Management Control Systems 4th Ed 2017 [PDF]

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MANAGEMEN丁 CON丁ROL SYS丁EMS Performance Measurement, Evaluation, and lncentives



Kenneth A. Merchant University ofSouthem Ca=fo「nia



Wim A. Van derStede London SchooI of Economics Fou「thedition  ‘        一 章



②耽rson  一や∴∴∴ ---‥/一,



PEARSON EDUCA「lON LiMiTED



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Names: Merchant, Kemeth A., author. l Van der Stede, Wim A-, author・ Tltie: Management controi systems. performance measu「ement, eValuation and incentIVeS / Kemeth A・ Merchant,



UnlVerSrty Of Southem Caiifomia, Wim A. Van der Stede, London SchooI of Economics・ Description: Fourth EditiOn. l New York: Pearson, [2017] i Revised edition of the authors’Management controI



SyStemS,2012. identifiers: LCCN 2016053625i lSBN 97812921 10554 (Print) i iSBN 97812921 10585 (Pd用



iSBN 9781292181875 (epub) Cost contro口Manageriai accounting. l Performance-Measurement. i Cost control-Case studieS. i Manage「ial accounting-Case studies・



BR看EF CON丁EN丁S



Preface



xiii = Remediestothe Myopia Problem



Acknowledgements



xvi 12 Using Financial BesuItsControIs in the Presence of Uncontro=able Factors



SECTION I The Controi Function of Management



SECTION V Corporate Govemance, impo巾ant 3 ControI-ReIated RoIes, and Ethics



「 Management and ControI



13 Corporate Govemance and Boards



SEC丁ION II



Of Directors



Management ControI Altematives



14 Controilers and Auditors



and Their E什ects



15 Management Cont「oi-Related



3 Action, Persomel, and CuituraI Controis 1     1



4 Controi System Tightness



33 86 28 73



2 BesuIts ControIs



5 Cont「oI System Costs



6 Designing and EvaIuating Management



ControI Systems



221



Ethical issues



SEC丁ION VI



Management Contro! When FinanciaI Results Are Not the Primary Consideration 16 Management Controi in Not葛for-PrOfit



SECTiON I=



Organizations



Financial Results ControI Systems Index 7 Financiai Responsib冊y Centers     261



8 Pianning and Budgeting



9 1ncentive Systems



SECT音ON看V



Performance Measurement lssues and Their Effects lO FinanciaI Performance Measures and Their E什ects



397



CON丁EN丁S.



Preface Ackno wIedgemenきs



Xiii Prevention vs, Detectjon Xvi Cond砧ons detem面白g



COntrOis



SEC丁ION i



PersonneI controIs



The ControI Function of Management



Cultural controIs



1 Management and ControI      3



Personnel/cuIturai controis and



the controi probIems



Management and controi



8 E什ectiveness of persomei/cuitura1



Causes of management controi probiems



1 2   controIs



Characteristics of good management controI



15 Conciusion



ControI problem avoidance



15 Notes



Controi aitematives



19 MtskyandAssocfates, hc.



Outiine of this text



19 777e Pfathum Pohte LandDeaI



Notes



20 句reOn PhamaceuticaIS, hc.



Leo Js Four-P/ex 77?eater



22 AxeonNV



Wbng :s Phamaq′ Phvate Hれess, hc.



23 4 Contro- System Tightness



AtfanねHome Loan



25



Tight results controI



Tight action controIs



SEC丁ION =



Tight personnei/cultural controIs



Management Cont「oI AItematives



Conciusion



and their Effects



N otes Controts at the Be伯gio



2 ResuIts Controis



ResuIts controIs and the controI probIems Eiements of results controIs



Conditions determining the effectiveness Of resuIts controis



Conciusion N otes OHlce Soんf/ons, hc.



Puente HWs 7dyofa Koois tra AutogI℃ep



Houston Fear/ess 76, hc.



33 343 73 8 42464 6485 87 17 8



Prevaience of results controis



Casho Reso万 PCL: A Breakdown h"的e Ehforcement



Of Management Contro1



5 Controi System Costs Direct costs lndirect costs



Adaptation costs



Conciusion N otes Ph〃ゆAncterson Suns励)e Fashion: Ffaud, 777e匂



3 Action, PersonneI, and Cuiturai Controis



and Misbehavior among 86



E/7岬Ioyees



Better Beau功hc。



Action controis



86 HtFbo匂Inc.



Action controIs and the controi problems



91 A脆nfis Chemica/ /ndus紡es



器97⋮⋮器器嵩 1 28聖霊義1 4。1 42 1 68 1 7。聖霊詣高棚∴⋮嵩2。6∵Ⅸ



the effectiveness of action



Management ContrQI Systems



Choice of controi tightness Adapting to change Keeping a behavioraI focus



Maintaining good controi Notes



Dfagnosfro Products Co/pOrafron



Game Shop, hc.



1 2 9 0 1 1 2 3 2



Choice of controIs



2 2 2 3 3 3 3 3 4 2 2 2 2 2 2 2 2 2



M了at /s des〃ed and what /s Me咋‘‘



lncentive system design



221



Fam均y Care?peci主催ts Medica/



Group, /nc.



Supe/℃Onductorねchno/ogies, /nc.



Raven Cap伯方LLC



SECTION IV Performance Measurement



VaIue creation 261



Market measu「es of performance



Accounting measures of performance 261 lnvestment and operating myopia



Return-On-investment measures



Types of financiai responsib冊y



262  Of performance



267 Besidua=ncome measures as a possibie



The transfer pricing probiem



269  SOIution to the ROi measurement



Conciusion



274  Probiems



Notes



275 Conclusion



Kranworfh Chair Co/POration



275 Notes



Zumwald AG



283 BehaviolaI lmp〃caf/ons ofAi研he Deprecfation



Gbbal /nvestoIS, /nc.



285  Accoun加g Po〃ey Choices Las Fe〃ete/fas de M5x/co, S.A. de C. V:



Target se同ng



PIaming and budgeting practices, and criticisms



Conclusion



RQyaI Messanen NV 777e Stimson CompaIry MuItゆ/e Vさrsions of肌e Pfan Wtesse Semicond[/Ctor Co/pOra的n



VtsuSon, hc": Bushess Shess Testing



Haengbok BancoIp Co/めhdye /ndustries, /nc,



King Ehgh了eeI面g Group, /nc. Be庇shiIe /ndustrfes PLC



○○ Remediesto the Myopia



ProbIem Pressures to act myopjca=y Reduce pressures for short-term PrOfit



Controi investments with preactjon reviews Extend the measurement horizon (use iong-term incentives)



Measure changes in vaIue directiy



9 lncentive Systems



353



Purposes of incentives



355 Measure a set of value d「ivers



Monetary incentives



357 Conciusion



X



lmprove the accounting measures



8  8 0 1   3 5 5 6 0 4  4 5 5   5 5 5 5 6 4  4 4 4   4 4 4 4 4



N otes



2 2 3   3 3 3 3 3 3 3 3



Pianning cycIes



9799飢 1 01 21 31 523323342



Purposes of pIanning and budgeting



297 /n〔面stIfal EtectIOnics, /nc.



4 14 14 1 4 14 14242424344



Choice of financial responsibiIity centers



8 Pianning and Budgeting



7  8 9 1 4   6 9  9 9 0 0   0 3  3 3 4 4   4



and Their E竹ects



Advantages of financial resuits



CenterS



N otes Harwood Medical /nstIひments PLC



10 Financial Performance Measu「es



Financial Resuits ControI Systems



COntrOi systems



Group rewards



Conciusion



252 Issues and Their E什ects



SEC丁ION音i看



7 Financiai Responsibility Centers



Criteria for evaiuating incentive systems



4 5 0 0 1 4 5 4 6 6 7 7 7 7 7 8 3 3 3 3 3 3 3 3



6 Designing and Evaiuating



Contents



Notes



461 14 Contro=e「s and Audito「s



Caねlytic SoIuf/ons,爪c・   _



462



Do万munderLKopp e/ GmbH



470



Mainrfeigh t



4 4 5



Sys tem



788801



Johansen七: 771e New Scoreca/d



SねtoiI



629



Contro=ers



629



Auditors



633



ConcIusion



639



Notes



640



Don Pusse〃: E〆pehences ofa Con書roM9〃CFO 641 Desktop Solu書ions, /nc・ W: Audit of書he St. Louis BIanCh



12 Using FinanciaI ResuIts ControIs in the Presence of Uncontro11able Factors



Desktop SoIutions, /nc. (B): Audit Of C)peI省f/ons GI℃up Systems



517 And伯W G, Scave朽ChiefRisk O研cer



The controliab冊y principie 丁ypes of uncontroiiable factors



Contro=ing for the distorting e什ects



Of uncontroIiabies



520 15 Management Control-ReIated Ethica=ssues 522 Good ethical anaiyses and



Other uncontroIIabie factor issues



529



Conclusion



529 why do peop-e behave unethicai-y?



Notes



530



Olympic Car Wash



531 controi-reIated ethica=ssues



Be伯ng Chuang ¥七VさhicIe G′Oup



532 spreading good ethics within



their importance



678 682



Some common management



Ho筋7]an Discount Drugs, /nc・



534



Howard BuiIding CoIpOIation, /nc・



541



Bank of me Deserf 44)



554



Bank of the Dese万(B)



556



F栃e Han伯st Resねurant GIりup 44)



561 conser胞five Account/ng in肋e GeneI省/



Hne HaWest Pestaurant Group @)



565



an o「ganization



684



689



ConcIusion



691



N otes



692



Two Budget T却gets



694



Mahle Sfate Universi書y



SECT看ON V



777e “Sa/es Acce/eIation ProgIam ’’



Corporate Gove「nance,



771e E*pimg So#ware License



lmpo巾ant Control-Related



W伯匂PLC



Roles, and Ethics



Mean Screens USA, Inc, Lemout & Hauspie?peech Products



694 695697698699700701708



Products Division



Educaf/on Fbod SeWices at CentraI



1 3 Corporate Govemance and Boards of Directors



677



Ethics@ Cisco



Laws and regulations



574 SEC丁看ON VI



The Sarbanes-Oxley Act



575 Management ControI When Financial



Boards of directors



580 ResuIts Are Not the Primary



Audit committees



583 consideration



Compensation committees Conc山sion



Notes



言器16 Management Cont「oI in



A仰w MotoI℃ar Co仰Oration



588 Not-for-PrOfit Organizations



Go/den Parachutes?



594 Corporations, B corporations’and



FねCi#c Sunwear of Ca〃fomfa, /nc.



598  n Ot-fo r- P rOfits



E/うtrOpic Communications, /nc・



61 0 Key d冊erences between for-PrOfit



Bio/Precise Medica/ Devices, /nc,



625  and noトfor-PrOfit organizations



721



722



723



Xi



Contents



Goai ambiguity and confIict



724 Notes



SCI Onねho: Achievhg, Measuhngタand



D輔cuIty in measuring andつ東



rewarding performance



725  Communic∈涌ng S脆tegic Success



Accounting d冊erences



727 University of Southem Ca〃fomia:



ExtemaI scrutiny



728  Respons酬iリCenter Management dystem 746



Empioyee characteristics



731



ConcIusion



731 1ndex



CHAP丁ER I Management and Control



Management control is a critical function in organizations. Management control failures can



lead to large financia=osses, rePutation damage, and possibly even organizational failure. Tb illustrate this, let us start with some examples in the financial services sector that, Since the financial crisis have been beset by a raft of control failures related to rusty information systems;1 misconduct related to misselling丘nancial services such as pay-PrOteCtion insurance



stemming from aggressive sales-based tactics;2 allegations that financial services companies



helped their clients evade taxes;3 manipulation of interest rates, SuCh as the venerable LIBOR fthe benchmark inter-bank rate that is used to calculate interest rates on m箪Or financial trans-



actions throughout the world);4 faults in intemal controIs surrounding the reporting of commodity prices by banks, trading desks; mOre isolated but crippling unauthorized urogue trades,,;5 and anti-mOney-laundering violations,6just to name the most striking ones. Tb provide some more detail about one particular case to demonstrate its relevance to management controI systems (MCSs) and the signi丘cant risks when they fail, the Financial Services



Authority (FSA) fined UBS, a Swiss-based global bank, f29.7 million (discounted from f42.4 million for early settlement) for systems and controIs failings that allowed an employee



(Kweku Adoboli) to cause substantial losses totaling US$2.3 bi11ion as a result of unauthorized trading. In particular, UBS, failings included the following:7 苺The computerized system operated by UBS to assist in risk management was not effective in



COntrOlling the risk of unauthorized trading. ミ The trade capture and processing system had significant deficiencies’Which Adoboli



expIoited in order to conceal his unauthorized trading. The system allowed trades to be booked to an intemal counterparty without su飴cient details, there were no effective methods in place to detect trades at material ofr皿arket prices’and there was a lack of integration



between systems. ミThere was an understanding amongst personnel supporting the trading desk that the operations division,s main role was that of facilitation. They focused mainly on e飴ciency as opposed to risk control, and they did not adequately challenge the front o綿ce.



ミThere was inadequate front o綿ce supervision. The supervision arrangements were poorly



executed and ineffective. 一三 The trading desk breached the risk limits set for their desk without being disciplined for doing so. These limits represented a key control and de宜ned the maximum level of risk that



the desk could enter into at a given time. This created a situation in which risk taking was not actively discouraged or penalized by those with supervisory responsibility.



Chapter l. Management and ControI e Failing to investigate the underlying reasons for the substantial increase in profitability of



the desk despite the fact that this could not be explained by reference to the end-Of.day risk POSitions.  一‥



㊥ Profit and loss suspensions to the value of $1,6 billion were requested byAdoboli, and these



were accepted without challenge or escalation. The combined factors of unexplained profit-



ability and loss suspensions should have indicated the need for greater scrutiny.



The FSA report concluded that these failings were particularly serious because:8 ㊤ Market confidence was put at risk, given the sudden announcement to the market and size of



the losses amounced. Negative announcements, SuCh as this, Put at risk the con丘dence



which investors have in financial markets. ㊥ The systems and controIs failings revealed serious weaknesses in the firm,s procedures’



management systems and intemal controIs. ㊤ The failings enabled Adoboli to commit financial crime.



Global regulators have similarly exposed flaws in banks, intemal controI systems that allowed traders to manipulate interest rates, SuCh as LIBOR, arOund the world・9 Tb add, Stuart



Gulliver, the chief executive of HSBC, the largest financial institution in Europe, admitted that 負our anti-mOney-laundering controIs should have been stronger and more effe証ive’and we



falled to spot and deal with unacceptable behavior.,,1O



The press headlines to which these examples are selectively referenced speak for themselves"



Of course, nOt all banks have been entangled in each and every issue. However, that the list of those being caught in these nets has been so Iong, SParing few, is surprising for organizations



whose reputations are among their most valuable assets. Failures of this type and magnitude also damage the integrity of the wider market and financial system on a global scale. But these failures have also been costly money-Wise, Where the wave of fines and lawsuits that has swept through the financial sector since the丘nancial crisis has cost big banks a whopping $260 bil1ion, aCCOrding to research from Morgan Stanley. The report also suggests that寝actions taken



by banks to prevent future litigation issues include everything from changing remuneration [compensatio巾policies twhich we discuss under the rubric of res融s co庇roZs in Chapter 2 and ince融ve eys亡e肌s in Chapter 9] to a greater focus on `non孟nancial metrics’[Chapter ll], adding compliance staff [Chapters 3 and 14], tO elevating chief risk o鯖cers to boards [Chapter 13] and using `robo-SurVeillance’in trading rooms [a form of ac亡iorl CO庇rOZs which we discuss in Chap-



ter 3],, (brackets added).11 clearly, the issues illustrated here touch on, and cut across, many Of



the issues we discuss in this text. Tb add, though, here is a quote from a F証αnC王c[汀fmes columnist that builds nicely on the



above but extends it to other sectors: It turns out that bankers may not be aIone・ The traders who rigged Libo「 and foreign exchange rates cheated ciients out of money・ Vo漢kswagen’We nOW know’deIjbe「ateiy po11uted our air" The carmaker had a choice‥ insta= additionai emissions cIeaning equipment; admit that its diesei cars were not very fueI e怖cient; Or SPeW Out iilegai amounts of



nitrogen oxide" lt chose the iast of these options, and covered it up by designing software to deceive the US regulators, […] This round-the-WOrId tour of fraud aIso takes in



Toshiba. The nucIear-tO-Semiconductor congIomerate was hit by a record fine from



Japan,s stock exchange and ordered to improve its governance and intemal controIs, in the wake of a $2bn accounting scandaI〇 〇〇。,] Not even the tech industry has proved immune. European 「esearchers reveaied this week that Googie has been charging adver-



tisers for haying their ads seen on YouTube, eVen When fraud-detectjon systems discover that the `viewer, is a robot. That practice is cleariy not in the same Ieague as rate-rigging, 4



yearS of accounting fraud or emjssion test decejt" But the disc-osure reinforces a grow-



ing sense that companies around the wor-d are pushing ethjcaI boundaries twhich we



Another article commen亡ed that the issues at vw were predictable because ofvw,s lax board-



rOOm COntrOIs (which we discuss in Chapter 13) and its peculiar corporate culture (Chapter 3): “The scandal clearly also has to do with structural jssues at vw... There have been warnings



about vw,s corporate governance for years’but they didn,t take it to heart and now you see the



reSult,,, says Alexander Juschus’director at IVOX’the Geman proxy adviser.13 Effedive cultures’StruCtures’and controIs are quintessential as the above examples suggest, but not only in the foaprofit sectorras the next example i宣lustrates twe discuss non-PrOfit organ-



izations in Chapter 16). Consider the case ofan award-Winning teacher who at the time headed



Atlanta,s public schooIs, and who had been praised by the American Association of SchooI Administrators for the significant gains in student achievement she had overseen, Where AtIanta’s schooIchildren made sizable gains on the standardized tests used to determine yearly pro-



greSS. At one school, forinstance’the share of 13irear-Olds who passed the test・s maths section



rOSe from 24% to 86%, and the share of those who “exceeded expectations,・ rose from l% to 46% - both in a single year・ However,



…he state of Georgia aI-eges that those remarkab-e -eaps rested on neither pedagogy nOr determjned study, but something far more invidious‥ Cheating・ A report by a speciai investigative team [・○○] found wjdespread evidence of cheating [・・"」・ Sometimes teachers



gaVe PuPiis the correct answers. sometimes they erased pupi-s’answers after the test and filied in the correct ones themse-ves. The jnvestigative team fer「eted out cheating by ana-



1yzing erasure marks on test sheets" They f-agged c-assrooms wjth an average number of



WrOng-tO-right erasures more than three standard deviations above the state average. The Chance of that occurring randomly is one in 370・ More than ha-f of Atlanta’s elementary and



middie schoo-s had such cIassrooms’and many had erasures more than 20 to 50 standard



deviations above the norm. of the 178 teachers accused of having taken part in the cheating, 82 confessed. [The head], Said the report’either knew or should have known what was



gOing on"暮・・"I Prosecutors did not charge me headJ with taking part in the cheating, but



With put的`面でaSOnabIe pressure” on pwhc匝and feachers fo do we帰nd for crea+ ing `fan envfronment where achie面g the des胸end resuIt was more inportant鵬刷fe



This is an example ofresults controIs (Chapter 2) and’。eady no亡Only the fmtional but also the



behavioral displacements that they can create触pters 5 and ll)’in part due to target pressure



伽pter 8)’but a]so empIoyees, and organizations, moral failures伽pters 3 and 15).



Excessive target pressure was also identified as a cuIprit jn the accounting scandal at Tbshiba that was mentioned in passing earlier:



In Aprii 2015, an improper accountjng scanda- came to light that infIated profits by weII OVer $1bn at Tbshjba’the Japanese industrja- conglomerate’Which makes -aptops, memOry Chjps and nuclear reactors- A paneI of externa。awyers and accountants that was



aPPOinted to investigate was said to have uncovered emails showjng that Hjsao fanaka, Chief executive・ and Norio Sasakj, former chief executive and then vice-Chairman,



``instructed emp-oyees to de-ay the booking of costs to make the financial figures Iook better” [.・・書and that “the prob-ems were worsened by reporting procedures for projects that



Were time-COnSuming and old-fashioned" Some of the paperwork was being done by junior emP10yees in their first few years at the company",, Experts further commented that =the acCOunting issues at Tbshiba a-so exposed concerns around Japanese corporate govern-



anCe PraCtices [which we discuss in Chapter 13], inc-uding the weak roie of externai



5



Chapter l. Management and Controi directors and the extensive power that many former chief executives continue to exe卜 cise.”1三㌔he scathing paneI report aiso detaiIed what it said `’were `institutionai’accounting



maIpractices・[Chapter 5] and a corporate culture [Chapter 3] in which empIoyees were afraid to speak out against bosses’push for increasingIy unachievabIe profits [Chapter 8〇・ [○○.] Pressures to meet aggressive, Short-term PrOfit targets [Chapter l「]一known as `the



cha=enge,一eXisted from the presidency of Atsutoshi Nishida’Who headed the company from 2005 to 2009 and remained an adviser. Those pressures escaiated as the company’s eamings deteriorated in the wake of the globai financial crisis and […] the Fukushima



nuclear accident. The panei declared that Mr" Tanaka and Mr" Sasaki were aware that profits were bejng inflated and djd not take any action to end the improper accounting・ In some instances, the report added, tOP eXeCutives pressured empIoyees to achieve their ta「gets



with suggestions that the company may withdraw from underperfo「ming businesses if they



were not met, But the paneI found no evidence any of the three current and former chief executjves had given specific instructions to divjsion chiefs to infIate profit figures",,16 They described a corporate cuIture - One Of exerting pressure on empIoyees to meet aggressive, Short-term PrOfit targets spanning three generations of chief executives - in which



emp10yeeS Were afraid to speak out against bosses when they pushed for unreaiistic eamings targets・17



The consequences of failures of organizational control (which we define more precisely in



the later sections of this chapter) can reach far and wide beyond the organizations in which they take place. As mentioned above’the banking failures have undermined the integrity ofthe wider market and financial system on a global scale, But there are other m亘ior impacts:



Sharehoiders and customers are obvious victims of the current flood of bad news. They are seeing their investments shrink’having their cars reca=ed and paying too much fo「



goods and services. But there is another set of Iosers: the empIoyees and shareholders of the companies that try to piay fair" Back in the ea「iy 2000s’a COmPany Ca=ed WorIdCom



upended the telecommunications industry by repeatediy posting profit margins that its rivais simply could not match. Five big groups’inciuding AT&T, reSPOnded by siashing



about 5 per cent oftheircombined workfo「ces- mOre than 20,000jobs" In 2002, WorIdCom was exposed as the US’s iargest accounting fraud and its chief executive sentenced to jaii・



However, the empIoyees who were laid off at rivaI companies did not get theirjobs back.18 And in the case ofAtlanta’s schooIs:



[…l the scandal,s real casualties are Atlanta’s schoo漢chiidren・ SchooIs that cheated their



way to fa-se improvements Iost federal funds which couId have been used to make actuai improvements. Because of their apparently high test scores’Strugg=ng pupiis were denied



the heip they needed and deserved・ A generation of Atlanta,s students have, in fact・ been



Ieftbehind.19 We discuss these impacts in the light of organizations, co岬ora亡e soc証reやons油揖ty and their concems about sus亡c血αb拒ty and the wider stakeholder communities in Chapter 16. Not all control failures are as consequential, Or Of similar magnitude’aS the examples listed



above; yet they can, and do, inflict costs and/Or embarrassment. For example’



[〇〇〇] this happened when Deutsche Bank paid $6 bi=ion to a hedge fund client by mistake in a `fat finger’trade, Where a junior member of the bank’s forex saies team, WhiIe his boss



was on hoiiday, PrOCeSSed a gross vaiue instead of a net vaIue, meaning that the trade had ・too many zeroes’" Whereas the bank recovered the money from the U・S. hedge fund the next day, the incident wasバan embarrassing bIow to the bank,, and it aIsoバraised fresh questions about Deutsche,s operationaI controis and risk management.’’The $6bn error



6



aisQJaised questions about why it was not spotted under the bank’s ・four eyes principie, [an acf/o凡OOntroI djscussed in Chapter 3一, requirjng every trade to be reviewed by another



Other examples of this type also occur in the public sector and do not always invoIve money



being inadvertentlywired. This happened at the Bank ofEngland (BoE)whre its head ofpress mistakenly sent an email to the media revealing that officials were quietly researching the impact of Britain,s ex沌om the European union, a m担blunder given the secrecy of this Study. wha亡had caused this mistake? The “auto-COmPlete,, tool in BoE・s internal email service.



The BoE confirmed that fo11owing this incident’it had switched off auto-COmPIete fron its emaiI



SyStem - that is’Staffnew have to write the皿name of the recipient of their email messages rather than being automa〔ically proposed through the outlook auto-COmPlete functiona]ity ``to preserve the securi亡y ofits data.,,21



叫oyees do not always have to steal or engage in fraudulent activities to cause harm. Sometimes it su描ces tojust “faH asleep.,, This happened when a bank teller was making a pay-



ment OfC64.201eut as he制asleep亜ft his finger on the number 2 key accidentally put亡ing through a payment ofC22,222’222.22. The payment almost went through when the supervisor Who was supposed亡O be looking out for such mistakes allegedly faifed to notice and approved the transaction. The mis亡ake was spotted only by another col]eague who managed to correct it



before it was too late.22 As we will see, this Is an example of a rather simple fnter血o融 PrOCedure. wediscuss internal controls as one type ofwhat we call czctto柵roZs in Chapter 3,



and we discuss how tightly they should be applied in Chapter 4. The example further illustrates that not every controI problem invoIves fraud’yet adequate controI systems must also be able to



PreVent mistakes. Furthermore’When there are irregularities or control breaches’mOney or



ince姐ves like bonuses are not always亡he motive for the wrongdoing. For example,



[〇〇・] two cIerical workers at the Laguna NigueI’Ca冊ornia-based service center of the U,S.



immigration and Natura-ization Service (一NS) were accused of destroying thousands of



immigration documents, inc-uding visa appIications, PaSSPOrtS, and other papers. Accordjng to the probe, the clerks started shredding unprocessed paperwork after an inventory reVeaied a processing backlog of about 90’000 documents" A month Iate川e backIog was rePOrted to be zero・ The shreddi=g aI-eged-y went on for about another month to keep the



bacl(iog at zero, u剛NS officials discovered the shredding spree during an evenjng



Although it is not entirely clear what the clerks, motives were’there were no bonuses



involved here’and maybe they were concerned about keeping theirjob and庇lso not doing theirjob well or being lazy and cutting corners. Nonetheless’their actions were completely



inappropriate’and thus proper controI systems are needed to mitigate such undesirable



Howeve叩Ore COntroIs should not always be equated with better controIs. when copious



MCSs are stifling’they can exacerbate rather than mitigate controI problems怖discuss this further in Chapters 4 and 5vyhere we consider not only direct’eXPlicit・ mOre easily quantifia-



ble, Out-Ofpocke亡COStS’but also various types of繭rect,垂yCtt COStS Of tightening the contrOIs. For example, When froancial irregular工ties were discovered at Eurostat, the European Commission,s statistical service’it was not immediately clear whether these had occurred for the personal enrichment ofthose invoIved; instead・ SOme argued that the “secret accounts,, may



at least initia11y have been set up to give Euros亡a〔 a way to pay for research quickly without



gOing through the commission,s cumbersome procedures. Ironically then’While the commisSion had elaborate procedures to prevent financial fraud’these procedures may not on]y have



PrOVed insufficient (because they 。early could be circumvented), they may actually have made



7



Chapter l. Management and ControI the problem worse. Because tortuous form-filling was required to request funds, requeSterS had to jump throug血number of bureaucratic hoops to get anything approved, and funds delivery WaS nOtOriously sIow,てOmmission o飴cials and sta任may have taken to cutting comers and finding “creative’’ways to expedite the process. Of course, these ``work-arOunds’’should be a red



flag for possible expIoitation and potential improprieties, tOO.24 By this point, it should be no surprise that we are claiming, but also that it is widely accepted,



that good MCSs are important. Comparing the books and articles written on management control is di飴cult, however, because much of the MCS language is imprecise. The term ``control’’as



it applies to a management function does not have a universally accepted definition. An old, narrow view of a MCS is that of a simple eyberrle亡fc or regu血亡証g system invoIving a single feedback



loop analogous to a thermostat that measures the temperature, COmPareS the measurement with the desired standard, and, if necessary, takes a corrective action ftum on, Or O埠a fumace or air



conditioner). In a MCS feedback loop, managerS meaSure Performance, COmPare that measurement with a pre-Set Performance standard, and, if necessary, take corrective actions.25



In this text, however, We take a broader view. Many management controIs in common use, such as direct supervision, emPIoyee selection and retention, and codes of conduct, do not focus on measured performance. They focus instead on encouraging, enabling, Or SOmetimes forcing empIoyees to act in the organization’s best interest. This is consistent with the observa-



tion that all the above examples have one key question in common: how can organizations of



all types ensure that their empIoyees up and down the hierarchy carry out their jobs and responsibilities properly? Moreover, SOme management COntrOIs are proαC互ve rather than reacfive. Proactive means that the controIs are designed to preve庇problems before the organi-



zation su任ers any adverse effects on performance. Examples of proactive controIs include



Planning processes, required expenditure approvals, Segregation of duties, and restricted



access. Management control, then, includes all the devices or systems that managers use to ensure the behaviors and decisions of their empIoyees are consistent with the organization’s



Objectives and strategies. The systems themselves are commonly referred to as manage耽e虹



CO庇ro工γS亡e肌S (MCSs). Designed properly, MCSs influence empIoyees’behaviors in desirable ways and, COnSe-



quently, increase the probability that the organization will achieve its goals. Thus, the primary 旬批正orz of management control is to influence behaviors in desirable ways. The berle庫ofmanagement control is the increased probability that the organization’s o聯ectives will be achieved.



