profit/loss: + 211 liquidity surplus/shortage:-\- 1,012 NHS excess/shortfall: -\- 3,332 fiscal profit/loss: -\- 841

(amounts in GBP * 1000)

Exhibit 6-26. Summary key-figures screen (after profit and loss iteration).

The facilitator asks if the participants have questions or want to bring in additional considerations. This is not the case. As can be seen, after this iteration the MIS and fiscal target are reached and the NHS result is barely affected. So the only target that still needs to be considered is the financing target. This will be done during the balance-sheet iteration.

Task: feasible-solution search \ select subset of alternatives and set total remittance The three alternatives which will be considered in the balance-sheet iteration are: - capital increase, - current-account increase Amsterdam, - local borrowing. The total remittance should equal GBP 1.0 mln.

Task: feasible-solution search \ select alternative and determine maximal remittance at aggregate level The three options of this iteration are discussed. For each option the task mentioned above takes place. - Capital increase. There are no problems to be expected with the capital increase

alternative. Oostbeek discussed this option with other members of the Eurochem fiscal & financial department. It is possible to increase the capital by GBP 1.0 mln.

- Current-account increase Amsterdam. Using the accounting module (component 1) it can be seen that the transfers, (against new transfer prices!) equal GBP 19.3 mln annually. Increasing the current account from Amsterdam from 30 days to 50 days would result in:

20/365 * GBP 19.3 mln = GBP 1.06 mln.

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So the maximal remittance of this alternative equals GBP 1,060,000. At the beginning of the meeting of the first day, this has been discussed.

- Local borrowing. On the first day of the meeting Berkers, Derecks and Oostbeek already explained that the maximum for the local borrowing (the Northampton West Bank loan) alternative is set on GBP 1.0 mln, because of the Eurochem contracts with a few banks in the UK. The maximal remittance of this alternative equals GBP 1.0 mln. In case the loan would be borrowed from the first of July onwards, interest (before tax) on this loan (for Year 5) would be:

6.7% * 6/12 * GBP 1 mln = GBP 33,500

The amount of the loan should be decreased with this amount. So the effective maximal remittance of the loan becomes:

GBP 1,000,000 -\- GBP 33,500 = GBP 966,500

Task: feasible-solution search \ summarize information on subset of alternatives For the balance-sheet iteration, the situation is summarized on the flip chart, see exhibit 6-27.

total remittance required: GBP 1 mln maximal remittances per alternative: - capital increase: GBP 1,000,000 - current account increase Amsterdam: GBP 1,060,000 - bank loan: GBP 966,500

Exhibit 6-27. Maximal remittances per alternative (balance-sheet iteration).

Task: preference ordering \ select relevant criteria Analyst Nijboer presents the checklist with criteria (preference-ordering module, component 2) on one of the public screens. "NHS effects" is the only item of the checklist which is taken into account. It is mainly taken because the current-account alternative influences the capital employed as determined by the NHS, see chapter 2. Other criteria of the checklist are not included, because the differences between the alternatives are small.

The criterion "authorization" is added as the three alternatives require different authorization levels. The criterion "long-term solution" is added, because a capital increase has a different time perspective than the other two alternatives.

Task: preference ordering \ determine actual remittance per participant The participants fill in their preference-ordering worksheets, which are then collected by the facilitator and entered into the preference-ordering module (component 2) by the analysts. On request of the facilitator the participants confirm that the outcome matches their "gut feeling".

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Task: preference ordering \ discuss differences and make group decision The results of this preference ordering, as presented on the public screen, can be seen in exhibit 6-28.


actual remittances per participant

Derecks Berkers Katwijk 0*Brian Oostbeek Terwolde

total remittance

1,000 1,000 1,000 1,000 1,000 1,000

capital increase

1,000 0 0

1,000 0 0

current account

0 1,000 1,000

0 1,000 1,000

local bank loan

0 0 0 0 0 0


Exhibit 6-28. Screen with actual remittances (balance-sheet iteration). The screen shows that the current account alternative is preferred by most participants. However the outcome for O'Brian and Derecks deviates. On request of the facilitator, the normalized weights are shown on the public screen, see exhibit 6-29.


normalized weight per participant in percentages

Derecks Berkers Katwijk O'Brian Oostbeek Terwolde NHS effects 33X 24% 33X 30Z 24% 281 authorization - 35X 25Z - 40X 291 long-term solution 67% 41Z 42* 701 36Z 43Z

100Z 100X 100% 100% 100% 100%

Exhibit 6-29. Screen with normalized weights (balance-sheet iteration).

O'Brian explains the deviation. He says they have no opinion concerning "authorization", as this is a divisional head office activity. Furthermore they have a higher weight for "long-term solution", as in the UK situation, too often problems have been solved in a temporary way.

Katwijk points out that he understands the local desire for a long-term solution, but in view of the uncertainty with regard to developments in the market he prefers to stick to the current-account alternative because it is more flexible. O'Brian and Derecks agree to this.

Task: decision making \ budget recalculation Total remittance needed is GBP 1 mln. An extension of the payment term by 19 days is sufficient to obtain this as:

19/365 * GBP 19.3 mln = GBP 1 mln.

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The facUitator asks analyst Francen to calculate the key figures after an increase of the Amsterdam payment term from 30 to 49 days. For the last time the summary key figures are presented, see exhibit 6-30.


summary key figures MIS profit/loss: + 208 liquidity surplus/shortage: + 63 NHS excess/shortfall: -\- 3,322 fiscal profit/loss: -\- 843


Exhibit 6-30. Summary key-figures screen (after balance-sheet iteration).

Task: problem solving \ formal agreement by authorizer The facUitator writes the action steps which need to be authorized on the flip chart: - Transfer-price decrease for genetics from Amsterdam. The first action step will be

authorized by Katwijk. This concerns the transfer-price decrease for generics from Amsterdam by about 20%. Exhibit 6-31 shows the old and the new prices for the generics in NLG as calculated on the night of the first day.

articles: Nimatapine Nalvodexine Cotergenine Olupentine

old 21.— 82.—

990.— 27.—

new 17.--66.— 790.— 21.—

Exhibit 6-31. Old and new transfer prices for generic products.

- Internal selling-price increase to Taiwan. All the destination articles, which are sold to Taiwan, will be increased by 20%. Exhibit 6-32 shows the old and the new prices, for these articles in GBP (as calculated on the night of day 1).

articles: Briconcyl Ogmentin Sastril 10 Sastril 50 Darmicum Opanol Morvelan

old 29.25 74.75 18.31 91.40 9.54 3.53 14.34

new 35.10 89.70 21.97 109.68 11.45 4.24 17.21

Exhibit 6-32. Old and new internal selling prices to Taiwan.

Katwijk wUl approach the Far East regional manager to obtain formal authorization for the internal selling-price increase to Taiwan. This has been discussed with the people involved before the group session.

- Transfer-price decrease for Biosulfine: The third action step is the transfer-price decrease of 40% for the Eurobitec article Biosulfine. The current price is GBP 6.50

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per unit. So the new price will be GBP 3.90. In cooperation with marketing director Gisbers, Katwijk will try to get this authorized by the financial director of Eurobitec. Related to this issue, Katwijk proposes another action. He thinks relationships between Oxford and Europhar UK in general should be improved. He will bring this up at the meeting with the financial director of Eurobitec. He will also discuss this with marketing director Gisbers.

- Increase of the payment term from Amsterdam. The following action step is increasing the current account from Amsterdam from 30 to 49 days. On request of Katwijk Berkers will submit this action for authorization by Marcus, the financial director of Europhar. Berkers says he does not expect any trouble.

Katwijk proposes a last action step: a check for the currency-exchange rate and interest stability. The two financial specialists (Berkers and Derecks) do not consider this relevant as the interest rate and die exchange rate are very stable. They consider this a waste of time.

The facilitator asks if there are any questions or comments amongst the participants. Since there are not, he asks Katwijk to close the meeting. Katwijk thanks the participants, analysts and the facilitator for their contribution. He stresses that he enjoyed the open, informal and constructive attitude of all involved and the meeting is closed.

THE EUROBITEC NEGOTIATIONS

Above, the decision process and system use are described in some detail for the month of April Year 5. Use of system elements during the period May-September Year 5 is now globally described below. Please note that the use of the system in this period differs from its original purpose: to determine a financing policy. In the part described below, the system is used to support negotiations with Eurobitec. This subsection shows the close link between decision support and negotiation support.

All action steps decided upon during the group session are authorized and implemented in the beginning of May Year 5. At the end of May Year 5, Eurobitec in Oxford is faced with an overcapacity problem in the production area. This is due to the recent start of the business in Oxford. In this initial phase the plant is not yet working at full capacity. In order to solve this problem the management of Eurobitec proposes to relocate tabletting and packaging activities of the product Sofanaat to Oxford.

At this moment the raw material Biosulfine is produced in Oxford. Biosulfine is then transported to Europhar in London, where it is used to produce Sofanaat tablets. Then these tablets Sofanaat are packed by Europhar. The original situation is shown in exhibit 6-33.

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raw materials

X.Y.Z

Eurobitec f raw

material Biosulfine

Europhar f

semi-finished Sofanaat (tablets)

Europhar T

finished Sofanaat (packed)

Exhibit 6-33. The production process for Sofanaat.

Management of Eurobitec wishes to relocate tabletting and packaging activities from London to Oxford. However, Europhar in London would then get overcapacity problems. A shift of these activities would seriously affect Europhar's business. Europhar people have the impression that Oxford is trying to roll off its problems on London.

