Rohm and Hass

Case Evaluation

Management Control Systems

Presented By

(873/10) Ms. Maria Holm Bohsen

912/10 Mr. Igor Stepanishchev
(201/46) Nipak Das
(270/46) Sanglap Banerjee
Table of Contents
1. What are the problem areas for budgeting for I.T. at RH ?........................................................................3
2. What is the impact of such problems in the meeting of organizational objectives?..................................4
3. What is the group’s recommended solution?............................................................................................5
3.1. Residual Income of Economic Value Added (EVA)..............................................................................6
3.2. Transfer Pricing...................................................................................................................................6
3.3. Market Based Transfer Price...............................................................................................................6
3.4. Cost Based Transfer Pricing................................................................................................................7
 1. What are the problem areas for budgeting for I.T. at RH ?

II. Current Performance Measurement system in place in Rohm & Haas

1. Rohm & Haas is using the ROI based divisional performance measurement for profit &
investment centres.
2. They are treating the ISMS as a cost centre whose managers are responsible for those costs
that are under their control.
3. As ROI expresses divisional profit as a percentage of assets employed in the division it has
the potential to create serious dysfunctional effect.
4. Use of ROI here may be motivating the managers to avoid allowing acquisition of assets by
the ISMS division which would decrease the ROI of the division (even though in the long run
it would improve the performance of the company as a whole. e.g. if the current ROI of the
division is 20% it would not acquire an asset which would earn a return of 18% though the
weighted average cost of capital of the company is 15%)
5. Similarly, a division which has a very low ROI may be tempted to improve ROI acquiring
assets which will improve its ROI although its earnings will be lower than the cost of capital
of the company.

This graph shows the change in EPS of R&H in comparison to the change in Budgetary allocation the ISMS group
70.00%

60.00%

50.00%

40.00%
EPS
30.00% ISMS(Budget)

20.00%

10.00%

0.00%
1 2

1-1983 2-1984

III. Failure to quantifiably justify the benefits derived from using IT services like voice based messaging
1. ISMS is not able to justify in dollar terms ( On the basis of ROI) the services they are
providing
2. The committee approving the budget do not see or understand the relationship between the
projects of the different departments and the necessary investments of the ISMS

IV. Inaccurate forecasts of user demand of IT services

 1. Forecasts based on data collected from interviews with managers of various departments in
conjugation with historical trends.
2. Managers failing to fully apprehend the increase in computing recourses they require
V. Corporate Guidelines
1. Unrealistic target MIS ratio - fixed at 0.8% of R&H’s worldwide sales
2. Contribution of ISMS to R&H’s revenue is growing at a higher rate than that of the other
departments but the MIS ratio is inflexible & not taking into account the growing importance
of the ISMS department.
3. Missing benchmark about “needed level of excellence of IT department”. Managers don’t
need technical terms rather a comparison parameter with their competitors.
VI. No consideration of “hidden costs”
1. Obtaining additional space at the home office would require inconveniencing the other
departments & would require the expenditure of about $4 million for conversion costs for
what was at best a temporary solution (hidden costs: short term solutions, moving costs in
term of time and employee’s efficiency)
VII. Bureaucratic Controls in the management hierarchy.
1. Rigid organizational structure
2. Managers in the product groups had to report to both their business group & their region
 2. What is the impact of such problems in the meeting of organizational
objectives?

Complication:

1. Short-sightedness in terms of technological deployment in the IT department would lead to

competitors catching up & eventually outpacing R&H in innovations, efficiency & customer
acquisition due to superior performance contributed by their respective IT departments. It will
expose the company to the risk of digressing on their corporate strategy which is stated as
technological advancement and meeting customer demand in superior way. (p. 56 1 column)

2. Greater Research efforts

a. Computer applications were essential to the success of the research department
b. Computers were needed to do advanced modelling & simulation.
c. Computers processing power is being used to increase efficiency & reduce the trouble of
actually creating many new substances that would turn out to have no practical value
d. Computers were needed to provide greater efficiency & provide competitive advantage vis-a-vis
other companies.

3. Communication ease
a. Having text & voice messaging was tremendous time saver for the various centres of R&H
located in different parts of the world
b. Lot more information could be transmitted fast & cost effectively

4. As a manufacturing firm producing materials across a broad range of industries, Rohm and Haas has
to understands the importance of responsiveness and the criticality of time-to-market. The company
specializes in forming teams of scientists and innovators from around the globe to develop materials
for other firms’ products. With employees distributed in over 200 offices spread across the world,
delivering world-class application performance presented a key challenge for the IT department.
Problems that could be faced with one Mainframe & one Data Centre:
a. Network latency
b. R&H have over 200 locations globally, so a large percentage of their users were accessing
the company’s files & applications remotely over the WAN. The high latency would slow
some of the applications down to a point where it was difficult for people to use them at all
c. Improving the user experience in all of their other applications was key as well. They have so
many applications, & they need to improve performance across the board

5. Computers can positively in recruiting & retaining talent.

Though upgrading of adding additional capacity is preferable as some redundancy is encountered in such
areas as peripherals & staffing when a second computer is added.
 3. What is the group’s recommended solution?

