Managing Conflicts in Global Pharmaceutical Giant Galena Inc

Overview of Galena Inc

It was a long virtual web meeting and worse, it was inconclusive. Grace Jackson, Director -procurement in the Canadian division of Galena Inc, was quite irate in the manner US sub-division’s manager, Kyle Sanchez, was unilaterally trying to push the Sale of Caltona, a patented drug of choice for prevention and treatment of osteoporosis, to a new customer in US. Kyle S, President of US operations was arguing that this is in the best interests of the company as a whole, despite consistent and predictable orders from Galena’s Canada division, for the past 5 plus years. Ethan Rice, Global logistics head was also present to mediate and so was Anissa Khan, CFO to try and facilitate a negotiated settlement on behalf of Galena’s corporate team. But despite corporate’s best efforts, nothing of substance transpired at the end of the meeting and everyone decided to go back to the drawing board.

Galena is global pharmaceutical giant, with corporate headquarters in Ottawa, Canada. The rest of the world is arranged into five regions, viz – North America; Latin America; Western Europe; Eastern Europe, Middle East and Africa; Japan, Asia and Pacific. Each of these regions serve a number of countries within its jurisdiction. The company has nearly 35000 employees who include scientist researchers and various operational and functional specialists addressing health related concerns, both chronic and life-threatening. Since the regulatory mechanisms in every country in the pharma industry is different, each country unit operates autonomously and individual unit performance forms the basis of performance evaluation, including bonuses. Some of the key company wide performance indicators, aligned to its strategic objectives, against which performance is measured, are stated below. Specific target measures were negotiated between Corporate and the divisions and depends on individual country unit’s overall market circumstances and other factors.

• Sales growth
• Earnings growth
• Go to market – cycle time
• Product quality and Innovation 
• Customer responsiveness

The current issue centred around a prescription drug called Caltona, (see product description in Table 1), which had a steady offtake of 180,000 strips by the Canadian division from the US subsidiary. Although the company had its headquarters in Canada, it chose to manufacture most of its products in the US, primarily because US was a huge and profitable market, with easy access to highly skilled talent. Besides the tax rate in US was always lower and most importantly, the FDA approval process is so comprehensive that it becomes easier to release the drug for medical prescriptions and treatments in other countries. The net tax rate in US is 21% and in Canada is 38%.

Background on the Conflict

The US sub-division itself has a steady capacity of 600,000 strips of Caltona of which 400,000 strips are reserved for the US Market. Combined with the Canadian demand, capacity management was quite efficient, with only 20,000 strips available for any additional orders that inevitably come up in any given year.

Currently the transfer pricing from US to Canada is based on a full absorption costing approach Table 2, with a modest mark up $2 per strip on full cost. This pricing policy in itself has been an unresolved point of contention between the US and Canadian divisions, however there was an uneasy calm due to the fact that there are no reliable and competitive alternate sources of supply yet, for the Canadian division. Besides there was still a decent margin that was possible in the Canadian market, as they were able to sell it C$40 per strip.

With all these dynamic conflicts in the background, the US division threw a bombshell, a month back, by informing the corporate and the Canadian division that they will not be able to fulfill a steady supply of the 180,000 strips anymore, as they have received a special order of 80,000 strips from within US, and the buyer, a major public health institution, has offered on very competitive bidding, a price of US$32 per strip, Moreover this institution has also guaranteed an increase in the offtake based on the US division’s ability to provide timely supplies and service. Clearly, the US division saw an advantage in the pricing with US$ 6 in addition to what the Canadian division was currently offering. Additionally, there will be a $2 savings per strip, due to reduced freight, duty and other logistical charges. The US division was still willing to supply 120,000 strips, which will be the current remaining capacity after fulfilling this special order, although should the Canadian division choose not to buy, it can easily find buyers, at a conservative estimate of US$26 minimum, per strip. It has been the  corporate’s policy, with regard to the US division to allocate fixed costs based on finished goods units of output (strips).

On receiving this jolt, the Canadian division went back to the drawing board to explore the possibility of manufacturing this formulation (Caltona) in Canada itself and came up with a set of projections (Table 3). This project can be executed within a one-year time frame. Table 4 also provides the cost structure, including the cost of the active ingredients and other costs, should the Canadian division decide to go on its own. Corporate has also estimated that a similar cost structure may prevail in US, if capacity is expanded at that location.

Current Issue with Caltona

There was also an alternate supplier from within Canada, who may be able fulfill the gap of 60,000 strips, assuming that Canada still buys 120,000 strips from the US division. However, the pricing quoted by the local manufacturer is higher at C$38 per strip, with a firm price guarantee, for at least one year. However, beyond this period, price may fluctuate based on so many factors such as fluctuations in Raw Material costs, exchange rates and so on.
 

With all these muddied waters in the background Ethan and Anissa will need to come up with a plan and possible alternate solutions, that will also be well aligned with Galena’s objectives  of divisional autonomy, goal congruence between divisions and corporate, more effective performance evaluation and improved employee motivation.

Required: Take on the role of Anissa Khan, CFO, and provide your recommendations in a report form to the senior management team. Your report should be supported with relevant workings and schedules. You may assume an exchange rate of USD 1 = C$1.4, when you make the projections.

Required (alternate): Show your workings in Excel for the following questions

1) Prepare an Income statement in contribution format, showing the after-tax operating Income, for each of the following scenarios, for both the US and Canadian divisions:
a. Special customer order is accepted by US, and the Canadian division procures Caltona from a local supplier for the shortfall it might face
b. Special customer order is rejected by US and it stays committed to Canadiandivision’s internal order, fulfilling the total requirements.
c. An alternate transfer price that US may be willing to accept, in lieu of rejectingthe special customer order, to maintain the same total contribution margin.
d. The Canadian division manufactures at its own facility for Canadian needs (after one year) and the US manages to sell all of its output, including the special customer order.

2) Evaluate the above scenarios and make your recommendations.

3) What is the minimum transfer price that may be acceptable to the selling division (US), in US dollar terms, prior to receiving the special customer order?

4) What is the maximum transfer price that may be acceptable to the buying division in Canadian Dollar terms, prior to the US division receiving the special customer order?

5) What is your evaluation of the extant transfer price between the US and Canadian divisions prior to receiving the special customer order?

6) If the special-order in US is accepted, what is the minimum (selling division) and maximum (buying division) transfer price acceptable?

7) From a strategic perspective, is the expansion of capacity in Canada, a viable alternative? What are the factors that may require in-depth consideration, if the company decides to go ahead  with expansion?

Table 1 – Product description

Table 2 – US Division – Cost structure (US $) for inter-company sales, Canada

In addition, there is a total capacity maintenance cost of $4,200,000 for the manufacturing capacity of 600,000 strips of Caltona in the US Division

Table 3 – Canadian Division – Manufacturing Costs projection (Canadian dollars)

Table 4 - Data to calculate cost per strip of Caltona in Canada (CAD)