As explained, the Europhar divisions are independent profit centers, see chapter 3. Bargaining is the predominant character of the meetings between the two companies. In the negotiations that take place with regard to this relocation of tabletting and packaging, a transfer price for the packed Sofanaat needs to be determined. Until now, Biosulfine and not Sofanaat has been sold to Europhar.

On behalf of Europhar, Katwijk negotiates with Eurobitec. As Europhar and Eurobitec belong to the same fiscal unit, fiscal effects of the relocation for the unit as a whole are nil. For the problems caused in the financing and commercial area, Europhar requires adequate compensation. From the point of view of Europhar, the aims of these negotiations are: - to minimize the degree of tabletting and production activities that are relocated to

Eurobitec, - to obtain a low transfer price for the packed Sofanaat that replaces the Biosulfine.

Katwijk considers arranging a second group session in order to determine a negotiation policy towards Eurobitec. After discussing this with Marcus, the Europhar financial director, they decide not to do so. Since the overall policy, which is already determined at the end of April is clear, a new group session is not necessary.

133


To determine the negotiation policy, various meetings are held. In evaluating the various negotiation strategies, Katwijk, Derecks, Terwolde and Berkers are involved. Support is provided by analyst Nijboer. Analyst Francen, the facilitator, O'Brian and Oostbeek are not involved. In various stages of the negotiation process, Terwolde works out the consequences of the relocation and transfer-price alternatives and together with analyst Nijboer the financial, commercial and fiscal key figures for the various alternatives are calculated. This is done by using the accounting module (component 1) and the disaggregation module (component 3).

As Katwijk is able to present hard figures on the commercial and financing consequences of this unexpected move from Eurobitec, he is able to make a strong case. After a series of negotiation talks a compromise with Eurobitec is reached in September of Year 5. The main point of this compromise is that only the tabletting activities are relocated to Eurobitec. The packaging activities remain with Europhar. Another point of the compromise is that the transfer price for Sofanaat tablets is relatively low. This low transfer price is an adequate compensation for the negative commercial and financing effects.

task. / activity

preparations actualize and review first day of the group session résumé of the actualize and review task determine maximal remit, at aggregate level & disaggregation select relevant criteria determine actual remittance per participant discuss differences and make group decision budget recalculation second day of the group session résumé of the profit and loss iteration determine maximal remittance at aggregate level select relevant criteria determine actual remittance per participant discuss differences and make group decision budget recalculation the Eurobitec negotiations negotiation support

component / module 1

a c c o n

X

X X

X

X X

X

X

g u 1 a t

X

2 P r e f o

X X X

X X X

f i n i m

X

3 1

X

X

X

r e f e r

X

legend: 1,2,3: component 1, 2 or 3 accon: accounting module gulat: regulation database prefo: preference-ordering module finim: financial-impact module disag: disaggregation module refer: reference database

Exhibit 6-34. Use of the various modules during the experimentation period.

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SUMMARY OF COMPUTERIZED-SUPPORT USE

In exhibit 6-34 the use of the various modules during the experimentation period is summarized.

6.5 Conclusion

The previous section gives us a description of six months experimental use of the system.

The system is presented to Europhar at the end of March in Year 5. When performing "real-life" tests, the researcher has no full control over the experiment. From the point of view of the experiment, we are pleased to observe that a problem came up in the beginning of April Year 5. This problem gave us the possibility to test the system in a "real-life" situation.

We would like to put forward that system use during this period was still experimental as, for example, the facilitator is still somebody external to Europhar and the decision support system was not yet integrated in the MIS.

A last point to note is that before and during the group session, the participants used the system for decision support and stuck to the decision-process structure. After the group session, mainly the computerized support was used for negotiation support. As explained in chapter 4, negotiation support is not the aim of the system.

With the prescriptive empirical model in experimental use for six months, we have a basis to evaluate the system.

135


136

7

EVALUATION

7.1 Introduction

The second research question, as formulated in chapter 1 (B'), is the following:

What are the effects of the use of the prescriptive empirical model on organizational decision making?

As explained in chapter 1, the prescriptive empirical model should be regarded as an experimental system and not as a full system. The aim of the evaluation of the empirical model is to establish the value of the proposed concept: the prescriptive conceptual model. In this chapter we evaluate the prescriptive empirical model.

We realize, however, that "evaluation is perhaps the most difficult aspect of decision support systems development especially since such systems are evolutionary in nature", see Keen and Scott Morton [1978, p. 213]. Choosing when to evaluate them is as difficult as choosing how.

The decision to evaluate the system in September of Year 5 is mainly based upon the consideration that in September the attention of the participants shifted towards preparing the budgets for Year 6. Although various plans existed to add new features to the system, these would not be carried out until after the budget-preparation period due to time constraints of organizational members involved.

Turning to the question how to evaluate the system, Keen and Scott Morton [1978] present a multitude of evaluation approaches to be matched to a specific situation. Each of these approaches can contribute to insight in the performance of the prescriptive empirical model and hence in the feasibility of the prescriptive conceptual model.

As Keen and Scott Morton only consider approaches to evaluate systems already in use, however, one indicator of system performance is omitted: system use itself. We consider system use during the experimentation period as described in the previous chapter our "hardest" and best indicator of system quality: during six months, the system has been used to solve "real-life" problems, see chapter 6. In this period, system use has been supported by the participants and top management. As rather large sums of money were involved in decision making, this expresses confidence in the system.

Following Keen and Scott Morton [1978] the following approaches have been considered for evaluation of the experimental system:

137

EVALUATION Ch. 7

Output of the system The ideal performance measure would be to determine the impact of the system on financing, commercial and fiscal company goals. The exact determination of system impact, however, is impossible, see exhibit 7-1. In the first place, the effect is disturbed as most changes in the environment are reflected in the company goals. Another aspect is that the figures that result from financing decisions are subject to negotiations with the various authorities. Thirdly, it should be realized that the time lag between financing decisions and company goals is about three or four years. As a surrogate measure, we will use the impact on company goals as expected by the participants.

financing decisions

disturbing factors

financing, fiscal -► and commercial

effects

interpretation -► and

negotiation

time l a g

company g o a l s

Exhibit 7-1. The indirect effect between financing decisions and company goals.

Changes in the decision process As decision-process structure is one of the main elements of the system, it will be clear that we compare the decision process before and after introduction of the system. To gain insight in the process structure before and after introduction of the system, meetings have been recorded on video and audio tape and computer use has been logged by means of the specially designed logging facility. The previous chapter shows that the decision process after system implementation neatly matches the process structure as designed in the prescriptive conceptual model. Time spent on decision making and number of alternatives are also analyzed. For a comparison of the decision situations as described in the chapters 5 and 6, see exhibit 7-2.

138


relevant actions with frequency information available but not shared with other participants considerable loss of time due to search for information number of times that participants are missing need for properly actualized budget information on alternatives lacking number of operational or relocation alternatives evaluated number of financing alternatives evaluated (at aggregate level) general complaints about the complexity of the issue disaggregation without systematic selection of articles quantitative insight in consequences of actions impossible when needed sensitivity analyses with regard to external parameters impossible when needed no proper introduction or résumé when relevant change of subject of the meeting without proper conclusion manual calculation error choice task mixed with integrative-design task

legend: ai frequency of actions during the meeting of July Year 4 b: frequency of actions during the group session

Exhibit 7-2. Comparison of frequency distributions of actions taken during two meetings.

Manager's assessment of the system's value This method is the one on which our evaluation is mainly based, see the next section. Keen and Scott Morton [1978, p. 223] describe this evaluation method as "effective" as decision makers "frequently have a very shrewd sense of what a resource or service is 'worth'". This is not to say that we would not have preferred a harder, more objective way of performance measurement. According to Ives and Olson [1983], however, "user information satisfaction provides a meaningful 'surrogate' for the critical but unmeasurable result of an information system, namely, changes in organizational effectiveness".

Anecdotal evidence Keen and Scott Morton consider it useful that a more formal evaluation is supplemented by "anecdotal" evidence such as insights, examples, opinions and events collected by a skilled observer. In our case this anecdotal evidence, like letters and internal memos, supplements the evaluation interviews. Quotes taken from the anecdotal evidence are included in the overall evaluation as presented in section 7.3. An example is presented in exhibit 7-3. Note that this letter is adapted to the Europhar situation, see chapter 5.

139

EVALUATION Ch. 7

Mr N. Katwijk Manager European Region Europhar International BV Amsterdam The Netherlands

London, June 2nd, Year S.

Dear Mr Katwijk,

As decided earlier this week, the evaluation of the TP-DSS system is scheduled for our Europhar UK board meeting on June 14th. On your request, X send you our view on its value in advance. Derecks and I have discussed both the group session on the 28th/29th April in Amsterdam and the work and effort that went into the preparation of that meeting. Preparation As is well appreciated, the complexity of the difficulties faced by Europhar UK Ltd with the interrelationship of the NHS and the fiscal authorities has been a problem looking for a solution for a number of years. In addition, our financing problems, one way or other, are chronic. Therefore, it was with enthusiasm that we viewed the system devised by Delft University. We found the whole system well researched and considered that all the relevant factors with their interrelationships and effects had been carefully assessed and included. Personal Wizard proved to be an adequate piece of software. Pre-reading and instruction were also thought to be of good quality. The group session Due to the high quality of the preparation for this meeting and the positive attitudes that were taken by the participants (team setting), the meeting turned out to be extremely valuable. It was well controlled by the facilitator without his deliberately trying to influence the participants' views. The group contained sufficient expertise for the task and, as has already been stated, was well motivated. There were good practical facilities and the software modules worked. By the end of the second day it was clear that the value of the system was well appreciated, particularly as it was possible in two days to reach clear decisions with a positive effect on all three aspects (financing, commercial and fiscal) of our complex problem. This is particularly rewarding as these difficulties have been constant for a number of years and it appears that the reason that they have not been solved previously was our inability to relate adequately the cross-effects of a number of interrelated decisions reached in isolation. In summary, both Derecks and 1 found the meeting stimulating and the system practical and valuable. Yours Sincerely,

Europhar UK Ltd J. O'Brian, General Manager

Copy : Mr R. Marcus, Financial Director Mr V. Gisbers, Marketing Director

Exhibit 7-3. A letter from the UK general manager.