Management and controI Management control is the back end of the management process. This can be seen from the various ways in which the broad topic of management is disaggregated.



Management The literature includes many definitions of management, All relate to the processes of organiz-



ing resources and directing activities for the purpose of achieving organizational objectives. Inevitably, those who study and teach management have broken the broad sutlject into smaller,



more discemable elements. Table l.1 shows the most prominent classification schemes. The first column identifies the primary management functions ofthe value chain: PrOduct or service development, OPerations (manufacturing products or performing月elivering services), market-



ing/Sales (丘nding buyers and making sure the products and services ful乱I customer needs), and finance (raising money). Virtually every management school o縦ifS COurSeS focused on only



One, Or Only part ofone, Of these primary management functions. 8



Management and control



ltlble l,1 D肺erent ways of categorizing the b「oad area of management __.基



Functio購S.



Resources



Product(OrSerVice)deveiopment Operations



Money



Marketing/Saies Finance



P「ocesses



PeopIe



Objectivesetting



Strategyformuiation



Machines



ManagementcontroI



Information



souI℃e. K A Merchant, Modem Mar)agemenf Con章ro/ $ystems而xt and Cases (Upper Saddle BIVe「, NJ PrentlCe Hal=998)' P 3



The second column of Table l.1 identifies the major types of resources with which managers must work: PeOPle, mOney, maChines’and information. Management schooIs also offer courses organized using this 。assification- These courses are often called human resource manage-



ment, aCCOunting and finance, PrOduction and operations management・ and infomation sys-



tems, reSPeCtively. These are sometimes also referred to as the support management functions.26 The term m伽ageme庇co庇roZ appears in the third column ofTable l.1’Which separates the managemen血nctions along a process invoIving objective setting’Strategy formulation’and manage-



ment control. Control, then, is the back end of the management process. The way we use the term management control in this text has the same meaning as the terms execu亡iorrand s軸的′ irxpZe-



me庇伽iorl. In most organizations’focusing on improving MCSs will provide higher payoffs than



wi皿一CuSing on improving strategy. Afor加e study showed that 7 out of lO CEOs who fail do so not because of bad strategy, but because ofbad execution.27 The above examples reinforce this・ tOO.



Many management COurSeS’including business policy’Strategic management’and manage-



ment controI systems, focus on elements of the management process. Tb fdeus on the control



function of management, We muSt distinguish it from objective setting and strategy formulation.



Objective setting Knowledge ofo切cc。ves is a prerequisite for the design of any MCS and, indeed’for any purposeful activities. Ol)jectives do not have to be quantified and do not have to be financial’



although that is how they are commonly thought of in for-PrOfit organizations. A not-forprofit organization・s primary objective might be to provide shelter for homeless people, for example; but even in these organizations’there have been calls to express the achievement



of these obje⊂tives in financial or叫c[S誼nancial terms, SuCh as social return on investm。nt,28 H。WeVer, many for-PrOfit organizations also have nonfinancial objectives’SuCh as



related to sustainability or personnel development and we11-being (see Chapter 16). In any organization, however’emPIoyees must have a basic understanding of what the organization is trying to accomplish. Otherwise’nO One COuld claim that any ofthe empIoyees’actions are purposive, and no one could ever support a 。aim that the organization was successful.



In most organizations, the ohectives are known. That is not to say that all empIoyees always agree unanimously as to how to balance their organizations, responsibilities to a11 of their stakeholders, in。uding owners (equity holders), debtholders’emPIoyees・ SuPPliers, CuStOmerS, and the society at large. They rarely do.29 That said’Organizations develop explicit or implicit



compromise mechanisms to resolve conflicts among stakeholders and reach some level of agreement about the objectives they will pursue. As Jason Luckhurst’managing director of



Practicus, a UK-based prQject-management reCruitment firm, argueS:



Hb achieve organizational success], it takes a cIear vision around which the entire business [can] be designed, [and一案think it is something you shouId be abie to communicate



9



Chapter l. Management and Cont「oi



simply to everyone, Whether a client or [an empIoyee]. Having a simpIe and easiIy undeト



stood statemettt of intent is vitai for setting cIear objectives and targets.30



Strategy formuIatiorm Having set the fim’s strategic intentions or objectives, Stra亡egies then define how organizations



should use their resources to meet these objectives. Awell-COnCeived strategy guides empIoyees in successfully pursuing their organization’s o旦iectives; it conveys to empIoyees what they are



SuPPOSed to be doing" OI., aS Mr. Luckhurst at Practicus states: AI=he planning in areas as diverse as marketing, branding, financing and training言S designed around書oun objective - aS are [ou印ncentive [systems]" We have a detailed road map, but it starts with a simpIe vision that everyone can understand and buy into. Eve「y-



thing e-se we do comes on the back of those goals" In effect, We Can reVe「Se-engineer the



business to those objectives,31 Many organizations develop formal strategies through systematic’Often elaborate, Planning



processes (which we discuss further in Chapter 8). Put differently, they have what can be called an証e融ed stra亡egy・ However, Strategies can sometimes be left largely unspecified. As such’ some organizations do not have formal’Written strategies; instead they try to respond to opportunities that present themselves. M亘ior elements of these organizations’strategies e桝eIge from



a series of interactions between management, emPloyees’and the environment; from decisions



made spontaneously; and from local experimentation designed to learn what works well. Nonetheless, if some decision-making consistency exists, a Strategy Can be said to have been formed, regardless of whether managers planned or even intended that particular consistency. In that



sense, StrateglC VISIOnS SOmetimes come about through dynamic organizational processes rather than through formalized strategic planning.32



Not even the most elaborate strategic visions and statements are complete to the point where



they detail every desired action and contemplate every possible contingency. However, for pur



poses ofdesigning MCSs, it is useful to have strategies that are as specific and detailed as possible, if those strategies can be kept current. The formal strategic statements make it easier for



management both to identify the feasible management control altematives and to implement them effectively. The management controIs can be targeted to the organization,s critical success factors, SuCh as developing new products, keeping costs down, Or grOWing market share’rather than aiming more generally at improving profitability in otherwise largely皿specified ways. Formal strategic statements are not a sufficient condition for success’however. As Adrian



Grace, managing director ofBank of Scotland - Corporate, StateS: i have seen businesses with 400-Page documents outlining their strategy and it’s ciear



they should have spent Iess time outlining the vision and more time thinking about how they wi一一de-iver on it. You can have the best vision in the worid but if you can’t put it into



effect, yOu are WaSting your time・33



It is on the execution side of the management process that MCSs play a critical role. Jason Luckhurst explained: The d冊erence between merely having a strategic vision and achieving strategic success is



having a detaiIed understanding of what that vision means for every leveI of the business how much funding you need, the branding and marketing strategy’Which channeis you wⅢ



deveIop, how many peopIe you need in which areas and when and what the organizationaI



structure wi= be, it is also important to revisit the vision often and be aware of how ciose



you are to achieving it at any given stage. This helps everyone in the company to stay focused.34



10



Management and controi



Management contrOl Mc胴ge肌e庇co証rO=ecuses on execution, and it invoIves addressing the general question: Are



our empIoyees likely to behave appropriately? This question can be decomposed into several PartS: ㊧ First, do our empIoyees understand what we expect of them? e¥ Second, Will they work consistently hard and try to do what is expected ofthem - that is’Will they pursue the organization’s objectives in line with the strategy?



㊧ Third, are they capable ofdoing a goodjob?



Finally, ifthe answer to any ofthese questions is negative, What can be done to solve the man-



agement controI problems? All organizations who must rely on their employees to accomplish organizational objectives must deal with these basic management control issues. Addressing management control issues’therefore’invoIves reflecting on how to influence’direct, Or align



empIoyees, behaviors toward the achievement of organizational objectives consistent with the espoused strategy・



From a management COntrOI perspective’Strategies should be viewed as useful but not



absolutely necessary to the proper design of MCSs. When strategies are formulated more 。early, mOre COntrOl altematives become feasible’and it becomes easier to implement each



form of management control effectively. Managers can’however’design and operate some



types of MCSs without having a 。ear strategy in mind. As Adrian Grace, managing director ofBank of Scotland - Corporate, PrOffers‥ “Ifyou don,t have [a strategy] but you know how to



deliver, yOu might still make it. Success in business is 25% strategy but 75% execution.,,35 or, the other way around’tO devise a strategy and write it down is one thing; it is another



thing entirely to make the plan work in practice" That said, there is some evidence that organizations with formal systems for managing the execution of strategy outperform those



that do not.36



Behavioral emphasis Management contrOl invoIves managers taking steps to help ensure that the empIoyees do what is best for the organization. This is an important purpose because it is people in the organiza-



tion who make things happen. Management cOntrOIs are necessary to guard against the possibilities that people will do something the organization does not want them to do’Or fall to do something they should do. For example’aiming to achieve greater cost contrOl is open to ques-



tion without reference to people because costs do not control themselves; PeOPle control them. As many examples throughout the text will illustrate’emPIoyees can work against or around



systems, thereby leaving many ot)jectives unmet or producing unintended consequences.



This behavioral orientation has Iong been recognized by practitioners. For example, Roman stanek, Chief executive of GoodData in San Francisco’a business analytics company’aCknowト



edgedthat: Having a vision and having confidence doesn’t mean anything unIess you’re able to communicate it to your team [...]" The ability to communicate weli didn’t come easily for me・ l



always assumed that everybody wou-d see things the same way I see them’and now I understand it takes a Iot of time to get peopIe a佃ned"37 If a11 empIoyees could always be relied on to do what is best for the organization・ there would be



no need for a MCS. But empIoyees are sometimes unable or unwi11ing to act in the organization’s



best interest, SO managerS muSt take steps to guard against the occurrence of undesirable behaviors and encourage desirable behaviors. 11



Chapter l. Management and Controi



Causes of manag婁ment COntrOi probiems Given the behavioral focus of controIs, the next logical question to ask is: What is it about the empIoyees on whom the organization must rely that creates the need to implement MCSs? The causes of the needs for controI can be class綿ed into three main categories: lack of direction,



motivational problems, and personal limitations.



Lack of direction Some empIoyees perform inadequately simply because they do not know what the organization wants from them. When thisねck qfdirec亡Iorl OCCurS, the likelihood of the desired behav-



iors occurring will be haphazard or random. Thus’One function of management control invoIves informing empIoyees as to how they can direct their contributions to the fu皿Iment



of organizational objectives. Indeed, this is also the key point that came through in the quote from Stanek above.



Lack of direction is not a trivial issue in many organizations, although it is often taken for



granted (as the quote from Stanek also suggests). For example, SurVey eVidence collected by KPMG, a big-four professional services company providing audit’taX, and advisory services’



from approximately 4,000 US empIoyees spanning a11 levels ofjob responsibility across a wide



range of industries and organizational sizes revealed that 55% ofthe sample respondents had a



lack of understanding of the standards that apply to their jobs.38 Moreover, a Study of 414



World-at-Work members in mostly managerial positions at large North-American companies suggested that 81% of the respondents believe that senior managers in their organizations



understand the value drivers of their business strategy; 46% say that middle management understands these drivers; but just 13% believe non-management emPIoyees understand them" This indicates that organizational goals are not cascading down to al1 1evels in the organization"



And while 79% ofthe respondents in this study believed that their employees, goals are aligned with organizational goals, 44% also stated that empIoyees set goals based on their own views rather than direction from leadership.39



Another survey from KPMG asked what factors might cause managers and empIoyees to engage in misconduct, Which, aS We Will see across several chapters in this text’is an impor-



tant management controI problem. The answer, in fifth place and mentioned by 59% of the respondents, WaS “a lack of understanding of the standards that apply to theirjobs.,40 Another survey of 5,00O respondents, induding ``techies’’(e.g. software developers or engineers), indi-



cated that only 28% ofthe techies said they understood their companies, vision compared with (also only) 43% of non-teChies.41 And, in a university one of the authors of this text is familiar with, a Staff survey revealed that only half of the empIoyees responded a節rmatively to the question whether “they had a dear understanding ofthe purpose and objectives of [the university],・, whereas (also only) 68% said this to be the case for the ohectives oftheir department.42



All told, then, it should not be taken for granted that empIoyees have a clear understanding of direction. Tb the contrary, the survey evidence suggests that a lack of direction may be quite a



COmmOn OCCurrenCe.



Motivational probIems Even if empIoyees understand what is expected of them’SOme do not perform as the organi-



zation expects because of mo亡iva亡ionc[Z probZe肌s. Motivational problems are common



because individual and organizational objectives do not natura11y coincide - individuals are selfinterested.



12



Causes of management contrOi probIems



EmpIoyees sometimes act in their own personal interest at the expense of their organization’s interest. Frederick Taylor, One Of the m亘ior丘gures in the scie庇折c m肌age肌e庇movement that took place in the early twentieth century, WrOte: “Hardly a competent worker can be found



who does not devote a considerable amount oftime to studyingjust how sIowly he can work and still convince his empIoyer that he is going at a good pace.珂3 such q的r亡aversion and other se折 証eres亡ed behaviors are still a problem today. Gary Gill, the author of KPMG,s Fraud Barometer



for Australia, believes that broad economic conditions have a significant effect on fraud levels: ・・It goes up following a boom period. People want to maintain their standard of living’eVen if it means criminal activity享4 Another survey suggests that fraud is on the increase in the United Kingdom・s public sector as austerity programs imply personnel reductions and fewer resources



being spent on intemal controIs, aCCOrding to a report from PwC’a big-four competitor of



KPMG.4与 overall, SurVey eVidence suggests that wasting’mismanaging’and misappropriating organizational resources, amOng Other types of empIoyee misconduct’are PreValent in most organiza-



tions.46 Even ostensibly inconsequential forms of wasting time on the job can have high costs. su血g the Intemet while on the job’for example, has been estimated to have cost US empIoy-



ers in the bi11ions of dollars per year"47 All told, SurVey Participants in the most recent report by



the Association of Certified Fraud Examiners estimated that the typical organization loses 5% of its amual revenue to fraud. Applied to the estimated 2014 Gross World Product’this figure translates to a potential global fraud loss ofmore than $3・7 tri11ion.48 staggering as these statis-



tics may be, they suggest that it should not be taken for granted that empIoyees will always reliably act with the best interest of their organizations in mind. Because of this’the costs to organizations are nontrivial・ tO Say the least.



Indeed, the most serious forms of empIoyees, misdirected behaviors, SuCh as fraud, Can have severe impacts, including deteriorated empIoyee morale, impaired business relations’lost rev-



enues from damaged reputations’investments in improving controI procedures’legal fees and settlements of litigation, fines and penalties to regulatory agencies’and losses from plummet-



ing stock prices. Many of the examples that we included at the start of this chapter illustrate this,49 and various fraud or integrity surveys’SOme Of which have been conducted over many



years by mgivr organizations, reinforce this with statistics.50 These huge fraud costs can be traced back to human weaknesses but also’and importantly,



as we will see later in this text, tO the lack of effective MCSs. Anecdotal assertions abound. For example, One manager Claimed’rather brashly’that ・・every single person in your [business] is trying to steal from you.,,51 Another manager’s estimate’While more measured’Sti11 suggests



that: Between lO and 20% of a company’s emp-oyees wi= steai anything that isn’t nailed down・



Another 20% wilI never steai; they would say it is mora11y wrong. The vast majority of peop-e are situationa一一y honest; they won’t stea冊here are prope「 COntrO-s"52 Regardless ofthese oplnlOnS’One might argue that “stealing,, is a rather literal’PeCuliar・ and



perhaps too extreme or negative type of behavior to illustrate se距nterest.嶋king偉stealing’’



less literally, many Other foms of misaligned behaviors occur when employees’for example’ manipulate their performance reports’either by falsifying the data or by taking decisions that artificially boost performance’With the intention of eaming higher’but undeserved’incentive



pay (see also Chapter 15). The most common cause of this is reported to be pressure to do “whatever it takes・, to meet business targets.53 This goes to the heart of res融s co庇roZs (which



we discuss in Chapter 2) and related perfomance targets (Chapter 8) and incentives (Chapter 9). Well-designed MCSs are needed to protect organizations against these behaviors. However, in addition to focusing on how MCSs can be used to prevent or mitigate these negαfive or dy垂ncfroれaThehaviors, this text,s emphasis is also’eVen Primarily’On how MCSs



13



Chapter l. Management and ControI Can be empIoyed to motivate pos注ive or prod」C亡ive behaviors; that is, how they encourage



empIoyees to wQI-k consistently hard to accomplish organizational objectives. As we will disCuSS further below, whenever feasible, mO高vc証ort should be the primary focus of effective



MCSs, mOSt COmmOnly brought about through res【克s coutroZs (Chapter 2) while also providing



any necessary behavioral constraints and/Or mitigating any behavioral displacements through a well-designed combination or “configuration’’of ac亡Zorl and perso柵eZ産油uraZ co庇rOIs



(Chapter 3).54



Persona=imitations The final behavioral problem that MCSs must address occurs when employees who know What is expected of them, and may be highly motivated to perform well, are Simply unable to Perform we11 because of any number ofother limitations. Some ofthese limitations are perSOn-SPeCific. They may be caused by a lack of aptitude, training, eXPerience, Stamina, Or



knowledge for the tasks at hand. An example is the too-COmmOn Situation where empIoyees are promoted above their level of competence; that is, When empIoyees are `くover their heads.’’Sometimes jobs are just not designed properly, CauSing even the most physically fit



and apt empIoyees to become tired or stressed, leading to on-the」ob accidents and decision



Regarding lack of training, for example, I11inois-based Ace Hardware was forced to restate



its eamings for four fiscal years because of a $152 mi11ion accounting error made by a poorly trained empIoyee, Who incorrectly entered accounts in ledgers in the Finance department at the company’s headquarters. Ace CEO Ray Gri飴th stated: “We are embarrassed by it. We did not provide the training, OVerSight or checks and balances to help that person do (the) job.”55



Errors such as these are not uncommon. For example, When Bank of America, a global USbased bank, disdosed that it had made a signi丘cant error in the way it calculates a crucial



measure of its financial health, Which led the bank to report that it had $4 billion more capital than it actually had, the error raised serious questions about the “quality of its accounting



empIoyees.,,56 similarly, at Ttsco, the largest UK supermarket chain, When it announced to have overstated its expected profits by f250 million, One COmmentatOr Observed that “even if



there was no fraudulent intent and the problems stem from a misunderstanding of the rules […], the apparent scale of the error suggests that, at the very least, Tesco’s intemal controIs



need a thorough overhauL,,57



MoreoveI., reSearCh in psychoIogy and behavioral economics suggests that all individuals, even intelligent, We11-trained, and experienced ones, face limitations in their abilities to per-



Ceive new problems, tO remember important facts, and to process information properly (or rationally). In looking at the future, it has been shown, for example, that people tend to overestimate the likelihood of common events and events that have occurred relatively recently (both



Of which are easier to remembeD as compared with relatively rare events and those that have not occurred recently. Such biases may, for example, affect employees’propensities to assess



risks by biasing their estimates ofeither the likelihood or impact, Or both, Ofcertain risk events.



Sometimes training can be used to reduce the severity of these limitations. Nonetheless, these limitations are a problem because they reduce the probability that empIoyees will make the correct decisions or that they wi11 correctly assess the problems about which decisions should be made.58 These three management controI problems - lack of direction, mOtivational problems, and



PerSOnal limitations - Can Obviously occur simultaneously and in any combination. However,



a11 that is required to ca11 for the necessity of effective MCSs is that at least one ofthese problems occurs, Which will almost inevitably be the case in complex organizations as the above arguments and examples have suggested.



14



Characteristics oLgood management contrO一



耽have a high probability of success’Organizations must therefore maintain good management



.ontr。l. G。。d.。ntr。I means that management can be reasonably confident that no major unpleasant surprises will occur・ The label ou亡Qfcor軒oZ is used to describe a situation where there is a high probability ofpoor performance’either overall or in a speci丘c performance area’



despite having a sound strategy in place.



However, eVen gOOd management controI still allows for some probability of fallure because pe7佃t control does not exist except perhaps in very unusual circumstances. Perfect controI



would require complete assurance that all controI systems are fooIproof and all individuals on



whom the organization must rely always act in the best way possible. Perfect control is obvi-



ously not a realistic expectation because it is virtually impossible to install MCSs so we11 designed that they guarantee good behaviors. Furthermore’because MCSs are costly, it is rarely, if ever, COSt effective to try and implement erro“gh controIs even to approach the ideal-



ized perfect control・



The cost of not having a perfect controI system can be called a co庇ro川oss. It is the diiference



between the performance that is theoretically possible given the strategy selected and the per-



fdrmance that can be reasonably expected with the MCSs in place. More or better MCSs should be implemented only if the benefits by which they would reduce the control loss exceed the costs, Except in cases where the consequences of failure are incalculable’OP亡imc[! co佃O! can be



said to have been achieved ifthe control losses are expected to be smaller than the cost ofimplementing more controIs. Because of controI costs, Perfect control is rarely the optimal outcome (or even conceivable). The benchmark, therefore’is adequate control rather than perfect con-



trol, eXCePt again in cases where failure is not an option and where control must be uncompro-



misingly focused on avoiding fallure at any cost (such as in nuclear plants).



Assessing whether good control has been achieved must be future-Oriented and objectivesdriven. It must be庫ure-Orie庇ed because the goal is to have no unpleasant surprises in the future; the past is not relevant except as a guide to the future’SuCh as in terms of experiences or lessons leamed from control failures. It must be o坊ec亡豊ves-drtven because the ot)jectives repre-



sent what the organization seeks to attain. Nonetheless’aSSeSSing whether good control has



b。。n a.hieved is di飴cult and subjective. It is di飴cult because the adequacy of management control must be measured against a future that is inevitably di鯖cult to predict’aS are Predic-



tions of possible unintended consequences of the controIs. Good control also is not established over an activity or entity with multiple ot)jectives unless performance on 。f significant dimen-



sions has been considered. As di飴cult as this assessment of management control is’however’it



should be done because organizational success depends on good MCSs. As the examples at the beginning of this chapter illustrate’Organizations that fail to implement adequate MCSs can suffer loss or impairment of assets, deficient revenues’eXCeSSive costs’ inaccurate records, Or rePOrtS that can lead to poor decisions’legal sanctions, Or business disruptions. At the extreme’Organizations that do not controI performance on one or more critical



dimensions can fail,



ControI problem avoidance Implementing some combination of the behavior-influencing devices commonly known as



MCSs is not always the best way to achieve good control; SOmetimes the problems can be avoided. AγOfdc[rlCe meanS eliminating the possibility that the controI problems will occur・



15



Chapter l. Manageme=t and Controi organizations can never avoid all their controI problems’but they can often avoid some ofthem by limiting expt)sure to certain types of problems and problem sources’Or by reducing the max-



imum potential-loss if the problems occur. Four prominent avoidance strategies are activity elimination, autOmation, Centralization, and risk sharing.



Activity eiimination Managers can SOmetimes avoid the controI problems associated with a particular entity or activity by turning over the potential risks’and the associated profits’tO a third party through such mechanisms as subcontracting, licensing agreements’Or divestment. This form of avoid-



ance is ca11ed act[v互y轟肌inc[tiorh Managers who are not able to controI certain activities’Perhaps because they do not have the



required resources, because they do not have a good understanding of the required processes’ or because they face legal or structural limitations’are those most likely to eliminate activities.



Here is an example: when the German financiaI regulator ordered Deutsche Bank ‖to do more to enSure that



commodity prices cannot be manipu-ated by its traders,,・ the bank responded that it償has since shut trading desks dedicated to energy・ agricu-ture’dry bulk and freight and base



metais. Other commodity businesses have been transferred to Deutsche,s non-COre bank where they wiI- be wound down or so-d’While some partS remain active・,, adding that “we significant-y sca-ed back our commodities business and exited entireIy non-PreCious meト als trading・ As we have previous-y said, We COntinue to cooperate With authorities in their



industrywide review of certain benchma「ks and are investing to further improve our cOntrOl environment.,・59



when managers do not wish to avoid completely an area that they camot controI we11’they are



wise at least to limit their irrvestments, and hence (some of) their risks, in that area. An example is 。oud computing, Which means that companies obtain computing resources (processing, StOrage’



messaging, databases, and so on) from outside’and pay only for what they use, rather than



develop their own computing infrastructure and run their own systems. With the increase in demand for servers to store and process data, many COmPanies would need to multiply their server capacity manyfold’fdr which they sometimes have neither the money nor the skills’nOr the



interest, because doing so細1s outside of most companies, core competencies. By using 。oud computing services’丘rms can leave a11 that to be managed by those who have the competencies



and, hence, Can PrOVide essential controI over the process. Whereas this does not eliminate all risks, it partially avoids some controI problems related to data management and a11 that it entails. Indeed, many COmPanies have been expanding their use of 。oud services’With growing numbers running systems such as email services’human resources, and administrative pro-



cesses via the 。oud, aS We11 as data storage and backup. James Petter’UK managing director of



EMC, the data storage and software group’Said: “Organizations move to the 。oud for a number of reasons, but they most often relate to agility, CO庇rOhand efficiency,, (italics added). “More



than just hosting services, the 。oud is ensuring availability and perfomance’PrOteCting data



and helping businesses with change management by depIoying functions and lessening disruption,,・ Joe King, Senior vicei)reSident at JDA, the supply chain software group’added.6O



The economics-based literature that focuses on whether specific activities ftransactions) can be controlled more effectively through mrke亡s (extemal) or through organizational hferarchIes



(intemal) is known as trcmsac亡{on cost econo扉cs. A detailed examination of the theories and



evidence in this field of study is outside the scope ofthis text.61 wejust note that the cost/benefit tradeoffs of dealing with management control issues intemally do not always favor arms-1ength’



market-based transactions or inter-Organizational arrangements’and thus a care餌balance has



16



Controi probiem avoidance



to be struck.62 Referring back to the doud services, for example, One issue that sometimes holds companies back is a concem about security. As such’Organizations wi11 always have to rely on



MCSs intemally, Which have been found to be e鉦ctive in a broad range of settings. The preva-



1ence oflarge diversified organizations has depended to a large extent on good MCSs.



