Presented by :

Case Highlights
Abrams Company Manufacturer of variety of parts for use inautomobiles, trucks, buses and farm equipment. Three major group of parts-Ignition, transmission andengine parts. These parts sold to OEMs and wholesales who in turnsold these parts as replacement parts to consumers.

Product Division
A separate OEM department. Major sales to OEMs

Remaining parts sold to AM marketing division.

AM Marketing division
Sold manufactured parts to wholesalers. Operated several company owned parts distribution warehouses in the US and foreign markets. Measured on annual ROI.

ROI=Profit/ Assets at the beginning of the year

1992 Sales break up

Total Sales= $500 MN

Ignition parts= $130 MN

Transmission parts= $100 MN Engine parts= $90 MN AM Division= $180 MN High expected growth in AM segment due to highnumber of vehicles sold.

ROI calculation
Profit-overheads-imputed taxes Totals assets current liabilities

For each plant, a target ROI was calculated. Eachproduct division s OEM sales were traced to the plantsthat made the parts.
Book value was used to value property, plant, andequipment.

OEM Sales performance

Individual sales department for each of productdivisions. Worked closely with the clients to cater to their needsand develop new products.

Measured on an annual sales revenue target.

Each of the sales departments had its own customers.

Critical Success factors OEM

Ability to design innovative and dependable parts meeting customer squality, performance, and weight specifications Meeting delivery schedule requirements to minimize parts inventories. Controlling costs AM business Availability of parts Quality Price

Incentive Compensation plan

Plant managers-Based on profit variance

Sales to AM division had no incentive for the plantmanagers even if it contributed to positive profitmargin variance.

Issues
Transfer pricing Sales were made at market price. For parts not sold in market anymore, MP was adjustedfor inflation. For parts never sold as OEM, disputes occurred whichsometimes needed Finance manager s interference.

AM division treated as captive customer

OEM customers were given preference over AMdepartment. AM division had nowhere else to go. They were notallowed to sell competitors parts. No incentive for selling to AM division.

Excessive Inventories
Both product division and AM division carried excessive inventories.

Goal Congruence
The companys management s goal was to increase thesales of AM division to 50% of the Abrams totaloutside sales. For individual OEM sales team, the goal was tomaximize the revenue from the OEM sales. For plant managers, the OEM sales improved thebonus and also the OEM sales contributed to the ROI calculations also.

FIRST DISPUTE
Internal sales of parts were made at outside OEM market prices. Inflation adjustment factor was used to determine prices after several years. Problem: It occurred when the part transferred was strictly an AM part and there was no current orformer OEM market price that could be adjusted for inflation. Solution: The division which is transferring the part to AM can follow COST PLUS PRICING.

COST PLUS PRICING = Cost to manufacture + Profit Margin

This profit margin can be decided mutually by the Manufacturing division and the AM division after consultation with the Vice President Finance so that no disputearises in future over the transfer price or the profit margin. So, the AM price in later years can be calculated by using the same COST PLUSPRICING method or using inflation factor to adjust the prices.

OEM Customer: Should be more Demanding

OEM Customer should be more demanding meaning that the divisions should try to fulfill the demands of OEM customers because these customers are the ones who would drive the sales of AM division. Remember,AM division is the After Sales market or the Replacement market for original parts. Any customer who use saparticular carwouldaskforthe Genuine Spare Parts onlyduetobetterreliability andlongtermbenefits.

Return On Investment (ROI)

ROI method should not be the sole criterion to judgeprofitability.

It should be supplemented by other measures like:

Profit Margin = Net Profit/Sales

Return On Equity : Net Income/Shareholder's Equity

And also Gross Profit Margin & Operating Margin. Also, the AM division will have a huge ROI as compared to other divisions as there is no machinery, plant and equipment installed. It is just a trading firm.

Profitability Analysis
Transmission Division: Sales=$124000NetProfit=$11200 Net Profit Margin=9.03% AM Division: Sales=$180000Cost=$100000 Net Profit Margin=Many times greater than Transmission Net Profit Margin & ROI will be too high of AM Division as compared too ther manufacturing divisions. So,AM divisionis probably the most profitable division of Abrams & the demand of AM division should not be compromised with. It should not be treated as a Captive Customer.

Incentive System
Problem: Incentive system is linked to the profit margin on sales only to OEM customers. It does not include the sales to the AM division. So, the plant managers would have no benefit/advantage to sell to the AM division as it does not increase their incentive. Solution: The incentive should be linked to the sales to AM division. Margin on sales of AM division is high so the overall profitability of the organization would also improve. This will lead to a Win - Win Situation for all the 3 stakeholders which are AM division, Plant Managers & Manufacturing divisions and the company as a whole.

Excessive Inventory : Why??

Improper demand forecasting It should forecast the demand more adequately. More number of workers employed Take a closer look at the actual number of workers required so that the production does not suffer. This is pointed out Vice President of Planning when he said: Thank Goodness, we have a generous vacation policy here. At least, the inventories used to get down to a reasonable level at year end when the production volume is low because of a large number of employee holiday vacations It suggests that Planning is not accurate.

Demand Forecasting
It is mentioned in the case that generally all the AM division & the manufacturing divisions carried excess inventories throughout the year.

Problem:
Where as, the manufacturing divisions did not favor the AM division whenever competing demands we replaced by the AM division & OEM customers may be due to the reason that the manufacturing divisions did not have stocks to sell to the AM division. Solution: So , here the company should develop a proper Demand Forecasting Strategy and producing only that much quantity which is required by the AM division & the OEM customers.

It can also follow the CHASE strategy.

This will solve the problem of excess inventories to a large extent.

Overhaul Inventory & Production System

It is very much possible that manufacturing divisions are closely working with the OEM customers(Ancillary Units) as these are generally long term contracts and it could fully understand the demand situation in a better way. So, the problem of excessive inventories should not arisenormally.

In such a case, the Manufacturing division needs to have a lookat inventory management system.
It can follow the Lean Manufacturing or use Just In Time(JIT) It should various other inventory control systems such as Inventor y Turnover Ratio etc. to check the accumulation of inventory.

Evaluation
The companys management control system is not so efficient due to following reasons: The 3 product divisions OEM sales department are separate leading to high inventory costs. AM being a marketing division has different target to be met than the OEMs sales departments.

AM has to meet annual ROI target.

OEM sales departments have to meet annual sales revenue target.

Beginning of the year net assets are being used for ROI calculation.

Strengths
Manufacturing plants are profit centers. Innovation Cost-Effectiveness Quality of products

Service quality

Weaknesses
High inventory costs due to separate 3 OEM sales departments AM division is a profit center. Plant managers bonus not linked to selling to AM division . So, he would prefer to sell outside.

Recommendations
Combine the 3 product divisions OEM sales department. Reduce inventory.

Make AM division a revenue center.

Plant managers bonus should increase with favorable gross margin volume variance caused by sales to the AM division. Change ROI method