140

Sec. 7.2 QUESTIONNAIRE AND ANSWERS

7.2 Questionnaire and answers

Following Keen and Scott Morton's approach of the manager's assessment, see above, evaluation interviews played a major role in determining system performance. In September Year 5, questionnaires were sent to all participants with the request to think about the questions in advance. The interviews took place during October Year 5. It is important to realize that, as described in the previous chapter, the participants used the system together before the interviews took place. Exchange of information and opinion with regard of the system took place on a regular basis. It is likely that parts of the questionnaire were discussed amongst participants in advance. This implies that the answers given are not independent of each other. We used individual interviews to elicit as much comment as possible. Another reason for individual interviews was that it was much more practical than a group interview, especially as two participants live in the UK.

We did choose for evaluation by means of structured interviews for the following two reasons: - As all participants had to fill in the same questionnaire during the interview, it

would be possible to compare and aggregate the answers. The questionnaire had the advantage that no important aspects would be forgotten.

- In case not all issues were exactly covered by the questionnaire, the interviewer would have the possibility to elicit comments.

The interviews took on average one hour and a half. After the questionnaires were filled in, they were signed for agreement. Besides the interviews with participants, two short interviews took place with top managers (Gisbers and Marcus) involved. During these interviews a few questions from the participants questionnaire were presented. We would like to stress, however, that perception by top management of the quality of the system was completely indirect: none of the two top managers had any direct experience with the system. Their point of view was fully based upon the signals that they received from the organizational members that were involved. These two interviews took 15 minutes each. For a detailed description of the set up and outcome of the interviews, see Van der Ven [1989a].

Answers to the questions are relevant. Perhaps even of greater relevance, however, are the comments provided. In combination with the answers given, it is our impression that the comments give a profound insight in the points of view of the organizational members involved. In exhibit 7-4 a scheme with the answers of the participants is provided. Answers concern the impact on three categories of variables: company goals, confidence and insight, and the decision process.

141

EVALUATION Ch. 7

question A: impact on company goals 1 impact on financing company goals 2 impact on commercial company goals 3 impact on fiscal company goals 4 impact on financing, commercial and fiscal goals A * n It n n n it n

B: impact on confidence and insight 1 general problem understanding of transfer pricing I It it it it it n tt

2 general problem understanding of the UK situation 2 * tt n n tt it it it

3 insight in the reasons behind a specific decision 4 insight in effects of financing alternatives 5 insight in effects of external parameters 6 insight in regulations 7 insight of one's own point of view 8 insight of point of view of other participants 9 insight in financial impact (cost) 10 insight in disaggregation 11 insight in reference prices 12 confidence in the decisions made 1 2 * n u n it it

13 acceptance of the decision within the organization i » n it it it it it n

C: impact on the decision process 1 number of financing alternatives evaluated 2 time spent on decision-making (notes deterioration) 3 effectiveness of time spent in decision making 4 effectiveness of communication with participants 5 effectiveness of communication with non participants

*

*

* *

* *

answer ni -----ni 1 -2 ----1 ---1 ----ni ---1

mi 2 1 3 1 -

mi 5 1 2 -1 1 -4 2 1 --3 --2 -

mi -see 1 1 2

frequency si 4 5 2 2 2 si -1 2 2 4 5 2 1 3 5 4 5 -5 2 1 1 si 6 main 4 3 2

hsi ---1 3 -

hsi ----- -1 -2 2

1 -- 2 1

2 1 -2 1

1 hsi --text 1 2 -1 -

legend: * : answers from the two top managers ni : no impact mi : modest improvement si : significant improvement hsi : highly significant improvement

: no opinion

Exhibit 7-4. Frequency distribution of answers on impact of system use.

The seven-point scale that was used in the questionnaire ranged from "highly significant deterioration" to "highly significant improvement". The answers on question C-2 (time spent on decision-making) are the only ones that indicate a deterioration. The frequencies of the answers obtained for question C-2 are:

-: highly significant deterioration, 1: significant deterioration, 4: modest deterioration, 1: no impact, -: modest improvement, -: significant improvement, -: highly significant improvement, -: no opinion.

Exhibit 7-4 shows that the impact is positive in most cases. In a few cases there is no impact but, except for time spent (question C-2), the impact is never negative.

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Exhibit 7-5 presents the contribution of the various system elements to system performance.

question D: contribution of the system elements 1 contribution of 2 contribution of 3 contribution of A contribution of 5 contribution of 6 contribution of 7 contribution of 8 contribution of 9 contribution of 10 contribution of 11 contribution of 12 contribution of 13 contribution of 1A contribution of 15 contribution of 16 contribution of 17 contribution of 18 contribution of 19 contribution of

the authorizer role the analyst role the facilitator role the three roles system use outside the group session system use during the group session actualize and review task feasible-solution search task preference-ordering task dlsaggregatlon task the entire process structure the accounting module the regulation database the preference-ordering module Che financial-impact module Che dlsaggregatlon module the reference database Che six software modules the problem specification

answer ni 2 1 ----------2 -_ --_ -

spc 2 --1 ----2 ----2 --1 . -

frequency pc 1 2 1 3 A 2 3 5 3 A 2 3 1 1 A 2 3 2 2

lpc 1 3 5 2 -A 2 1 1 2 A 1 -1 -2 -A A

_ ----2 -1 ----2 3 2 2 2 2 --

legend: ni : no impact spc : small positive contribucion pc : positive contribution lpc : large positive contribution

: no opinion

Exhibit 7-5. Frequency distribution of answers on contribution of system elements.

Exhibit 7-5 shows that the contribution is positive in most cases. In some cases there is no impact but the contribution is never negative. We considered it important to search for a clear interpretation of the results. The null hypotheses that we consider are:

the system does not cause any improvement with regard to the company goals, the system. does not have any positive impact on problem understanding, insight or confidence, the system does not have any negative impact on time spent, the system does not have any positive impact on the decision process, system elements do not contribute positively to system performance.

section A:

section B:

question C-2: section C (other):

section D:

We use the following decision rule for rejection of the null hypotheses: - all six participants answered the question, so there are no "no opinions", and - all six answers are positive (except question C-2). This means that all participants

marked an "improvement" in the sections A, B or C (except question C-2) or a "positive contribution" in section D. For question C-2 (time spent) all answers should be negative.

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EVALUATION Ch. 7

The choice for this decision rule needs some explanation. From a statistical point of view, the respondents are a sample. The central question is, what is the population (or universe) to which this sample relates.

With regard to Europhar, all organizational members involved were interviewed. In other words, we interviewed the complete population, see Newbold [1988, p. 8]. So sample and population are identical. By presenting all answers, like we did above, all information that exists is already conveyed to the reader. We only need to summarize the results. This is the domain of descriptive statistics, see for instance Harnett [1982, p. 2].

It is also possible to consider the respondents a sample of the population of all decision-makers who might participate in a similar experiment. "Similar" means using a similar system in similar circumstances. Both the system and the circumstances must be similar, to provide that the answers have the same probability distribution. We include "similar systems" rather than identical systems, because different companies constitute different environments to the experiment and need different - adapted -versions of the prescriptive conceptual model. The answers of our sample would then be used to estimate the opinion of the entire population with regard to the effect of the use of a similar system in a similar company. This is the domain of inductive statistics, see Harnett [1982, p. 2 and 250] and Newbold [1988, p. 231].

AJI obstacle of using statistical inference is that the sample is not taken at random as all respondents are drawn from the same experiment. By consequence, the answers of different respondents are not independent. Organizational members are already working close together for a number of years. System development and system use are explicitly a group effort and the impact of the system is extensively discussed amongst participants and with top-management. The evaluation questionnaires were sent in advance and it is likely that these are also discussed amongst organizational members before the time of the interviews. So in fact we have drawn one respondent only: the group of organizational members involved. That the group opinion is determined by means of individual interviews, does not change this fundamental issue.

Given this point, however, we still want to aggregate the answers given by the six participants to a rejection or non rejection of the null hypotheses. Presuming mutual independence, we might use a statistical test to select a decision rule. Note that the selection of this decision rule is not based upon formal statistical inference. Statistics is only used to provide guidance.

As the results are measured on an ordinal scale, a non-parametric test is used, see Harnett [1982, pp. 695-696]. We have a sample of matched pairs (the before and after introduction situation), so the matched-pairs sign test is appropriate.

Below we present the way of calculation for all questions except question C-2 (time spent). The approach to question C-2 is similar. (We only have to interchange the roles of positive and negative.) We compare the "after introduction" situation with the "before introduction" situation. The before introduction situation is by definition "no

144


impact". We apply a one-sided test. If we require 2.5% significance, we get the table that is presented in exhibit 7-6, see Conover [1980, pp. 434-435].

n - Is P(X-l) - 50.00X (> 2.5X) n - 2: P(X-2> - 25.00* (> 2.51) n - 3: P(X-3) - 12.501 (> 2.5Ï) n - A: P(X-4) - 6.251 (> 2.51) n - 5: P(X-5) - 3.12Z (> 2.5X) n - 6: P(X-6> - 1.56Ï (< 2.51) n - 6: P(Xa5) - 10.94* (> 2.51)

legend: n: number of respondents with a positive or negative opinion. X: number of respondents with a positive opinion.