Automation Automa亡ioれis a second avoidance possibility" Managers can sometimes use computers, rObots’ expert systems, and other means of automation to reduce their organization’s exposure to some



controI problems. These automated devices can be set to behave as required’and when they are



operating properly, they perfom more consistently than do humans. Computers eliminate the human problems of inaccuracy, inconsistency, and lack of motivation" Once programmed’COmputers are consistent in their treatments of transactions’and they never have dishonest or dis-



loyal motivations. Here is a representative quote from the mining industry: Rio Tinto has roiIed out fuliy automated driverless t「uck fIeets at two of its iron ore mines in



the Piibara in Weste「n Australia。 [.○ ○寒“Our autonomous fIeet outpe「forms the named fieet by



an ave「age of 12 per cent, PrimariIy by eiiminating required breaks, absenteeism and shift



changes,,, said Andrew Harding’Rio,s iron ore chief executive・償In=OVation and technoIogy is critica=n our e什OrtS tO improve safety.” […] The worId’s biggest miners are turning to technoIogy to cut costs〇 〇〇〇〇] This fo=ows a similar trend across a wide range of industries,



from car manufacturing to computing, Whereby robots o「 artifjcia=nteIIigence are increas-



ingIy taking roles traditionaIly performed by humans. […寒“Removing people from the mine environment is safer” said Dr. CarIa Boehi, a Iecturer at Curtin University - “tt has cost



advantages too, It can be very costiy for companies if empioyees are hurt onsite"’’音…] ``We



have also seen a 13 per cent reduction in Ioad a=d hauI costs due to the greater e冊Ciency’”



Mr. Harding said. Dr. Boehl said embracing techno10gy COuid create more interesting jobs whiie making Iower skilled positions obsoIete・ ‖You wiii tend to Iose the boring, rePetitive



jobs performed in the 50 degrees centigrade heat in the Piibara but you can aIso create new imovative rotes in ana-yzi=g data and deve-oping techno-ogy’,, she said"63



As technology has advanced, Organizations have substituted machines and expert systems for people who have been performing quite complex actions and making sophisticated judgments and decisions. In hospitals, for example, artificial intelligence systems are able to perform many of the tasks doctors and nurses used to perform. These systems monitor the patients’conditions



and trends and alert the medical staffofpossible problems; they assist in making diagnoses; they order the needed drugs; and they check for potential drug interactions and allergic reactions. Computer-aided insertions of central venous catheters are more accurate and reduce complica-



tions (such as punctured arteries that can lead to infections).64 And so on. Importantly, these systems allow hospitals to avoid one of the behavioral problems - the personal limitations ofthe medical staff. In the vast majority of situations, these systems are more likely than are medical personnel to recall all the details of every condition’medication’and possible complications to



initiate the proper response, Needle iIjection robots use tracking algorithms to keep the blood vessel aligned, and thus, are mOre aCCurate. Hence’these systems make it more likely that no



major, unPleasant surprises wi11 occur; in this case, aVOidable medical errors and complications. Similarly, many legal tasks, although sometimes quite complex’are Variations on a theme,



where the production of certain types of legal documents does not di任er vastly from one instance to another. Legal firms are therefore increasingly using what is called docume庇



asse肌bfy s〔昨wclre, allowing them to reduce the time needed to put together a certain type of



legal document (such as a trademark registration or a real estate lease) to a fraction ofthe time it takes an empIoyee to do the same and, POSSibly, mOre COnSistently and accurately with fewer



17



Chapter l. Management and ControI



errors. Moreover, autOmating these onerous processes reduces costs and allows lawyers to spend mor釦ime dealing with their clients.65



Another example is where banks (when they have not exited parts of the trading business as Deutsche Bank did in the example above) have sped up digital trading to settle trades via automated processes to minimize human intervention because traditional trading over the phone has come under intense regulatory scrutiny due to a11eged manipulation ofbenchmarks such as



CurrenCy fixes and interbank lending rates. Automation leads to a better dient experience at lower cost with stronger control, thereby reshaping a once opaque but lucrative business to become less risky・66



In most managerial situations, however, autOmation can provide only a partial controI solution at best. One limitation isjねsめ据ty. Humans have many talents - Particularly those invoIv-



ing complex, intuitive judgments - that no machines or decision models have been able to duplicate. There are often also regulatory constraints, Where the regulators maybe understandably wary of fu11y autonomous systems in some settings, SuCh as in health care, In other set-



tings, SuCh as automated trading in banks, they may welcome them. Regulators may find fully autonomous or ``self-driving’’cars not yet feasible, but they are likely to welcome semi-autOnO-



mous systems that help ・・take the human error out of driving・,・67 A further limitation is cos亡. Automation often requires mayor lnVeStmentS that may be justifi-



able only if improvements in productivity, aS Well as in control, are forthcoming. Finally, autO-



mation may just replace some controI problems with others, Or introduce different control issues. The elimination of source documents can obscure the audit trail; the concentration of information in one location can increase security risks; and placing greater reliance on com-



Puter PrOgramS Can eXPOSe the company to the risks ofprogrammer errors or fraud.



CentraIization Ce庇rc揖za亡iorl Of decision-making is a third avoidance possibility, Which is a key element of almost all organizations’MCSs. High degrees of centralization, Where a11 the key decisions are



made at top management levels, are COmmOn in small businesses, Particularly when they are



run by the founder or owner. High degrees of centralization also exist in some large businesses Whose top managers sometimes have reputations for being “detail oriented’’or ``control freaks.’’



When that is the case, tOP management reSerVeS the important, and sometimes the not-SOimportant, decisions for themselves, and in so doing, they avoid having the lowe「level employ-



ees make poorjudgments. Centralization inevitably exists to some extent in a11 organizations, aS Well as at all levels of



management within organizations, aS managerS tend to reserve for themselves many of the most crucial decisions that fall within their authority. Common candidates for centralization are decisions regarding major acquisitions and divestments, mqjor capital expenditures, negOtiation of pivotal sales contracts, Organization changes, and hiring and firing of key personnel・



However, in most organizations of even minimal size, it is not possible to centralize all critical decisions, and other controI solutions are necessary. As we wi11 see in Chapters 2 and 7, reSults



COntrOIs play a critical role when decisions are decentralized. When decisions are decentralized, reSults controIs need to be in place to hold the managers who erjoy the decision authority



accountable for the results of their decisions. Accountability for results is what makes delegated authority legitimate.



Risk sharing A丘nal, Partial avoidance possibility is risk sharing. Sharing risks with outside entities can bound



the losses that could be incurred by inappropriate empIoyee behaviors. Risk sharing can involve buying iJISurarlCe tO PrOteCt against certain types of potentia11y large losses the organization



18



might not be able to afford. Many comPanies purchase fidelity bonds on empIoyees in sensitive



positionsifuch as bank te11er9 to reduce the fim,s exposure. These insurance COntraCtS PaSS at least a portiorl-of the risk of large losses and errors to the insurance PrOViders. Another way to share risks with an outside party is to enter into ajo而ve融re agreement. This shares the risk



These avoidance alternatives are often an e任ective partial solution to’Or bounding of’many



of the controI problems managerS face. It is rarely possible to avoid all risks because fims are rewarded for bearing risk’but most fims use some forms of elimination’autOmation, Centrali-



zation, and risk sharing in order to limit their exposure tO the management COntrOI problems.



Control altematives For the controI problems that cannot be avoided, and those for which decisions have been made



not to avoid, managerS muSt implement one Or mOre COntrOl mechanisms that are generally called mc[Jlαgeme姉OntrO s. The collection of control mechanisms that are used is generally



referred to as a maⅢge肌e柾COrl面eystem (MCS).



MCSs vary COnSiderably among organizations and among entities or decision areas Of any single organization. That said, they commonly in。ude a co肌b血ion of action’reSults, and personnel/Cultural controIs’Which we discuss in depth in the next twO Chapters. The MCSs of



some organizations consist primarily of trying to hire people who can be relied upon to serVe the organization well. Other organizations provide modest pe血mance-based incentives’and



still others offer incentives that are highly leveraged. Some organizations base incentives on the accomplishment of targets defined in terms of accounting numbers, Others use no血ancial measures of performance, and still others evaluate pe血mance supeCtively. Some organizations have elaborate sets Of policies and procedures that they expect emPloyees to follow’ whereas others have no such procedures’Or they allow the procedures that were onCe in place



to get out of date" Some organizations make extensive use of a large profdssional internal audit staff甲hile others only ensure to be in minimal compliance with regulatory requirements in



this regard. These are just examPles. The distinctions that can be made among the MCSs in use Management COntrOI choices are nOt random, however. They are based on many factors. some controIs are not effective’Or are nOt COSt-effective’in certain situations. Some typeS Of



controIs are better at addressing particular types of problems’and different organizations and different areas within each organization often face quite di任erent mixes of controI problems.



some types of controIs have some undesirable side effects that can be particularly damaging in



some settings. And some contrOIs merely suit particular management Styles better than others.



A mgiv purpoSe Ofthis text is to describe the factors affecting management COntrOI choice decisions and the effects on the empIoyees and the organization when different choices are made.



Outline of this text The text discusses MCSs from several different angles, eaCh the focus of one m担section・



section II distinguishes controIs based on the o輝Qf co融’Which can focus on the results produced (resuZ亡s cond)’the actions taken ouon cort亡rO[)’Or the types of people empIoyed and their shared norms and values (persormeZ ond c血r。 cond). Chapters 2-6 in Section II



discuss each of these forms of control, the outcomeS they produce (Which can be both positive and negative恒nd the factors that lead managers to Choose one object of controI over another.



19



Chapter l. Management and ControI Section IⅡ focuses on the major elements of月rlCmC壬。iresl庇s-CO融rOZ $rste肌S, an important type of re糾lts control in which results are defined in financial terms. This section includes dis-



CuSSions of financial responsibility structures (Chapter 7), Planning and budgeting systems cehapter 8), and incentive systems (Chapter 9). Section IV discusses some m砧Or PrOblems managers face when they use financial results-



COntrOI systems and, Particularly, the performance measurements that drive them. These prob-



lems include the tendency of accounting measures to cause managers to be excessively



Short-term Oriented (myopiO, the tendency for retum-On-investment measures of performance to cause poor investment and performance evaluation decisions, and the likelihood of negative behavioral reactions from managers who are held accountable for factors over which they have



less than complete control. Throughout Chapters lO-12, We also discuss several approaches Organizations can rely on to mitigate these problems.



Section V discusses some key organizational control roles, including those of controllers, auditors, and audit committees of the board of directors. It also discusses recent developments



in corporate govemance (Chapters 13 and 14) as well as common control-related ethical issues and how to analyze them (Chapter 15). Given the focus on缶nancial results controIs in primarily Sections III and IV, in the final sec-



tion (Chapter 16), We COme back to broaden this focus by discussing the pertinence of MCSs even when financial results are not the primary rc[isorl d枕re ofthe organization, SuCh as in non-



PrO丘t organizations, Or Where there are broader missions or concems beyond the financial



realm, SuCh as regarding sustainability and corporate social responsibility.



N otes I See, for example, and selectively only, “Royal Bank of  8 Scotland Fined f56m for IT Meltdown,’’FirlarlCZc[Z TimeS ∴∴ 9



(November 20, 2014), Online at on.ft.com/14PBtV9. 2 See, for example, and selectively only, ``Banks Braced for



Additional f22bn in PPI Claim Payout,’’F壬rlanC融Ti肌es lO



(Apri1 4, 2016), Online at on.ft.com/1VoDSwj. 3 See, forexample, andselectivelyonly, “BNPParibasMade ll



``Libor Probe Said to Expose Collusion, Lack of Intemal ControIs,’’Bfoomberg (February 15, 2012), Online at



WWW.bloomb e rg.com. “HSBC Reveals Problems with Intemal ControIs,” The



New Ybr友Hmes Uuly 12, 2012), Online at nyti.ms/NO7PkC. “Bank Litigation Costs Hit $260bn - With $65bn More to



Ethical and Legal Mistakes, Says Chairman,’’瑞ncmc融



Come;’軸narlC拙Times (August 23, 2015), Online at on.



Tt肌es (February 15, 2015), Online at on.ft.com/1ITIq14.



ft.com/1JHtTIP.



4丁bomanyarticles on the LIBORscandalhave appeared in 12



“Bankers Not Only Ones Pushing Ethical Boundaries;’



the press to make a sensible selection. For a taste, and



Ffrl肌C融n肌es (September 25, 2015), Online at on.ft.



indicatively on獲y, tyPe “Libor Investigation’’in the search



COm/lFmAXiS.



box on next.ft.com.                       13



5 See, for example, and selectively only, ``Hong Kong Mar-



ket Regulator Fines RBS for Trading ControI Failure;’ 14



“Boardroom Politics at Heart of VW Scandal,’’F[rICⅢCZaZ



Tf肌es (October 4, 2015), Online at on.ft.com/1hiUICQ. `Atlanta’s SchooIs - the Reckoning,’’The Economis亡(Apri1



B上oombe7官(Apri1 22, 2014), Online at bloom.bg/1VKR912; “London Whale Complains of Unfair Blame for $6.2bn 15



6, 2013), Online at www.economist.com.



JPMorgan Losses,” FfJtCmC融TZmes (February 23, 2016),



T壬mes Uuly 16, 2015), Online at on.ft.com/1fMNz7h. “Scathing Report Says Tbshiba CEOs Had Role in Accounト



online at on.ft.com/1SR98Ek.              16



6 See, for example, and selectively, ``BNP Paribas Made Ethical and Legal Mistakes, Says Chairman;’op. cit.; ``HSBC



Monitor Says Bank’s Compliance Progress Too SIow - 17



`Accounting Scandal Set to Shake Up Tbshiba,’’瑞narlC出



ing Scandal,’’Ft朋71Cねは涌es (July 20, 2015), Online at



On.ft.com/1KgFnZB. “Tbshiba Chief Hisao Tanaka Resigns over $1.2bn Account-



Bank Needs to Do More to Fix Corporate Culture, Update



ing Scandal,’’F主rmれC融n肌es Ouly 21, 2015), Online at on.



耽chnoIogy, Compliance Monitor Says,’’T五e W〔亜Sfree亡



ft.com/ 1ed zVbE.



Jo肌mZ (Apri1 1, 2015), Online at on.w?j.com/1ajxzqz. 18



7 “FSAFines UBS f29.7 Million for Significant Failings in 19 Not Preventing Large Scale Unauthorized Trading,’’ 2O F証arlC[d Serv[ces A【丑JIOrめ′ (November 26, 2O12), Online atwww.fsa.gov.uk/librar)γtOmmunication/Pr/2012/105. 21



Shtml or at www.fsa.gov.uk.



20



Ibid.



“Bankers Not Only Ones Pushing Ethical Boundaries,’’op. cit. `Atlanta’s SchooIs - the Reckoning,’’op. cit.



``Deutsche Bank in $6bn `Fat Finger’Slip-Up,’’F証ancrdZ



耽mes (October 19, 2015), Online at on.ft.com/1QMFz2q. ``Bank of England Moves to Stamp Out `Fat Finger’Errors,”



F証oncic[据meS Uune 14, 2015), Online at on丘.com/1 JNEF5M.



Notes



22 “Bank Clerk Nods Offwith Finger on Keyboard and Gives



Away f189m,’’Ever血g Sfαnd。rdjJune ll, 2013), P. 3. 23 “丁Wo Accused of INS Shredding Spree,’’The Los Angeles Ti肌es (January 31, 20O3), P. B5.



37 `A Good Manager Must Be More Than a Messenger,’’Ifte



New Ibrk Tines (May30, 2013), Online at nyti,mS/12Skw5l. 38 KZMG2005/2006加fegrfty Sl[rVey (KPMG LLP, 2005). 39 World-at-Work, Sibson, and Synygy,現e Sfate QfPe7Jbr-



24 “The Road to Perdition: Are the EU,s Financial ControIs so



marlCe M融geme庇(Survey Report, August 2004); and J.



Exasperating that They Force Its Own Staff to Evade



Kochanski and A. Sorensen, ``Managing Performance



Them?,’’The EcoJtOmist Uuly 24, 20O3), P. 39.



25 For an academic article on the various concepts of man-



Management,” W)rksp肌(September 2005), PP. 21-6.



40 KPMG 20I3 Jrl亡egr[ty SI上rγの′ (KPMG LLP, 2013), P. 16,



agement control, See T. Malmi and D. A. Brown, “Manage-



Online at www.kpmg.com/CN/en/IssuesAndInsights/



ment ControI Systems as a Package ○ ○pportunities,



ArticlesPublications/Documents/Integrity-Survey-



Challenges and Research Directions,” Ma朋geme庇 Acco肌血gReseclrCh, 19, nO. 4 (December 2008), PP. 287-



300. For a lighter reading, See also ``How Not to Lose Control,’’FinarlCe & Marlageme叫, 242 (Apri1 2016), PP. 14-15,



online at www.icaew.com. 26 Fora dassic text, See, for example, M. E. Porter, Compe缶 t章γe Adv肌でage: Creat誼g arld SzJS亡a諒ing Superior Pe所〕r-



m仰ce (NewYork: The Free Press, 1985), Chapter 2.



27 ``Why CEOs Fail,’’For亡lme (June 21, 1999), Online at



2013-○○201307.pd王 41 ``The Other Side of Paradise,’’The Ecor10肌is[ (January 16,



2016), Online at econ.st/1URPB3P. 42 A [university] staff survey (2016); SOurCe Withheld for COnfidentiality reasons, 43 F.嶋ylor, The Princ珂es qfScfe批准c Mcmageme71亡(New



York: Harper, 1929). 44 “EmpIoyee Fraud Is a Growing Problem, Survey Shows;’ The AIJS亡r〔龍an (June 25, 2010), Online at www.adelaide-



WWW.businessbuilders.bz/why-CeOS-fail.pdf. See also “How to Execute a New Business Strategy Successfu11y,’’



F narlC融Post (August 8, 2013), Online at natpo.st/21KIsrs.



28 M. Hall, Y Miユユo, and E. Barman, “Who and What Really



45 “PWC Survey Shows Rise in Fraud by Public-Sector Sta埠’’



The Jndependerit Uuly 4, 2010), Online at www.indePendent.co.uk.



Counts? Stakeholder Prioritization and Accounting for



46 KPMG20]3 hl亡eg申y S肌vqy, OP. Cit.



Social Value;’JourrlaZ QfM肌agemenてStudies, 52, nO. 7



47 `Are EmpIoyees Wasting Time Online?’’pCWorld.com



(November 2015), PP. 907-34. 29 See R. E. Freeman, S亡rcl亡egic M肌。geme7砧A StakehoZder



ApprocICh (Cambridge: Cambridge University Press, 2010). See also “Shareholders vs. Stakeholders: A New



(August 2, 20Ol); See also ``These Charts ShowWhatWe’re Not Doing because We’re Online A11 the Time,’’BIJS証ess



血srder (October 21, 2013), Online at read.bi/16qZVGz.



48 Assodαtio放ずCert昨ed Frαl」d E糊m五ers - 20ユ6 Repo「亡亡o



Idolatry,’’TJle Economis亡(Apri1 24, 2OlO), Online at econ.



t九e NαtiorlS (ACFE, 2016), Online at www.acfe.com/



St/KAIp7h; `Analyse This,’’The EcorlO扇st (Apri1 2, 2016),



rttn2016.aspx (hereafter AC押20J6 ReporO.



Onlme at eCOn.St/1V9hSFB, 30 “Keep Sight ofYourVision,’’The S肌dqy T血es (March 23,



2008), Online at www.business.timesonline.co.uk. 31 Ibid.



49 See, for example, ``Bank Litigation Costs Hit $260bn With $65bn More to Come,’’op. cit.



5O KPMG 20J3玩亡egrdy Surγqy, OP. Cit.; ACFE 20ヱ6 Repoγt,



Op.Cit.



32 A seminal framework for “strategy analysis’’is that by M. E.



51 “Thou BetterNot Steal,”Fbrbes (November 7 1994), P. 170.



Porter, Co机petitive SけC叱gy; 7tc手刷Iq 【JeSゆr Amlyz血g Jn血s-



52 “Crime Is Headed Up - and So Is Business,’’Boston Gfobe



tries肌d Co7xpedtors (New York: The Free Press, 1980). A



(February 15, 1983), P. 47.



Seminal contributor to the “emergent strategy’’view is H.



53 KPMG 20ヱ3血fegrftySl上rV切OP. Cit.



MmtZberg, “Crafting Strategy,’’Harvc[rd B重上Sfrzess Reγiew,



54 For a recent study of``configurations’’ofthe various types



65, nO. 4 (July-August 1987), PP. 66葛75. For a recent edi-



Of MCSs that organizations empIoy, See, for example, D. S.



tion ofa textbook on strategic management, See R. M. Grant,



Bedford and T. Malmi言`Configurations of Control: An



Co庇emporαJγ Strcl亡egy Arlalysis, 9th ed. (Ch主chester, UK:



Exploratory Analysis,’’Marlageme庇Acco肌亡irlg Research,



Wiley, 2016). For a recent empirical study on the ``ongoing



27, nO. 2 (June 2015), PP. 2-26. For another recent study



riddle’’of formal and/or emergent plaming practices, See



in a non-PrOfit setting that pertinently illustrates the



R. B. Bouncken, V Fredrich, and R. Pesch, “Configurational



“inter-relatedness’’of pay-for-Performance, autOnOmy



Answer to the Ongoing Riddle of Formal and/Or Emergent



(related to inceれ亡ives or resI克s corl[「OZs), and mission con-



Planning Practices,’’Jour7rd QfBI」S証eSS Research, 69, nO. 9



gruence (related to persoれnel在uturaZ co庇roj), See M. A.



(September 2016), PP. 3609-3615.



Barrenechea-M6ndez and A. Ben-Ner, “Mission Congru-



33 “Keep Sight ofYourVision,’’op. cit.



ence, Incentives and Autonomy: An Empirical Analysis of



34 Ibid.



Child-Care Facilities in Minnesota, the U.S.;’Wo手短ng



35 Ibid.



Paper (2016), Online at papers.sioe.org/PaPer/848.html.



36 R, S, Kaplan and D. P. Norton, Exec山dorl Pre耽誼m (Bos-



ton, MA: Harvard Business SchooI Press, 2008); See also



D. C. Hambrick and J. W. Frederickson, `Are Ybu Sure You



55 “Poorly Trained Finance Worker Makes $152m Flub,’’ CFO.com Uanuary 14, 2008), On獲ine at ww2.cfo.com,



56 “Bank of America Finds a Mistake: $4 Billion Less



Have a Strategy?,’’Acclde ny QfManc[geme柾ExecL証ve, 15,



Capital,” The New Iかk Times (January 14, 2008), Online



no. 4 (November 2001), PP. 48-59.



at nyti.ms/1mR3FLb.



21



Chapter l. Management and Contro1 57 “Not So Funny: Booking Revenues, Like Comedy, Is All



62 For a more detailed discussion and overview of the issues



about Timing,’’The EcorlO肌畦(September 27, 2014),



related to inter-Organizational controIs, See S. W. Ander-



onlineatecon.st/1qxwvPw. ∴ ..



son and H. C. Dekker, “The Role ofManagement ControIs



58 For a flavor ofresearch in this area ofbehavioral econom-



in Transforming Firm Boundaries and Sustaining Hybrid



ics, See, for example, R. Thaler, Misbe庇v証g: The M疎[rlg



Organizational Forms’,, Fo即lda亡ioJIS and TTe71ds in



QfBe庇viorαZ Econom[cs (London: Allen Lane, 2O15).



Accou批±れg, 8, nO. 2 (November 2014), PP. 75-14l・



59 “German Regulator Warns Deutsche Bank on Commodity



63 “Rio Tinto Shifts to Driverless Trucks in Australia;’瑞ncm-



Trading,” Firlam貢aZ Ti肌es (June 19, 2014), Online at



c融n肌es (October 19, 2015), Online at on.ft.com/



on.ft.com/T9Xacd. 60 “Companies Take to The CIoud for Flexible Solutions,’’



FinarlC融Ti肌es (January 28, 2014), Online at on.ft.



COm/1evKHmS.



61 Oliver Williamson is genera11y recognized as the most PrOminent theoretical contributor in the area of transac-



tion cost economics, and went on to win the Nobel Prize in Economics for it in 2009. For a layman’s overview ofsome



Of the key ideas behind his semina量contributions, See “Reality Bites,’’The Econo肌is亡(October 15, 20O9), P. 92.



1WIIJGh. 64 See, for example, ``Medical Robotics: To the Point,’’The



Economfs亡(Apri1 11, 2015), Online at econ.st/1JpkkjU. 65 “Curbing Those Long, Lucrative Hours,’’The EcorlOmisf



(July 22, 2010), p. 66. 66 ``Banks Speed Up Shift to Forex Automation,’’Financ融



Times (June 22, 2014), Online at on.ft.com/11hky2N. 67 “Google’s Self-Driving Cars Get Boost from U.S. Agency,’’



BZoombeng (May 30, 2013), Online at www.bloomberg. COm.



CASE STUDY Leo’s Four-P看ex Theater



Leo’s Four-Plex Theater was a single-location, four-



number of the first ticket sold from the ending



screen theater located in a small town in west Texas,



number.



Leo Antonelli bought the theater a year ago and hired



2. The amounts of cash collected were counted daily



Bi11 Reilly, his nephew, tO manage it. Leo was concemed,



and compared with the total value of tickets sold- The



however, because the theater was not as profitable as he



cash counts revealed, almost invariably, 1ess cash



had thought it would be. He suspected the theater had



than the amounts that should have been co11ected.



some controI problems and asked Park Cockerill, an



The discrepancies were usually small, less than $1O



accounting professor at a college in the adjacent town, to study the situation and provide suggestions. Park found the following:



Per CaShier" However, On One day two weeks before Park’s study, One CaShier was short by almost $1OO.



3. Just inside the theater,s front doors was a lobby with a



1. Customers purchased their tickets at one of two



refreshment stand. Park observed the refreshment



ticket booths located at the front of the theater. The



Stand,s operations for a while. He noted that most of the



theater used general admission (not assigned) seat-



stand’s attendants were young, PrObably of high schooI



ing. The tickets were coIor coded to indicate which



or college age. They seemed to know many of血e cus-



22



movie the customer wanted to see. The tickets were



tomers, a m亘iority ofwhom were of similar ages, Which



also dated and stamped “good on day of sale only.’’



was not surprising given the t:heater,s small-tOWn loca-



The tickets at each price (adult, Child, matinee,



tion. But the familiarity concemed Park because he had



evening) were prenumbered serially, SO that the



also observed several occasions where the stand’s



number of tickets sold each day at each price for



attendants either failed to collect cash from the custom-



each movie could be determined by subtracting the



ers or failed to ring up the sale on the cash register.



Private Fitness, inc,



4. Customers entered the screening rooms by passing



passes with Bill Reilly,s signature on them. These



through a tumstile manned畦an attendant who



PrOblems did not account for all of the customer test



separated the ticket and placed partJ)f it in a locked



count discrepancies, however. Park suspected that the



`stub box., 1七st counts of customers entering and



ticket co11ectors might also be admitting friends who



leaving the theater did not reconcile either with the



had not purchased tickets, although his observations



number of ticket sales or the stub counts.



provided no direct evidence of this"



Park found evidence of two speci丘c problems. First,



When his study was complete, Park sat down and



he found a few tickets of the wrong coIor or with the



wondered whether he could give Leo suggestions that



wrong dates in the ticket stub boxes" And second’he



would address all the actual and potential problems,



found a sometimes sign脆⊂ant number of free theater



yet not be too costly.



CASE STUDY Wong’s Pharmacy



Thomas Wong was the owner/manager of Wong’s phar-



Although the store thrived in its early years’Perfor-



macy, a Small, Single-location drugstore. The store was



mance in the last few years had not been good. Sales



founded by Thomas’s father, and it had operated in the



and profits were declining’and the problem was get-



same location for 30 years. All of the empIoyees who



ting worse. The performance problems seemed to have



worked in the store were family members. All were hard



begun approximately at the time when a large drug-



workers, and Thomas had the utmost trust in all of them.



store chain opened a branch two blocks away"



CASE S丁UDY Private Fitness, lnc,



“Idon・tknowhowmuch moneyI might have lostbecause 丘gure out a way to make my business work effectively



ofKate. She is a long-time friend whom I thought I could without my having to step in and do everything myself.,,



trust, but I guess that trust was misplaced. Now I,ve got Rosemary Worth was talking about the conseto decide whether or not to fire her. And then I,ve got to quences of a theft that had recently occurred at the 23



Chapter l. Management and Controi business she owned, Private Fitness, Inc. Private Fitness



upkeep, SCheduling of appointments, and record keep-



WaS a Small health club locateq互Rancho Palos Verdes,



ing. Kate was paid a salary plus a commission based on



Califomia, an uPSCale community !QCated in the Los Angeles area. The club offered personal fitness training



gross revenues. During normal business hours when Kate was teaching a class, One Of the other instructors,



and fitness classes of various types, including aerobics,



Or SOmetimes a part-time clerical empIoyee, WaS aSked



SPinning, body sculpting, air boxing, kickboxing, hip



to staff the front desk in retum for an hourly wage, Pri-



hop, SteP and pump, dynamic stretch, Pilates, and yoga.



Vate Fitness was open from 5:30 a.m. to 9:00 p.m., Mon-



Personal training clients paid $50 per hour for their



day through Friday. It was also open from 6:00 a.m. to



instructor and use ofthe dub during prime time. Dur-



noon on Saturday and noon to 3:OO p.m. on Sunday.



ing sIower times (between 9:OO a.m. and 4:00 p.m.) the



Rosemarywas still in the process ofbuilding the vol-



Price was $35 per hour. The price per student for each



ume necessary to operate at a profit. Typically, One Or



hour-long fitness class was $12. Some quantity dis-



two private fitness clients were in the facility during



COuntS Were Offered to clients who prepaid. Unlike the



the prime early morning and early evening hours. A



large health clubs, Private Fitness did not oifer member-



few clients came in at other times. Classes were sched_



Ships for open access to fitness equipment and classes.



uled throughout the times the club was open. Some of



Prior to starting Private Fitness, Rosemary had been



these classes were quite popular, but many ofthem had



WOrking as an aerobics instructor and fitness model.



