HKU922

NEALE O’CONNOR

PCL: A BREAKDOWN IN THE ENFORCEMENT

OF MANAGEMENT CONTROL
PCL was a leading European consumer electronics, lifestyle and healthcare company that had
entered the Chinese market in 1985. While its consumer electronics business grew steadily in
China, the costs of returned sets in its TV division amounted to 5% of the division’s total
sales in 2008. Even more worrying was that 37% of the returned TVs were of good quality
and had been returned without good reason. PCL taskforces set up to study the situation found
that control measures designed to handle returns were simply not being carried out by staff
and third-party after-sales service centres. What could PCL do to remedy the situation?

Consumer Electronics Industry in China

With a population of 1.3 billion and rising disposable incomes, China had become the second-
largest market for consumer electronics in the world. 1 Analysts forecasted a compounded
annual growth rate of 9.8% through 2014 for consumer electronics, with growing demand for
TV sets and computers in smaller cities and rural areas being the main driver.2 As the market
in the big cities had become saturated, market competition had moved increasingly to smaller
cities and rural areas. Sales of consumer electronics products in these markets were further
enhanced by the government’s subsidy programme, which offered rebates for purchases of
consumer electronic goods in rural areas. Another government programme that allowed
consumers to trade in old electronic appliances for new ones in nine provincial areas since
2009 had also helped to stimulate demand.

Television Market in China

It was no surprise that China, a country that produced 42% of the world’s total shipment of
TV sets,3 had a strong TV market. Domestic manufacturers alone accounted for three-quarters

1
Euromonitor (April 2009) “Consumer Electronics in China”, http://www.euromonitor.com/Consumer_Electronics_in_China
(accessed 20 June 2010).
2
Business Monitor International (2010) “China Consumer Electronics Report Q3 2010”, http://www.pr-inside.com/china-
consumer-electronics-report-q-r1905491.htm (accessed 10 June 2010).
3
Zhang, K. (26 April 2010) “China TV Market to Enjoy Solid Growth in 2014”, iSuppli, http://www.isuppli.com/Display-
Materials-and-Systems/MarketWatch/Pages/China-TV-Market-to-Enjoy-Solid-Growth-in-2014.aspx (accessed 20 June 2010).

Grace Loo prepared this case under the supervision of Professor Neale O’Connor for class discussion. This case is not intended
to show effective or ineffective handling of decision or business processes.
© 2010 by The Asia Case Research Centre, The University of Hong Kong. No part of this publication may be reproduced or
transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise (including the
internet)—without the permission of The University of Hong Kong.
Ref. 10/478C

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 10/478C PCL: A Breakdown in the Enforcement of Management Control

of its Liquid-crystal display (LCD) TV market in 2009.4 Driven by consumers’ preference for
large-sized TVs and by falling prices, China was forecasted to surpass North America as the
largest LCD TV market in the world, with sales reaching 29 million units in 2010, translating
to more than 30% in growth year-on-year. 5 The growth would be driven by consumers
replacing their cathode ray tube (“CRT”) sets with liquid crystal display (“LCD”) sets,
especially in third- and fourth-tier cities.6 International brands faced fierce competition from
domestic brands, which enjoyed advantages in both cost control and distribution, and price
wars were common as domestic brands lowered their prices to increase market share. Large
retail chains played a critical role in the retail market for consumer electronics in China, and
competition for shelf space in such chains was fierce. Manufacturers became involved with
the promotions, marketing, and supply chain management of these chain stores in order to
build relationships with them.7 Others opened their own branded stores so they could have a
direct hand in shaping consumers’ purchase experience.

PCL Consumer Electronics: Background

PCL was a high-tech multinational company based in Europe. Since its establishment in the
late 19th century, it had diversified into multiple industry segments. The diversification
strained its resources, and consequently PCL had reshaped the organisation to focus on the
healthcare and electronics sectors.

PCL’s consumer electronics division (“PCL Consumer Electronics”) was a global player in
digital and electronic devices, bringing the latest technology and human-centred designs to
market. Its product portfolio included colour TV sets, DVD players, audio products, PC
monitors and PC peripherals. PCL Consumer Electronics had a sales and service presence in
more than 50 countries and manufacturing sites in France, Hungary, Belgium, Brazil, Mexico
and Argentina, despite heavy outsourcing of its production. PCL Consumer Electronics
placed a strong emphasis on emerging markets such as China and India. It entered China in
1985, and by 2008 its sales team on the mainland had grown to 550 people, with annual sales
of US$752 million [see Exhibit 1].

Repairing the Broken System

Returned Sets
In 2008, the handling of returned TV sets cost PCL an average of US$6 million, equalling
about 5% of its annual TV sales. The costs covered freight from the dealer to PCL’s
warehouse, repair and refurbishment costs at the factory workshop. While PCL spent a hefty
sum each year servicing returned goods, about 37% of the returned goods were no-fault-found
(“NFF”) returns, translating to a loss of US$2.2 million for PCL. NFF returns also included
demo sets and slow-moving goods that were not supposed to be returned [see Exhibit 2].