I. Setting up the price for services in investment calculation must be done on the basis of the best
practices in the industry. Put in other words the IT department should find a benchmark price for
IT services they offer
II. Introduce benchmarks to measure appropriately the operating efficiency of ISMS workforce
1. Benchmarks should be used to guide employee’s behaviour towards optimal
performance & for performance evaluation in the ISMS division.
2. New System of Performance Evaluation like RI or Transfer Pricing should be put in place
in R&H
III. Introduce rules in the system to approve acquisition of new investment by IT department
IV. Introduce a financial measure to assess the investment worthiness, e.g. payback period, ROI, IRR
etc. Having at the moment only costs of equipment, the company has to estimate the useful life
of the investment and revenue
- Estimating revenue is done by estimation of demand of internal customers based on own
estimates
- Useful life could be based on legal rules, however since the speed of improvement in the
industry is unpredictable, depreciation life should be based on the estimated development
of the technology
a) Introduce technical benchmarks in terms of capacity remaining & capacity reached. After a
particular threshold is crossed, capital investment should be done. Examples for technical
benchmarks could be
- The speed of the IT system compared to the competitors
- The advancement of IT systems compared to the best available technology
- The KPI which are used as a benchmark will have to be decided by the division. Examples for
KPI would be
o Waiting time
o Number of inquiries per hour which could e proceeded per hour
V. R&H is treating the ISMS as a cost centre whose managers are responsible for those costs that
are under their control.
1. As ROI expresses divisional profit as a percentage of assets employed in the division it
has the potential to create serious dysfunctional effect.
2. R&H should adopt better methods of evaluating the performance of the ISMS division
like Transfer Pricing methods.
3. They should be allowed to retain the profits they make by selling their services to the
company’s other divisions.
4. Autonomy should be provided to the managers of the ISMS division to make capital
expenditure budgets for their division with their retained earnings.
 3.1. Residual Income of Economic Value Added (EVA)

Since RI = Pre Tax Profit – Imputed Interest Charge, RI deals with the problems of ROI adequately
because any investment that will earn higher than the capital charge will improve the RI.
Therefore the RI motivates the divisional managers to acquire only those assets that will improve the
performance of the company as a whole. Thus, the RI method sets the same profit objectives for the
same assets in different divisions.

3.2. Transfer Pricing

It refers to the mechanism for distributing revenue between different divisions which jointly develop,
manufacture & market products & services. The fundamental principle is that the transfer price should
be similar to the price that would be charged if the product were sold to the outside customers or
purchased from outside vendors.
A multi product firm like Rohm & Hass must use it ISMS firm as a profit centre.
The Transfer price for the services provided by the ISMS to the other responsibility centres must be
accounted for as its revenue.
Other responsibility centres must treat transfer prices of services received by them as their costs.
Transfer pricing would provide each division with relevant information required to make optimal
decisions for the organization as a whole.
It would promote goal congruence, i.e. actions by divisional managers to optimize divisional
performance should automatically optimize the firm’s performance.
It will facilitate ‘Sourcing Decisions’ - decisions on whether to procure goods & services from another
division or from outside vendors. Sourcing decisions also include the decision to sell to another division
or to an external buyer.
Three alternatives can exist:
To use Market Based Transfer Price
To use Cost Based Transfer Price
To use Negotiated Transfer Price

3.3. Market Based Transfer Price

The transfer pricing system should provide rules for setting transfer prices without interventions by
corporate management. The ideal transfer price should be based on a well – established, normal market
price for the identical product being transferred. The market price may be adjusted downwards to
reflect savings accruing to the selling unit from dealing inside the company, e.g. there would be no bad
debt expense & smaller advertising & selling costs when products are transferred from one sub unit to
another within the firm.
 3.4. Cost Based Transfer Pricing

Cost based transfer prices should be used only on the condition that competitive prices are not available
for similar products, i.e. Market Based Transfer Prices are not available.
Profit mark-up should be based either cost or on investment. Irrespective of the base selected – full cost
or variable cost – the mark-up should be based on the return that an independent company
manufacturing similar products expects to earn by selling its products to outside customers.
ISMS should not use full cost for setting transfer prices as it might fail to achieve goal congruence
between the division & the firm. This creates the problem of asymmetric information & the buying
decision may not have the information on the amount of upstream fixed costs & profit included in the
transfer price. This might result in pricing decisions, which fail to optimize the firm’s profits. Even if full
information is available to the division, it may not reduce its profit margin for improving profit for the
firm as a whole.
A two step pricing method could be used where the full costs are segregated into fixed & variable costs.
Both fixed & variable costs may include profit mark-up. Total variable costs would be charged to the
purchasing division depending on the actual services being transferred by the ISMS division. Fixed costs
would be charged periodically based on the capacity reserved by ISMS division to cater to the needs of
the buying division. E.g.

Division A purchases services S from ISMS division.

Let us assume that division A has estimated its monthly requirement of service S at 5000 Computer
processing hours.
Suppose ISMS has reserved part of its capacity for Division A & has assigned a fixed cost of $20000 per
month to the reserve capacity.
If the variable cost per hour of computer processing is $5, the full cost would be :
$5 + 20000/5000 = $9 per hour.

If actual transfer in any month equals estimated quantity of 5000 computer processing hours, division
A would be charged :
$9*5000 = $ 45000 for the transaction.

Under ‘Full Cost’ method the amount would be calculated as

$5*5000 = $ 45000

Under ‘Two step’ pricing the amount would be calculated as

$5*5000 + $20000 = $45000

Both the methods produce the same results on the condition that the actual transfer matches
the estimated demand. E.g.

If actual transfer in a particular month is 4000 computer processing hours, then

Under ‘Full Cost’ method the amount would be calculated as
$9*4000 = $ 36000

Under ‘Two step’ pricing the amount would be calculated as

$5*4000 + $20000 = $40000
If two step pricing method is not feasible, i.e. the buying division cannot estimate the demand for the
service in advance & consequently the selling division cannot reserve a part of the capacity to provide
that service, goal congruence could be achieved by the ‘Profit Sharing Method’.
The services can be transferred at standard variable cost & each division is credited with a prorated
share of the actual contribution earned. But one drawback of the method is the difficulty in arriving at a
mutually agreed basis for sharing the contribution. An arbitrary allocation of contributions would impair
the measurement of the division’s profitability.