Case 15-5 Xerox Corporation Recommendations

Recommendations: 1. Domestic Transfer Pricing Domestic transfers of Xerox utilized a full standard cost price method while foreign transfers used an arm’s length market price method. From the case, we do not know how the sourcing decisions are made. Even so, setting the transfer price using the competitive market price is still better than setting the transfer price using cost-based transfer prices. If Xerox can use the market price for their foreign transfers, we recommend they use it for domestic transfers as well. Using the market price as their domestic transfer price can help Xerox better respond to a competitive pricing threat. In addition it does not require the corporate controller to step in to arbitrate transfer price disputes. 2. Multinational Transfer Pricing Xerox’s using of arm’s length market price method for foreign transfers seems fair. The method conforms to the US tax laws and to the OECD guidelines, which are also adopted by many non-OECD governments, too. OECD has 30 member countries, while Xerox operates in more than 160 countries worldwide. Therefore, that would mean such a transfer pricing strategy carries a greater taxation risk than solutions tailored to each country. Xerox could suffer double taxation or penalties in some countries. Also, there are many different ways of calculating the arm’s length price. We can see three traditional methods introduced in the textbook: Comparable uncontrolled price method, Resale price method, and Cost-plus method. There are some other non-traditional methods that are based on OECD guidelines and may be accepted by US or some other foreign governments. For examples, the Profit Split method, the Transactional Net Margin method, or APA, Advance Pricing Agreement. Xerox may want to explore all the possible alternatives and choose the best method in determining the arm’s length price. We also suggest Xerox can use some outside consultants in dealing with the transfer pricing and regulation issues. Many big accounting firms, such as Deloitte and KPMG, provide these services. Xerox may consider using the transfer pricing softwares developed by these accounting firms. Some enterprise system providers, like Oracle, also have good transfer pricing software that may be very helpful for the companies. 3. Transaction Exposure We don’t think all the business units should be responsible for their transaction currency exposure. The payables and receivables in different parts of the overall firm may naturally hedge each other. So, we think that the transaction currency exposure is best handled through centralized coordination of the corporation’s overall hedging

needs. This is likely to be cheaper and simpler, and it prevents the subsidiary manager from becoming a foreign exchange rate forecaster and speculator. We want them to focus on the main business operations. 4. Translation Exposure Subsidiary managers should not be held responsible for translation effects, but we don’t think that Xerox discounts the boosted financial results for unit performance measurement if the currency goes in a favorable direction for the foreign operation is a good way of evaluating the performance of subsidiaries. We suggest Xerox compare budgets and actual results using the same metric and isolate inflation-related effects through variance analysis. It can avoid unfair rewards or penalties and it is an easier method to understand and carry out than their current practice. Tracking Budget Initial Projected Ending Setting Initial 1 2 3 Budget Projected 4 5 6 Ending 7 8 9

5. Economic Exposure The subsidiary manager should be held responsible for the dependence effects of exchange rates resulting from economic exposure. It is appropriate for the control system to evaluate the subsidiary manager on decisions that would have enabled the subsidiary to respond to real exchange rate changes. Real exchange rate changes require important strategic and operating decisions. It is good for Xerox to have regular discussions about the currency and proposals for increasing market share or profits. 6. Performance Evaluation of Foreign Subsidiaries The performance measures are driven by the Manufacturing Support which is the central support function. The Venray plant is legally owned by Rank Xerox but it is evaluated by MS. In addition, the Venray product array supports more than one business division; therefore, Venray has to report to several other divisions besides MS. We suggest Xerox let the local people familiar with the culture and market manage their local environment and evaluate its business units according to their legal entities. It is easier for Xerox’s local subsidiary managers to see more of a direct link between their decisions and actions, including related evaluative feedback. In addition, this can aid in avoiding distortions of the plant's performance caused by transfer pricing and currency translation.