The TV Return Process

After-sales service for PCL’s TV division was handled by authorised service centres
(“ASCs”), which were third-party service centres authorised and managed by PCL’s after-

4
Ibid.
5
SinoCast Business Beat (14 April 2010) “Corning: China to Become World’s Biggest LCD TV Market”,
http://www.tradingmarkets.com/news/stock-alert/glw_dtek_corning-china-to-become-world-s-biggest-lcd-tv-market-
910387.html (accessed 20 June 2010).
6
GfK Retail and Technology (29 March 2010) “Overview of China’s LCD Market”,
http://www.gfkrt.com/news_events/market_news/single_sites/005606/index.en.html (accessed 30 June 2010).
7
Von Morgenstern, I.B. and Shu, C. (September 2006) “Winning the Battle for the Chinese Consumer Electronics Market”,
https://www.mckinseyquarterly.com/High_Tech/Hardware/Winning_the_battle_for_the_Chinese_consumer_electronics_marke
t_1855 (accessed 20 June 2010).

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 10/478C PCL: A Breakdown in the Enforcement of Management Control

sales service team. Under China’s consumer law, consumers could return a defective TV set
to the retailer from whom they made the purchase within five days or exchange it for a new
one within 15 days. Retailers sent PCL sets returned by customers to the company’s ASCs,
which would decide whether to accept the return and repair them. If the defect was serious,
the ASC would send the set back to PCL’s factory for repair.

Investigation
In response to the high volume of returned sets and high NFF returns, PCL’s management
appointed the product marketing manager of the TV division, who was also familiar with the
return process, to look into the matter so appropriate actions could be taken. He formed a
taskforce that brought together the sales operation manager, the service manager and the
financial controller of the TV business. The team set out to investigate the situation and
uncovered a number of causes for the problem.

Neither retailers nor ASCs had been trained in educating customers about product
performance or the criteria for accepting returns. Retail stores usually used high-definition
signals for product demonstrations, but most consumers used cable TV at home. As a result,
consumers often became dissatisfied with the picture quality after they took the TV set home
and would try to exchange it for a new set or simply return it. While PCL had established
return criteria that were as stringent as those of its competitors, retailers and ASCs often failed
to execute them properly, accepting returns without proper screening.

Chain retailers were significant players in China’s consumer electronics market, and
consumer electronics companies could not maintain their market share without selling
through them. Because no international TV brand possessed unique product features or
technical advantages that differentiated its products in the market, manufacturers’ best option
was to make concessions in their negotiations with chain stores in order to maintain good
relationships with them and in turn receive higher visibility at the point of sale. PCL, for
instance, cut its profit margins and accepted returns of slow-moving models and demo sets in
order to secure prominent display locations in the stores. In addition, PCL salespeople had to
meet sales targets and required the support of dealers to achieve these targets. This made it
hard for many salespeople to say no to unreasonable returns because doing so might
jeopardise their relationship with the dealers. Moreover, they put little effort into investigating
the returns, despite established approval procedures for returned goods.

PCL’s after-sales service team, which was responsible for overseeing the ASCs, did not report
to the TV division directly, but instead reported to the general manager of the organisation, a
line of reporting that reduced the incentive for the after-sales team to control TV returns or to
monitor the third-party ASCs stringently. Not only did the ASCs fail to inspect the returned
sets carefully, they sometimes faked their inspection records instead of rejecting the return of
TV sets. The situation was further aggravated by the fact that PCL had no punishment policy
for fraud or incompliance on the part of ASCs.

Action
The team came up with a series of actions based on their initial assessment of the situation.
The sales team’s annual performance appraisals would be linked with TV returns and the cost
of servicing returns, and this new measure was communicated by the TV sales director to all
the salespeople. The service manager also communicated to ASCs a new policy whereby they
would be fined three times the labour charge for each fake inspection record discovered.

The project team forecasted that their plan would reduce the return rate to 3.5% and the NFF
rate to 20% within two months, but their projection did not materialise. In fact, the NFF return

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 10/478C PCL: A Breakdown in the Enforcement of Management Control

rate went up to 40% after two months. Upon further investigation, the general manager and
the production manager of the TV division discovered two reasons for the rising rate of NFF
returns, despite their efforts. First, the sales team was under enormous pressure to meet their
sales targets, which was set at 132% of the sales of the previous year, a rate that exceeded
actual market growth. In order to reach their targets, they put pressure on the dealers to
increase their purchase volumes, leading to higher inventory levels and tighter cash flow. To
counter these problems, dealers negotiated with salespeople to accept returns and to allow
exchanges of demo sets and slow-moving goods for new models. The second reason was that
the after-sales service team had failed to take punitive action against the ASCs for fake
inspection records. There was little incentive for the service team to respond to the ASCs’
transgressions, as it did not report to the TV division and its performance indicators were not
linked to the amount of goods returned.