Exhibit 7-6. Table with probabilities.

For example, "n = 6: P(X = 6) = 1.56%" means: Given the null hypothesis and six respondents with a positive or negative opinion (n = 6), the probability that six respondents give a positive answer (X = 6) is 1.56%. The figures of this table can be translated into the decision rule that we presented above.

With the exception of question C-2 on time spent, there are no negative answers. Thus we can make a distinction between non-rejection of the null hypothesis caused by lack of observations, because of "no-opinion" answers and non rejection because of "no-impact" or "no-contribution" answers. We would like to stress, that in a statistical sense, this does not make any difference. That we decided to make a distinction in the presentation of the results, is because we consider it relevant for the interpretation. The following two examples might illustrate this issue:

- According to four respondents, the disaggregation module (question D-16) had a "large" (answered twice) or a "very large" (also answered twice) contribution to system performance. As two respondents were not directly involved in software use, they indicated "no opinion".

- With regard to the impact of system use on problem understanding (question B-2), the respondents answered as follows: Two times "no impact", two times "modest improvement" and two times "significant improvement".

From a statistical point of view, both answers are identical in the sense that four positive answers are given, which means that the null hypothesis cannot be rejected. In the case of the disaggregation module (question D-16), however, all participants involved are positive. The only problem is that we lack observations. The case of problem understanding (question B-2) is different: two respondents deliberately answer that their problem understanding did not increase. Therefore, non rejection of the null hypothesis caused by one or more "no-impact" or "no-contribution" answers (in some cases combined with "no opinion" answers) is interpreted as no impact or no contribution. Rejections caused by one or more "no-opinion" answers only, are interpreted as lack of observations. The classification shows that we require a lot

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EVALUATION Ch. 7

before we grant the classification positive impact or positive contribution as for this classification we need a positive answer from all six participants. Note that we use the term significant in another sense than in the questionnaire.

question A: impact on company goals 1 impact on financing company goals 2 impact on commercial company goals 3 impact on fiscal company goals 4 impact on financing, commercial and fiscal goals B: impact on confidence and insight 1 general problem understanding of transfer pricing 2 general problem understanding of the UK situation 3 insight in the reasons behind a specific decision 4 insight in effects of financing alternatives 5 insight in effects of external parameters 6 insight in regulations 7 insight of one's own point of view 8 insight of point of view of other participants 9 insight in the financial impact (cost) 10 insight in disaggregation 11 insight in reference prices 12 confidence in the decisions made 13 acceptance of the decision within the organization

C: impact on the decision process 1 number of financing alternatives evaluated 2 time spent on decision making (note: deterioration) 3 effectiveness of time spent in decision making A effectiveness of communication with participants 5 effectiveness of communication with non participants

ov jd

legend: ov jd! overall judgement * : a non-significant deterioration for time spent p : positive impact n : no impact

: lack of observations

Exhibit 7-7. Overall judgement on impact of system use.

On the basis of the information provided in exhibit 7-5, the five system elements with the highest scores are: - problem specification, - decision-process structure, - facilitator role, - group session, - six software modules.

The answers on these five questions dominate the answers on the other questions. For an explanation of the meaning of dominance, see Albers [1987, pp. 93-99]. For a detailed account of all results that were obtained, we refer to Van der Ven [1989a].

146


question Ds contribution of the system elements 1 contribution 2 contribution 3 contribution 4 contribution 5 contribution 6 contribution 7 contribution 8 contribution 9 contribution 10 contribution 11 contribution 12 contribution 13 contribution 14 contribution 15 contribution 16 contribution 17 contribution 18 contribution 19 contribution

of of of of of of of of of of of of of of of of of of of

the authorizer role the analyst role the facilitator role the three roles system use outside the group session system use during the group session the actualize and review task feasible-solution search task preference ordering task disaggregation task the entire process structure the accounting module the regulation database the preference-ordering module the financial-impact module the disaggregation module the reference database the six software modules the problem specification

ov jd

n n

* P P * P p P P

* P n ----

* P * P

legend: ov jd: overall judgement * I top-five score p : positive contribution n : no impact

: lack of observations

Exhibit 7-8. Overall judgement on contribution of system elements.

7.3 Overall evaluation

In this section the results as shown above, the comments given during the evaluation interviews, the analysis of the decision processes as described in chapter 5 and 6 and the anecdotal evidence are integrated into an overall evaluation.

Company goals Most participants considered the impact on the integration of all three aspects to be "significant" or "highly significant". A comment made was that "the sum of total integration was more important than the component elements". Top management indicated that they expected that the system caused a "significant improvement" of the attainment of company goals. The comments stressed the capacity of the system to integrate the three main aspects of financing decisions: financing, commercial and fiscal.

General problem understanding It is interesting to note that general problem understanding is not significantly increased, according to the participants. Background of these answers could be that all knowledge concerning the various aspects was already available within the company. At the time of the evaluation in Year 5, the participants and top management were already working closely together for nearly five years in order to solve transfer-pricing and financing problems. All aspects related to the problem were already extensively studied. This is perhaps best expressed by one of the comments made: "I considered

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EVALUATION Ch. 7

myself already an expert" and: "ample expertise on the financing, commercial and fiscal aspects ... was [already] available". The two top managers, however, both had the impression that problem understanding within the organization had increased. This in contrast to the participants.

Insight in reasons behind a specific decision The "why" behind a decision is better understood. When the decision processes in chapters 5 and 6 are compared, this will be clear. In the comments, different system aspects are indicated as the cause for this increased insight. The group session, the software modules, the process structure and the integration of financing, commercial and fiscal aspects are named as causes for the increased insight.

Insight in the effects of financing decisions and external parameters on company goals / accounting module This module is seen as an "excellent 'what-if tool" which helps to communicate the impact of the various alternatives to the other participants. The insight in the effects of financing decisions is increased significantly. As far as the external parameters are concerned, the Eurobitec relocation operation is named a few times. As not all participants were involved in the Eurobitec negotiations the improvement of the insight was not significant. The frequent use of the accounting module both inside as well as outside the group session, however, can be regarded as an important indicator of its performance. Comments made stress both the usefulness of this module inside as well as outside the group session.

Insight in regulations / regulation database Regulations are of overriding importance. The task descriptions in the prescriptive conceptual model, for example, indicates regulations as input for nearly every task. According to some participants, the system contributed to better insight in regulations due to a more effective communication with the experts within the group. Although the "structured approach [of the regulation database] provided a fresh view", the regulation database was seldom used and is the only module which got a "no impact" evaluation. We consider the cause of this to be twofold. Firstly, the set up of the regulation database already provided this "fresh view". The participants already knew most of its contents (the regulations), because they were involved in setting up the module. Therefore, no further need to consult the database existed. Secondly, it is our impression that the on-line storage of information in text mode, at least for this purpose, is not suitable. The approach lacked flexibility.

Insight in one's own and other's point of view / preference-ordering module As the outcome indicates, the strength of the preference-ordering module was especially that it provided insight in the point of view of others. It was considered a "very good aid for mtra-group communication" as "others were 'forced' to express and explain their point of view". Own preferences ("gut feeling") of participants were already well understood. With regard to this aspect, some additional points were made. Firstly, that "informality of the meeting was of great importance" as "together with the structured approach it stimulated explicit disclosure". Secondly, the multi-criteria technique was considered to be "complex". Additional training was requested as

148

Sec. 7.3 OVERALL EVALUATION

participants wanted to "play around with this module" for better understanding. A last point that was made was that the tool should not be used as a "voting instrument", but only to build "consensus".

Insight in the financial impact / financial-impact module Although not all participants were involved in the use of this module, all answers given were positive. Especially "the reasoning behind it", as discussed in chapter 3, was considered useful. The module "revealed previously unknown consolidated impacts" and the outcome was sometimes considered "surprising".

Insight in disaggregation / disaggregation module Of all modules, the disaggregation module obtained the highest scores. These scores dominate the scores for the other modules. Insight in the disaggregation effect scored also very high. Background of these scores is the introduction of the NHS-destination ratio. This new concept is a "very effective tool" as it "reduces a complicated activity to a single sheet of paper". The destination-ratio "was frequently used" during the experimentation period. It is realized that "without computer support the calculation of these effects would have been impossible". The need for the combined use of the disaggregation and accounting module was put forward.

Insight in reference prices / reference database The contribution of this module was not highly valued. This is not because the information provided was not considered useful. The reason is that "reference prices were already systematically calculated" and therefore the database "provided no new information", although the reference database provided some extra facilities which were appreciated. In other words, a reference database already existed within Europhar.

Confidence in the decisions made Both participants and top management indicated a significant impact of system use on their confidence. The two elements that caused this higher confidence were: integration of all aspects (financing, commercial and fiscal) and the structured approach to decision making.

The degree of acceptance within the organization Although not all respondents answered this question, especially the comments indicate that the confidence within the organization increased. In relation to the degree of acceptance two aspects were relevant: the negotiations with Eurobitec and the authorization procedures. With regard to Eurobitec "the negotiation position improved" as Europhar was "able to convince by means of hard figures". With regard to authorization procedures, the system and expertise "gave top management greater confidence in decisions made". As Gisbers and Marcus both indicated a "significant increase" for "confidence in the decisions made", this point of view is endorsed by top management itself.