Only one or two students, and some classes were can-



She had won many local fitness competitions and was a



Celled for lack of any clients. However, Kate’s market-



former finalist in the Ms. Fitness USA competition. She



ing efforts were proving effective. The number of



Wanted to go into business for herself to increase her



Clients was growing, and Rosemary hoped that by the



Standard ofliving by capitalizing on her reputation and



end ofthe year the business would be earning a profit.



knowledge in the growing fitness field and to have



As the quote cited above indicates, however, Rose-



more time to spend with her two young children. Pri-



mary gradua11y realized that Kate Hoffman was stealing



Vate Fitness had been operating for six months.



from the club. On one occasion when Rosemary came to



Tb open the dub, Rosemary had to use almost all of



the club she noticed $60 in the cash drawer, but she



her personal savings, Plus she had to take out a bank



noticed when she was leaving that the drawer contained



loan. The building Rosemary rented, located in a con-



Only $2O. She asked Kate about it, and Kate denied that



Venient strip mall with ample parking, had formerly



there had been $60 in the drawer. Rosemary wondered



been operated as a fresh food market. Rosemary spent



if other cash amounts had disappeared before they had



about $15O,000 to renovate the facility and to buy the



been deposited at the bank. While some clients paid by



necessary fitness equipment. The club was comprised



Credit card or check, Others, Particularly those attend-



Of丘ve areas: an eXerCise room, a rOOm COntaining aero-



ing丘tness classes, Often paid cash.



bic equipment (e.g. treadmills, Stair climbers, Station-



Rosemary became very alarmed when, during a cas-



ary bicycles, CrOSS-COuntry Ski machines), a rOOm



ual conversation with one of the other instructors, the



COntammg Weight machines and free weights, men’s



instructor happened to mention to Rosemary some sur-



and ladies’locker rooms, and an o飴ce.



Prising “good news.’’The good news was that Kate had



Rosemary contracted with five instructors she knew



brought in a new private fitness client who was working



to run the classes and training sessions. The instructors Were a11 capable of running personal training sessions,



Out in the l:00-2:00 p.m. time period on Monday, Wednesday, and Friday. Kate was doing the training



but they each tended to specialize in teaching one or



herself. However, Rosemary checked the records and



two types of fitness classes. Rosemary herself ran most



found no new revenues recorded because of this new



Ofthe spinning classes and some ofthe aerobics dasses.



Client. She decided to come to the club during the



The instructors were paid on commission. The commis-



Period to see if this dient was indeed working out.



Sion, Which ranged between 20% and 50% of revenue,



Since the client was there and no revenue entry had



Varied depending on the instructor’s experience and on



been made, She confronted Kate. After丘rst explaining



Whether the instructor brought the particular client to



that she had not yet gotten around to making the book-



Private Fitness.



keeping entry, Kate finally admitted that this client had



As manager of the business, Rosemary hired Kate



been writing her checks out to Kate directly, in



Hoffman, One Of the instructors and a long-time friend.



exchange for a discount. Kate said that she was very



Kate’s primary tasks included marketing, fac・ility



sorry and that she would never be dishonest again.



24



Atlanta Home 」oan



Rosemary realized she had two major problems.



But how could she ensure that her business received



First, She had to decide whaLto do with Kate, Kate



all the revenues to which it was entitled without



WaS a Valuable instructor and a longtime friend, but



being on site at a11 times herself? Should she leave



her honesty was now in question. Should she forgive



Kate’Who promised not to steal again, in the man-



Kate or fire her? Second, Rosemary also realized that



ager position? Or should she hire one of the other



She had an operating problem. She did not want to



instructors’Or Perhaps a non-instructor, tO become



SteP in and assume the managerial role herself



the manager? And in either case, Were there some



because she had significant family responsibilities to Which she wanted to be able to continue to attend.



PrOCedures or controIs that she could use to protect her business,s assets?



CASE STUDY AtIanta Home Loan



In late 2002, Albert (Al) Fiorini was becoming more and



the Orange County Chapter of the Califomia Associa-



more frustrated and depressed. In September 2002, he



tion of Mortgage Brokers. under his direction, AHIJs



had taken a leave of absence t:O retum tO SChool to eam



business grew rapidly in its first quarter of operation.



his MBA’and he had trusted some empIoyees to run the



By the summer of20O2, the company consisted offour



mortgage lending business he had founded. Now it was



telemarketers and eight loan officers, all of whom



dear to Al that those empIoyees had schemed to wrest



WOrked from their homes.偽Ielecommuting,, was con-



COntrOl of the business away from him. And amazingly,



Venient for the empIoyees because Atlanta was a large



they seemed to have been successful. A=amented,



City with heavy tra鯖c,



``They didn’t just steal some of my assets. They stole my



Al established banking relationships that allowed



Whole business!,, Being 2’500 miles away and busy with



AHL clients to borrow money at wholesale rates. The



his studies’Al fdt nearly powerless to stop them. He had



actua1 1oan terms varied depending on the clients, FICO



SPent many Sleepless nights wondering what he could



scores.1 In summer 2OO3, banks might offer an AHL 。i-



and should do to get his business back. He also thought



ent with a very high FICO score (over 620) a rate of



about where he went wrong - What he should have done



6.25-6.75% on a fixed 30-year mOrtgage. This rate pro-



to prevent this problem from happening in the first place.



Vided the bank with an opera亡ing margin of l.5% to



2.0%. AHL eamed a fee of l.50% ofthe loan amount for every loan funded. This provided AHL with an aver-



丁he company



age revenue per loan of $3,2OO.



Atlanta Home Loan (hereafter AHL) was a mortgage lending and financing company based in Atlanta, Georgia. AI Fiorini founded the company in Apri1 2OO2, With an initial investment of about $4O,000. He started OPerating the company from his home.



Al had many years of experience in the mortgage



banking industry. He had worked for several different COmPanies and had also served a yea‡a6-PreSide虹of ま -



¥



-



25



す



工



手



I 手 ノ



Chapter l. Management and Controi



AHL bought leads from list brokers for $0.2O per



COmPany and the fees due to the loan o鯖cer involved.



name. These lists provided垂formation as to whether



AHL paid the loan o飴cers 4O% of this total loan reve-



the individuals owned their honges; if so, When they



nue on loans that AHL originated, and 60% on loans



bought their homes; and when, if ever, they had refi-



they originated (by generating their own leads), At



nanced their mortgages.



dosing, AHL received its funds directly from the pro-



The telemarketers called people on the lead lists to



Ceeds. A broker’s check would be ovemight mailed to



assess their interest in refinancing. Al knew from



AHIJs o飴ce, Or the money would be wired directly into



industry experience that telemarketers should gener-



AHIJs general account.



ate a minimum of one lead per hour. They were paid a



COmbination of an hourly wage plus a performance bonus ($1O.OO) for each lead produced. Since most of



them worked part-time, AHIJs telemarketers gener-



Back to schooI For years Al had been thinking about earning an MBA



ated, On aVerage, about four new leads per person per



degree. In June 2002, he was admitted to the executive



day.2 They gave the leads, the potential clients’names,



MBA (EMBA) program at the University of Southem



to AI Fiorini. Al distributed the names to AHIJs Ioan



California in Los Angeles, and he decided to enroll.



o鯖cers.3



While in Califomia, he planned to start another mort-



The loan o鯖cers helped the prospective clients to fi11



gage lending company.



Out their loan applications and to assemble the needed



Al had several options for AHL. He could find some-



backup documents, SuCh as W-2s, Pay Stubs, and bank



One tO run it; he could try to sell it; Or he could shut it



StatementS. After the clients, information had been col-



down. Ifhe chose to shut it down, he would turn the



lected, O鯖ce support personnel, Called “loan proces-



unfunded applications over to a contract processing



SOrS,’’would order an appraisal and a credit report,



firm. The contract processing firm would be responsi-



OPen eSCrOW, and independently verify the financial



ble for ordering credit reports and appraisals and for



information. After all the information was collected



interfacing with the escrow companies and attomeys



and verified, the completed創e would then be submit-



until the loans were funded. For its services, this firm



ted to the prospective lenders either electronically or in



WOuld charge AHL $3OO-$400 per contract.



PaPer form.



AHL did not yet have electronic links to the procesSOrS’触es that would allow monitoring of the progress



But Al decided that he did not want to close AHL, It WaS a PrOfitable business with considerable growth POtential. In September 2OO2 alone, AHL Ioan o鯖cers



Of the applications before they were submitted. Capa-



Were PreParing to submit 30-40 new applications to



bilities for those links were being put into place. How-



banks for funding, and the volume ofbusiness was con-



ever, eaCh application required a credit inquiry, SO Al



tlnulng tO grOW. Al enlisted the services of a business



monitored the activities of his Ioan o鯖cers by tracking



broker who placed a value of $600,OOO on the company.



the number of credit inquiries each requested. This



However, Al doubted that he had enough time to find a



PrOVided him with an early indication of how many



buyer before he left for Califomia. He decided to find



applications were being submitted. The loan applica-



SOmeOne tO OPerate the company in his absence.



tion/lead ratios varied from 5% to 20% depending on the ski11 of the loan o鯖cer. Al also dosely monitored



these ratios and their trends. In the mortgage lending industry, a 30% “fallout ratio’’fthe proportion of loans submitted to processing



A partner Joe Anastasia4 was one ofAHIJs Ioan officers. He had



that were not funded) was typical. AHrs fallout ratio



20 years’experience in the mortgage lending business.



WaS Slightly less than 30%.



AlthoughAl had known him for only about two months,



Once approved, the lega=oan documents were pre-



his initial judgments about Joe were quite favorable.



Pared. At that time, Al knew the revenue due to his



Joe seemed to have excellent sales ability; he was peoPle-Oriented; and he was knowledgeable about all areas



Of mortgage lending and financing. On his resume, he 2 AHL also developed leads from the Intemet, aS it operated the website www.lowerrate.com.



3 In Georgia, unlike in some otherstates, loan officers are notlicensed.



26



described himself as “dependable and honest.’’Before



joining AHL, Joe had worked for lO years as vice president of operations for a sizable financial corporation



Atlanta Home Loan



and had previously operated his own mortgage service



Wilbur would be quite good at sales. He had the requi-



COmPany for three years. Since Joejoined AHL, he had



Site knowledge, and “he was smooth.’’On the basis of



dosed a higher loan volume than any ofthe other loan



these quick judgments, On September l, 2002, AI Signed a written partnership and licensing agreement



o航cers.



2002, Al and Joe reached a verbal partnership agree-



With Wilbur. This agreement stated that AI would offer Wilbur the use and privileges of AHL as an ongoing business until he retumed, and Wilbur would provide



ment. Joe would invest $8,40O, Which was used to rent



AHL with his management services. AHL would make



Impressed by Joe’s background and performance, Al



decided to make Joe a deal to be his partner. In July



an o鯖ce and to purchase some o飴ce equipment, and



COmmission payments to Wilbur at lOO% on all loans



Joe and AI would share AHIJs profits equally.



dosed less a monthly licensing fee of $5,OOO or lO% of



Curiously, however, On the day when the two parト



all revenue, Whichever was greater. Wilbur would also



ners were to meet their new landlord, Joe did not show



be responsible for interviewing and hiring all new Ioan



up for the meeting. AI could not find him for two days.5



O鯖cers, Paying the expenses of running the o鯖ce, and



In the first lO working days after becoming Al’s part-



managing the entire sta鯖i



ner, Joe showed up in the o鯖ce only three times,



Al did not feel comfortable letting Joe continue to



Wilbur asked for authority to sign checks written against AHIJs main bank account, but Al refused.



run the company. Two weeks after their partnership



Instead, aS a geSture Of good faith, Al left with Letitia



agreement had been struck, he made Joe a deal. In



Johnson (the o飴ce manageD four signed, blank checks



exchange for teminating their agreement, Al agreed to



Written against the main account. Al’s instructions to



PayJoe lOO% of the fees eamed on loans that Joe



Letitia were that the checks were not to be used with-



dosed. Al then brought in an acquaintance, One With



Out Al’s permission.



banking experience, tO run AHL in his absence, but this



Letitia had been with AI since May 2002. She had



manager lasted only three days before quitting. Faced



effectively managed the telemarketers and had dem-



With limited options and desperate to find someone to



OnStrated her loyalty to Al. In August 2OO2, because



run the company before he left for Los Angeles the next



Of sIow funding loans, AI was unable to pay Letitia



day, Al tumed again to his first option - Joe. Joe apoIo-



her full salary. He asked her whether she would like



gized for his absences with the admittedly weak excuse



to find empIoyment elsewhere or go through the



that “he had been partying, but it wouldn’t happen



hardship with AHL. Letitia responded that she would



again.’’So Al and Joe reinstated the previous agree-



like to staywith AHL. AI promised to pay Letitia the



ment. When Al left for Los Angeles in August 2002,



deferred part of her salary as soon as some loans got



AHL had 90 loan applications in the pipeline, COnStituト



funded, Which they did in September. Al trusted



ing nearly $300,000 in potential revenue.



Letitia,



AI started monitoring AHL from afar. He leamed



Later that month, When Joe found out what was hap-



that in the following two weeks, Joe went to the o鯖ce



Only four times. One day he took a large batch of loan



Pening, he became quite upset. Not only was he no Ionger the managing partner of AHL, he thought Al



飢es home and did not retum to the office for three days.



OWed him a lot ofmoney. He wanted his $8,400 investment back. But Al refused to pay him until he retumed



A new partner and licensing agreement



all of AHrs leads and loan files in his possession. Not Only had his dereliction ofduty caused AHL great harm, but none of Joe’s Ioans had cIosed since August, Which



In September 2OO2, Al made a丘nal decision that he



Al found suspicious.6 In response, Joe創ed a civi=aw-



COuld not trust Joe. He tumed to Wilbur Washington,



suit demanding payment.7



to whom Al had been introduced by Joe several months earlier. Like Al and Joe’Wilbur had considerable expe-



rience in mortgage banking, Al judged quickly that



27



圧∵- 崎鮎OI



Chapter l. Management and ControI



Monitoring from Califomia



Al had been monitoring the activity in the BofA account on the Intemet from Los Angeles. He noticed



While he was no Ionger managi塾the day-tO-day operations of the company, AI continued tb monitor AH己s



OPerations closely. Daily, Or aS SOOn aS the information WaS aVailable, he tracked the empIoyee head count, the



number of leads produced, Credit inquiries requested, 1oan applications funded, O鯖ce expenses, and bank



activity. AI was also on the phone three to four hours Per day亡alking with empIoyees and, Particularly, loan O鯖cers. He thought that this would allow him to monitor the employees’emotional states, an important lead-



ing indicator of forthcoming company performance. Al also had all of AHLs corporate mail forwarded to his



California address. AI was particularly concerned



about Wilbur keeping overhead expenses in line with PrOduction levels so that he would be able to pay the empIoyees’tO Whom AI continued to feel a responsibil-



ity, aS Well as Al himself. In late September’Wilbur hired a new loan procesSOr. Al knew from experience that every loan o鯖cer



believes that there is never enough processor time available to get “his’’particular loan documents com-



Pleted on a timely basis. But Al,s experience also told him that each processor should be able to fund 20 loans Per mOnth, SO the company needed only one processor for every four loan o鯖cers. Al thought that Wilbur was



now empIoying one’Or maybe even two, tOO many PrO-



CeSSOrS and/Or Salaried, OVerhead personnel. He sent



Wilbur a note telling him that his processor-tO-loanO綿cer ratio was too high. But Wilbur reacted angrily.



He told Al ``not to tell him what to do:, that he was managing the company in the best way he saw fit.



that the four checks had been written without his



knowledge and that they had all bounced. He immedi-



ately called Wilbur for an explanation. Wilbur told Al that he had withdrawn money from the account to pay



the empIoyees" Al did not believe this explanation, in



Part because the checks were made out to Wilbur and not run through the payroll account where payroll



taxes would be withheld if the checks were meant for



empIoyees. On October 7, 2OO2, AI sent a fax and certi-



fied letter to Wilbur and Letitia and also spoke directly to them, Ordering them not to write any more checks



Without his permission and to make sure that there Were Su鯖cient funds in the account to cover the checks



they wrote. with the retumed check charges, the main AHL account was already $1,533.09 overdrawn.



Al also called BofA to stop payments on the four Checks and asked the bank to transfer the funds from the general checking account to a side payroll account



to which Wilbur would not have access. However, Wilbur managed to release the stop payments on the Checks. He transferred the money from the payroll account back into the general account and cashed the



Checks. Bank personnel apparently assumed that



Wilbur had authority over [he account since he had deposited the funds in the first place.



Angry and frustrated, Al decided that he could no



Ionger trust Wilbur and could not do business with him. On October 9, 2002, Al asked a friend ofhis who used to



be a sales manager in the mortgage company that Al had worked for previously to act as his agent. The friend WaS tO gO tO AHrs o鯖ce and fire all the empIoyees.



Among other things, AI was particularly concemed that



Subsequent events



AHL had over lOO client創es with sensitive personal



At the time Wilbur took over the operation ofAHL, four



agent went to the AHL premises to fire the empIoyees,



information that might be misused. However, When Al,s



loans, Which would generate total revenues of $11,700,



they all refused to go" AI called in the police to support



Were about to be funded. This amount was supposed亡O



the firing action, but when they arrived, Wilbur told the



be wired into AHIJs main corporate checking account



POlice that he was the owner, nOt Al- Not knowing who



at Bank ofAmerica (BofA). When the loans funded,



WaS te11ing the truth, the policejust left.



however’On October l, 2002, Without Al,s pemission,



On October 14, 2002, AI sent a letter to all lOO+



Wilbur personally collected the four checks himself



AHL dients whose loans were in process that the com-



from the dosing attorneys, POOled them together, and



Pany had to drop their applications. The key phrase in



deposited them into BofA. After depositing the checks,



the letter was, αwe are no Ionger going to be able to ser-



Wilbur immediately wrote checks to himself and Leti-



Vice your application.’’



tia for the entire amount of $11,700 using the four pre-



Signed checks Al had left.8 However, Since Wilbur WrOte the checks against uncleared funds, the checks bounced.



28



Atlanta Home Loan



On October 15, Wilbur opened a new account at Citi-



OVer $7,50O in legal fees and travel costs, and he wasted



ZenS Bank & Trust (CBT) in Atlanta,且bank where he



Substantial time and energy dealing with these frivo-



did his personal business and where he knew the man-



lous lawsuits.



ager personally. Wilbur wired the funds being held in AHIJs corporate name at the offices of the dosing attor-



During all this time, the AHL persomel were maintaining their daily routines. Wilbur renegotiated a lease



neys into this new bank account. He now had signing



with the landlord and established AHL as his own com-



authority over the checks.



Pany. AI suspected that Wilbur had used all of his



Al discovered the second bank account when a ``wlel-



means of persuasion to mislead the empIoyees in order



come,, 1etter from CBT arrived tO his California address.



to break their bonds with Al. Al received his $5,OOO



AI was outraged that personnel at CBT did not ask



licensing fee in September, but that was the last money



Wilbur for any corporate documents:



he received. By December, Al realized that he had already lost at least $15,000 in licensing fees, and pos-



Wiibur showed no documentation whatsoever. ‥ Ybu



WOuid expect highly reguIated institutions like banks to provide better protection for the pubiic, but , ‥



Al immediately called bank personnel and informed



Sibly more that might have been realized from the



funding of the loans in the pipeline. Moreover, he had lost his company. AI said, Sadly, “I have no idea how much revenue ended up being taken in my name.’’



the manager that Wilbur had opened a fraudulent



Sensing defeat, Al亀nally asked the Georgia Depart-



account with CBT. But CBT refused to freeze the



ment of Banking and Finance to withdraw AHIJs mort-



account or return the money. As a last resort, Al



infomed the Atlanta police and the FBI, thinking that



gage banking license. Not only had he lost his business and his income, he had also lost his credit rating since



they might be interested in this identity theft case.



he had incurred bills that he was unable to pay. And in



However, POSSibly due to the relatively sma11 amount of



February 2003, AI was forced to sell his home.



money invoIved, neither the police nor the FBI gave the CaSe any attention.



Tb make things worse, the day Wilbur opened the



In the summer of 2003, Al had sti11 not decided what he should do. Should he fight to regain controI over



AHL? But what was left of it? Perhaps only about



fraudulent bank account at CBT, he also乱ed two appli-



$25,OOO worth of equipment. Or should he give up, let



cations for warrants for Al’s arrest. Wilbur claimed that



these crooks get away with it, and try to rebuild some-



AI was the one who had taken the proceeds received



where else?



from the dosing attorneys out of the company’s



Al also pondered how he had gotten into this mess.



accounts. Al had to return twice to Atlanta to defend



What might he have done to prevent this disaster from



himself. Both cases were dismissed, but Al incurred



happening?



This case was prepared by Professors Kenneth A. Merchant and Wim A. Van der Stede, and research assistant Clara (Xiaoling) Chen. Copyrlght @ byKenneth A. Merchant and Wim A. Van der Stede.



29



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CHAP丁ER -2 Results ControIs



If asked to think about powerful ways to influence behavior in organizations, mOSt PeOPle WOuld probably think first about pay-for-Performance, Which is no doubt an e任ective motivator.



For example, at Thor Industries, a large recreational vehide manufactureI., CEO Wade ThompSOn attributes much of the company’s success to its incentive compensation system. Among



Other things, the company shares 15% of each division’s pretax profits with the division managers, because, Mr. Thompson explained, “I want every one of our company heads to feel like it is their business, in their control. If they don’t perform, they don’t get paid very much. If they do,



there is no cap to what they can make.・,1 Indeed, Vicky Wright, managing director at Hay Group,



a compensation consultancy firm, argueS:



[Many] companies on the Most Admjred Iist [a list of companies produced annuaIiy by Fortune] have chief executives who understand what performance measurement is aIi about・ It’s about Iearning how to motivate peopIe - how to Iink those performance meas-



ures to rewards.2 Pay-for-Performance is a prominent example of a type of control that can be ca11ed resl庇s



CO庇rOZ because it involves rewarding empIoyees for generating good results. Identifying what



aregood results, aS We Will see, is crucial. Indeed, following the financial crisis through to today, Pay-for-Performance systems, eSPeCially in banks, have received a hard look, in part because, rather than producing “good’’results, they have been bashed for having bred “bonus cultures’’



Ofgreed and short+ermis机. Even the chief executives of such mgivr banks as Barclays admitted that their bonus systems were overly “geared,’’created temptations for empIoyees to “cut cor-



ners;’and may have backfired through “ethica=apses,” while the chief executive of Deutsche



Bank touched on the basic underlying motivational effect of bonuses by contemplating that ``[he] ha[d] no idea why [he] was offered a contra⊂t With a bonus in it because [he couldn’t



imagine he would] work any harder or any less hard in any year, in any day because someone is going to pay [him] more or less.,,3 Nonetheless, eVen in the aftermath of the宜nancial crisis, investors, regulators, and politi-



Cians did not indiscriminately call to do away with pay-for-Performance; rather, their calls for reform were typically directed at making compensation more cわsely tied to souJld performance,



particularly long-term Value creation.4 Setting aside possible idiosyncrasies ofthe丘nancial sector, Where one could argue that good



empIoyees work hard every day in other organizations without monster bonuses, reSults controIs of the pay-for-Performance variety are widely used, eVen increasingly so in the non-PrOfit



SeCtOr. For example, the National Health and Hospitals Reform Commission in Australia argued that the fee-for-SerVice system of healthcare rebates often fails to promote the most e任ective



Chapter 2. Pesuits ControIs treatments because doctors get paid for each consultation or clinical activity regardless of whether the呼tient recovers well or not. In considering how to refom this system’the Commis-



sion recommeridedto link the pay ofdoct:OrS and nurses to measures ofhow well they treat their patients or how quickly they are seen.5 similar initiatives to create負accountable care organiza-



tions,, by providing extra rewards for e鯖ciency and quality performance have also been considered elsewhere, Particularly in the United States.6 ・くThe idea is to see whether shifting financial



incentives for hospitals can make people healthier and save the U.S. money before Medicare’s



hospital trust fund becomes depleted’Which could happen by 2024.・,7 clearly, designers of results controIs of the pay-for-Performance variety have寝good,, result§



te.g. 1ong-term Value creation) - eVen Perhaps lofty results (e.g. making people healthier and saving a country,s healthcare system from ruin) - in mind when implementing themブbrought



about through the motivational, reSults-driven effects such systems purportedly can have.



Anecdotal as well as research evidence, however, have repeatedly thrown the potency of these systems into sharp relief by suggesting that either they have weak or no effects or, Where they



do, they can produce the wrong results or have severe unintended consequences. Even so, and despite, Perhaps’a PreValent emphasis on pq)′-for-Performance in many con-



texts, the rewards that can be linked to results go far beyond monetary compensation. Other rewards that can be usefully tied to measured performance include job security’PrOmOtions’



autonony plum assignments, and recognition. (We discuss the vast array of rewards that can be given more fully in Chapter 9.) Furthermore, reSults controIs create mer[亡ocrcIC{es. In meritocracies’the rewards are given to the



most talented and hardest-WOrking employees, rather than to those with the longest tenure or the right social comections・ At Koch Industries’a COnglomerate’reSults controIs are seen as the “secret



sauce,, with two main ingredients - meritocracy and operational efficiency. Charles Koch, its boss, is proud to proclaim that “workers can eam more than their bosses [and] high-SChool-educated



farm boys from Kansas can rise faster than Ivy League MBAs,, based on their performance.8 The combinat:ions of rewards linked to results inform or remind empIoyees as to what result areas are important and motivate them to produce the results the organization rewards. Result§



controIs influence actions or decisions because they cause empIoyees to be concemed about the consequences of their actions or decisions. The organization does not dictate to employees what actions or decisions they should take; instead’emPIoyees are empowered to take those actions or



decisions they believe will best produce the desired results. Results controIs also encourage empIoyees to discover and develop their talents and to get placed into jobs in which they can



Perform well. For all these reasons, We虹designed results controI systems can help produce the result§



desired. A review of studies on the use of incentives to motivate performance found an average



gain in perfomance of about 22% stemming from the use ofincentive programs.9 Like all other forms ofcontroIs, however, reSults controIs do not operate in isolationlO and’equally・ CannOt be



used in every situation. They are effective only where the desired results can be clearly defined and adequately measured by the organization’and where the measured results can be su飾-



ciently controlled by the empIoyee.11 we discuss the conditions for the eifective use of results controIs in greater depth in this chapter.



Prevalence of resu看ts contro看s



Results controIs are commonly used for controlling the behaviors of empIoyees at many organizational levels. They are a necessary element in the empIoyee empower肌e庇aPPrOaCh to man-



agement, Which became a m車vr management trend starting in the 199Os.12 Results controIs



34



Prevaience of resuits cont「ois



are particularly dominant as a means of controlling the behaviors ofprqfessioれα! empZayees;



those with decision宙r誼orZty, like managers. Reengineering guru Michael Hammer even defines a professional as “sdineone who is responsible for achieving a result rather than ifer]



perfoming a task.,,13 Results controIs are consistent with, and even necessary for, the implementation of decentralized forms of organization with largely autonomous entities or responsibility centers (which



we discuss in more detail in Chapter 7). For example, business pioneer Alfred SIoan observed that he sought a way to exercise effective controI over the whole corporation yet maintain a



philosophy of decentralization,14 At General Motors (and numerous other companies that fol1owed), the results controIs under SIoan’s leadership were built on a return-On-investment



(ROI) performance measure (which we discuss in more detail in Chapter lO)・ By using this type



of controI system, COrPOrate management COuld review and judge the effectiveness of the variOuS Organizational entities while leaving the actual execution of operations to those responsible



for the performance of the decentralized entities - the entity managers.