Second Try
Dissatisfied with the outcome, the general manager of PCL Consumer Electronics appointed
the service director, who reported directly to him, to lead the taskforce. The service director
was also given the authority to handle issues that did not usually fall within his scope of
responsibilities in order to tackle the problem. Once appointed, the service director put
together a new cross-functional team, with each member responsible for a specific area for
improving the return rate and NFF return rate, as follows:
x Service director—served as team leader
x Service manager—managed the ASC network
x Chief financial officer—responsible for the financial results of the team
x TV sales operation manager—engaged in dealer management
x Service financial controller—performed service cost computation and analysis
x TV product manager—concerned with process implementation and improvement.

The team set specific targets:

x TV NFF return rate to be reduced from 40% to 20%
x TV return and exchange rate to be reduced from 5% to 3.5%
x Total savings of US$1.13 million within six months.

The service director also applied for some US$4,500 as a bonus for the team, to be used for an
outing or teambuilding exercise if it could meet its targets. The general manager of the
consumer electronics division endorsed the proposal and also incorporated the project targets
into the bonus scheme of the team members such that they would lose their annual bonuses if
the targets were not met.

The team analysed the situation and the following actions were drawn up to remedy the
situation:
x Given that both the sales team and the ASCs were failing to enforce the established
criteria for accepting returned goods, PCL had ended up being more accepting of returned
goods than its competitors. To manage the situation, the TV sales operation manager was
put in charge of rotating the regional sales managers and salespeople geographically in
order to prevent the sales team from becoming too friendly with the dealers.
x The TV sales operation manager and service director were put in charge of ensuring that
no models that had been phased out for more than six months would be accepted for
return.
x The TV sales operation manager and service director were also put in charge of defining
clear and sound criteria for inspection and acceptance of returned merchandise.
x The TV product marketing manager and service director were put in charge of organising
training on the return process and criteria for all individuals involved in making decisions

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 10/478C PCL: A Breakdown in the Enforcement of Management Control

in the return process.

The team quickly got to work, defining the criteria and monitoring measures to control the
return process:
x For goods that were defective upon arrival at the dealers’ warehouses, PCL would accept
return only if they were functionally defective or there were serious cosmetic failures vis-
à-vis PCL’s standards for finished goods.
x For defective goods returned within 15 days after purchase by consumers, only functional
failures would be accepted as grounds for return.
x Returned goods were to be accepted only after approval by cross-functional personnel.
x Returned goods would be required to come in their original PCL packaging, with all the
original accessories.
x Models that had been phased out for more than six months would not be accepted for
return or exchange.

PCL’s regional service managers and engineers would also visit the top 10 ASCs for returned
goods—which together were responsible for 40% of monthly returns—and provide training
sessions with detailed working instructions to the ASCs. A new incentive and penalty scheme
for ASCs was also drawn up, with the following mandates:
x Increased labor charges for inspection of returns.
x Penalties for NFF returns.
x Quarterly bonuses to those with the highest levels of compliance.

On the sales team side, the TV sales operation manager worked closely with the TV sales
directors to draw up a detailed rotation plan. Field salespeople were required to visit top
dealers within their respective regions on a weekly basis to solicit feedback and to implement
follow-up actions. The plan was fulfilled after seven months and extended to 52% of the
salespeople.

The project team met every two weeks for reviews as remedy measures were implemented.
Immediate actions were taken to correct any weaknesses that had materialised and warnings
were issued to those responsible for them. The team was able to adhere closely to the project
schedule.

After six months, the NFF return rate was reduced to 12%, surpassing the team’s target of
20%. The return and exchange rates dropped to 3.2%, surpassing the team’s 3.5% target. The
team did not meet the target of US$1.13 million in savings, though it came quite close at
US$1.1 million, and thus the team was awarded its bonus.

Epilogue
After the hard work of PCL’s two taskforces, PCL finally managed to bring the issue of the
high return rate of its TV sets under control. The work of the two taskforces had revealed a
major issue in enforcement within the organisation. Even the best strategy or business plan
could only be effective if it was properly executed. What could PCL do to ensure that internal
control measures would be enforced properly to achieve organisational objectives in the
future?

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 10/478C PCL: A Breakdown in the Enforcement of Management Control

EXHIBIT 1: ORGANISATIONAL CHART FOR PCL CONSUMER ELECTRONICS IN CHINA

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 10/478C PCL: A Breakdown in the Enforcement of Management Control

EXHIBIT 2: FLOW OF TV SALES AND RETURNS

SALES TEAM DEALERS

ASCs 1. Customer Returns CHAIN

-After sales RETAILERS
service team 2. Dealer Returns* -Sales People
FACTORY -Failed to inspect CUSTOMERS
the returned sets 3. Fake Returns
carefully

Returned TV sets (US$6 million) 5 days money back

(NFF=37%) 15 days exchange

TV Sales

TV Returns

*Note: Dealer Returns = Demo sets + Slow moving disguised as TV returns

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