The number of financing alternatives evaluated As the comparison of the decision process before and after implementation of the system already shows (see chapter 5 and 6), the number of financing alternatives (at

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EVALUATION Ch. 7

aggregate level) evaluated during a meeting increased from 4 to 13. The answers from the participants indicate a significant improvement, mainly due to the analysis and review task in April of Year 5. "For the first time the whole range of alternative financing actions were considered at one session. Previously a single alternative would have been selected on expediency grounds".

Time spent and effectiveness of time spent Time spent is the only aspect of the system that obtained negative scores. According to five participants, time spent increased, "mainly in April Year 5". The impression of the participants that time spent in preparation increased, is supported by the comparison of the decision processes as described in chapter 5 and 6. The effectiveness of time spent, however increased substantially, according to the participants. "More time was spent in developing background knowledge and in developing alternatives -this must be a good thing". "The quality of time spent was significantly higher". "Due to interest and the need to understand, more time was involved than originally anticipated".

Effectiveness of communication The effectiveness of the communication between participants increased significantly. According to the comments, the following elements are believed to have contributed to better communication between the participants: - all participants were present at one meeting, - informality of the meeting was combined with a structured approach, - more background knowledge was available. It was put forward that "some previous sessions were not an example of effective communication". This last comment is supported by the descriptive empirical model in chapter 5. According to five participants, the effectiveness of communication with other organizational members improved. Communication with the support staff and Eurobitec were named in this respect.

Structure of the decision process One of the five highest scores obtained is for the structure of the decision process. Here is put forward that "previous attempts on group-decision making have resulted in few decisions of any value being made" and that "before introduction of the system, the decision process was very unstructured". Use of the software modules and the facilitator role are considered "essential". The three tasks feasible-solution search, preference ordering and disaggregation are considered to have contributed significantly to system performance. The highest scores were for the disaggregation task. Lowest scores, although still significant, were for the preference-ordering task.

Roles of organizational members The use of explicitly defined roles and the role of the facihtator did contribute significantly to system performance. As the authorizer and analyst role already existed, no significant difference was noticed in comparison with the old situation. With regard to the facilitator role the comments can be summarized as follows: "This central role was extremely important to keep the discussion on the correct track. The facihtator had the role of watchdog. He maintained the decision-process structure. The

150

Sec. 7.3 OVERALL EVALUATION

combination process structure - facilitator can be regarded as the strongest point of the system. It was important that the facilitator did not try to influence the participants views." The facilitator role obtained one of the five highest scores. With regard to the three roles in general, the comment was made that the explicit introduction of team setting was realistic and necessary. With regard to the analysts the comment was made that their extra contribution was very much linked to the use of the software modules. Nijboer's positive contribution during the actualize and review task was explicitly mentioned.

System use inside and outside the group session The group session had one of the five highest scores and was described as "the best meeting on the UK I ever participated in". It was considered that during the group session, the structure, roles and software were integrated. Due to this integration, the system "achieved it's proper value" during the group session. Outside the group session, both the preparation and the Eurobitec negotiations after the session are considered to have benefitted from the system. Although not all participants were sufficiently involved in the actualize and review task to give an opinion, the answers that were obtained were positive. The task was considered to have been "the basis of the group session and the follow up". In itself, however, this task made "relatively little impact". The Eurobitec negotiations after the group session benefitted from the system due to better understanding of the "integral relationship" between the various aspects of the problem. As not all participants were involved, however, scores are not significant.

All six software modules The contribution of the six software modules to system performance obtained a "top-five" score. The "integration of all modules was effective". "Computerized support played an extremely important part in speeding up the process. Previously such decisions would have been reached only after a series of meetings which would have required the attendance of the whole group at each meeting. This is not practical in view of the time constraints of each participant." "Personal Wizard proved to be an adequate piece of software".

Problem specification Problem specification also obtained a "top-five" score. Exclusion of operational and/or relocation alternatives is considered "unavoidable" because "inclusion would have led to a vague discussion as the expertise with regard to these matters was missing amongst participants". Limitation of the problem space, however, "is only possible when the budget (especially sales) has been actualized in advance". The inclusion of non-pricing financing alternatives was merited as "it enabled participants to concentrate on all financing problems simultaneously".

7.4 Conclusion

As explained in chapter 4, our design approach was explicitly to keep the system "simple and sufficient". In an internal Europhar publication, see Van der Ven [1989a], the system is described by Europhar as "advanced and sophisticated". The comments

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EVALUATION Ch. 7

on the multi-criteria technique also indicate that the participants have another view on the simplicity of the system.

A second conclusion is that none of the system aspects in itself is sufficient to provide effective decision support. It is the integration of problem specification, decision-process structure, roles of organizational members and computerized support that aid the participants in their decision-making task. It is the entire concept, and not merely the software modules or one of the other aspects that leaded to improved decision making. To stress this point, we would like to finish this chapter with a piece of "anecdotal evidence". In the beginning of May Year 5, just after the group session, the author, who also performed the role of facilitator, had an informal chat with Katwijk. Katwijk said the following:

"Over the weekend, I have been thinking. We have been struggling with problems in the UK for several years on end. We did not manage to master the problem. Now you come around with your system, sway your arms in front of us during two days, and see, you manage to 'solve' our problem as far as the UK problem can be solved. How can you succeed where we could not? We are not that stupid and you are not that smart.

I have been thinking. It was not you, Mike, neither the software, nor us. What you did was, you blended all know-how available in the group together by means of the structure and you combined it with computers which checked our expectancies by means of 'what-if. It was the combination of all things which made it a success".

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8

SUMMARY AND CONCLUSIONS

8.1 Summary of findings

International transfer pricing is a good example of an area where multinational corporations are confronted with a "hostile, complex and turbulent" environment. Consequently, it is a good test case for the approach to aid organizational decision makers as described by Huber [1984b]. In chapter 1, we formulated our hypothesis that group decision support systems are helpful for improving decision making with regard to transfer prices in the pharmaceutical industry. The first research question (A') which we tried to answer in this thesis is:

What are the characteristics of the prescriptive conceptual model?

The three main conclusions with regard to this first research question are:

- The provision of computerized decision support is in itself not sufficient for improving group decision making. In addition to computerized tools, clear roles of the support staff and participants should be defined. Problem specification, use of support tools and roles of organizational members should be integrated by means of a prescriptive decision-process structure.

- Within organizations, usually sufficient hardware and software is available to provide group decision support. In our case, we used two personal computers and the software tool Personal Wizard. High technology is not a prerequisite for effective decision support. It might even be argued that sophisticated technology distracts the attention from more important issues like problem specification, decision-process structure and roles. From a cost perspective, our approach to group-decision support is a viable one. No expensive hardware is needed to set up a decision room. The decision room is created on an ad-hoc basis by using the personal computers of the participants involved. Besides the cost aspect, this approach offers the possibility to experiment freely and to introduce group decision support gradually into the organization. We consider our approach especially valuable for providing group decision support at the administrative level, see also chapter 4.

- The multi-criteria technique used in the preference-ordering module was clearly new to the participants. They considered the approach complex and requested additional training. On the basis of literature study, however, we considered our approach extremely simple and exactly fitting into our "simple and sufficient" approach. In chapter 4, we discussed the practicality gap. The evaluation of the preference-ordering module indicates that this practicality gap is even larger than we expected.

The second research question (B') that we tried to answer in this thesis is:

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SUMMARY AND CONCLUSIONS Ch. 8

What are the effects of the use of the prescriptive empirical model on organizational decision making?

In complex cases like ours it is very difficult to establish a direct cause - effect relationship between company goals and the instruments used. The aim of the system is to aid decision makers by means of implementation of the prescriptive conceptual model. Improvement of decision making is the focus of attention. As it is in our case impossible to measure the direct impact of the system on company goals, evaluation of the experimental system took place by means of a scala of secondary criteria for performance measurement. These criteria relate to: - the quality of the chosen solution as perceived by participants and top management, - the actual decision process and actual use of the system compared to the

prescriptive conceptual model and the descriptive empirical model, - the improvement of the decision process as perceived by top management and the

participants. Applying these criteria shows that the quality of the decision process has improved.

Although the system is developed specifically for the Europhar company, the points of departure of the prescriptive conceptual model have been checked by means of: - a survey among transfer-price experts, see Van der Ven [1989a], - study of transfer-pricing literature, - study of the environment and structure of the pharmaceutical industry. Hence we made it plausible that within most European pharmaceutical companies: - international transfer pricing, and not management-control transfer pricing is the

focus of attention, - transfer-price determination is a part of the problem of local company financing

and transfer prices are one financing instrument amongst various others, - transfer prices are decided upon by a group of experts and managers. As system use and system evaluation at Europhar both indicate an improved decision process, we consider this experiment a first test of a more generalizable prescriptive conceptual model. On the basis of various contacts within the European pharmaceutical industry, we expect that our approach can contribute to more effective decision making for other pharmaceutical companies as well.

Our experience might be helpful for others who are active in the area of designing group decision support systems. It is our impression that in design, careful attention should be paid to the following issues:

- Proper analysis of the task structure is of overriding importance and should receive sufficient attention. In this respect, we consider the technique as developed by Bots and Sol [1987] useful. This technique is an excellent aid to "structure an ill-structured problem".

- In group decision support literature, the problem of "minimum frequency of use" of a system is usually approached by means of widening the scope of the group decision support system. The design should be such that group decision making related to various organizational areas can be supported, see Huber [1984b].

