Las Ferreterias de Mexico, S.A. de C.V.

We had been operating our company like a family, but maybe were too big to operate that way. I think some of our people have gotten lazy, and our performance has suffered. That is why I asked for the design of a new incentive compensation plan. We need to be more competitive to survive. I want our people to focus on what they can do to improve company performance, and if were successful, I am quite willing to share a good proportion of the procceds of our success. !ernando "onzalez #hairman and #$% &as !erreterias de 'e(ico, ).*. de #.+.

THE COMPANY
&as !erreterias de 'e(ico, ).*. de #.+. ,!erreterias- was the second largest retailer of lumber, building material, and home improvement products and materials and homeimprovemen product ans equipment in 'e(ico. !erreterias operated ./ stores in 'e(i(o #ity and troughout most of the nortern regions of 'e(ico. $ach of !erreterias stores offered between 01,111 to /1,111 stock keeping units ,)23s- in a retail sales area, an outside lumberyard area, and in a garden center. The total store areas ranged from 01,111 to 45,111 square feet. !erreterias was founded in 061/ in a suburb of 'e(ico #ity by !ernando "onzalezs grandfather. %ver the years, the company added more locations. It was listed on the 'e(ican )tock $(change in 06.4. In /11/. $7I8IT 0 &*) !!$T$9I*) :$ '$7I#%, ).*. :.+. Income )tatement as of 0/;40;/11/ ,<s 111=et sales /,/0>,5?1 #osts of sales 0,5./,>@1 "ross 'argin >44,.@1 )elling, "eneral and *dministrative $(penses 4@@,5.1 :epreciation $(pense >5,@?1 Interest $(penses 0?,4/1 Total $(penses ?5@,>?1 $arnings before Ta(es 0@>,/41 Incesome Ta( <rovision 5., /?1 =et $arning after Ta(es 00@,661 !erreterias had saies of /./01 million pesos and profits of almost 0/1 million pesos ,see summary financial statements in $(hibits 0 and /-.

)tarting in the late 06.1s, !ernando "onzalez launched a maAor company needed to emulate the methods of the large *merican homebuilding retailers, such as Bome :epot and &owes, in order to survive. Thus, improving market share and improving operation efficiencies becme !erreteriasC strategic priorities. The store managers enAoyed considerable autonomy. They were responsible for hiring, firing, and supervising their storeCs personnel. While the store hnd the same architectural designs and some basic stock keeping requirements, the individual store managers were allowed to adapt their merchandise offerings, their inventory levels, and their advertising and promotional activities to their local markets, which were quite diverse. The store managers were given considcrable latitude to reduce princes to move e(cess inventory or to meet competition. They were responsible for making credit granting decisions, although for large accounts they were e(pected to ask finance personnel at headquarters to perform a credit check. *nd some aggressive store managers tried to generate new business by calling on prospective customers themselves. The ./ store were organized into nine geographical regions. The regional managers, each of whom was a former store manager, provided oversight and advice. *t the of the case, one 'e(ican peso worth appro(imately 3))1.01. Their role was seen as an important part of the management structure because most of the store managers had little formal education. %nly a few were college educated, and few of those had formal business education. $ach region also contained a regional sales office with specialisis who worked with larger customers, though, were made through the store nearest to the Aob. The corporate staff of !erreterias provided a range of centralized function, including purchasing, human resources, marketing, real estate, and investor relations. Inventory was shipped to the store from one of three regional warehouses. *ll !erreterias employees were paid a base salary or hourly wage plus a bonus based on a share of the companys overall profits. These bonuses were small, usually in the range of / D 5 percent of base salary, depending on organization level. In addition, !ernando "onzalez typically provided some discretionary bonus awards to employees whose performance in a given year was e(emplary. "enerally, though, these types of bonuses were not considered to be effective at motivating behavior, as was indicated in the comment by 'r. "onzalez presented at the beginning of the case. * =$W I=#$=TI+$ <&*= In Euly /11/, 'r. "onzalez hired a consulting firm to design a new performance based compensation plan. Be asked his chief financial officer and head of human resources to assist the firm with its work. 'r. "onzalezCs original intent was to include all company salesmen, buyers, and managers in the new incentive plan. *fter a series of interviews, however, the consulting firm reported that it would not be easy to measure the performances of either salesmen of buyers. While most customers were assigned to one particular salesperson, it was difficult to assess whether a sale came from the assignes salespersonCs offorts. 'any customers had dealt with !erreterias for years, and they placed their orders regardless of whether or not they received a call from a !erreterias salesperson. )ome of the large contractors had also established personal relationships with one or more corporate or regional staff, and oftentimes they called their friends for advice, rather than relying on the salesperson