Many large corporations have gone through the process ofinstituting decentralized forms of Organization with a concurrent increased emphasis on results control. For example, DuPont replaced a complex management hierarchy by splitting the company into 21 strategIc bus証ess



硯克s (SBUs), eaCh of which operates as a free-Standing unit. The SBU managers were given



greater responsibility and asked to be more entrepreneurial and more customer-focused. They Were also asked to bear more risk, because a large portion of SBU managers’compensation was



based on SBU performance (sales and profitability). The managers noticed the change. One SBU manager said, “When I joined DuPont [21 years ago], ifyou kept your nose clean and



WOrked hard, yOu COuld work as Iong as you wanted. [But today] job security depends on results.・,15 The change was perceived as being successful: A Bus証ess Wcek article noted that’ “The image of DuPont has morphed from giant sIoth to gazelle.”16



In 2010, Sano丘-Aventis, a large pharmaceutical company, divided its vast resources into



decentralized disease-based units, eaCh with its own departments for research and development, regulatory affairs, marketing, and sales - a Plan designed to identify promising drugs more quickly and weed out failures before spending large amounts of money on unsuccessful drugs. One industry expert noted that “the [model of] fully independent units, OPerating under the parent company’s umbrella, [constitutes] a break丘om the traditional big pharma business model, and represents companies’interest in duplicating the flexibility and cost-e鯖ciencies of



small biotech and biotech-1ike companies.,・17 By establishing accountability for a fu11y integrated entity’s results, Where the entity manager dosest to the business makes the tradeoffs and takes responsibility over the entity’s budget, the company aims to instill a ``performance cul-



ture’’that encourages both operating discipline (e綿ciency) and greater responsiveness to Iocal



business needs (flexibility). In other words, decentralization attempts to replicate an “entrepreneurial model’’within



typically large corporations, Where entity managers are given decision authority but then held



responsible for the results that their decisions prOduce. Accountability for results was exactly the driving motive behind a recent reorganization into “reporting segments’’at Air Products



Chemicals Inc., a large industrial gases producer, Which Sei丘Ghasemi, Air Products’chiefexecutive, Claimed would retain Air Products’leadership position through “a decentralized, Simpler,



and more e鯖cient structure which creates true profit and loss (P&L) accountability at many



levels of the organization.,,18



Similarly, When Nick Reilly became CEO in late 2009 0f troubled Opel, the German car man-



ufacturer owned by General Motors, he announced that he wanted to encourage an entrepreneurial spirit at Opel by delegating most decisions to country heads and dismantling GM’s bureaucratic style of centralized management that fostered a “debilitating culture of passing



the buck.,, =It might seem obvious, but it isn,t the way GM was managed and there was definitely 35



Chapter 2 ・ Resuits Controis



some confusion about who was accountable," he said.件From the top line of revenue to the bot-



tom line ofprt脆t, this is now the responsibility ofthe managing directors ofthe m亘ior entities’”



Rei11yadded-19’一‥



However, managerS Will act in an entrepreneurial manner necessary to thrive in competitive



environments not only if they are subjected to the same market forces and pressures that drive independent entrepreneurs’but also if they are promised commensurate rewards for the risks



they bear from doing so. As such, Richard Chandler’founder of Sunrise Medical’a medical



products company, defended his company,s decentralized organization and lucrative incentives by stating that “people want to be rewarded based on their own efforts. [Without divisional



accountability] you end up with a system like the U・S. Post O飴ce. There,s no incentive [for



workers to excel] :,20



Results controIs need not be limited to management levels only; they can also be driven down to Iower levels in the organization, aS many COmPanies have done with good effects. Lincoln Electric, a WOrldwide leader in the production of welding products’SerVeS aS the poster



child of companies that use results controIs down to the lowest organizational level. Lincoln Electric provides wages based solely on piecework for most factory jobs and lucrative performance-based bonuses that can more than double an empIoyee,s pay・21 This incentive system has created such high productivity that some of the industry giants (General Electric’Westinghouse) found it difficult to compete in Lincoln Electric’s line ofbusiness (arc welding) and exited



the market. A Bひsiness Week article observed that存in its reclusive, iconoclastic way, Lincoln



Electric remains one of the besトmanaged companies in the United States and is probably as



good as anything across the Pacific.,,22 And even though Lincoln’s legendary庇e証l,e Pe直r-



maJICe fystem has essentia11y remained the same since it was installed in 1934, the company is still ac。aimed for its systems and perfomance today, SuCh as in the book The Modeγn F{rm.23



Whereas decentralization is an effective way to empower empIoyees in a results-COntrOI context, there can, and even should, be limits to empowerment in certain circumstances. One prob1em is infighting, aS eXemP皿ed at Sears’a Struggling US retailer・ Edward Lampert’the investor



who had tried for eight years to tum around the company’=divided Sears into more than 30 units, eaCh with their own presidents, Chief marketing officers’boards of direc亡ors and profitand-loss statements, Which former executives say has caused infighting.,・24



Other issues stem from loss of economies of scale or increased costs and ine鯖ciencies, Or



even inconsistencies, and complexity・ This is reflected in the situation that Alex Gorsky’a



21-year Johnson & Johnson veteran who was named CEO in Apri1 2012’inherited:



The J&J that Gorsky inherited was superficia=y easy to understand: 40% of sales came from drugs, anOther 40% from medical devices’and the rest from consumer products" Dig deeper and it was unimaginab看y compiex: 275 operating companies, 450 distribution cent-



ers, mOre than 120 manufacturing sites’500 outside manufacturers, and 60 enterprise resource-Planni=g SyStemS〇一t was more a flo制a of speedboats than a singie ship" in the past, that famous decentralization inspired entrepreneurial thinking・ Lately’it caused quaI-



ity-COntrO- probIems that bedevi-ed the company"25 Gorsky said: “We have to be more decisive and disciplined’and more e鯖cient- Otherwise’it is too complex, and it costs too much.,, part of that was addressing decentralization‥ Gorsky



introduced a program to centralize procurement, Which would enhance J&J’s buying power. He



also ordered up new quality and compliance controIs to ensure consistent standards.26 Decentralization may also increase overlap’and curiously’it ``may also create more oppor-



tunities for corruption by increasing the number of decision makers with the power to exploit the decision-making process for personal gain.・,27 For example’When pursuing rapid growth



in China, French hypermarket Carrefour faced systemic corruption among its management



ranks at the loca=evels. Unlike the centralized approach to management that Wal-Mart 36



Resuits controis and the controi probiems



employed in China, Carrefour empowered local managers to take charge of virtually all aspects of runIr料g their stores, including product pricing and promotions, SuPPlier selection,



and store desig丘Whereas this high degree of flexibility gave ample leeway for managers to



expand fast in the early stages of building the chain, it also encouraged widespread bribe-



taking at the loca=evel and, OVer time, led to higher operating costs and reputation risk than would a centralized system.28



But decentralization puts decision making cIosest to where the detailed knowledge and



understanding of the business resides, allowing greater responsiveness. `A decentralized structure provides better information over time, Which helps decision-making and accountability,’’



said Lambert of Sears,29 and echoed by Airbus chiefFabrice Bregier‥



Now is the time to give a littie bit more power to iocai teams in our countries, in our pro-



grams, in our pIants [as] we need to take decisions faster. This is a weakness of Airbus. it takes much too -ong to make decisions,一want to speed it up and simp-ify it.30



The chief executive at China’s Huawei, Ren Zhengfei, Put it as follows:



The future mode=s to give the biggest say to our Iocai teams who are cIosest to our customers and empowerthem so they have flexibiIity in interaction with customers, The headquarters or corporate functions w冊change into a more supporting and service function"31



And at Samsonite, the luggage maker, Chief executive Tim Parker said: i think we were trying to run a very centraIized business in a marketpIace where our conSumerS d田ered enormousiy. We had to decentraIize our decision-making, So we created



an Asian business, a Europe business and an American business, and that a=owed each management team to concent「ate on -oca- customers"32



The multitude of examples above also illustrate that firms can decentralize by geographical regions, business groups or segments, PrOduct lines, Or a Variety of other lines of delegation in their organization structure. One critical point, however, is that dece庇rC亜za亡王orl Or “delegation



Ofdecision rights’’to managers, and the design of証cendve eys亡ems to motivate these managers



to generate the desired results, are tWO Critical organizational design choices in a results-COntroI context; they are part ofwhat organizational theorists call the o7ga証zc証o融Z arc柾亡ec亡ure.



This literature maintains that organizational choices about decentralization and incentive systems should be madejoir亘ty, and that concentrating on one element to the exclusion ofthe other



will lead to poorly designed organizations.33



Resu看ts controIs and the controi problems



Results controIs provide several preventive-tyPe benefits, Well-de宜ned results inform empIoy-



ees as to what is expected ofthem and encourage them to do what they can to produce the



desired results. In this way, the results controIs alleviate a potentia=ack of direction. Results COntrOIs also can be particularly e任ective in addressing motivational problems. Even without



direct supervision or interference from higher up, the results controIs induce empIoyees to behave so as to maximize their chances of producing the results the organization desires. This



motivational effect arises particularly when incentives for producing the desired results also further the empIoyees’own personal rewards. Finally, reSults controIs also can mitigate per-



SOnal limitations. Because results controIs typically promise rewards for good performers, they Can help organizations to attract and retain employees who are con丘dent about their abilities.



37



Chapter 2. Pesuits ControIs



Results controIs also encourage empIoyees to develop their talents to position themselves to eam the r鼠Ilts-dependent rewards.34



The perforIrihce measures that are a part of the results controIs also provide some nonmotivational, detection-tyPe COntrOl benefits of a cybemetic (feedback) nature, aS WaS mentioned in Chapter l. The results measures help managers answer questions about how various



strategies, Organizational entities, and/Or emPIoyees are performing. If performance fails to meet expectations, managerS Can COnSider changing the strategies’the processes’Or the man-



agers・35 Investigating and intervening when performance deviates from expectations is the



essence of a mrlage肌e庇-dy-eXCePttOrl aPPrOaCh to management, Which large organizations



COmmOnly use・



Elements of resu看ts controIs



The implementation of results controIs invoIves four steps: (1) defining the dimension(s) on



which results are desired; (2) measuring performance in the chosen dimensions; (3) setting



performance targets for employees to attain for each ofthe measures; and co providing rewards



for target attainment to encourage the behaviors that will lead to the desired results. While these steps are easy to list, eXeCuting them effectively can be challenging.



Defining performance dimensions Defining the right performance dimensions invoIves balancing an organizations’responsi-



bilities to all of their stakeholders, including owners (equity holders), debtholders, emPIoyees, SuPPliers, CuStOmerS’and the society at large. Should a firm,s sole aim be to maximize



shareholder retums, Or Should it also, Or eVen Primarily, be customer- Or emPIoyeefocused? Are these performance foci mutually exclusive, Or are they rather mutually reinforcing?36



Where do performance dimensions such as imovation and sustainability belong? And so on. As challenging as defining the desired performance dimensions may be, it is equally critical to choose performance measures that are coJtgruerlt Or品grled with the chosen perfomance



dimensions because the goals that are set and the measurements that are made wi11 shape employees, views of what is important. Phrased differently, W庇tyou measL‘re is w姐you get・



For example, firms may define one of their desired perfomance dimensions to be shareholder value creation, and yet measure performance in terms of accounting profits. This implies that empIoyees are likely to try to improve the measured pe所かmcmce (in this example, aCCOunting profits) regardless of whether or not it contributes to the desired pe7舟rmc耽e (in this example,



shareholder value). We discuss this problem, and the di鯖culties related to this particular exam-



ple, further in Chapters 5’10・ and ll・



Similarly, fims may aim to pursue innovation’yet they end up measuring patents創ed.



Anxious to promote innovation, many COmPanies offer incentives to their empIoyees to



develop patentable ideas, and such incentives are likely to produce results in the fom of an increase in the number of patents乱ed. But as Tbny Chen’a Patent attOmey With Jones Day in Shanghai, nOteS, “PatentS are eaSy tO創e, but gems [can be] hard to find in a mountain



ofj皿k.,,37 citibank・s chief executive, Michael Corbat, Slightly rephrased this adage by proclaiming that ・you are w砧you meaSL‘re・,,38 He felt he needed to measure perfomance in five categories to try to a11eviate the singular focus of managers on one measure’eXaCtly becauseyou get



whcltyOur meaSure・ His plan was welcomed by an analyst who commented that =the most



important job of a CEO is to make sure that the right incentives are in place [because] improper measures lead to improper behavior・,,39 we discuss the use of multiple measures of



38



EIements of resuits controIs



Performance, SuCh as by way of so-Called scorecards, Which Mr. Corbat advocated at Citibank, inChapterll. _ The problem of misalignment has also been at the heart of some of the work by Jean Tirole,



the 2014 Nobel Prize winner in economics. Tirole examines the undesirable consequences that performance-dependent incentives in the measured areas can have, either by skewing how empIoyees approach theirjobs, Shifting e任brt away from less-eaSily measured (and hence unre-



warded) tasks such as Iong-term investments, emPIoyee development, and within-firm cooperation; Or by undermining work ethic by encouraging excessive risk-taking, inducingバmanaged’’



pe正brmance or producing “fudged・・ performance metrics.4O The first part of this problem - the



Skewing part - is known in the literature as the m血t亡as短ng problem, and we discuss it in more



detail in Chapter 5. Even though Bfoo肌be7官COnCluded that ``there’s a role for Tirole to advise on how to struc-



ture compensation without inciting the kind of disastrous risk-Chasing that sparked the financial crisis,,41 this important congruence problem also surfaces in many other sectors’



including the non-PrOfit sector・ For example, a Study by the Home O鯖ce in the United Kingdom found that organized tra鯖cking was a “thriving industry’’that “makes a killing,’’amass-



ing healthy profits with little risk of detection. The study suggested that one ofthe reasons for



this was the ill-defined performance targets that the police had to meet. Solving high volumes



Of simple crimes such as petty thefts and home burglaries is easier and cheaper than the longdrawn-Out and expensive police work that is needed to crack down on tra綿cking rings. Even



though the goal was to reduce crime, the result may have been that hardened criminals were leto請42



Hence, nOt Only do firms need to decide what is desired, but they also must ensure that their measurements of the desired performance dimensions are aligned with what is desired・ If they are not, the results controIs are likely to encourage employees to produce l‘JldesIred results. The results controIs can then be said to have肌王rlterlded coJtSeql上enCeS.



Measuring performance As per the above, then, meaSurement is a critical element ofa results-COntrOI system. The oセject



of the measurement is typically the performance of an organizational entity or an employee during a speci丘c time period. Many o車iec互ve financial measures, SuCh as net income, eamings



per share, and retum on assets, are in common use. So, tOO, are many Objective nonfinancial measures, SuCh as market share, CuStOmer Satisfaction, and the timely accomplishment of certain tasks. Some other measurements invoIve s担yec亡ive judgments invoIving assessments of qualities; for example, “being a team player’’or “developing employees e任ectively.’’



Performance measures typically vary across organizational levels. At higher organizational levels, mOSt Of the key results are defined in either stock market terms (such as share price) and/Or丘nancial or accounting terms (such as a retum on equity). Lower-1evel managers, On



the other hand, are tyPically evaluated in terms ofoperational measures that are more controllable at the loca1 1evel. The key result areas for a manager in charge ofa manufacturing site’for



example, might be a combination of measures focused on production e鯖ciency’inventory control, PrOduct quality, and delivery time" The variation in the use of丘nancial and operational



performance measures between higher- and lower-level management creates a届nge in the management hierarchy. That is, at SOme Critical middle organizationa1 1evel’Often a profit



center level (see Chapter 7), managerS muSt tranSlate financial goals into operational goals. These managers’goals are defined primarily by financial measures, SO their communications with their superiors are primarily in financial terms. But because their subordinates’measures



are primarily operational, their downward communications are primarily in operational termS.



39



Chapte「 2. BesuIts Controis



If managers identify more than one result measure for a given empIoyee’they mu§t attaCh



weigh亡噛to each measure so that the judgments about performance in each result area can be



aggregated info in overall evaluation. The weightings can be additive. For example, 60% ofthe overall evaluation is based on retum on assets and 40% is based on sales growth. The weightings can also be multiplicative. For example’aChievement of profit and revenue goals might be



multiplied by a score assessed on the basis of environmental responsibility. If the environmental responsibilityscore is less than 70%’Say’the multiplier is zero, yielding no bonus. Sometimes’



organizations make the weightings of performance measures cxpZicit to the empIoyees・ aS in the



example just presented. Often’however’the weightings are partially or totally impZic互such as



when the performance evaluations are done supectively. Leaving the weighting implicit blurs the communication to empIoyees about what results are important. Employees are left to infer what results will most affdet their overall evaluations. That said’eVidence suggests that implicit



weights can generate improvements in performance and’thus, Can be effective as an alterna-



tive, Or at least complement, tO the explicit weighting of performance measures in incentive contracts.43



Setting performance targetS performance targets are anOther important results-COntrOl element because they affect behavior in two ways. First’they improve motivation by providing 。ear goals for empIoyees to strive



foL Most people prefer to be given a specific target to shoot for’rather than merely being given



vague statements like “do your best,, or “work at a reasonable pace享4 second’Perfomance targets allow empIoyees to assess their performance・ People do not respond to fdedback unles§ they are able to interpret it’and a key part of interpretation invoIves comparing actual pe血-



mance relative to target. The targets distinguish strong from poor performance. Failure to



achieve the target signals a need for improvement. (We discuss performance targets and target setting processes in more detail in Chapter 8.)



The following example illustrates both points. Maria Giraldo, a nurSe in the intensive care unit at Long Island Jewish Medical Center’uSed to be evaluated on such criteria as leadership・



respectfulness’and how well she worked with others. A few years ago’her hospital imple-



mented a new computer-based performance system that broke down her job description into quantifiable goals’SuCh as to keep infection rates for her unit low and patient satisfaction



scores high, a11 relative to specific target levels. Ever since this new system waS implemented,



at review time, the discussion does not linger on about how Ms. Giraldo had performed. Either she hit the targets, Or She did not. The clarity about measures and goals, and the reviews ``by the numbers” that they a11ow’Changed Ms. Giraldo,s views about success and what she needs to do to get ahead in her career- a11 for the better’She believed.45 (In Chapter 9, We discuss the



drawbacks of relying exclusively on ot)jective, formulaic performance evaluations in more detail.)



Providing rewards Rewards or ince証ves are the final element of a results-COntrOI system. The rewards included in incentive contracts can cOme in the form of anything empIoyees value’SuCh as salary increases’



bonuses, PrOmOtions,46 job security, job assignments, training opportunities’freedom, reCOgni-



tion, and power・ Punishments are the opposite of rewards. They are things empIoyees dislike, such as demotions, SuPerVisor disapproval’failure to eam rewards that colleagues eam’Or, at



worst, dismissal.



40



Eiements of resuIts cont「oIs



Organizations can elicit motivational effects from linking the prospect of rewards (or Punishment) tQ近eSults that empIoyees can influence. For example, Organizations can use



any of a numberof融rinstc rewards・ They can grant additional monetary rewards, SuCh as



in the form of cash or stock. They can use non-mOnetary reWards, SuCh as by granting high-



Performing empIoyees public recognition and more decision authority. Altematively, in entities where performance is mediocre or poor, they can threaten to reduce the decision



authority and power that managers derive from managing their entities or decline to fund PrOPOSed prQjects.



Results measures can provide a positive motivational impact even if no rewards are explicitly linked to results measures. people often derive their own intemally generated誼でrtrlStC



re胸rds through a sense of accomplishment for achieving the desired results. For example,



When William J. Bratton became the New York City police commissioner, he gave his police force one dear’Simple goal: Cut Crime.47 (Previously the thinking had been that crime was due



to societal factors beyond the department,s control, SO the police were measured largely by how



quickly they responded to emergency calls.) He also implemented a results-COntrOI system. He decentralized the department by giving the 76 precinct commanders the authority to make most of the key decisions in their police units’induding the right to set personnel schedules,



and he started collecting and reporting crime data daily. Even though Commissioner Bratton



lega11y could not award good performers with pay raises or merit bonuses, the system was deemed eifective. In the subsequent two years, m匂or felonies in New York fell first by 12% and then a further 18%’reSPeCtively. This clearly could not have been attributable to pay-for-Perfor-



mance in the strictest sense; it was instead due’at least in part, tO PrOViding o鯖cers with clear



goals and empowering them to go about fighting crime. Seeing the results of their initiatives may have given police o鯖cers a sense of accomplishment and a greater intrinsic motivation to



Perform well. The motivational strength of any of the extrinsic or intrinsic rewards can be understood in terms of several motivation theories that have been developed and studied for over 50 years, SuCh as e埠,eCrCmey鳳eo7γ Expectancy theory postulates that individuals, motivational force, Or effort, is a function of (1) their expec亡anctes, Or their beliefthat certain outcomes will result from



their behavior (e.g. a bonus for increased effort); and (2) their血erlCeS, Or the strength of their Preference for those outcomes. The valence of a bonus’however, is not always restricted to its



monetary value; it al§O may have valence in securing other valued items, SuCh as status and



prestige.48



Organizations should promise their empIoyees the rewards that provide the most powerful motivational effects in the most cosトeffective way possible. But the motivational e飾ects of the



Various forms of reward can vary widely depending on an individual,s personal tastes and cir-



CumStanCeS. Some people are greatly interested in immediate cash awards, Whereas others are more interested in increasing their retirement benefits, increasing their autonomy, Or improv-



ing their promotion prospects. Reward tastes also vary across countries for a number of reaSOnS’induding differences in cultures and income tax laws.49 However, if organizations can



tailor their reward packages to their empIoyees, individual preferences, they can provide meaningful rewards in a cost-e鯖cient manner. But tailoring rewards to individuals or small groups



Within a large organization is not easy to accomplish and is sometimes even seen as possibly, Or



even legally, inequitable. A tailored system will likely be complex and costly to administer. When poorly implemented’it can easily lead to empIoyee perceptions of unfalmess and poten-



tia11y have the opposite effects of those intended: demotivation and poor empIoyee morale. We discuss the choice ofdiiferent forms of incentives and incentive system design in more detail in Chapter 9.



三雲霧



41



Conditions determi巾ng the e情ectiveness of resuits contro!s Although they are an important form of control in many organizations, reSults controIs cannot



atways be used effectively. They work best only when dZ ofthe following conditions are present: 1. Organizations can determine what results are desired in the areas being controlled; 2. The empIoyees whose behaviors are being controlled have significant influence on the results for which they are being held accountable; and’



3" Organizations can measure the results effectively.



Knowledge of desired results For results controIs to work, Organizations must know what results are desired in the areas they



wish to control, and they must communicate the desired results effectively to the employees working in those areas. Res庇s des{rc[拙ty means that more of the quality represented by the results measure is preferred to less, eVerything else being equal・



As we allud。d to earlier, eVen if one might agree that (one of) the primary dbjective(S) of for-



profit firms or corporates is to maximize shareholder value, this does not imply that the desired results, eVen if the overall o旦iective is understood, Will be unequivocally known or have unam-



biguous meaning at all intermediate and lower levels in the organization. The disaggregation of



overall organizational objectives into specific expectations for all empIoyees Iower in the hierarchy is often di飴cult. Different parts of the organization face different tradeoffs.



For example, PurChasing managers create value by procuring good-quality’low-COSt materi-



als on time. These three result areas (quality, COSt, and schedule) can often be traded offagainst



each other, and the overall organizational objective to maximize profit provides little guidance in making these tradeoffs. The importance ofeach ofthese results areas mayvary over time and among parts of the organization depending on differing needs and strategies・ For example’a



company (or entity) short of cash may want to minimize the amount of inventory on hand’



which may make scheduling the dominant consideration. A company (or entity) with a cost leadership strategy may want to emphasize the cost considerations. A company (or entity) purL suing a unique product quality image or differentiation strategy may emphasize meeting or exceeding the specifications of the materials being purchased. Thus’tO enSure PrOPer PurChas-



ing manager behaviors’the importance orderings or weightings of these three results areas



must be made dear and aligned with the strategy. If the wrong results areas are chosen’Or if the right areas are chosen but given the wrong



weightings, the combination of results measures will not be congr脚亡with the organization’s



intended objectives. Using an incongruent set ofresults measures may then result in motivating empIoyees to take the wrong actions. In the above setting’for example, ill-guided cost consid-



erations may damage the company’s pursued product-quality reputation.



Ab皿y to infiuence desired results (COntrOllab皿y) A second condition that is necessary for results controIs to be effective is that the empIoyees whose behaviors are being contro11ed must be able to aifect the results in a material way in a given time period. This confro批品据typrinciple is one of the central tenets of responsibility accounting twhich we discuss in more detail in Chapters 7 and 12)・ Here are some repreSenta-



tive expressions that have stood the test of time of this perennial principle: It is almost a self-eVident p「oposition that, in appraising the performance of divisionaI



management, nO aCCOunt Shou-d be taken of matters outside the division’s contro一・50



42



Conditions determining the effectiveness of resuits controis



A manager is not norma=y heid accountabIe for unfavorabIe outcomes or credited with favorab-e o凸2S if they are c-ear-y due to causes not under his contro一〇51



The main ration乱e behind the controllability principle is that results measures are useful



only to the extent that they provide information about the desirability of the actions or deci-



sions that were taken. If a results area is totally uncontrollable, the results measures reveal nothing about what actions or decisions were taken・ Partial controllability makes it difficult to



infer from the results measures whether or not good actions or decisions were taken. In most organizational situations, Of course’numerOuS unCOntrO11able or partially uncontrol-



lable factors inevitably affect the measures used to evaluate performance. These uncontro11able in且uences hinder efforts to use results measures for controI purposes, As a consequence, it becomes di飴cult to determine whether the results achieved are due to the actions or decisions taken or, rather, tO unCOntrOllable factors or JIO王se・ Good actions and decisions wi11 not necessar-



ily produce good results. Bad actions or decisions may similarly be obscured. In situations where many significant, unCOntrO11able influences a任ect the available results



measures, reSults control is not eifective. Managers cannot be relieved of their responsibility to respond to some uncontrollable factors or be exempted from dealing with reasonable or normal uncertainty in their environment; but if these factors’Or the uncertainty’are difficult



to separate from the results measures’reSults controIs do not provide good information for



either evaluating performance or motivating good behaviors. We discuss the methods that organizations use to cope with uncontrollable factors in results-COntrOI systems in more detail



in Chapter 12.



Ab皿y to measu「e controIlabie resuits e惰ectiveIy Ability to measure the controllable results effectively is the final constraint limiting the feasibility of results contro工s. Often the controllable results that the organization desires’and that the employees involved can affect’CannOt be measured eifectively. In virtually all situations,



some掘ng can be measured; but often, however, the key results areas camot be measured



錐c亡王γeか The key criterion that should be used tojudge the effectiveness of results measures is the ability to evoke the desired behaviors. If a measure evokes the right behaviors in a given situation葛that is, ifthe measure can be said to be coれgruerl亡With the desired results area - then



it is a good control measure. If it does not’it is a bad one’eVen if the measure accurately reflects the quantity it purports to represent; that is’eVen if the measurement has little meas-



Tb evoke the right behaviors, in addition to being congrue加and co庇roZZc謝e, reSults meas-



ures should be precise, O切ec亡ive, [王metw and肌der如nda弛. Even when a measure has a1l ofthe above qualities, it should also be cos亡c研cie証; that is, the costs of developing and using the



measure should be considered.



Precision Measurements inevitably contain error, SOme random’SOme SyStematic. Error makes the meas-



urement inaccurate. Measurement accuraey refers to the degree of doseness of measurements of a quantity to its actual (true) value. Precisiowis the degree to which repeated measurements



under similar conditions show the same result; if they do, the measurements can be said to be re融bZe. Using a bull,s-eye analogy, aCCuraq′ describes the doseness of arrows (measurement)



to the target (true value). When all arrows are grouped tightly together, the cluster of arrows (measurement) is consideredpγeCこse since they all struck dose to the same spot, eVen ifnot necessarily near the bu11’s-eye.



43



Chapter 2. ResuIts Controis Reducing systematic error (or弛s) improves accuracy but does not change precision" However, it is n鏡possible to achieve accuracy in measurement without precision; that is’When the



measures ccntain’mostly random error or, thus’When they are unreliable. In other words’and in the bull・s-eye analogy, ifthe arrows are not grouped 。ose to one another’they cannot all be dose to the bull,s-eye. Therefore’1ack of precision is an undesirable quality for a results meas-



ure to have. But even precise measures that are biased (i.e. that contain systematic error) may not be of great use for controI purposes. If the degree of the systematic error is not known; then the measurement wi11 be systematically biased by either showing greater or lesser values than the actual value (see the next section on o巧ec亡i高ゆ・ It is obvious that some aspects of performance (such as social responsibility’leadership acu-



men, and personnel development) are difficult’Or eVen impossible’tO meaSure PreCisely’either



because the measurements contain random error or are systematically biased (such as may be the case when su11iective performance evaluations are used). Precision’therefore, is important



because without it, the measure loses much of its information value. Imprecise measures increase the risk of misevaluating performance. Employees will react negatively to the inequi-



ties that inevitably arise when equally good perfbmances are rated differently.



Objectivity An o卸ec亡工ve measure here means that it is not influenced by personal feelings’mental states’ emotions, taSteS, Or interpretations - hence, that it is肌btαSed. Measurement objectivity will be



inevitably suspect where either the choice of measurement rules or the actual measurmg lS done by the persons whose performances are being evaluated. Low objectivity is likely’for



example, Where performance is se11reported or where evaluatees are allowed considerable dis-



cretion in the choice of measurement methods. Indeed, and referring to the earlier definition



related to measurement precision, low objectivity is likely to introduce systematic error due to, for example, Selectivity, 1eniency, Or lack of self-Criticalness. If that is the case’the measure-



ment may be precise’but it wi11 not be accurate. Good measures for controI purposes therefore



should be both precise (reliable) and objective (unbiased).



There are two main ways to increase measurement objectivity. The first is to have the measuring done by people independent of the processes that generate the results’SuCh as by person-



nel in the controller,s department. The second is to have the measurements verified by independent parties, SuCh as auditors.