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Sec. 8.1 SUMMARY OF FINDINGS

Consequently, the support system should be of a general nature. In our experimental system, however, another approach is taken. We use a relatively easy to use software tool (Personal Wizard). Frequency of use should be guaranteed by use of the developed application-domain support by decision makers. We focus on integrating the decision support into the organization. So support should be available for all those who are concerned with determining transfer prices and other financing alternatives, whether working individually or with others. We have the impression that the importance of application-domain knowledge is not sufficiently stressed in current (group) decision support literature.

- When developing group decision support systems for use within organizations, it should be accepted that some decision makers are computer illiterate and wish to remain that way. These decision makers want to concentrate on their own area of expertise and prefer not to be "bothered" by computers. Therefore, not every participant should be forced to provide (some) of the input for the group session via a terminal. An alternative way of using a group decision support system is to have a staff member available who operates the computer in his role of "analyst". System use via an analyst can be seen as a gradual way of integrating group decision support in the organization.

- When implementing a (group) decision support system, careful attention should be paid to the existing infrastructure with regard to software tools available and formal information flows as provided by existing information systems. Whenever possible, the existing tools, which are already known to technical support staff and participants, should be used. Decision support should build on the infrastructure as far as information systems are concerned. Decision support should focus on making existing information more effective. It should be avoided to create new formalized information flows.

8.2 Future research

In essence, see Keen and Scott Morton [1978], development of decision support systems is an interactive ongoing process. Developments of decision support systems for transfer pricing should continue. Our research indicates the following new directions:

- The disaggregation module and the accounting module received the highest scores during the evaluation interviews. Technically speaking, integration of the disaggregation module and the accounting module is possible. What would be the implications for use and maintainability if this would be done? What are the advantages and disadvantages? How can the accounting- and disaggregation module be improved?

- The preference-ordering module is considered to be complex. What training is needed to stimulate effective communication with the help of this tool? How can the preference-ordering module be improved?.

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SUMMARY AND CONCLUSIONS Ch. 8

- Participants started to use the system for internal negotiation support. What enhancements to the system need to be made to support negotiations more effectively? How can the system be used during negotiations with, for example, fiscal authorities and health-care services? What facilities should be added to make it an effective internal and external negotiation support system?

- In an early stage of the development process, it was tried to bring regulations concerning transfer prices and other financing alternatives together in a knowledge-based system. After a few discussion drafts, it was realized that the development of such a system could not be handled within the framework of the research project. As explained in chapter 6, we decided to store fiscal information in text mode. As explained in chapter 3, regulations are the main concern in international transfer pricing. It is our impression that the development of a knowledge-based system for this area would be a very worthwhile exercise.

- The project limited itself to the decision room and other "close-proximity" decision support without using electronic mail. Communication between the divisional head office and the subsidiary, however, is of significant importance. During the six months of the experiment, frequent communication took place by means of telex, telefax, letters and visits. What would be the advantages and disadvantages of including video conferencing, electronic mail and other ways of communication? What would be the contribution of a local decision network at the head office?

- The project limited itself to the development of an initial "version 0" system, see chapter 1. The project was an explicit research project. After this "research" effort, it would be interesting to continue with "development". In this respect, the following aspects may be considered:

- The set up of a system in other software tools. What are advantages and drawbacks of using another tool? This question is especially relevant in case we want to implement the system at a company that uses other software tools for its own budgeting and reporting purposes.

- The integration of the software modules with already existing systems that provide financial management information. New budgets and transfer-price information, for example, could then automatically be incorporated in the software modules.

- According to Brussaard [1982], users often exaggerate the differences that exist between organizations. On the basis of this exaggeration, they claim that systems developed by others are not appropriate for their organization. System designers, on the other hand, also exaggerate, according to Brussaard. They usually claim that general use of their system is possible. As explained above, we claim that our prescriptive conceptual model can be used to develop decision support for other pharmaceutical companies. It would be interesting to test our claim by means of future experiments.

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164

List of exhibits

Exhibit 1-1. Categories of models 5 Exhibit 1-2. Overview of the research approach 8 Exhibit 2-1. Organizational structure of a typical pharmaceutical company. . 14 Exhibit 2-2. First part of the NHS-profit calculation 17 Exhibit 2-3. Second part of the NHS-profit calculation 18 Exhibit 3-1. Eccles' contingency approach to management control 26 Exhibit 3-2. Financial impact of a transfer-price decrease 35 Exhibit 3-3. Financial impact of an increase in current account 35 Exhibit 3-4. Financial impact of an intracompany loan 36 Exhibit 3-5. Calculation of the interest payments for an intracompany loan. 36 Exhibit 3-6. Summary of the financial-impact results 37 Exhibit 3-7. The place of pharmaceutical companies in Eccles' contingency

approach to management control 39 Exhibit 3-8. The importance of various kinds of transfer pricing for the

pharmaceutical industry. 40 Exhibit 3-9. The basic pattern between source company, object company and

destination 41 Exhibit 3-10. Relationships within a multinational 42 Exhibit 4-1. Proposed structure of the problem-solving task 52 Exhibit 4-2. Proposed structure of the decision-making task 53 Exhibit 4-3. Formula for normalized weight 55 Exhibit 4-4. Formula for total score 55 Exhibit 4-5. Table with total scores 55 Exhibit 4-6. A basic taxonomy of group decision support systems 57 Exhibit 4-7. Possible set up of an ad-hoc decision room 61 Exhibit 5-1. Organizational scheme of the Eurochem group 71 Exhibit 5-2. Relationships of object company Europhar UK Ltd 73 Exhibit 5-3. Summary of financing alternatives decided upon at the end of the

meeting in July Year 4 77 Exhibit 5-4. Summary of financing alternatives decided upon in August

Year 4 78 Exhibit 5-5. Frequency distribution of actions taking place durmg the meeting

of July Year 4 80 Exhibit 5-6. Structure of the problem-solving task in the descriptive conceptual

model 82 Exhibit 5-7. Structure of die scan task 83 Exhibit 5-8. Structure of the decision-making task in the descriptive conceptual

model 84 Exhibit 6-1. The prescriptive conceptual model compared to the descriptive

conceptual model 88 Exhibit 6-2. Structure of the problem-solving task in the prescriptive conceptual

model 90 Exhibit 6-3. Structure of the decision-making task in the prescriptive conceptual

model 92 Exhibit 6-4. Structure of the feasible-solution search task 95 Exhibit 6-5. Structure of the preference-ordering task 97 Exhibit 6-6. Global outline of the computerized support 99 Exhibit 6-7. Four types of variables. . . . ' 100

165

List of exhibits

Exhibit 6-8. Main menu of the accounting module 101 Exhibit 6-9. Summary key-figures screen 101 Exhibit 6-10. Main menu of the financial-impact module 102 Exhibit 6-11. Actual-remittances screen 103 Exhibit 6-12. Screen with weights per participants 104 Exhibit 6-13. Example of an input/output matrix presenting conversion factors. 105 Exhibit 6-14. Screen with destination ratios 106 Exhibit 6-15. The accounting module 112 Exhibit 6-16. Submenu of the financial-impact module 113 Exhibit 6-17. The preference-ordering module 114 Exhibit 6-18. The disaggregation module 115 Exhibit 6-19. Summary key-figures screen (at start of the group session). . . 120 Exhibit 6-20. Summary of financing, commercial and fiscal targets 122 Exhibit 6-21. Screen with destination ratios (profit and loss iteration) 124 Exhibit 6-22. Maximal remittances per alternative (profit and loss iteration). 125 Exhibit 6-23. Example of a preference-ordering worksheet (printout) 126 Exhibit 6-24. Screen with actual remittances (profit and loss iteration) 126 Exhibit 6-25. Screen with normalized weights (profit and loss iteration). . . . 127 Exhibit 6-26. Summary key-figures screen (after profit and loss iteration). . . 128 Exhibit 6-27. Maximal remittances per alternative (balance-sheet iteration). . 129 Exhibit 6-28. Screen with actual remittances (balance-sheet iteration) 130 Exhibit 6-29. Screen with normalized weights (balance-sheet iteration) 130 Exhibit 6-30. Summary key-figures screen (after balance-sheet iteration). . . . 131 Exhibit 6-31. Old and new transfer prices for generic products 131 Exhibit 6-32. Old and new internal selling prices to Taiwan 131 Exhibit 6-33. The production process for Sofanaat 133 Exhibit 6-34. Use of the various modules during the experimentation period. 134 Exhibit 7-1. The indirect effect between financing decisions and company

goals 138 Exhibit 7-2. Comparison of frequency distributions of actions taken during two

meetings 139 Exhibit 7-3. A letter from the UK general manager 140 Exhibit 7-4. Frequency distribution of answers on impact of system use. . . 142 Exhibit 7-5. Frequency distribution of answers on contribution of system

elements 143 Exhibit 7-6. Table with probabilities 145 Exhibit 7-7. Overall judgement on impact of system use 146 Exhibit 7-8. Overall judgement on contribution of system elements 147

166

Samenvatting in het Nederlands

EEN GROEPS-BESLISSINGSONDERSTEUNEND SYSTEEM VOOR TRANSFERPRIJS BESLISSINGEN IN DE PHARMACEUTISCHE INDUSTRIE

Dit proefschrift brengt verslag uit van een onderzoek naar de mogelijkheden van groeps-beslissingsondersteunende systemen voor het oplossen van transferprijs problemen in de pharmaceutische industrie. Onderzocht is welke de eigenschappen van een dergelijk systeem zouden moeten zijn (onderzoeksvraag 1). Vervolgens is een experimenteel systeem met deze eigenschappen gebouwd. Deze experimentele versie is gebruikt voor het oplossen van transferprijs problemen in de praktijk. Op basis hiervan is een indruk verkregen van de geschiktheid van het ontworpen systeem om besluitvorming te ondersteunen (onderzoeksvraag 2).