formally assigned to them. 'easuring the performances of the buyers was similarly problematic. The primary aspect of buyer performance that could be measured the prices paid for items purchased was affected by many factors over which the buyer had little control. These included the order size and market conditions. 8ecause of these measurement problems, the consultants concluded that the measures that could be tracked would not provide meaningful bases on which to assign bonus awards. They recommended that they work first on designing an incentive plan for managers, which included the individual store managers ,./-, regional managers ,6-. *nd corporate staff managers ,5-. ,=either !ernando "onzalez nor his chief operating officer was to be included in this planF the compensation committee of the companyCs board of directors determmed their bonuses-. The consultantCs suggestion for the management incentive plan included the following featuresF 0. 8onus pool. * total bonus pool would be created according to the following formulaF ? million pesos plus . percent of the corporate income before bonuses and ta(es in e(cess of 0/1 million pesos. The total bonus pool would be divided into three classes as followsF )tore managers @1G 9egional managers 05G #orporate staff managers 05G /. 9%I measure of performance. The bonus pools would be assigned to managers based on their entityCs return on investment ,9%I-. :efined as bonuseligible revenues minus e(penses divided by total store investments. The following gundelines were provided to facilitate the calculation of the 9%I for bonus purposes. The revenues eligible for bonuses include all shipments from the store e(cept those stemming from sales orders written by regional or head quarters personnel. The e(penses include all direct store costs and all regional and headquarters costs. The costs of significant regional and headquarters activities traccable directly to a given store HH. #ost of preparing a customer credit report, cost of a building upgrade would be charged directly to that store. *ll other costs would be allocated to the stores. *ctivity based allocations would be used where possible, such as in using the stores relative proportions of receipts into inventory to allocate purchasing e(penses. *ll other e(penses would be allocated based on a proportion of bonus eligible store revenues. 4. *llocation HHHH.. !or store managers who had been in that position for less than the full year and managers who transferred between stores during a year, bonus units would be assigned by the relevant regional manager,s- by applying the basic bonus unit award philosophy as closely as possible. The regional managersC bonus pool would be divided among the regional managers based on a proportion of the bonus units earned by the stores in their region divided by the total bonus units earned by all stores.

The allocation of the corporate staff bonus pool would be decided by !ernando "onzalez based on the corporationCs annual 9%I performance. ?. !orm of the awards. 8onuses were to be paid in cash as soon as the financial statements were prepared and audited and the amounts could be calculated. #%=#$9=) 8$!%9$ I'<&$'$=T*TI%= *s 'r. "onzalez looked over the consulting firmCs design, he had some concerns. !irst, it was obvious to him that the new plan would increase the companyCs compensation e(pense. Bow much would that e(pense increase, and would the benefits of the plan be worth that e(penditureI )econd, he knew that he would have to be the one to announce the implementation of the plan. Be had to anticipate what his managersC reactions would be. What were they mostly likely to complain aboutI Is this plan fair to all of the managersI *nd, finally, he still lamented the fact that personnel in the regional sales and corporate purchasing organizations were not included in this plan. If their individual performances could not be measured obAectively, was there some other way he could motivate them and reward them for performing their roles, which were critical to the companyCs successI Juestions 0. $valuate the proposed performance measurement and incentive plan /. Bow, if at all, would you modify the proposed planI