TimeIiness T王肌e軸ess refers to the lag between the empIoyee,s performance and the measurement of



results (and the provision of rewards based on these results). Timeliness is an important measurement quality for two reasons. The first is motivational. EmpIoyees need repeated perfor-



mance pressure to perform at their best. The pressure helps ensure that the emI)loyees do not become complacent, inattentive’SIoppy, Or WaSteful. Measures’and thus rewards’that are



delayed for significant periods of time lose most of their motivational impact. The sustained pressure can also encourage creativity by increasing the likelihood that employees will be stimulated to repeatedly search for new and better ways to improve results. As The F証a近aZ Times noted about deferred bonuses in banks,偉beloved by the regulators because they allow the payout to be adjusted if conditions change’[they do’howeve巾reduce



the motivational value of bonuses - by the time the empIoyees receive the money they may not remember what was being rewarded’,・52 making it also unlikely that the rewards will affect or



adjust the behaviors that led to those results.



A second advantage is that timeliness increases the value of interventions that might be necessary. If significant problems exist but the performance measures are not timely, it might not



be possible to intervene to fix the problems before they cause (more) harm.



44



Conditions determining the e値ectiveness of resuIts controIs



Understandability Two aspects互肌ders亡anda掘dy are important. First, the empIoyees whose behaviors are being



controlled mdst urrderstand what they are being held accountable for. This requires communi-



cation. Training, Which is a form of communication, may also be necessary if, for example, employees are to be held accountable for achieving goals expressed in new and different terms,



such as when an organization shifts its measurement focus from accounting income to, Say, economic value added (more on this in Chapter ll)・ Second, emPIoyees must understand what they must do to influence the measure’at least in



broad tems. For example, PurChasing managers who are held accountable for lowering the costs of purchased materials will not be successful until they develop strategies for accomplishing this goal, SuCh as improving negotiations with vendors’increasing competition among ven-



dors, Or WOrking with engineering personnel to redesign certain parts" Similarly, emPloyees



who are held accountable for customer satisfaction must understand what their customers value and what they can do to affect it. The same holds for teachers in universities who often do not understand what specific teaching skills or approaches result in better (or worse) teaching



evaluations by their students at the end ofthe term. When empIoyees understand what a measure represents’they are empowered to work out what they can do to influence it. In fact’this is one ofthe advantages of results controIs‥ gOOd



controI can be achieved without knowing exactly how empIoyees will produce the results.



Cost e情ciency Fina11y, meaSureS Should be cosf e伊cZe証A measure might have all of the above qualities and yet be too expensive to develop or use (e.g. when it invoIves third-Party SurVeyS Of customers’



say, tO COllect the data), meaning that the costs exceed the benefits. When that is the case’the fim may need to settle for an altemative’mOre COSt-e鯖cient measure. Advances in technoIogy



and data analysis, SuCh as related to αbig data,,, have made data that had hitherto been hard to obtain or analyze more readily available. But data are not information’and these data do not



uniformly have good properties, Where much of it is unstructured. For example’understanda-



bility in terms of the claimed relationships with specific actions and decisions often is particularly problematic. And even o助ectivity can be an issue, Perhaps surprisingly, because, aS it has been said, “tOrture the data long enough and they wi11 confess to anything.,,53



For example, Califomia,s MemorialCare Health System is part of a movement by hospitals around the United States to change how doctors practice by monitoring their progress toward goals. What is different this time’SOme hospital executives argue’is that ``new technoIogy ena-



bles closer, faster tracking ofindividual doctors’,, where MemorialCare is keeping detailed data



on how the doctors perform on many measures’including adolescent immunizationsブmammO-



grams, and keeping down the blood-Sugar levels of diabetes patients. The results are compiled,



number-CrunChed, and eventually used to help detemine how much money doctors wi11 eam, where the new insurance payments also factor in quality goals. An assessment of this ``doctordata,, system indicates that it has helped reduce the average stay for adult patients’trimmed the



average cost per admitted adult patient’and led to improvements in indicators of quality’ including patient re-admissions, mOrtality’and complications. This has not been uncontentious, however. Cardiologist Venkat Warren said that he worried that負some bean-COunter Will



decide what performance is,・ and wondered whether doctors would be pushed to avoid older



and sicker patients who might drag down their numbers.54 Overall, many meaSureS CamOt be dassi亀ed as either dearly good (effectivO or poor (inef



fective). Different tradeoffs among the measurement qualities create some advantages and disadvantages. For example, meaSureS Can Often be made more congruent’COntrOllable’PreCise



and objective if timeliness is compromised. Thus, in assessing the effectiveness of results 45



Chapter 2. Results Controis measures, many di鯖cult judgments are often necessary. These judgments are discussed in



more detail throughout several chapters of this text.



ConcIusion This chapter described an important form of control, reSults control, Which is used at many lev-



els in most organizations. Results controIs are an indirect form of control because they do not



focus explicitly on the empIoyees, actions or decisions" However, this indirectness provides some important advantages. Results controIs can often be e節ective when it is not clear what



behaviors are most desirable. In addition, reSults controIs can yield good controI while allowing



the employees whose behaviors are being controlled high autonomy. Many people, Particularly those higher in the organizational hierarchy but also so-Called knowZedge workers, Value high autonomy and respond well to it, although they may not always respond well to the measures



used, Particularly when these suifer from significant weaknesses in terms of the various measurement properties we discussed.



Results controIs are therefore clearly not effective in every situation. Failure to satisfy all three effectiveness conditions - knowledge of the desired results, ability to affect the desired results, and ability to measure controllable results effectively - Will impair the results controIs’



effectiveness, if not render them impotent. Worse, it could produce dysfunctional side effects’



various forms ofwhich we discuss in later chapters.



That said, reSults controIs usually are the major element of the management controI system (MCS) used in all but the smallest organizations. However, reSults contro量s often are supple-



mented by action and personnel/Cultural controIs’Which we discuss in the next chapter.



Notes l “Lord ofthe Rigs,’’励rbes (March 29, 2OO4), P. 68. 2 “Measuring People Power,’’Forさ肌e (October 2, 2000), P.



186. 3 “Bank Bonuses: Bashing Ignores the Benefits for Investors,,, FirlarlCiαけtmes (November 27, 2015), Online at on.



a Manufacturing Firm,’’嵐上rOPearl Accol抑血g Reγ[e丁年24,



no. 2 (2015), pp. 241-76.



11 As an example of several results-COntrOl issues that can arise when these condi亡ions are not met, See S. Kerr, “The



Best-Laid Incentive Plans;’HαrVard BllSfrleSS Re高ew, 81,



4 Ibid. See also “Geithner: Link Executive Pay to Perfor-



no. 1 Uanuary2003), PP. 27-40. 12 See, for example, K. H. Blanchard, J. P. Carlos, and W. A.



mance:’The Was砧ng亡orl Hmes (June lO, 2009), Online at



RandoIph, The T加ee Keys fO Empowerment (San Fran-



WaShingtontimes.com.



cisco, CA: BerretトKoehler Publishers, 1999). AIso see ``C.



ft. com/ 1 kXpBJ9"



5 “Performance Pay Likely for Doctors,’’The Austrd誼n



(May 6, 2009), Online at www.theaustralian.com.au. 6 ``Hospitals Prescribe Big Data to Track Doctors at Work’’’



Oswick,伍Engaging with EmpIoyee Engagement in HRD Theory and Practice,,, Humarl Resource Deve!opmerl亡 Re高ew (2015), PP. 1-9, Parti⊂ularly Figure l, P. 2.



The W硯SfreetJoIJr棚Z (July ll, 2O13), Online atwww" 13 M. Hammer, Bのりrld Reengineering: How血e Process-CenW♀き・COm・



7 “Medicare,s $963 M皿on Experiment,’’軌s[rleSS Week



tered Orga庇如亡io証s Charlging Our Work肌d Our Lives



(New Ibrk: Harper Business, 1996).



(September 6, 2O12), Online at www.bloomberg.com. 14 A. P. Sloan,砂地rs証h Gerlera耽oto「s (NewYork: Dou-



8 “From AIpha to Omega:’T庇Ecor10mist (August 15,  bleday, 1964). 2015), Online at econ.st/1J5S3AE.        15 “For DuPont, Christmas in April’,, Busi71eSS Week (Apri1



9 S. J. Condly, R. E. Clark, and H, D. StoIovitch, “The Effects  24, 1995), P. 130. ofIncentives onWorkplace Performance: A Meta-Analytic 16 Ibid., P. 129.



Review of Research Studies,,, pe垂rmarlCe Improveme庇17 ``Sanofi Seeks E描ciencies with New Model:’The Bosfon Qmr亡erly, 16, nO. 3 (2003), PP. 46-63・



10 I, Friis, A. Hansen, and TVamosi, ``On the Effectiveness of



46



Gfobe (August 16, 2010), Online at www.boston.com. 18 `Air Products Unveils Widespread Reorganization,’’The



Incentive Pay: ExpIoring Complementarities and Substi-



W拙S亡reet JourrlαZ (September 18, 2014), Online at on.



tution between Management ControI System Elements in



W垂com/ 1w5yrGy.



Notes



19 “In Break with Past, No More Passing the Buck at Opel,’’



35 See, forexamp獲e, D. Campbell, S. Datar, S. L. Kulp’andV.



Reu亡ers (December 6, 2009), Online_at WWW.reuterS"COm.



G. Narayanan, ``Testing Strategy with Multiple Perfor-



20 R. H. Chandler, quOted in “Sunrise Scam Throws Light on



mance Measures: Evidence from a Ba獲anced Scorecard at



Incentive Pay Programs,’’The Los AngeZes TZmes (January



1与, 1996), p. D3・ 21 The details of Lincoln Electric’s legendary JrlCe融ve Pe)佃r-



martce?yste肌are described in the case bearing the compa-



ny,s name at the end of Chapter 4. See also “Ohio Firm



Relies on Incentive-Pay System to Motivate Workers and Maintain Products,’’T九e W拙S亡reet JoI上γmZ (August 12, 1983), P. 23; and “Lincoln Electric‥ Where People Are Never



Store 24,,, J。urrlaZ Qf財arlagemerl亡Acco肌血g Research,



27, nO. 2 (Fal1 2O15), PP. 39-65. 36 ``Shareholders vs. Stakeholders: A New Idolatry;’T心e



Econo証s亡(Apri1 24, 2010), PP. 65-6. 37 ``patents, Yes; Ideas, Maybe,7’丑e EcorlOmis亡(October 14,



2010), pp" 78-9・



38 “Citi’s CEO Is Keeping Score;, The Wa甘sfree亡JourmZ (March 4, 2O13), Online at www.w吏i・COm.



Let Go,” Hme (June 18, 2001), P. 40. Tbday, the company’s



39 Ibid.



website states that最Every year since 1934, eligible empIoy-



40 See, for example, R. Benabou and J. Tirole’αBonus Cul-



ees have received a profit sharing bonus in December.



ture: Competitive Pay’Screening and Multitasking,’’



Lincoln,s payfo叩erformance culture’reWards empIoyees



Working Paper ]8963 (Cambridge, MA: National Bureau



for their contributions to the success and profitability of the Company. The average bonus award over the last lO years is 4O% of an employee,s year to date’base eamings’’



of Economic Research, 2O13). 41 ``Banker Bonuses Get a Nobel Dis,’’Btoomberg VIew (Octo-



ber 13, 2014), Online at bv.ms/1toxQQN.



(www.1incolnelectric.com/en-u S/COmPany{areers/Pages/



42 “Making a Killing,’’The Ecor10mfs亡(July 16, 2OO9), P. 36.



1incoln-tradition.aspx; aCCeSSed December 2015).



43 D. Campbell, ‖Nonfinancial Performance Measures and



22 ``This Is the Answer,’’BIJS証ess Week Uuly 5, 1982), PP・ 50-2.



Promotion-Based Incentives,’’Jo置上rmZ qf Accou庇ing



23 J. Roberts, The Modern Fim: Orgarliza亡io7mZ Designjbr



Researc九, 46, nO. 2 (2008), 297-332・



Peげor肌c[JICe arld Growth (New York‥ Oxford University



Press, 2004). 24 “Lampert Cuts Sears Below 50% to Meet Redemptions,’’



44 G. P. Latham, “The Motivational Benefits ofGoal-Setting,”



Acαdeny qf晩rtc[gemerlt Execudve, 18, nO. 4 (November



2004), pp. 126-9・



Bfoomberg (December 4, 2013), Online at bloom. 45 “Performance Reviews bythe Numbers’’’The VI硯Street



bg/1RodSO2. 25 “Embracing the J&J Credo,’’Bc[rrO証; (December 14, 2013),



online at www.barrons.com. 26 Ibid. 27 “OECD Casts Doubt on Indonesia Growth View,’’The W班 Stree亡JoL[rrlaZ (September 27, 2012), Online at on.w車



COm/10ao9zG. 28 “Carrefour Contends with Bribes in China,” Forbes



(August 27, 20O7), Online at www.forbes.com. 29 ``Lampert Cuts Sears Below 50% to Meet Redemptions,” Op.Cit・



30 `Airbus ChiefBregier to Empower Local Sites in Company Overhaul,,, BZoo肌beI官(September lO, 2O12), Online at



www.bloomberg,COm. 31 “Huawei,s Chief Breaks His Silence;’B重JSiness Week (May



9, 2013), Online at www.bloomberg.com.



Jou刑αZ (June 29, 201O), Online at online.w争j.com.



46 See, for example, D. Campbell, ``Nonfinancial Performance Measures and Promotion-Based Incentives,’’Jour-



朋Z QfAccourl亡王rlgResearch, 46, nO. 2 (2008), 297-332.



47 `A Safer New York City:’Business Week (December ll,



1995), p. 8l. 48 V. H. Vroom, Worたarld Mot高ation (New York‥ Wiley,



1964).



49 E, P. Jansen, K. A. Merchant, and W, A. Van der Stede,



``National Differences in Incentive Compensation Practices: The Diffc正ng Roles of Financial Performance Meas-



urement in the United States and the Netherlands, Acco肌血g, Org肌浸;αfiorlS and Socie助34, nO. 1 (January



2009), pP" 58-84・



50 D. Solomons, D高siomZ Pe函)rmanCe: Measuremeri弛融 Corl亡rOき(Homewood, IL: Richard D, Irwin, 1965), P. 83・



32 αSamsonite Sees Rapid Growth in Asia,,, The W軸Streef



51 K. J. Arrow,寝Control in Large Organizations,,7 in M" Schiff



Jo工」rrmさ(December 29, 2013), Online at on.wsj.



and A. Y. Lewin (eds.), Be庇VtoraZ Aspects qfAcco肌血g



COm/ 1 zDPRcr.



33 See, for example, J. Brickley, C. Smith, and J. Zimmerman, Marlageria! Ecor10m[cs肌d O7gC血zatio庇l Arc柾tec-



ure (Boston, MA: McGraw-Hill Irwin, 2001). 34 For the so-Called “selection e任ect’’benefits of (results)



controIs, See, for example, D. Campbell’``EmpIoyee Selection as a ControI System,’’JourrlC[Z QfAccou証fug Research,



50, nO. 4 (September 2012), PP. 931-66.



(Englewood Cliffs, NJ: Prentice Hall, 1974), P. 284. 52 ``Bank Bonuses: Bashing Ignores the Benefits for Investors,” op. cit.



53 `A Different Game: Information Is Transforming Tradi-



tional Businesses,,, The Economist (February 25, 2010), online at http:〃econ.st/KAlqb8. 54 “Hospitals Prescribe Big Data to Track Doctors at Work’’’ Op・Cit"



47



CASE STUB)V O冊ce Solutions, lnc,



In December 2014, Bob Mairena, PreSident of O鯖ce



Both Bob and Cindy had an entrepreneurial spirit and



Solutions, Inc., an O鯖ce supply distributor based in



were looking for an opportunity to start their own busi-



Southem Califomia, WaS COnSidering making a signifi-



ness. They saw an opportunity in the early 1980s. Per-



cant change in the compensation plan for his sales per-



sonal computers were just coming into prominence,



sonnel. The company,s current compensation plan for



creating a new need for computer supplies. Traditional



a11 sales personnel was based on sales commissions’



office supply companies did not have the technical



plus the potential for an incentive of 2-4% for achievement of some specific sales goals.



expertise to sell computer supplies effectively. Bob and



Cindy prepared themselves by taking computer classes



However, Bob had come to believe that a commis-



at night・ By 1984, they had gained enough expertise to



sion-based compensation system was appropriate



start a company called Data Extras’the predecessor to



only for the few individuals bringing in significant



O鯖ce Solutions.



amounts of new business, those whom he called



For several years, Data Extras successfully pro-



“hunters.・, Most of the company,s salespeople were



vided supplies to companies with computers. Eventu-



not hunters; they were not generating significant



ally, however’COmPuter SuPPlies became a commodity,



amo皿ts ofrrew business. Theywere more like account



and the expertise and consulting services that Data



managers who, Bob thought, Should be compensated



Extras offered were no Ionger as valuable and the



with a lower-risk plan based on a relatively high pro-



business was not scalable. Bob and Cindy made a stra-



portion of guaranteed salary’SuPPlemented with a



perfomance-dependent bonus. Because of lower job pressure and more stable compensation’the account



managers should be paid less than sales reps. O鯖ce



tegic decision to expand the business to carry a full line of o範ce supplies. In 1989, the Data Extras name was changed to O飴ce Solutions to reflect the change



in service scope.



Solutions could use the cost savings to funnel more



Over the years, O範ce Solutions grew both organi-



money to the relatively few salespeople who were



cally and by acquisition. In 2014’it was generating



generating growth opportunities for the company・



approximately $36 m皿on in annual revenue. The



But Bob was not yet totally sure how the new system



company had llO empIoyees’induding 40 salespeople



should be designed and what kind of transition would



who sold four product lines‥ O鯖ce supplies’Office fumi-



be required to get the salespeople comfortable with



ture, facility supplies, and print services. (Exhibit l



the change.



shows an organization chart.) O飴ce Solutions used



23 company-OWned trucks to deliver its products to



The company



O鯖ce Solutions used sophisticated management



O鯖ce Solutions, Inc., headquartered in Yorba Linda’



techniques. Its distribution system was very e範cient.



Califomia, SOld and distributed a full range of o鯖ce



The company carried only the most basic supplies in



supplies to customers in Southem Califomia’from San



its own warehouse. Most of the products sold were



Diego in the south to Santa Barbara in the north. The



delivered to them on the following morning and



company was founded in 1984 by a husband-and-Wife



delivered to the customer with a 98.5%飢I ratio. The



team, Bob and Cindy Mairena.



company was also metrics-driven. A vital-factor



Prior to starting Office Solutions, Bob worked for UPS and Cindy worked for an o鯖ce supply company・



48



spreadsheet’Which tracked sales, Sales leads・ and multiple other measures’WaS PrOduced regularly・ An



Office SoIutions, lnc. electronic ticker on the wall tracked call-SerVice statistics in real time.        _



Adding to the management challenges in the industry, Sales of o鯖ce supplies were shrinking. As customers



0鯖ce Solutions had many long-tenured empIoyees



moved toward digital information sharing, they needed



and a fun working atmosphere. For example, Bob was a



fewer supplies such as paper, tOner, files, and binders.



PrOPOnent Of fitness. He encouraged empIoyees to wear exercise gear at work, and most of them participated in



tive, Single-digit sales growth in 2013,1 but the big-box



a company exercise break twice a day.



COmPanies in the industry were reporting continuing



O鯖ce Solutions offered every empIoyee, eXCluding



Some privately owned distributors posted small posi-



sales declines. Sales at O航ce Depot fel1 4% in 2013,



those induded in any other incentive plan, a quarterly



exduding effects of the merger with O綿ce Max. Staples’



incentive of l% of salary if the company made its



sales declined 5% in 2013, and the company announced



quarterly profit numbers. This incentive was designed both to enhance unity of purpose and to share profits



plans to 。ose more than 225 of 2’OOO stores.2



and risks with the empIoyees.



The O冊ce Solutions strategy O鯖ce Solutions managers’understanding of the com-



lndustry environment Until the mid-1980s, the office supply industry was



dominated by sma11, independently owned dealers, some owned by the same families for generations. Then three large big-box retailers - Staples, O鯖ce Max, and



O飴ce Depot葛aS Well as consolidators - SuCh as Corpo-



rate Express, USOP, and BT, Who were more focused in the commercial contract space - entered the market.



petitive landscape allowed it to carve out a successful



COmPetitive niche. They categorized industry custom-



ers using a pyramid paradigm (see Figure l). At the bottom of the pyramid were small customers, defined



as businesses with l-15 empIoyees. These customers typically bought o飴ce supplies directly from retail out-



lets or online.



Figure l Customer pyramid



These o鯖ce supply giants built nationwide distribution



networks and retail presence. They enjoyed economies



ofscale, and they shaved margins. Among other things, they offered “loss leaders;’selling some popular prod-



ucts at or below cost to attract new customers. In 2013, Staples, the largest o鯖ce supply retailer, had annual



revenues of $23 billion. O鯖ce Depot and O飴ce Max



merged in November 2013 and had combined 2013 revenue of $17 billion. The success of the big葛box stores



drove thousands of independent dealers out of busi-



ness. But in 2014, the office supply industry still included the two remaining big-box companies, thou-



sands of independent retailers, and, increasingly,



online retailers such as Amazon that had moved into the o鯖ce supply space. By early 2015, an additional



merger between Staples and Office Depot had been negotiated and was awaiting FTC approval.



The independent dealers that survived consolidation and the onslaught ofthe retailers were strong deal-



ers that were competitive, Independents still owned



about 35-45% of the market, and they were especially strong in the small and medium business space. Two m亘ior wholesalers served this market. They both pro-



At the top of the pyramid were enterprise customers, defined as businesses with 25O+ empIoyees. These businesses typically had multiple empIoyees purchasing o飴ce supplies, but prices and product choices were



controlled with a contract between the company and the dealer that was negotiated at the corporate level・



Staples and O鯖ce Depot served most of the enterprise



customers. pricing strategy was the key to winning



enterprise business. Dealers in this market segment Offered popular products at low prices to win contracts;



margins for some products could be as Iow as 5%. These dealers had to bid carefully and have an excel-



lent understanding of product mix so that they could



win contracts and still eam a reasonable profit.



vided depth and breadth of product o任erings and pub-



1ished the two major marketing catalogs that were customized by the individual dealers to provide branding consistency in their speci丘c markets.



1 M. E. Biery (2014). 0綿ce Supply Stores Seelng Profit Margins Erased,



Forbes.com, April 13. 2 sEC創ings・



49



Chapter 2. PesuIts Controis



。。塁謹書蒜詰詰寄聖霊 customers with 15-250 empIoyees. These businesses typica11yworked with dealers and had a single decision



increase product penetration by introducing, marketing, and selling additional products and services



to existing customers.



3" Acquisition: Sales reps were expected to open



maker responsible for all ofthe o飴ce supply purchases.



doors for the acquisition ofnew customer accountS.



commercial customers were the most likely to value



After the door was opened, O飴ce Solutions sup-



strong relationships and excellent customer service・



ported the reps as needed with specialists in the



office Solutions had recently started moving up the



areas of fumiture, Printing, and janitorial sup-



customer pyramid’COmPeting for enterprise-level con-



plies. At the enterprise level’Sales reps were



tracts. Bob recognized the mergers of the big-box sup-



expected to identify when current contraCtS



pliers as an opportunity. Enterprise customers usually



expired and to register O鯖ce Solutions for the con-



considered three bids. With only two, Or maybe only



tract bid process. Once in the bid process’O鯖ce



one, big box distributors remaining’Bob reasoned that



solutions management became involved with the



o鯖ce Solutions could be a viable second or third option.



contract negotiations (e.g. pricing) and responded



The role of the sales representatives was different at



directly to customer queries without the input of



the enterprise level. They were responsible for initially



requesting participation in the RFP and for building enough of a relationship to understand the expectations



and priorities of the customer. The formal bid response and margin management waS Wholly provided by cor-



porate. once the contract was established, the role of the representative became less important as customer



service provided more direct and immediate contact and problem resolution.



Bob also recognized the move towards e-COmmerCe.



He committed a growing share of company resources towards the company website and online marketing. A major growth engine for O飴ce Solutions was the



acquisition of other office supply dealers. Over the years, O鯖ce Solutions had acquired quite a few smaller



companies. The purchase of an office supply company was, in essence, the purchase of the target’s salespeo-



ple and their customer relationships. Every effort was made to retain the target・s salespeople for at least a



year, at Which point their customer relationships were



the sales rep. Sales personnel were also charged with maintaining the accuracy of the information in Office Solutions’



sales-related systems.



The reps were not reSPOnSible for pricing because they did not understand the business well enough to



consider all the relevant factors and all of the dynamics affecting pricing. The o飴ce supply market in Southern Califomia was



huge, eStimated at $1.2 billion per year, SO Plenty of



opportunities existed for Office Solutions sales personnel. The sales people were free to develop new busi-



ness wherever they thought their potentials were highest; they were not assigned to sales territories.



They could use Office Solutions, customer-relation-



ship-management (CRM) system and identify potential customers that were not already buying from o飴ce Solutions. The salespeople lived all over South-



em califomia, and they tended to call on customers near where they lived.



transferred to O飴ce Solutions.



The sa!es roie The role of the sales personnel at O鯖ce Solutions was



thre efold :



The existing sales compenSation PrOg ram sales personnel were included in a commission-Plus-



bonus program"3 They eamed a commission of 25% of



1. Retention: Sales reps were responsible for keeping



the gross profit generated by sales to their customers. A



their current customerS happy・ Customer service



commission-based compensation structure had the



responsibilities included consultative services’



obvious benefit of making the sales compensation costs



ensuring that customer orders were handled correctly and on time, handling rush orders and other



3 In 2O14, a few sales persomel were in different compensation



special requests’and general relationship building. programs・ They had joined O飴ce Solutions as part of an acquisition,



2, Penetration: Sales reps were responsible for increas-



ing sales to their existing customers" They could 50



and they remained on the comI)enSation structure proVided by their former empIoyer.



Office Solutions, Inc.



.fabIe l Caicuiation of base bonus



was vital for management to correct slumps before they



materialized into Iow sales numbers. Achievement



二一.義 Bo「tusea喜ned



Ofgrossprofitgoal



(%grossprofit)



100.00-104,99%



0.4%



Managers and sales reps met together as a group every month to discuss their performance against their official goals and the other measures on the



VFSS. The meetings could be unpleasant for those



105.00-109.99%



0.5



who did not meet their goals. Performance against



110.00-114.99%



0.6



goals was also discussed during annual perfomance



115.00-119.99%



0.7



>120%



0.8



Fina11y, O億ce Solutions held annual sales meetings



where the top sales reps were recognized. Bob found



that the recognitions were surprisingly motivating. He variable. If sales declined, COStS declined with them, thus reducing profit risk.



explained: l can think of some saIes reps who were perfectIy



Bonuses were paid only if the sales personnel met or



content with their compensation, but became very



exceeded their gross profit goal. The goal was set by top



unhappy when they were no Ionger recognized as



management based on a targeted growth rate. Sales



one of the top saIes reps at the saIes meeting"



managers met with their sales reps to explain the goal



and to secure commitment to the goal. They spent time breaking down the goal by month’CategOry, and cus-



Concems



tomer and discussing how it could realistically be



Bob recognized some shortcomings in the current com-



achieved.



pensation structure. First’it did not seem to provide



The base bonuses ranged in value from O.4% to O.8% Of the gross profit eamed by the sales rep’s accounts



according to the step function shown in Table l. The



sales reps could eam an additional bonus of O.15% of gross profit for each of three smaller product categories



adequate motivation to generate new business. Bob noted that while there were some exceptions, Most peopIe don’t enjoy hunting・ Hunting onIy hap-



pens when you have to and that happens when you are buiIding your book of business・



(fumiture, facility supplies, Printing) if they exceeded a category revenue goal・ These sales categories were



Bob wanted the sales reps to generate more new busi-



smaller and more volatile than the o鯖ce supply cate-



ness. He had ambitious growth goals for the company.



gory, but they were also more profitable・



But many, Perhaps even most, Of the sales personnel



Under this system, bonuses amounted to a rela-



could seemingly eam enough money to satisfy their



tively small part ofthe overall compensation package’



lifestyle needs just by retaining the customers that they



maxing out at less than 4.8%4 0f a sales rep,s total



Were already serving.



COmPenSation.



