Management Control Systems

Professor Bob Madden

March 3rd, 2011
Case 7-3: Qal!ty Metal Ser"!ce Center
Matt Stone #20070$221%
Bradley Morr!son #200$0$30&%
Quality Metal Service Center is a metal distributor, which sells to smaller users of
metal products than the big manufacturer/suppliers such as Bethlehem, Crucible, etc. To
be competitive they must have shorter lead time and all around better customer service
to cover the etra cost of small lot sales and ma!e their product worthwhile to
customers.
Quality has three main strategic ob"ectives. Their first ob"ective is to focus sales efforts
on targeted mar!ets of specialty users. Quality metals focuses on sales of specialty
metals and competes on differentiation of product rather than cost. This will help them
avoid commoditi#ed good mar!ets where they cannot compete based on price. They aim
to produce higher tech, higher return products and sell these to customers. These
mar!ets of high tech metals have less competition and better profit margins. Their
second ob"ective is to identify geographic mar!ets where metals are being consumed.
They use database technologies to have accurate, up to date, sales forecasts on hand
and they service these needs by preparing for orders before they occur, which will
shorten lead$time and improve the benefit of their services. They also use these to
allocate products on hand by location and service each location in a manner that wor!s
best for the region%s customers. Their third ob"ective is to develop techni&ues and
mar!eting programs that will increase mar!et share. Their fast lead time allows
customers to adopt '(T inventory avoiding high carrying costs and obsolescence. )s
&uality has saved costs on their own '(T system through short lead time they can help
customers achieve this cost savings as well. This helps customers to have the most up
to date metal products available on the mar!et as needed. (n addition they offered a
wide range of processing services. These modifications to products reduce need for
customers to have and use specialty tools, as well as cut down on time they need to
complete "obs.
The management Control systems should support the implementation of these three
main strategies through influencing management behavior to act in accordance with
these corporate goals in maintaining a superior &uality of service to the consumer.
*ach of the four regions have a manager who is evaluated based on return on assets
and aims to eceed a set goal of +,- of pro"ected profit. .en /ichards, a district
Manager is responsible to the vice president of the Midwest division and has a set of
functional managers who report to him. 0hile many of these functional managers
operate independently of head office, the purchasing decisions of each division is
influenced by the central database and the control in place that re&uires head office
approval on any capital ependitures in ecess of 12,,,,, have to be approved by
central management. This ma!es the divisions heavily dependent on central
management for investment decisions and they also must trust that they are instructed
on the best possible data for their area.
0ithin these regions the district manager are also evaluated on the /3). This
measurement allocation has a split of 45- weighted on district and 65- on region. This
may cause dysfunctional behavior where a manager may wish to act in the best interest
of his district rather than the region or company as a whole.
)n eample of dysfunctional behavior is shown when .en /ichards from the Columbus
7istrict is reviewing a capital investment program. .en is showing a large /3) over 8,-
and although ta!ing more pro"ects could improve the corporate profitability he may
refuse these pro"ects if his compensation is reduced by the current bonus program.
)s shown in ehibit 8 central office9s assessment through their database shows that his
divisions has demand for processed metal products. This will improve lead$time on
orders further differentiating their product, as well as fulfill ob"ectives 2 and 6. Terms of
the deal are shown which are better summari#ed in ehibit : showing that all corporate
criteria are met in terms of paybac! period internal rate of return and show a positive
;<= showing that at this discount rate, and assuming that a better pro"ect is not
available.
)lso the manager must rely on central offices sales pro"ections as if they are lower they
could show a loss and an increased asset base &uic!ly erasing any bonus they would
have received. This dependence and added ris! can cause the managers to be even
more li!ely to turn down these prospective investments.
)s shown in ehibit five while this investment will improve profitability, even in the short
term, .en will be motivated to turn down this pro"ect. 0hile it causes him to increase
cash flows by 1:,,,,, it will reduce his bonus by >.6?-. This will cause him to loo! at
the district financials and re"ect the pro"ect although they benefit the company.
The cash flows in ehibit : also show growth throughout this investment period. The !ey
to fast growth is to generate returns and further reinvest the returns into additional high
yield pro"ects. To compete in this mar!et and establish themselves as a @growth firmA
Quality must generate high returns wherever possible and reinvest this money to further
their ability to grow as a company according to their three main ob"ectives.
(ssues
Control over capital ependitures B Cimit of 12,,,,,
*valuation on /3) and Bonus (ncentive program B Counter intuitive
/3) motivates managers to invest in positive ;<= pro"ects that will enhance
future cash flowsD
The Compensation plan is not motivating the managers to ma!e those
investment decisions, rather to not invest at all as the payout rate would be
decreased for more assets overplayed thus effecting bonus
)ssets over$employed will increase change to profits and therefore reduce
ad"usted profits and the payout rate charged to the base salary
3verall evaluation scheme is counterproductive towards organi#ational
ob"ectives, manager9s motivations.
Bonus <lan (ncentive deters managers from ta!ing on investments that will
re&uire large asset employment and may have positive /3) or *=) results
/3) as evaluation may wor! counterintuitive itself as, the Columbus division for
eample with high profitability will be hesitant to invest in opportunities with a
lower /3) then their Target /3), that would benefit organi#ational cash flows
otherwise
/ecommendations
Management Control systems be made consistent with framewor! used for
decisions about capital investments.
o Currently inconsistent, Managers do not have full authority over
investment decisions
o /3) evaluation and Bonus plan is inconsistent with ob"ectives.
o (nvestment decisions should be made by division with less control from
EQ if evaluated on that basis
*=) could be used for investment decisions
o *=) proposes multiple advantages over /3), *=) on proposal will
increase
o *=) supports the third organi#ational goal that the company has
established to find techni&ues to increase mar!et value
)s *=) has a strong correlation with changes in the company
mar!et value
Fsing *=) as an evaluation on investments could help managers
analy#e if it will help grow *=), and therefore enhance
shareholder value
(f they were to continue to use /3) as a basis for providing a bonus to
managers, ma!e it consistent with how the managers are evaluated
3ne suggestionG /emove assets over$employed from e&uation or
add fleibility, so that managers will not be penali#ed in their
bonus on investment opportunities.