Vier modellen en hun onderlinge relatie staan centraal in dit onderzoek. Deze modellen zijn: A. een beschrijvend empirisch model, B. een beschrijvend conceptueel model, C. een voorschrijvend conceptueel model, D. een voorschrijvend empirisch model. Een beschrijvend empirisch model (A) beschrijft de besluitvorming zoals die in een specifieke pharmaceutische onderneming is aangetroffen. Met name op basis van dit model is de achterliggende besluitvormingsstruktuur blootgelegd: een beschrijvend conceptueel model (B). Vervolgens is een voorschrijvend conceptueel model (C) ontworpen. Dit model geeft weer hoe de besluitvorming op effektievere wijze zou kunnen plaatsvinden. Het voorschrijvend conceptueel model is gebaseerd op analyse van de bestaande situatie (het beschrijvend conceptueel model (B)) en studie van literatuur op het gebied van beslissingsondersteuning, transferpnjzen en de pharmaceutische industrie. Het voorschrijvend conceptueel model geeft een antwoord op onderzoeksvraag 1. De implementatie van dit voorschrijvend conceptueel model leidt tot wat is gedefinieerd als het voorschrijvend empirisch model (D). De evaluatie van dit experimenteel systeem op basis van gebruik in de praktijk verschaft inzicht in de sterke en zwakke kanten van het voorschrijvend conceptueel model (C). Op deze wijze wordt een antwoord verkregen op onderzoeksvraag 2.

Op basis van literatuurstudie wordt geconcludeerd dat de pharmaceutische industrie zich bevindt in een complexe, vijandige en turbulente omgeving. Een belangrijk aspekt hierbij is de verhouding van de industrie tot de gezondheidsautoriteiten die verantwoordelijk zijn voor de kosten van het medicijngebruik. Daarnaast blijkt dat deze industrietak wordt gekenmerkt door een hoge mate van centralisatie, internationalisatie en vertikale integratie. De diversificatiegraad binnen de industrietak is echter laag.

De kenmerken van pharmaceutische bedrijven zoals hierboven genoemd leiden tot de konklusie dat het transferprijs beleid in deze bedrijfstak kan worden gekwalificeerd als "internationaal transferprijs beleid". Dit internationaal transferprijs beleid wordt immers bepaald op basis van regelgeving in diverse landen bij grensoverschrijdende transfers

167

Samenvatting

van goederen tussen verschillende delen van eenzelfde onderneming. Deze regelgeving is met name afkomstig van fiskale en gezondheidsautoriteiten. Daarnaast spelen financieringsaspekten een belangrijke rol. Transferprijs mutaties moeten dan ook worden beschouwd als één - zij het slechts één - van de financieringsinstrumenten die de onderneming ten dienste staan om geld binnen de onderneming te transfereren. Andere instrumenten zijn dividenden betaald aan een houdstermaatschappij, interne royalty betalingen, doorbelastingen van kosten en dergelijke. Tevens wordt gekonkludeerd dat het reëel is om te veronderstellen dat de betrokkenen bij het vaststellen van transferprijzen samenwerken in een "team" waarbinnen kennisuitwisseling centraal staat. De betrokkenen zijn fiskale specialisten, financieringsspecialisten, de prijscoördinator en tenslotte lokaal en centraal management. Door hen wordt naar consensus gezocht.

De analyse van de in de pharmaceutische industrie bestaande transferprijs situatie zoals hierboven omschreven wordt bevestigd door een enquête die onder 12 transferprijs experts is gehouden. Deze twaalf experts zijn werkzaam in de Europese pharmaceutische industrie.

Op basis van literatuurstudie op het gebied van beslissingsondersteuning worden bij het ontwerp van een groeps-beslissingsondersteunend systeem de volgende vier aspekten van belang geacht: - een probleem-specificatie, - een besluitvormingsstruktuur, - een rolverdeling voor de betrokken personen, - computerondersteuning. Naast deze vier aspekten is het van belang dat het gebruik van het systeem niet beperkt blijft tot computerondersteuning voor vergaderingen (de zogenaamde groepssessies). De betrokkenen moeten het systeem zowel binnen als buiten deze groepssessies kunnen gebruiken. Het systeem is dan ook niet ontworpen voor algemene groeps-beslissingsondersteuning maar specifiek voor het toepassingsgebied transferprijs bepaling. Hiermee hangt samen dat de groepssessies niet plaatsvinden in speciaal hiervoor gebouwde ruimtes (zogenaamde "beslissingskamers") maar in één van de vergaderzalen van de betrokken onderneming zelf. Zodra dit wenselijk wordt geacht moet een groepssessie kunnen worden gehouden. De computerondersteuning tijdens de groepssessie wordt geleverd met behulp van personal computers die ook buiten de groepssessie voor beslissingsondersteuning worden gebruikt.

De vermelde analyse van de bestaande situatie, die leidt tot het beschrijvend empirisch model (A), vindt plaats bij een grote Europese pharmaceutische onderneming (in deze dissertatie als "Europhar" aangeduid). Uit het op deze analyse gebaseerde beschrijvend conceptueel model (B) blijkt dat het groeps-besluitvormingsproces het best kan worden omschreven door het begrip "negatieve selektie". "Negatieve selektie" houdt in dat in principe de eerste oplossing waar de betrokkenen mee accoord gaan wordt gekozen. Systematische generatie en evaluatie van alternatieven vindt niet plaats.

Het ontworpen systeem (het voorschrijvend conceptueel model (C)) wordt beschreven aan de hand van de vier hierboven genoemde aspekten. De probleem-specificatie bakent het terrein af tot een financieringsprobleem. Tevens wordt er een onderscheid gemaakt

168

Samenvatting

tussen de financieringsproblematiek op korte en lange termijn. De korte termijn situatie wordt geanalyseerd op basis van een tot in detail gespecificeerde begroting. In de besluitvormingsstruktuur wordt een expliciet onderscheid gemaakt tussen de taken "voorbereidend ontwerp", "integrerend ontwerp" en "keuze". Er wordt dus een fasering aangebracht. In de rolverdeling worden de volgende rollen onderscheiden: participant in het besluitvormingsproces, autorisator van het besluitvormingsproces, analist en "facilitator". De analist is degene die zowel in als buiten de groepssessies de computer bedient. Hij is ook degene die de applikatie mee ontwikkelt. De facilitator struktureert het besluitvormingsproces, zowel in als buiten de groepssessies. De computerondersteuning bestaat uit drie databanken en drie rekenmodules. De databanken bevatten gegevens over de regels omtrent financiering zoals die door diverse autoriteiten zijn gesteld, kosteneffekten van de diverse financieringsalternatieven, en referentieprijzen. Twee rekenmodellen zijn specifiek voor transferprijs- en financieringsproblemen, en zijn bestemd voor de kwantitatieve "als-dan" analyse. Het derde rekenmodel is bestemd voor het toepassen van multi-criteria analyse. Doelstelling van dit rekenmodel is om effektieve communicatie tussen de leden van de groep te bevorderen. Het wordt niet gebruikt om een "groepsmening" of "groepsgemiddelde" uit te rekenen.

Op basis van het hierboven omschreven voorschrijvend conceptueel model (C) wordt een experimenteel systeem (het voorschrijvend empirisch model (D)) gebouwd en geïmplementeerd. Hiervoor wordt het softwarepakket "Personal Wizard" van Comshare gebruikt. Het experimenteel systeem is bestemd om besluitvorming met betrekking tot de Engelse dochteronderneming van Europhar te ondersteunen.

Na zes maanden experimenteel gebruik vinden de evaluatiegesprekken plaats. Hierbij wordt het gebruik op basis van het beschrijvend empirisch model (A) met het gebruik op basis van het voorschrijvend empirisch model (D) vergeleken. De zes participanten en twee topmanagers nemen deel aan deze interviews. Het blijkt dat het voorschrijvend empirisch model (D) niet alleen wordt gebruikt voor beslissingsondersteuning, doch ook voor ondersteuning van onderhandelingen met een aan Europhar gelieerde onderneming. Uit de evaluatie interviews komt naar voren dat zowel op financierings-commercieel als fiskaal gebied de invloed van het experimenteel systeem positief is. Bij de vraag naar de belangrijkste elementen van het systeem worden met name die elementen genoemd die bijdragen tot een integratie van alle aspekten, zoals de beslissingsstruktuur, de groepssessie en de rol van de facilitator. Daarnaast bieden volgens de participanten de rekenmodellen tot dan toe ongekende mogelijkheden voor de "als-dan" analyse.

Drie punten komen uit dit onderzoek naar voren: - Computerondersteuning op zichzelf is geen garantie voor verbetering van de kwaliteit

van de besluitvorming. Andere aspekten zoals hierboven geformuleerd dienen in het ontwerp te worden meegenomen.

- Beslissingsondersteuning voor groepen is in principe mogelijk met reeds in veel organisaties aanwezige hard- en software. De relatief dure "beslissingskamers" zijn dan niet noodzakelijk. Naast het kostenvoordeel biedt dit ook de mogelijkheid om groeps-beslissingsondersteuning geleidelijk in organisaties te introduceren.

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Samenvatting

- De multi-criteria techniek die onderdeel uitmaakt van de aangeboden beslissingsondersteuning kan, op basis van literatuurstudie, als eenvoudig worden bestempeld. De gebruikers vonden de techniek echter ingewikkeld. Dit duidt op een grote discrepantie tussen theorie en praktijk.