Second, the compensation structure was perhaps too lucrative. O鯖ce Solutions was competing with the



Additional accountabiIity O鯖ce Solutions tracked several measures in addition



big-box stores that had lower costs of sales. Bob wanted



to reduce his company,s overall cost of sales so that they were more in line with the competition.



to the o鯖cial gross profit goal in a report ca11ed the



Finally, the commission structure attempted to moti-



vital factor spreadsheet (VFSS). (Exhibit 2 shows an



vate the reps with αcarrots.,, The reps acted too much



excerpt from a VFSS.) This report tracked sales leads



like independent contractors. Bob thought that he



all the way from initial contact to a yes置Or-nO decision’



needed a better way to express dissatisfaction with job



as reported by the sales reps" The sales reps did not like



performance, and he needed o切ective criteria for ter-



reporting their leads in such detail, but the information



minating underperforming employees. He explained: In addition to setting the pay structure, yOu need to manage the activity・ You have to monitor what they



are doing and motivate them to se= more" PeopIe sIack off when they have met their own needs" For



51



Chapter 2. Pesults ControIs



exampIe, One Of our reps-1,II cail him lbm-SeemS



w冊am is a goOd example of someone Who shouId be an accOunt manager・ He has been with us



p。,fectly happy earning也0,000 a year. 1 suspeCt



that he spends as muCh time as a tennis instructor as he does as a SaIes rep・ We reprimand Tom



for many yearS and is our ♯2 salesperson, reSPOnSi-



ble for $2.5 m輔On in sales, He works 24/7. He is up all the time checking backorder repo「tS. The cus-



private-y afte「 every mOnthly sales meeti=g’but



that seemS tO be of no consequenCe tO him" By age 50’mOSt Of the reps are Cruising" They



are not out generating new aCCOuntS. i need to



grow the business" Shou-d =ire ali of my estabIished reps who are nOt W冊ng to hunt?



tomers iove him, He micro-manageS their accountS



to make sure that nothing goes WrOng" He does a great job of customer retention and seIiing more Categories of products to his acco…tS. But he hasn’t



generated even twO neW aCCOuntS eaCh year" I have



had asaies managergO With him to heip him deve10P new Ieads, but that is just not What he is good at.



A p「oposal for change Bob,s instinct was to leave the compensation plan for In determining what changes to make’Bob decided



those in the sales rep categoryjust as it was. The com-



that he should divide the sales personnel into two



pensation mix for the account managerS WOuld change



groups - Sales reps and account managerS - and differentiate their compensation programS. Those desig-



dramatica11y to a targeted 70% base salary and 30%



nated as sales reps would be just those personnel who



sion and bonus. The expected total compensation of



were bringing in significant amounts of new business.



the account managerS WOuld be set to be slightly lower



The sales reps, compensation structure WOuld continue



than the current comPenSation levels’reflecting the



to be based almost exclusively on commission. rfo i11ustrate the characteristics of a near-ideal sales



reduced compensation risk.



rep, Bob thought immediately of Marsha:



variable compensation, Which in。uded both commis-



Transition



Marsha is in her Iate 40s. She wili do about $3 miト Iion in saies this year・ She is a pure hunte「, and she



Ioves comPeting" She 10St a $600,000 account Iast year because her cIient was aCquired, but she has



rep-aced it a-ready" Her weakness is that she deals with too much minutiae" When she is ready’1 wiil



Through some early’CaSual discussions’Bob had got-



ten some indications that the transition to a new cOm-



pensation structure for the account managerS WOuld not be easy. Bob raised the subject first with William’



someone who was important to the company but also the perfect candidate for the switch to account man-



give her an asSistant to do computer Set-uPS and the like, 1 want her focused on new business"



ager. Bob offered William what he thought was a generous package: a base salary that was 90% ofWilliam’s



The non-hunter sales reps would be placed into the



current commission level, With the potential to eam an



account manager category・ Many of these personnel



were exce11ent at customer relations and retention of



additiona1 10-15% as a bonus. (Exhibit 3 shows Wil1iam,s compensation calculations.) But William



accounts, but, for whatever reason, they did not bring



resisted. He insisted that he wanted to continue as a



in significant amounts of new clients. Bob explained:



sales rep despite Bob,s wamings that there would be a



If a sales rep is on-y retaining existing customerS,



his or her job description should be changed to an account manage「 with a pay StruCture that makes sense for those job responSib嗣es. Theoreticaily I



would 10Ve tO have a cOmPany fu= of saies reps who are aggressive-y pursuing =eW business, but l don’t



want to use a saIes rep comPenSation model to pay



someone who is actual-y functioning as an aCcOunt manager or rea一一y working as an OutSide custome「



service representative"



52



lot more pressure tO Win new accountS Should he choose to remain in that role"



Bob suspected that the conversations would be even more difficult if the change in structure WaS combined with the reduction in expected compensation, aS Bob thought it should. For the reps who wished to stay on the commission structure’Should he add a



negative consequenCe if they failed to acquire new accou nts?



Bob knew that he still had some details to work out.



53



J> Exhibit2 Excerptfrom theVFSS



NewAccounts



Jan-14



Feb輸14



Manager「



8



Manager2



10



Manager3



Manager「



9



14



7



1



Manager5



Totai



Ap「-14



4



9



Manager4



Mar-14



31



13,448



10



22



21,730



9



43



23,271



2



18,861



6



8



4



2 1



35



52,671



16



28,146



6



0



59,864



67,255



5



1



4 2



39



67,957



2 6



2



22



8



6



4 1



37



4



17



0



0



丁ota!



10



6



4



Dec-14



9



8



22



Nov-14



9



9 2



26



Ocト14



3



3



26,750



Sep-14



5 10



3



37



Aug-14



20



1



0



Juト14



7



12



7



1



Jun-14



13



12



1



3



May-14



45,639



0



15



24



47,417



473,0



Manager2



9,559



9,278



13,053



18,043



20,620



22,450



21,629



27,317



32,833



41,019



31,279



32,591



279,6



Manager3



3,949



3,542



13,771



17,779



29,084



40,260



43,052



42,337



82,297



84,185



54,250



70,911



485,4



Manager4



19,583



37,788



18,107



Manager5 TotaI



Variance



Var% Bids:



847



26,956



TotaIGoai



54,133



37,750



(10,794)



87,882



69,000



(12,868)



-21.5%



」an-14



27



Manager2



16



Manager3



5



12



2 28



4 56



206,500



(99,926)



May-14



21



8,290



1,266 135,598



(132,285)



1,747



5,874



191,941



264,500



(128,902)



(104,309)



(132,468)



(149,642)



Jun-14



Jui葛14



Aug-14



Sep輸14



Oct-14



17



18



19



14



11



11



13



13



10



4



5 43



9



17



9 4



40



54



6



-39.8%



14



7



12



4



6



5



33



39



1,564,89



364,500



2,566,40



(89,579)



-42.4% Nov-14



(1,001,501)



-24.6% Dec-14



10



11



-39. 丁otai



11



6



4



3



8



10 4



2 26



4



274,921



353,000



-55,4%



284,



17,879



203,358



333,250



-35.2%



106,122



7,974



200,782



296,250



-48,7%



64,215



-48.4%



12



50



5,779



238タ750



17



5 70



106,465



-39.0%



35



13



106,574



(66,250)



Ap「-14



5,159 301



169,750



-45.0%



Ma「-14



5



Other



(59,610)



16,267



8,479



103,500



132,400



-12,8%



Feb-14



Managerl



72タ790



100,750



(14,867)



-28,6%



TotaI



1,125



4 2



20



20



Exhibit 2 Conthued



Opportunities



Jan-14



戸eb-14



Stagel- Qualifying



Stage2-lnitial



Stage3



Stage4



Stage5



430



Meeting



一Deveiopjng



Ma「-14



484



351



Proposal



ーPresentation



ーCommjtment



1,113



Stage6-Won



272



Stage7-Lost



180



TbtalA= Opportunities



1,548



379



1,214



192 1,678



426



1,337



284 226 1,847



425



216



293 244 1,894



270 1,956



200



57



318 268 1,902



577



146



319 299 1,843



149



157



169



1,292



1,300



289



157



162



53



134



127



56



1,318



Tbtai



394



367



155



51



Dec-14



576



357



164



47



1,305



Nov-14



566



368



166



45



1,225



Ocト14



552



366



174



51



1,316



Sep-14



340



108



58



304



520



219



1,382



Aug-14



416



121



98



1,357



541



440



114



70



Juト14



545



193



113



51



Jun-14



544



167



114



toBuy



May-14



507



163



118



TotaICurrent Opportunities



255



Ap「-14



50



994



348



387



418



436



321



318



413



440



468



333



1,971



2,092



2,158



2タ222



1,648



(Con tinued)



.」



l



言上



Exhibit 2 Continued



2013Web It●



AnaylCS S



」an-14



20812



eSSIOnS Users



Feb-14



17,825 7,813 8,851



Ma「-14



Ap「-14



18,806 8,297



8,045



7,974



14,681



PageVIeWS 35903 30,877 P/V.’t 1.73 2:48 17333,137 1.76 1.84 2:41



ageSISI



VisitTime



2:46



R t %NewVisits 6602% 66,55% 30,63% 31.61% Bounceae  0 67.09% 31,16%



May-14



18,780



2:42



Jun-14



18,182 15,957



33,426 1.88



2:44



Juト14



34,969 15,895



37,566 16,603



34,216 8,69



304,010 8,67



7:33



7:25



Aug-14



35,964



Sep-14



Oct-14



37,869



16,805 345,600



325,674 8,6



7:05



8.41 309,291



6:56



39,959



Nov-14



Dec-14



31,827



28,523



14,381 275,187



8,65 318,452



7:14



13,634



8,65 238,281 8.



7:06



6:



66.57% 67.10% 42.62% 43.87% 44,11% 44.29% 43.22% 43.76% 45,86% 30.11% 31,44% 35.92% 30,98% 31,52% 31.13% 29.45% 30.77% 31.69



Exhibit 3 W冊am’s Compensation Caiculator



Wiiiiam’s 2014 performance



2014Goai



丁otalRevenue



$2,104,350



OfficeSuppiyBev. FumitureRev.



GrossProfit



$505,495



$228,071



$150,868



$502,939



Percentage



Commission



25.00%



BaseBonus



,50%



FurnitureBonus Fac冊yBonus



$1,200



$(44,839)



-29,7%



7,1%



$(37,800)



-96.9%



Compensation



$134,700



$538,799



$2,694



$538,799 $538,799



PrintingBonus



4.9%



$35,860



$538,799



.15%



61,0%



$11,081



GrossProfitBase



.15%



-0.6%



$191,596



$538,799



$39,000



7.1%



$(7,795)



$239,152



$106,029



Va「iance%



$150,043



$1,403,717



$313,899



RevenuefromNewAccounts



Variance



$2,254,393



$1,411,512



FaciiitySupplyBev. PrintingRev.



2014Actual



$808 $808



0



lbtalCompensation



0



$139,010



ASOFFEREDTOWILLIAM 90%baseIlO%bonus BaseSaIary



$121,230



BonusPotentiaI



TbtaiCompensation



$13,470



$134,700



1f70%base130%bonus $94,290 $40,410



$134,700



This case was prepared by Professor Kenneth A. Merchant and Research Assistants Michelle Spaulding and Seung Hwan (Pe亡亘) Oh. Copyright ◎ by Kenneth A. Merchant.



57



CASE STUDY Puente H冊s Tdyota 1豊±血書



In December 2003, Howard Hakes, Vice president of



It was important for the dealerships to keep two important COnStituencies - manufacturers and custom-



Hitchcock Automotive Services’reflected on some of the



ers - happy・ The manufacturers allocated larger challenges his team faced in managing his company’s



stable of automobile dealerships. He illustrated his points by discussing the challenges faced at Puente Hi11s Tbyota’



numbers of their best-Se11ing models to their better perfoming dealers・ The manufacturers evaluated their dealers in terms of their abilities to fu皿I their



Hitchcock・s largest dealership’although all of the Hitch-



cock dealerships faced essentially the same problems.



market potential‥ tO meet Sales targets the manufactur-



ers set for each geographical trading area, known a§



This is very muCh a peoPle business. It,s peopie



the pr血ary mc[rたe亡αrea. The dealerships also had to



who give us our biggest SuCCeSSeS aS Well as our



satisfy the manufacturers’licensing and certification



biggest Chat-engeS. At ou「 Toyota StOre’in sales, I



standards. The manufacturers regularly performed



wouid say that about 20% of our peOPle are loyai



compliance audits to evaluate dealership practices in



to the comPany and 「ea一!y want tO do a good job.



comparison with the established standards. However,



丁heother80% arejustinthisforthe money " ‥ and



Howard Hakes believed that short of flagrant violations



they can make more mOney he「e than anyWhere



of standards (e.g. se11ing competing brands under the



eIse. Our comPenSation attraCtS SOme Very tai-



same roof), fu胤1ing market potentials was the pri-



ented people" But some O=hese peOPle are



mary factor affecting the dealers・ relationships with



sharks who try tO get aWay With whatever they



the manufacturers.



can. others have perSOnal probiems" They live



customer satisfaction was obviously important in



from payCheck to payCheck; that is their mentaiity・



obtaining repeat Sales and, hence, future profits. Cus-



s刷Others are CanCerS Whose bad habits can



tomer satisfaction surveyS Were given to every CuS-



spread" We coaCh and counSe一; We give written



tomer who bought or leased a vehicle or had one



notices; and for moSt Of the emp-oyees’OnCe they



serviced at a dealership. A copy of the survey given to



get the mesSage that is the end of the prObiems・



all Tbyota cuStOmerS Who purchased or leased a vehi。e



Butfor some Others ‥ ・



is shown in Exhibit l.1 The responseS tO these survey



I think the key to manageme=t in this business is



questions were mailed directly to the manufacturer



ali about managing attitude・ How can We keep the



and aggregated into a cus亡omer SC[。ザvc亡ion irldex (CSI)’



team moving in the same direction’tO get eVery-



to which considerable attention was paid by both the



body to be part Of the team’and prevent the can-



manufacturer and dealership managerS. Manufactur-



cers from spreading?



ers sometimes changed dealership vehicle a11ocation§



when CSI ratings fell below acceptable levels in three



The comPany and industry Hitchcock Automotive Services was a Privately held cor-



consecutive years.



Puente Hi!ls toyota



poration comprised of seven automObile dealerships -



three Tbyota dealerships and one each for Volkswagen,



puente Hills Tbyota (PHT) was a large Tbyota dealer-



Ford, Hyundai, and BMW - and a large body shop. All of



ship. Annual sales were about $85 million’in。uding



the entities were located in southem Califomia. Four of the dealerships, inc鵬ing Puente Hi11s Tbyota, Were Sit-



l Tdyota also required the use of a serv{ce survey’Which asked service



uated adiacent to eaCh other in City of Industry’Califor



customers a comparable set of questions focused on satisfaction with



nia, about 25 miles east of Los Angeles. The others were



(1) making the service appointment, (2) writing up the service orderJ (3) work quality証) work timeliness’(5) price’and (6) the facilities.



located in Anaheim’HermoSa Beach’and Northridge.



58



Puente H冊S lbyota



approximately $10 mi11ion from the body shop’Which



provided services to all of the Hitchcock dealerships in City oflndustry. PHT had a total of 145 empfoyees, and annual profits totaled about $1.8 million"



PHT had won many awards for excellent performance. For example, the dealership had been awarded Toyota’s President,s Award for overall excellence in



each ofthe prior 13 years.



In 2003, PHT moved into a new, State-Ofthe-art, $13 million facility with l19,000 square feet of space. The



only marginally profitable. Used vehicles provided a better profit source, aS Howard Hakes explained‥



This is one of the last barter businesses Ieft, For some new vehicies, there is only an $800 d田erence between the window sticker price and deale「 COSt,



sothere is not much margin and not much room for



bargaining. In used vehicles, We have a Iittle more



profit opportunity" We can sometimes take a tradein for$2,000, Put$1,500worth ofwork in it, and se= it for $6,000.



new building provided the latest in customer amenities, including a children,s play area, a mOVie theatre’



The service department was consistently PHT’s



efficient work layout areas, and room for growth.



most profitable department’With margins typically



PHT・s organization structure was fairly typical in



in the range of 15-2O%. (See comparison statistics



the industry. Reporting to the dealership general man-



from an industry consulting report shown in



ager were a general sales manager whose organization



Appendix A")



induded both new and used vehicle sales, a SerVice



As required by Tbyota, PHT managers kept separate



manager, a body shop manager’a PartS manager’and



records for new and used vehicle sales, aS ifthey were sep-



a director of finance and insurance (F&I) (see



arate departments’eVen though all PHT salespeople could



Exhibit 2). The one unique feature of the organization



sell both new and used vehicles. The separation of new



was the combined new and used vehicle sales depart-



and used vehicle profits required some a11ocations of



ment. only about one in five auto dealerships’tyPi-



expenses. with rare exceptions, all items of expense were



cally the smaller ones’had such a combined vehicle



split 70% to new vehides and 3O% to used vehicles, an



sales department. More typically, the managers of the



allocation formula that was typical in the industry. How-



new and used vehicle sales departments reported



ard Hakes knew that this formula was somewhat arbitrary.



directly to the dealership general manager. But PHT



For example, he knew that some forms ofadvertising’SuCh



managers liked the flexibility of having their sales per-



as halfhour television shows or “infomercials’’on Spanish



sonnel se11 whatever vehicle customers wanted, neW Or



language television stations’Were SOlely aimed at selling



used, and some customers wanted to Iook at both new



used vehides. But, he explained, ``I,ll bet we aren,t off by



and used vehicles.



Each of PHT,s departments was managed as a profit



more than 5%wi血the 70 -30 split. Maybe it’s 65 -35, One way or the other, but we won,t be fu血er offthan that.,,2



center. Many indirect or overhead expenses, SuCh as



All interdepartmental transfers were done at market



dealership administrative salaries and dealership



prices. Thus’for example’When PHT,s used vehicles were



advertising expenditures, Were aSSigned or allocated to



serviced in the PHT shop, the sales department paid full



the departments. Only some infrastructure-related



retail price for parts and labor. This policy gave the used



expenditures (e.g. rent and equivalent) and some other



vehicle manager some negotiating power in the service



expenditures over which the department managers



area. paying fu11 retail price ensured that intemal used



had little or no control (e.g. insurance, taXeS, legal, and



vehicle service jobs would not be given lower prlOrlty.



auditing) were not allocated to them.



Valuations of used vehicle trade-ins sometimes cre-



Exhibit 3 shows one page of the financial statement



ated disagreements. These valuations were important



report that PHT was required to submit monthly to



primarily because the sales personnel eamed commis-



Tbyota Sales Corporation. The other pages in this report



sions based on the profits of the負deals,, they dosed.



called for an extensive array of information, including



Such disagreements were commOn in dealerships



the profitability of the other departments’balance sheet



data, unit sales by model, PerSOnnel counts by depart-



ment and category, and a variety of performance ratios (e.g. total bonuses as a percentage of sales’grOSS PrOfit



average per unit of each model sold).



2 The industry consulting report showed that for FY 2OO2, the average ove血ead expenses (equivalent to line 57 in Exhibit 3) in the industry



were $2.6 mi11ion for new vehicle departments, Or 7.22% of sales (equivalent to line l in Exhiblt 3) or 94・48% of new vehi。e deparト ment profit (equivalent to llne 33 in Exhibit 3)・ For used vehicle depart-



The profitability of PHT,s departments varied widely.



ments, aVerage OVerhead expenses in the industry amounted to $1.4



As in most dealerships, neW Vehicle sales at PHT were



million, Or 8.12% of sales or 85-78% ofused vehicle department profit.



59



Chapter 2. Resuits Co=trOis because new car salesmen were often motivated to over pay the customer for trade-ins to secure the new car



The bonuses, Which were typica11y 250 -300% ofthe sales empIoyees, base salaries’PrOVided a sign誼cant



sale. And at PHT, and indeed allもealerships, needed



proportion of total compensation. The salaries were



repairs on trade-ins were sometimes not spotted at the



paid semi-mOnthly, and commissions and bonuses



time of the sales deal. This could happen anytime, but



were paid monthly・



at pHT it was most likely to happen on Sundays when



the service department was dosed and no service advisor could be called in for a second opinion on esti-



mated trade-in repair costs. As Howard explained:



Howard Hakes explained that one side benefit of having a combined new and used vehicle sales depart-



ment was that, COmbined, the department was generally profitable’Whereas new vehicle sales depart-



ments alone often were not.3 Howard wondered how



On Mondays, We Often have animated discussions between saies and service about the repairs that the



service department c-aims are required on trade-ins.



But we stick to the market price ruie! If the costs of



managers provided “profit-based,, incentives in sales



departments that were losing money. All of the sales managers・ bonus plan contracts also



induded the fo11owing wording:



repair are higher than what the salesmen had antici-



Adyustmen書s. “Any cancelIed saIes or subsequent



pated on Sunday’it eats into their deaI profit" lf they



changes to the account aS a reSuit of a retumed



don't agree with the service repair cost estimate’



product wil- be ca-cu-ated into the commissionabIe



they are free to sell the trade-in ``as-is,, on the whoie-



gross profit and w冊be used to caiculate you「 com-



saIe market. Sometimes they even get lucky when



missions earned for each month, AdjustmentS may



the repair prob-em isn・t spotted there either. That’s



aIso be made to correct errO「S, Or fo「 rewrites to



why some used vehicles come to be caIled ``iemons.”



the deai; unWinds, nuiI and voided deals; CuStOmer receivabIes not co=ected (including, but not Iimited



Performance measureS and incentives Compensation of line personnel at PHT was high’Pa手



ticularly given the empIoyees, generally relatively



to down paymentS’drive-Off fees, insu「ance coverage, Or Penaities on trade-in)’Or POiicy adjustmentS"’’



modest education levels. Even young salespeople’those



O書her Factors〇 ・・Other factors such as the Custome「



still in their early 2Os, COuld eam $6,OOO-$7,OOO per



Satisfaction lndex (CSI)4 and EmpIoyee Satisfac-



month if they hustled and followed up effectively with



tion Index (ESi〉5 score may be taken into account in



customers. Tbp sales personnel could eam $20’OOO per



determining bonuses"’’



month, Or eVen mOre. Some service technicians eamed over $10,OOO per month. Performance-based incentives were a significant part of the compen§ation of a11



1ine personnel.



How these non血ancial performance indices were



taken into account for bonus determination was left vague. They could be used in a positive sense’tO PrO-



vide “discretionary,・ bonus awards’Or they could be



A. lncentives in the saIes department



used to limit the formula bonuses. However, nO One at



pHT could remember any situations where they had A11 personnel in the sales department were paid a rela-



made a substantive difference in the bonuses awarded’



tively modest base salary plus incentive pay・ The saZes-



perhaps because at PHT・ the indices had never fallen men and c[SSisfcm亡SC[Zes marlαgerS eamed commissions



on the deals they closed. The average commission rate



was 2O% and 7% of deal gross profit for salesmen and assistant sales managers, reSPeCtively. The generaZ sa!es mc[rlClger; uSed ve柾cZe sc[Zes mcⅢC[ger; and saZes desk man-



c[gerS, bonuses were based on a proportion of departmental profit after overhead expenses but before taxes



(line 59 in Exhibit 3). The general sales manager and



desk sales managers were paid 2.25% and l.2-1.5% of this amount for the total sales department’reSPeCtively・



The L[Sed ve疑cZe soZes mc[Jmger WaS Paid 5% of this



amount for the used vehicle department only.



60



below acceptable levels. For comparison purposes’Appendix B provides



Puente Hilis Toyota



excerpts from a consulting report showing vehicle



replace the defective electronic module, hook up a test



dealership department manager compensation data. In



recorder, and tesトdrive the vehicle. The flag rate for



廊appendix, Schedule l shows data aboutthe amounts



thisjob might be 48 minutes. A technician who wanted



and forms of monetary compensation given to depart-



to cut comers might skip the test drive. Knowing that a



mentmanagers. Schedule 2 shows the measures used in



SuPerVisor would check the vehicle’s mileage-in and



allocating formula bonuses. Schedule 3 shows the inci-



mileage-Out, he would have to put the vehicle up on a



dence and size of discretionary (nonformula) bonuses.



hoist and run it for, Perhaps, three minutes to increase



B. Incentives in the service department



be able to complete the entire job in less than



the odometer mileage. But by cutting comers, he might



The service tec加lZcicmS Were Paid from $1O to $23 per



``flag hour,, of work completed. The actual hourly rate depended on each individual,s technical specialty and



their certifications (e.g. master technician). Flag hours



Were Standards set by the manufacturer for the accomplishment of specific tasks. The standards were



Set SO that an average qualified technician could



achieve them. However, it took technicians at PHT, Who were generally very experienced, about 45 minu亡es on average to do one fIag hour ofwork. For some



technicians the disparity between flag and actual



hours was much higher. Jesus Barragan, PHT,s service manager, Said ``Our top guy, Who is a `natural,’beats



the flag time by 600%.,, The disparity also varied by



15 minutes.



PHT managers had two types of controIs over these gaming behaviors. First, if the time spent on ajob was



Very loW service managers asked the technician for an explanation of the anomaly. Second, management mOnitored the number of “re-Checks,” instances where the PrOblem was “not fixed right the first time:’In the indus-



try, a l% re-Check rate was considered good. The reCheck rate usua11y could not go to zero because some of 血e蹄-Cheぐks were nor血e艇ぐ血皿でda皿を慮り九丁心e cause



might be simply that a needed part was unavailable. Technicians who cut comers were寝written up,,, that lS, glⅤen nOtice, and their ticket was deducted. “Bad



habits can be corrected; bad mechanics can,t,,, Jesus Barragan observed.



The ser庇e adl,isors eamed a base salary of approxi-



mately $2,000 per month. They also eamed bonuses as ん1lows:



Howard Hakes had some confidence that this gaming problem was under control because the service area



at PHT was averaging only about four re-Checks per month for approximately 70O completed servicejobs. If



8% eom肩ssとoれOn C直S亡O肌eγゼa書dねbor a融pαr吟



SerVice technicians were cutting comers in a signifi-



6% comm[ssforl On maれ早舟c亡urer-Pafd Zabor皿der



Cant Way, he estimated that the re-Check rate would be



WOrra n坊



Significantly higher.



6% co耽肌iss章oれOn妃bor aれdpαr亡S paidjbr証でerna砂 atP廿T



The service technicians at PHT were very loyal to the company, because αwe treat them as people, nOt



mechanics,’’Jesus said. “We also train and pay them



The PHT servfce manager was paid a base salary of $3,000 per month plus a bonus based on a percentage



Of the service department gross profit (before overhead



expenses). The percentage was 3.75% ifthe gross profit figure was $195,OOO or less in any given month; the



well・,,珊mover was virtually zero.6 But the mechanics



had to buy their own tooIs. Jesus Barragan noted that “one of our guys has bought well over $535,000 worth



OftooIs during his 36-year Career With us, but then, he makes $130,000 per year too.’’



PerCentage rOSe tO 4% if gross profit exceeded $195,000. The $195,00O was the total annual budgeted amount divided by 12.



Managemen=ssues Howard Hakes knew that his PHT management team



C・ GamepIaying temptations in the service area



had not solved all their problems. He lamented about the fact that, in general, Sales personnel were not effective



at following up with customers. Follow-uP meanS that



Because they were paid by the job, SerVice technicians had temptations to cut corners. For instance, for a 6 This is in stark con亡rast with turnover in the sales department, Which



typical Electronic Engine Control (聞C) repair, the Howard described as ``horrid’’(about 6O% per year, aS OPPOSed亡O



technician might be required to diagnose the problem,



Only about 5% in service).



61



Chapter 2. Results ControIs the sales staff keeps in touch with potential customers



inputs for the influential ratings of automobile reliabiト



ity published by the丘m J.D. Power & Associates and’aS with whom there has been an竜Litial contact. Fo11ow-uP



mentioned above, the manufacturers used those ratings



in。Iud。S 。utreaChes (e.g. phone calk∵ thank you cardD



to customers who visited the sales department but have not yet decided to purchase a vehicle’aS Well as sales



approaches to customerS Who are driving an older vehi-



cle that has recently been serviced at PHT. PHT had established regular processes for both types of fo11owup. For examPle, SerVice advisors were enCOuraged to explain to customerS Which service costs were likely to



occur on their older vehicle in the coming years and to



to allocate their vehi。es. As a consequenCe’in the quest



for “perfect,・ ratings・ CuStOmerS Were regularly “coached,, on how to complete the questionnaire at the



time they purchased a new vehicle. And, SOmetimes, dealerships asked customers tO drive to the dealership when they received the questionnaire from the manufacturer. When they arrived’the customer WOuld give



the questionnaire to a dealership empIoyee and receive a present’SuCh as a皿tank ofgas. The empIoyee would



invite the dient to visit the sales department. However・



these activities consumed time, and the service advisors regularly ignored them. Could incentives be provided to encourage fo11ow-uP and refdrral behaviors?



