Management Control System

Case Analysis on Abrams Company

Written by:

INTERNATIONAL UNDERGRADUATE PROGRAM

FACULTY OF ECONOMICS AND BUSINESS
UNIVERSITAS GADJAH MADA
2019
Problem Identification
Abrams company is a spare part manufacturer for automobiles, truck and agro agro industry. Their
three main products lines are ignition, transmission and engine parts that will be sold to the Original
Equipment Manufacturer ( OEM ) and wholesaler. Than the wholesaler will sold spare parts to aftermarket
(AM division). Every product has product division and each product division is managed vice president
and manager, in order to reach targeted or expected ROI. The current management has satisfied with the
current management system and performance measurement scheme but there are still problems that exist
in Abrams company.
The first problem is in the marketing strategy, Critical factor that determine the successfulness of
EOM Market is the ability to design the parts as innovative as possible and managers need to keep the
quality and specification based on consumer expectations. Such as delivering the parts on time which can
reduce the cost of inventory and cost control. In AM division, the availability of parts is a more crucial
thing for wholesaler rather than the quality and the price of the product itself.
Regarding the transfer prices, there was a dispute of spare parts sold by product divisions to the
AM division. Internal sales of parts were made at outside OEM market prices. The problem occured when
the part is being transferred by the wholesaler to AM division. Thus, there was no market price which was
to be adjusted to calculate the transfer price.
AM division is considered as a captive customer by the product division because AM division and
OEM customer ( outside customer ) has the same demand, the plant always favored OEM customer because
OEM customer could take its business elsewhere but AM division could not. AM division and an outside
OEM customer were placing same demand, Both AM division and three product divisions that will lead to
excessive inventories throughout the year. All the divisions maintain excess inventory.

Case Analysis
Question 1: Evaluate each of the concerns expressed by top management, and if necessary, make
recommendations appropriate to the circumstances described in the case?
Question 2: What is your overall evaluation of Abrams management control system? Describe any
strengths and weaknesses that you identified but did not include in answering the previous question. What
changes, if any, would you recommend to top management?

Question 1:
 The first concern of the managers include the increased friction because of arguments over the
appropriate transfer pricing of parts sold by the product division to the AM division. Such issue is
commonly faced by profit centres. The issue arises when the part was never sold in the OEM market, hence
there was no current or former OEM market price that could be adjusted for inflation. Recommendation:
Top management should set a transfer price that has been adjusted for inflation and approved by all division.
To discuss, divisions can conduct routine meetings and agree upon the appropriate transfer price and
communicate it to top management.
The second concern would be the unfair treatment of the AM division as a captive customer. This
issue often happens due to the shifting authority from top management to lower level. The regulation of
business as a profit centre has resulted in lower management - product division - being able to discontinue
sales to the AM division, while prioritising the sales to OEM. Especially since there is a policy that product
division managers are not penalised if they do not fulfill the requirements of the AM division in the initial
agreement. Recommendation: Product division manager should be penalised if they are unable to fulfil
the internal sales requirements and rewarded if they are able to fulfill those requirements.
The third concern would be that there is excess inventory carried by the AM and product divisions
due to lack of inventory control by management. Additionally, ROI is used as a measurement of the
manufacturing plants, however, this does not provide a fair representation to evaluate the company’s
performance because inventory will decrease during the Christmas holiday period, resulting in a lower
inventory level during the beginning of the year. Recommendation: Add or use other performance
measurement such as inventory turnover or other measurements that is related to inventory management

Question 2:
The company measures their performance by using ROI. Abrams ROI system does not consider
the additional investments that happen during the year, since they only contribute the benefit in the long
run and provide little effort to the current year. To increase and maintain the motivation of the employees,
Abrams company is implementing reward system. The incentive compensation plan is calculated precisely
based on an equation. The company is also made judgements about the performance of the managers. Their
performance is measured by comparing the actual profit with the budget profit. All in all, Abrams is already
adopting the low cost , market focus, differentiation, and ROI strategies. In addition, they have established
their own management control systems in order to reach company’s goals.

Strength:
 1. Company has a clear management structure
2. Company has a compensation system, such as, bonus for the employee
3. Company is able to save cost when it input internal. The AM marketing division will input
products from the other divisions, and sell it to the domestic and foreign market.

Weakness: The company has three different divisions. Each division work individually and lack of
connection. They purchase their materials separately and they hold excessive inventories most of
the year. Furthermore, the negotiation on price, might lead to low productivity and profit.

SUGGESTIONS TO PERFORMANCE MEASUREMENT SYSTEM:

1) ROI: Can be used with the other measurement such as balance score card to avoid the limitations
of ROI. Balance score card combined with ROI can create a good performance measurement
system which result in the improvement of the incentive compensation plan.

2) EVA: Can be used as the alternative beside using ROI suggestion to transfer pricing. A transfer
price fixed by the top management in compliance with the AM division and other divisions
involved which could be revised when it is out of date.Top management should implement a cost-
based transfer prices because when competitive prices are not available, transfer prices may be set
on the basis of cost plus a profit markup.

Conclusion: Abrams is a manufacturing company that produces parts for cars, trucks, buses and
agricultural equipment. There are three major groups of spare parts: ignition parts, transmission parts, and
engine parts. Abrams Company supervises and decentralizes in the production and marketing of its
products. To evaluate each division’s performance, the company will look upon their success in achieving
their own targeted ROI. Product marketing for internal and external parties is delegated to each sales
department in each division. Abrams Company makes the production and marketing divisions within the
company a profit center. Abrams company supervised and decentralized the profit center.

The Abrams Company top management decision on the profit center is a firm, clear and detailed
decision. It would be very good if it applied to small scale companies. However, the Abrams Company is
a large-scale manufacturing company that demands independence in each division. Therefore, this decision
has its own strengths and weaknesses as well as threats and opportunities.