170

Acknowledgements First of all I would like to thank my promotor, Henk Sol. He is a stimulating personality and knows the delicate balance that is required in academic research: on the one hand he stimulates his Ph.D. students to independent thinking and developing their own approach, on the other hand he encourages cooperation and requires that the various research projects fit into larger scientific programs.

From the start of the project onwards, I have had frequent contact with most members of the Ph.D. committee. I am grateful that they were willing to share their profound expertise with me. This expertise ranged from knowledge-based systems, statistics and methodology to multi-criteria techniques and transfer pricing. I enjoyed the discussions and the provoking comments. These comments contributed significantly to the quality of my research.

It will be clear that our research would have been impossible without the cooperation of "Europhar". I would like to thank the top-managers, the participants, the analysts and the joint steering committee members. In particular thanks for the hospitality and friendship that I encountered while working in the United Kingdom.

During the years, technical assistance of Comshare was a great help. I experienced our cooperation as an example of how universities and software houses can work together effectively in the area of software development. Special thanks go to Bert Jaspers, Henk Teunissen and Nely van Westerop.

I would like to thank all my colleagues at the Department of Information Systems in Delft for the pleasant cooperation. The comments on earlier drafts of my thesis and our discussions have been extremely valuable. I particularly like to mention Frans van Schaik, Pieter Bots and the other members of the Kongsi.

Many students were involved in development of the system. I enjoyed their informal and result-oriented approach. Especially thanks to Eric Dielessen. The technical support that he provided at "Europhar" and during the various presentations was of great value.

As the list on the next page shows, many institutions helped me to progress in my research. Some institutions gave me valuable information, others provided financial and practical support. For their help I would like to express my sincere thanks.

Last but not least I would like to thank Koos Schonewille and Jan van Boekel for their friendship and practical assistance. They showed a commitment to quality and service that is rare to find.

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List of contributing institutions

- AKZO, pharmaceutical division, Oss, The Netherlands - Association of the British Pharmaceutical industry, London, United Kingdom - Bouman & Company, Den Bosch, The Netherlands - Catacombestichting, Valkenburg, The Netherlands - Ciba Geigy, pharmaceutical division, Basel, Switzerland - Comshare, Delft, The Netherlands - Decision Analysis Unit, London, United Kingdom - Delft University of Technology, Delft, The Netherlands - Duphar, Weesp, The Netherlands - Euroforum, Eindhoven, The Netherlands - Foundation for Medical and Pharmological Research, Utrecht, The Netherlands - Gist Brocades, pharmaceutical division, Delft, The Netherlands - Grasso's Koninklijke Machinefabrieken NV, Den Bosch, The Netherlands - Hank Schut Management Consultants, Laren, The Netherlands - Hoffman la Roche, pharmaceutical division, Basel, Switzerland - International Medical Statistics, The Hague, The Netherlands - International Bureau of Fiscal Documentation, Amsterdam, The Netherlands - Management Forum, Guildford, United Kingdom - National Facility of Informatics, The Hague, The Netherlands - Nefarma, Utrecht, The Netherlands - Office of Health Economics, London, United Kingdom - Omnia Tangit Oeconomia, Tilburg, The Netherlands - Stibbe, Blaisse & De Jong, Amsterdam, The Netherlands - Tilburg University, Tilburg, The Netherlands - Pharmaceutical Computer Club, London, United Kingdom - Vidia, Zeist, The Netherlands

About the author

Michael van der Ven (1956) obtained his master's degree in business from Tilburg University in the Netherlands in 1983 (cum laude). He specialized in information systems and marketing. He developed an information system at Scott Bader Ltd, a British chemical company. After six month's study at the Sorbonne in Paris he joined one of the large European pharmaceutical companies in 1984. As a financial staff member, he was responsible for the financial side of transfer pricing.

On the basis of a research agreement between Delft University of Technology and this company, he started his Ph.D. research in the beginning of 1986. He presented his research on scientific and management conferences in various European countries. Michael van der Ven acted as a management consultant in the area of (transfer) pricing and group decision support.

172

Index

accounting exchange rate 37 accounting module 100, 112, 113, 148 aggregation 15 analyst role 64, 150 Annual Financial Return 17 application domain 60, 64 arm's length 31 authorizer role 63, 150 average capital employed 20 bounded rationality 4 case study 6, 9 centralization 1, 13, 14, 21 choice phase 50 choice task 51, 54, 62, 93 communication technologies 45 comparable uncontrolled price method 31, 32 competitive organization 27 computer illiterate 59, 155 computerized support 61, 64, 81, 85, 98, 110 computing technologies 45-47 Comshare 69 conceptual model 5 consolidated profit 43 cooperative organization 27 coordinating decision 48, 51 cost structure 12, 14 cost-plus method 32 current account 33, 35 decentralization 1, 12, 24 decision network 57-59 decision room 57-61 decision rule 143-145 decision support generator 60 decision support system 2-4, 6 decision-group effectiveness 46 decision-group technologies 45-47 decision-making paradigm 3, 45, 47 decision-making task 49, 50, 53, 84 Department of Health and Social Security 16 descriptive conceptual model 5, 7, 81-85 descriptive empirical model 5, 7, 74, 78-81 design phase 50, 51 destination company 42 destination ratio 107 destination third 42 disaggregation 15 disaggregation module 106, 115, 116 diversification 12, 26

173

Index

dividend 33 divisional profit 25, 26 divisionalization 24 EFPIA 11 empirical model 5 Eurobitec negotiations 132 Eurobitec UK Ltd 70, 71 Eurochem 69, 71 European commission 15, 16 European pharmaceutical industry 11, 12 Europhar 7, 71 Europhar Australia Pty Ltd 71 Europhar International BV 34, 67, 71 Europhar Taiwan Ltd 71 Europhar UK Ltd 7, 34, 67, 71 ex ante 25, 39 ex post 25, 39 excess/shortfall calculation 20 expertise sharing 54, 56, 63 export third parties 72 external sale 42, 73 external selling price 42, 73 facilitator role 63, 150 financial-impact module 102, 113, 149 financing alternative 38 fiscal unit 69, 93, 133 generic sales 18, 72, 73 generics 16, 113 governmental interference 13 group decision support system 4, 57 group session 58, 119-132, 151 gut feeling 126, 129, 148 hardware 61, 69 hidden agendas 56, 63 human ethical drugs 11 human health care 13 hyper games 56, 63 ill-structured 2, 48, 57 implementation task 50 infrastructure 89, 155 innovation 47 integral decision making 51, 85, 100 integrative-design task 51 intelligence phase 49 internal reporting system 100 internal sale 42, 73 internal selling price 42, 73, 121, 125

174

international transfer pricing 29-38 internationalization 2, 13 intracompany loan 34, 112, 122 inventories 113 joint steering committee 68 key figures 100 local borrowing 37, 102, 114, 122, 129 local decision network 58, 59, 156 local lending 79, 102, 103 logging facility 102, 116, 138 lotus 1-2-3 69, 74, 75 management information system 28, 69, 100 market structure 12 Maud 54 memo 58, 74 minimum frequency of use 59, 154 multi-criteria decision making 54 multi-criteria technique 55, 62, 94, 99, 103, 115, 148, 152, 153 multinational 1 myriad of problems 81, 91 negotiation support 56, 132, 156 NHS-profit calculation 17, 18 normalized weight 55, 127, 130 null hypothesis 145 object company 40, 73, 105-107 organizational decision making 4, 6, 43, 49 overall evaluation 147 parent company 14, 41, 71 partial decision 79, 85 participant role 63, 88 path 51 Personal Wizard 111, 140, 151, 153, 155 Pharmaceutical Price Regulation Scheme 17 pilot system 6, 9, 117 post-industrial 3, 4, 45-47 practicality gap 54, 153 preference ordering 88, 93-101, 125, 129, 150 preference-ordering module 102, 113, 114, 148 preparatory-design task 50, 51, 84 preparatory meeting 117, 119, 121 prescriptive conceptual model 5, 61, 87 prescriptive empirical model 6, 87, 108, 137 problem solving 48-50, 52, 53, 82-84, 89, 90, 92, 97, 99, B l problem specification 61, 78, 81, 88, 108, 151 profit and loss iteration 123-128 profit center 27, 28 project management 46

Index

project-management technologies 47 public screen 46, 57, 61 questionnaire 141 reference database 105, 115, 149 reference price 42, 73, 105 regulation database 102, 112, 147 relocation alternative 38, 78 remote decision network 58 reporting system 100 resale-price method 32 research approach 4, 87 research questions 1, 4 return on capital 17, 20 scan task 49, 83, 90, 108 scenario analysis 100 score 54-56, 99, 103, 115, 126 sensitivity analysis 100 share capital 33 simple and sufficient 64, 65, 111, 151 software house 68, 111, 116 software modules 112, 140 source company 41, 42 subgroup meeting 79 subsidiary company 14, 15, 33, 67 support staff 59, 63, 85, 100, 110, 150 system impact 138 System W 69 task structure 51, 62, 91, 100, 154 team setting 11, 25, 39, 6, 63, 85, 100, 140, 151 teleconferencing facilities 58 therapeutic area 13 three-tier demand system 15 total adjusted profit 17, 18, 20 transfer price 1, 23 turbulent environment 21, 45 user interface 60, 101, 111 version 7, 111, 156 vertical integration 13, 26, 41 weight 55, 99, 103, 115, 125-127, 130 well-structured 2, 79 what-if 60, 81, 85, 100, 148, 152 worksheet 103, 105, 126

176