Howard also worried that the CSI measure, Which



complete the questionnaire and send it to the manufacturer. Howard was not sure Whether some of his ``shark’’



salesmen also engaged in such practices’and if they did,



what he should do about it" Despite these issues’Howard was confident that



could provide useful infomation’SOmetimes had ques-



pHT was one Of the best-managed dealerships in the



tionable validity・ Howard had heard that some dealer-



COu ntry. ships regularly “gamed,・ the measures because they had



become so important. The CSI ratings were important



Chapter 2. Pesults ControIs



Exhibit l Continued



5 When you picked up you川eW ToyoぬWEHICしE DEしIVERY), did the foilowing occur…



Int「oduced to service area/pe「SOnnei (if department was open)



6 Did you have any concems with your vehicle WHEN YOU PiCKED IT UP from the deaIership?



□ No /SkゆめOues#on 7) ifyes,Pleasechecktheappropriateboxanddesc「ibetheconce「ninthebiank:phecka〃紡a書ap肋 □Noise/rattle:                  □WheelaIignment/Stee「ing: 口Malfunction:                   口Missingitem:



□NotcIean:                        ロOther: □Chip/SCratCh/dent:



HasthedeaiershipresoIvedtheconce「n?  □Yes  口No



PurChaselIease experience? 口No (Sk佃to Oues〃on 8)



口No /Sk佃to Oues歌on 9)



1 4 Although we do not identify you with your indiViduaI check box resuIts to the deaIership, may We aSSOCiate you「 name with



your w皿en comments? 口Yes, yOu Can ldentify me when sharing my COmmentS With the deaier 口No, i do notwish to share any information on this survey with the dealership



"  臆萱 64



◇



ibit 2 Puente H用s toyota: Organization structure



ーReco[ditjoning



manager (1 ) (hourly) -口0U「iy



empioyees (2)



65



Chapter 2. Resuits ControIs



Exhibit 3 Puente Hiiis Toyota: SampIe page of financiaI reporting package



NAMEOFACCOUNT 1



2 3



4



TOTA」SA」ES



TOTALGROSSPROF音T DEPARTMENTALSELしINGEXPENSES



SaiesCompensation



5



SaIesCompensation-Sciononly



6



SupervisionCompensation



7



SupervisionCompensation-Sciononiy



8



9



10



DeliveryExpenses



Financing,insurance&ServiceCenterCommissions



Financing,insurance&ServiceCenterCommissions-SciononIy



11



AdvertlSing-Departmental



12



interest-FIoorPlan



13



TOTAしSEしLINGEXPENSES(Lines4to12incl.)



14



DEPARTMENTAしOPERATINGEXPENSES



15



PolicyAdjustments



16



ClaimsAdjustments



17



Demos&CompanyVehicles-DepartmentaI



18



Invento「yMaintenance



19



Pe「someIT「aining



20



OutsideServices-DepartmentaI



21 F「eight



22



Suppiies&Sma=TooIs



23



Laundry&U両forms



24



Equipment&Vehicies-Departmentai



25



EquipmentMaintenance,Repair&Rental-DepartmentaI



26



MiscellaneousExpenses



27 SaIaries&Wages 28



29



Cie「icaiSalaries



Vacation&TimeOffPay



30



TOTALOPERATINGEXPENSES(Lines15to29inci,)



31



TOTALSEL」音NG&OPER,EXPS.(Lines13&30)



32



TOTAしSEしし.&OPER,EXPS,%OFGROSSPROFIT



33



DEAしERSHIP MONTH



DEPT.PROFIT(しOSS)(Line2しessLine31)



NEWCARDEPT Y丁D MONTH Y丁D



USEDCARDEPT MONTH Y丁D



■●’’ NAMEOFACCOUNT



DEA」ERSHIP MONTH



34



35



OVERHEADEXPENSES



Y丁D



NEWCARDEPT MONTH



Y丁D



USEDCARDEPT MON丁H



Y丁D



PRORATiONOPTIONA」



Rent&Equivaient



36



Saia「ies&Wages-Administrative&Gene「al



37



Owne「sSalaries



38



Pay「oi廿axes



39



EmpioyeeBenefits



40



PensionFund/ProfitSha「ing



41



Adve巾sing-GeneraI&institutionaI



42



Stationery&O冊CeSupplies



43



DataProcessingServices



44



OutsideServices-Generai&lnstitutionai



45



CompanyVehicies-Administration



46 Contributions



47



Dues&Subscriptions



48 Teiephone



49 Legai&Auditing 50 Postage 51



T「aveI&Entertainment



52



Heat,Light,Power&Wate「



53



Fu「nitu「e,Signs&Equip.-Depreciation,Maint",Repair&Bentai



54



insurance-OtherthanBu脚ngs&lmp「OVementS



55



Taxes-OtherthanReaIEstatePayments&incomeTaxes



56



Inte「est-OtherthanFioorPian&ReaIEstateMortgage



57



TOTA」OVERHEADEXPENSES(Lines35to56incI・)



58



TOTAしEXPENSES(Lines31&57)



59



ADJUSTEDDEPT,PROFiT(LOSS)(Line2Less58)



60 61



OPERATINGPROFiT(」OSS)(Line2Less58) NETADDITIONSORDEDUCTIONS(Pg,2Line77)



62



NETPRO円T(LOSS)BEFOREBONUS(Line60Less61)



63



Bonuses-Empioyees



64



Bonuses-Owners



65



66



67



NETPRO円T(しOSS)BEFORETAXES(Line62Less63,64)



EstimatedlncomeTaxes



NETPROFiT(LOSS)AFTERTAXES(Line65Less66)



67



Appendix A Puente …s toyota‥ Excerpts from Consulting Repo巾Showing automobife dealership and



department data (FY 2002)1



SaIes ($000) Net profit ($000)2 Retum on saies



Sales ($000) Net profit ($000)2



Retum on sales



Puente H冊s Toyota



Appendix B Puente Hi=s ’foyota‥ Excerpts from Consuiting Report showing depa直ment manager compensation data (FY 2002)       _



Scheduie l: Department Manager Compensation: lbtaI and Breakdown into Components - Base Salary, FormuIa Bonuses, and Discretionary Bonuses (OVeraiI averages)



(Averagetotaicompensation=$78,428)1



$31,901



$44,829



$5,104



Average($)



Percentreceiving 79.23% 64.48% 23.50% Average%oftotaicompensation 44.89% 36.77% 4.26%



(AveragetotaIcompensation=$72,195)1



$31,672



$40,376



$4,046



Average($)



Percentrecejving 85,04% 66.14% Average%oftotalcompensation 47.12% 38,32%



27.56%



5,03%



SERVICEDEPAR丁MENTMANAGERS (Ave「agetotaIcompensation=$61,422)1



$33,278



$30,575



$2,302



Average($)



Percentreceiving 90.00% 68,00% Average%oftotaicompensatjon 56.00% 34,26%



20.00%



3.53%



仁roTAL CoMPENS仰ON COnSIStS Of any or a= of the fo=0Wlng COmPOnentS. BASE SALARY, FoRMULA BoNUSES (maxlmum Of three), D】SCRETlONARY BoNUS, and



SpIFFS Def面trons.



’FoRMULA BoNUSES are based on quantltatlVe Performance measures (e g department proflt). Some contracts have up to three formula bonuses, although



lhe ma」Orlty Of the managers (6O%) recelVe One formuIa bonus only. Across departments, the frst fo「muia bonus IS On aVerage 85% of the total formula bonus AIso, the fl「St formula bonus IS On aVerage mOre than seven tlmeS larger than the second formula bo…S ’DISCRE丁IONARY BoNUSES are based on the supe「vISOr’s subJeCtlVe 」udgments of the managers’performances 「SpIFFS a「e mlSCe=aneous rewards (not reported above), WhlCh a「e difficult to characteriZe 「n a Standard way Common examples a「e the use of PrOmOtlOnal vehlCles and certaln lnCentlVeS PrOV「ded by the vehlCle manufacturers (e g vacatlOn trlPS) Although recelPt Of sp苗s IS COmmOn (about 63%



Ofthe managers recelVe them), the-r eCOnOmlC Slgnif'CanCe 'S relatlVeIy 10W (about $4,593 fo「 those who recelVe SPIffs, COmPared at $15,000 to $20,000 forthose who recelVe a dlSCretlOna「y bonus)



(Conthued〉



69



Chapter 2. PesuIts Controis



Appendix B (Continued) ScheduIe 2: Deaiership Perfor「珊nCe Measure Used in Department Manager Formula Bonuses (as a percentage of aii formula contracts)        _..



Formulabonus



Dealership



擁1、



Grossprofjt



1.8



Netprofit



27,0



Grossprofit Newvehiciesaies



6,4



Netprofit



Unitsales



0,0



Grossprofit



Unitsales



New=uSed



2,2



11.4



0,0



5.7



Unitsales



0.3



8,6



2.9



2.7



Netprofit



Netprofit



%Grossprofit %Netprofit



Pct,reCeiving



Servicedepartmentmanagers



AIidepartmentmanagers



0.0



6.9



5.7 0.0



5.7



10.9



43,3 54.8



UsedvehicIedepartmentmanagers



4.0



2.6



0.6



0.0 0.0



0.0



Grossprofit



Newvehiciedepartmentmanagers



2.3



8.6 0.8



Netprofit



0.0



0.0



9.4



Revenue



Body,PartS,&service



1.1



1.9 0.2



Grossprofit



70



6.9



2.9



0,0



Revenue



Service



2.9



4,6



8.6



8,6 14.3



lnventory



Grosspro冊



Parts



5,2



7,5



14.5



Netprofit



2.9



14.3



2.9



0.5



2.9 0.0



6.3



0.2



Grossprofit



1.7



4,6



Netprofit



lnventory



0,0



1.1



5,9



0,0 20.0



6,9 5,8



0.0



♯3



1.7



10,9



Inventory



Usedvehiciesaies



♯2



2.9 2.9



28.7 44.8



20.0 51,4



Doilars Averagediscretionarybonus %tot.comp.



23,5% 27.6% 20,0%



23.1%



$21,958



18.1%



$15,719



18,3%



$11,801



$16,664



17.7%



18.0%



㊨ASE STUDY Kooistra Autogroep



When he took over as CEO of the Kooistra Autogroep in



dealership, One Suzuki dealership’One Saab dealer-



2002, Tbm Kooistra made significant changes to his com-



ship, One Alfa Romeo dealership’and one combined



pany,s management controI system. Most significantly,



Chevrolet, Cadillac, Corvette, and Hummer dealer-



he decentralized decision-making authority, developed



ship. Opel (a brand of General Motors) had been the



a performance reporting system that included both



market leader in the Netherlands since the 1970s,



financial and nonfinancial information, and introduced



with a market share of almost lO% in 2006. Toyota



a pay-fo手performance system for the company’s dealer-



was the sixth-largest brand, With a 7% market share.



ship and department managers. Tbm explained:



Citroen had a market share of 4%, and Suzuki and



My father had been ruming this company iike a famiIy, but we’ve become too big to operate iike



this. Besjdes, We need to be more competitive to SurVive. That’s why i am so keen on implementing



the new pay-fo「Performance pian" With decentra臣 Zation comes accountabiIity for perfo「mance" 1f our



PeOPie are w=Iing to accept that accountab掴ty,



then I am quite wi11ing to share with them a fair proPOrtion of the company’s success・ But while the company’s managers seemed to value



Chevrolet had market shares of about 2-3%. The other brands sold by Kooistra - Saab, Alfa Romeo,



Cadillac, Corvette, and Hummer - all had market



shares of less than l%, For these smaller brands, the nearest competing dealership was typically located far away. In addition to the car dealerships, the Koois-



traAutogroep also owned abodyrepair shop and a car lea§e COmPany・



In the context of Dutch automobile retailers, Kooistra was large. Even in 2OO7, the typical Dutch car deaト



ership sold and serviced cars of only one brand from a



the increased authority and performance-related infor



single location. Most dealerships were family-OWned’



mation, their feelings regarding the pay-for-Perfor-



With about 20 empIoyees on average.



mance system were mixed. In 2007, Tbm was considering



In the early 2000s, aS a COnSequenCe Of the weak



whether he should try to reinforce the system by telling



economic conditions and increased competition, the



血e managers that the system was here to stay and that



financial performance of most Dutch car dealers dete-



theyneeded to leam how to make it work’Or Whether he



riorated. This performance deterioration gave rise to



should revise, Or POSSibly even abandon, the system.



many changes in the industry. One important change



was industry consolidation. Many larger car dealer-



丁he company



ships expanded through acqulrmg SeVeral formerly



family-OWned dealerships. Kooistra Autogroep was



Kooistra Autogroep was a family-OWned auto皿obile



among the first to expand the number of brands sold’



retailing company founded in 1953. Over the years,



standardize operating procedures, and expIoit econo-



Kooistra grew from a small company that sold and ser-



mies of scale.



viced cars of only one or two brands from a single location



In 2002, Tom Kooistra’s father retired, and Tom



to a top-2O player in the Dutch car dealership market.



took over as the company’s CEO. Tom chaired the



In early 2007; it owned and operated 13 dealership Ioca-



company’s top-management team (see Exhibit l).



tions se11ing lO brands of automobiles and empIoyed



AIso on the top-management team Were Anna Lub-



approximately 325 people.



bers, CFO, and eight managers. Five of the managers



The Kooistra dealerships were located in the city of



were dealership managers, eaCh responsible for sev-



Tilburg and in smaller surrounding towns in the



eral dealership Iocations selling between one and



southem part of the Netherlands. Kooistra owned five



five brands. Each dealership Iocation empIoyed a



Opel dealerships, three Tbyota dealerships, One Citroen



sales manager, a SerVice manager’a WOrkshop



71



Chapter 2. ResuIts ControIs “Itlble l Average retum on saies in the Dutch car



manager,1 and a parts manager. The other亡hree top-



1evel managers were respo鴫ible for the body repair



dealershjp sector (2001-2005)



shop,2 the car lease company声nd the group,s central



after-Sales department.3 These managers supervised receptionists, Salesmen’teChnicians, and ware-



housemen. AIso in the company was a central corpora亡e s〔aff responsjb上e for finance and accom亡jng,



marketing, quality management, PerSOnnel and



Source BOVAG Autodealers 2006 Peproduced with permlSSIOn



organization’uSed car auctions,4 and fleet sales.5



Although some of its dealerships had been perfom-



company,s management controI system needed to



ing quite well’reCent OVerall performance of the Koois-



change・ Tbm,s father used to make most ofthe signi缶cant



tra Autogroep was subpar, but still in line with industry



decisions across all the company’s operations. Tom,



averages. Tb ensure adequate resources necessary for



however, believed that he needed to decentralize deci-



business continuity, a rule of thumb in the Dutch car



sion-making. Tbm thought that the dealership managers



dealership business was that the retum on sales (net



should have substantial authority for the critical deci-



profit over sales) should be at least 2%. However’due



primarily to generally poor economic conditions’the



average retums of Dutch car dealerships had not been near this level since the late 1990s (see Table l).



sions in their business, including the hiring, firing’and



supervising of their dealership personnel; advertising investments; Sales promotions in their local market§;



and price reductions that might be needed to move



Intαes面轟



excess inventory or to meet the competition.



The new management COntrOI system



But Tom also believed that with decentralization came results accountability・ Tb make this accountabil-



As Kooistra Autogroep became a larger and more com-



ity possible, Tbm implemented three new systems when



plex organization’Tbm Kooistra concluded that the



he took over as the CEO in 2002: Performance reporting, budgeting, and payfor-Performance. These new



l some of the dealerships were lo⊂ated in dose proximity. For these



dealerships, KooIStra Autogroep maintained one central workshop managed by the after-Sales department (See Exhibit l)’Which



serviced several brands. The dealerships in the other locations had



their own workshop. The workshops essentially serviced both the



systems were to be implemented by fiscal year 20O3・



1, Performance reporting The new performance reporting system included both



sales and servICe departments. For service jobs, CuStOmerS Went



financial and nonfinancial information. It was used as



through the servICe department’Which determined the work that



an instrument to communicate the company’s most



needed done as well as the (estimated) cost and time for completion of the work. In addition, the workshop performed ge直eady work for new ⊂arS SOld by the sales department’installation of accessories



important objectives to the dealership and department managers; tO PrOVide these managers with the infor-



on new cars, and service and reconditioning work on used cars for



mation they needed to do their jobs; and to provide



resale by the dealership. 2 Like the service workshop, the body repair shop obtained busi-



feedback to top management so that they could moni-



ness intemally through the servICe deparment and from used car



tor the lower-1evel managers’performances. Tom



sales for re⊂OndltlOning body work. The body repair shop’however・



explained:



also had its own reception for walk-1n CuStOmerS’aS nOt all Dutch



car dealerships provided car body repair work. Another significant source of business consisted of contracts with insurance companies



3誌霊蒜慧豊霊嵩ksh。, W。S 。ul,e large, ,h。 r。l。 。f after-Sales manager was created to oversee several workshop super葛



My father needed to inform the deaiership managers and the department managerS Only about the most important performance indicators because he made most of the operationai decisions. i decen-



visors who, ln tu叫SuPerVISed the mechamCS (See Exhibit l).



4 customers who bought a car often expected the dealership to



t「aIized an important part Of his decision-making



purchase their old car. Like most dealerships’Kooistra Autogroep



authority" But when I made the operating managers



classi丘ed these used cars into two categories- Cars that were in good



enough condition were offered for sale by the dealership to used car



responsib-e for achieving the required perfor-



cus〔OmerS. Cars in poor condition’however, COnSidermg the repu亡a-



mance, l a獲so had to communicate much more



tion of the dealership, Were auCtioned off in batches by the auction



detaiIed perfo「mance information to them.



sales department to other companleS血at specialized in selling these



与篭悪霊窪謹書書誌窪謹書誌上g and maintaining relationships with, and selling cars to’COmPameS that



bought cars in large numbers.



72



One type of perfbrmance report, Which was referred to as the ``Balanced Scorecard” within the Kooistra organ-



ization, WaS distributed to the managers on a weekly



2. Bud9帥



Kooistra Autogroep



basisJt reported year-tO-date summary perfomance



very hard iook at them. In the end, however’I



on key metrics for each individual Eanager’s opera-



believe that we find the proverbiaI happy medium



tions (e,g. a dealership) with an indicatio旦Qf progress



for targets that we feeI the manager shouId be w冊



[OWards budget target accomplishment. Exhibit 2



ing to commit to"



shows this so-Called Balanced Scorecard for the Tbyota



dealership. In addition to the weekly balanced score-



But not only did the budgeting discussions serve a



card§, [he managers also received far more detailed



training role, they also were a valuable communication



monthly reports, With sometimes up to hundreds of



tool to focus discussions about the business, Which



line items pertaining to their areas of operation.



The dealership and department managers apparently used the performance reports actively. Tbm explained:



allowed Tbm and Anna to solicit information from



those who were dosest to the day-tO-day operations from which they themselves had become farther remove d.



Every Thursday at 2 o,cIock, the deaIership and



Tbm and Anna monitored performance through



department managers receive their Balanced



weekly reviews ofthe Balanced Scorecards. When they



Scorecards by emaii" When I waIk through the



saw performance patterns that were ofconcem to them



company on Thursday afternoon and the reports



because they were not consistent with the budget tar-



have not yet been emaiIed, department managers



gets and/Or the perfomance of other company entities’



ask me what’s up. The department managers are



they had conversations with the managers. The entire



interested in their performance and, Particuiar看y’in



top-management team also held monthly meetings to



COmParing their performance vis-a-Vis target・



review performance issues and discuss other company-



wide business matters.



2, Budgeting



The net profit budget targets were believed to be achievable with considerable eff。rt. As Exhibit 2 shows,



At the same time, Tbm introduced a formal amual budgeting process. Although various types of financial and nonfinancial information were considered during the budgeting process, the main focus was on determining net profit targets for the forthcoming year. Net profit was defined as revenues minus controlla-



ble expenses, Which in practice meant that most



the Tbyota dealership had almost achieved its 2OO6 net profit target even though there were still five weeks to go in the budget year. When asked’the Tbyota dealer-



ship manager estimated that at the time his budget was



approved, his likelihood of achieving the net profit tar-



getwas around 90%. He also pointed out that `Although I,ve made my budget in each of the past three years’it



corporate overhead allocations were ubelow the line’’



was rather cIose. But not a11 of my department manag-



on which the operating managers focused. However’



ers met their budget each year. My workshop depart-



Tbm felt that continued decentralization would eventu-



ally lead the company to improve its methods of allocating shared service costs to obtain more inclusive net profit numbers and’thus, tO allow even better account-



ability at lower organizational levels.



The budgeting process was intended to be bottom-



up. The responsible managers prepared their own budget proposals. The budget proposals were then



reviewed by Tbm and the CFO, Anna Lubbers, followed by what they both described as ``rather tough, SOmetimes vociferous, discussions’’with each manager. Tbm



and Anna decided the final budgets. The budget discussions served several useful pur-



poses. Most managers were inexperienced with budgeting and only few ofthem had had any formal business education. Anna noted that,



ment had some cost control issues and did not always



achieve its net profit targets.,, The Tbyota dealership was among the best-Performing entities in the Kooistra



Autogro ep. Some of the other dealership managers, however, complained that they had trouble meeting their budget targets due to factors outside of their control. For example, the combined Chevrolet’Cadi11ac’Corvette’and



Hummer dealership complained that recent hikes in fuel prices had negatively impacted car sales beyond what could have been foreseen atbudget time. He wasn’t sure,



however, that Tbm would be sympathetic if he failed to



meet his budget, Which he likely would this year" But Tbm also could sometimes “help’’the dealerships make their target・ Kooistra Autogroep had a sizable con-



tract with a big rental car company that specified the



For these and other reasons we can’t aiways trust



number and type of cars (e.g. small cars, medium-Sized



the initial budget proposais, SO We have to have a



family cars, VanS), but not the brand, that the rental car 73



Chapte「 2. ResuIts ControIs



company purchased. Thus’When the Opel dealership



dealership that had been acquired. These contract!



was cIose to making its targ疎but needed寝a little help’’’



fom could offer the Opel Astra血6del to the rental car



could not easily be renegotiated. Considering these faぐ



tors, Kooistra・s top managers admitted that the sales



company" Altematively, if the Tbyota dealership needed some help, he could propose the Tbyota Corolla instead. Tbm noted that, because of this leverage’he faced con-



siderable lobbying from the dealership managers to gO



bonus plan was limited in scope. It also was still su函



to change. Anna Lubbers’CFO’eXPlained that manage.



ment was considering fine-tuning the sales bonus plan



by incorporating other perfomance criteria - Perhapr



with their brand. He said, ・・I never hear any complaints



gross, Or eVen net, PrOfit per car.



rfom’s new pay-for-Performance system for managers



when good fortune comes their way. It,s only when they miss their targets that I hear them grumbling.’’



added a bonus element to the managers, compensation package. The bonuses were added on top of the manag.



ers, salaries. Target bonuses for dealership managers



3. Pay-for-Performance A third major change was the expansion of a pay-forperformance system for salespeople and the implementation of a pay-for-Performance system for dealership and department managerS. Some salespeople already received a bonus. But now 「Ibm introduced a pay-for-



performance bonus plan for the managers. Traditionally, COmPenSation for nearly all personnel



in the Netherlands was not performance-dependent. It



were set between lO% and 20% of amual salary・ rぬrget



bonuses for department managerS Were Set at 8% of annual salary・ For dealership and department manag-



ers, the bonuses were based on the extent to which the managers met their annual net profit targets as set dur-



ing the budgeting process. Only managers who met their



net profit target eamed their target bonus. No bonuses were paid for below- Or above-target Performance・



Both Tbm and Ama believed that the bonus plan



was based on ajob rating, an aSSeSSment Of the training



specifically, and the idea of payfor葛Performance more



and experience needed for executing a job’rather than



generally’WaS Putting the company on the right track.



on the individual performance of the empIoyee" Thejob



Tbm explained:



ratings were linked to pre-eStablished salary increases.



Hence, the relationship between levels of compensation



and actual empIoyee perfomance was usually weak. rfo bypass the limits of salary increases for a certain



job grade, tOP-Performing individuals often were promoted to jobs with a higherjob rating when those



I introduced bonuses Primariiy to make manage「S



conscious of the fact that something had changed […] that department managerS Were =Ot Oniy given



more decision-maki=g autho「ity but that thei「 respons輔ties to meet eXPeCted perfe「mance aIso had changed〇一think the p-an had that desired effect.



positions became available. For example, SOmetimes’



excellent car salespeople were promoted to sales man-



Management also had the authority to reduce any or



ager positions. These promotions sometimes happened



all bonus awards. However, in the first three years since



even when the dealership would have benefited more



implementation of the system’SuCh discretion had



from the individual,s continued selling efforts than it would from their management Skills.



For years at Kooistra, Salespeople had had monthly



never been applied. Moreover’the criteria that might



justify a bonus reduction were not yet Clear, aS Tom explained:



sales targets, defined in terms of the number of (new and used) cars sold. Some ofthe salespeople were eligible for bonus payouts. In 20O7’these bonus-eligible



salespeople eamed租8.50 per car sOld. In addition,



when the salesperson met his or her monthly sales target, the bonus amount waS doubled to鵜7.OO per car



for the month. On average, bonus paymentS Were about



25% of salary for salespeople who met their targets.



Theoreticaily we might reduce bonuseS because’ fo「 examP-e, administrative proCedures were nOt



fo=owed or customer Satisfaction ratings were tOO



Iow, But a bonus reduction wouid be a very Subjec-



tive decision. We need to articulate the criteria for such decisions more C-early. This is a priority for the coming year.



However, nOt all salespeople were yet eligible for bonuses. Of the 45 salespeople at Kooistra Autogroep, only 25 were bonus-eligible because some of them had



negotiated a compensation package without a bonus contingency when they were hired’SOmetimes at a



74



issues



payfor-Perfomance was a relatively unknown phenomenon in Dutch companies. For examPle’One Study



Kooistra Autogroep



Showed that in 2001, Only lO% ofthe department man-



Did the pay-for-Performance system provide a sig-



agers in Dutch car dealerships reGeived a formula



nificant motivational boost? Edwin thought the answer



bonus, and only 7% received a “discretionary’’(su切ec-



to this question was no:



tively assigned) bonus (see Exhibit 3). For sales manag-



ers, these percentages were somewhat higher: 20% and 7%, reSPeCtively (not tabulated in Exhibit 3).



However, SeVeral studies had shown that Dutch COmPanies (not just car dealerships) were increasingly



relying on pay-for-Performance practices, Which was



COmmOnly attributed to increased intemational comPetition. One study concluded that although only a minority ofDutch companies applied some form ofpayfor-Performance, the trend towards doing so was



upward, With 33%, 36%, and 4O% of a sample of Dutch firms using some form of pay-for-Performance in 1997 1999, and 2001, reSPeCtively.6



Because such systems were rare in Dutch dealer-



Ships, Perhaps not surprisingly, Kooistra Autogroep



Due to the economic situation, the last coupIe of



years were not good years, Consequentiy, my deaiership and some of my department managers



did not make their targets and did not receive their bonus. In my opinion, however, this has not affected



the motivation of any of us, We are a= stiil working hard. On the other hand, eVen in good years the IeveI of the bonuses is, I think, tOO 10W tO mOtivate, ParticuIar看y for the department managers. In aIl



truth, I wouIdn’t mind if we abolished the bonuses



for department managers,



On the other hand, Tbm Kooistra and Anna Lubbers Were COnVinced that the bonuses could, and did, affect motivation. Tbm explained:



faced considerable skepticism from its empIoyees When it first introduced its pay-for-Performance sys-



Our managers are ce「tainiy highly motivated. This



tem. A survey conducted by a consultant showed that



WaS true in recent years even though, due to the



the vast majority of Kooistra empIoyees preferred a



POOr eCOnOmic situation, SOme Of them were una-



Salary raise over a bonus, eVen if the raise was sign誼-



bie to rea=ze their performance targets. But l am



Cantlylower than the expected bonus. Tb i11ustrate this



COnVinced that they make considerable extra effort



POint, Edwin Vliering, a dealership manager,



When they have a chance to meet their targets. For



recounted the fo11owing conversation he had had with



exampIe, they organize extra sales activities when



one of his salesmen:



In terms of profit and sales volume, the last three+our years were genera=y bad years for Dutch car deaier-



Ships, At the beginning of 2006, One Of my top saies-



realization ofthe target is possibie. 1 also know that



they feeI good when they achieve their targets,



That is part of the motivation, But the money is Obviously important as weil.



men asked for a salary raise. I offered her a bonus



Anna Lubbers agreed that the bonuses could provide



instead. In her situatjon the bonus wouid have resuited



StrOng mOtivational effects, although she believed that



in more moneythan the raise she had asked for, eVen



that depended strongly on the likelihood that the man-



in the poor iast coupie of years. Nevertheiess, She



agers can meet their targets:



WaS unhappy, She ciearIy valued the security of a



It is important to set reaIistic targets. Only bonuses



fixed income, I’d say that she is quite representative



Of the vast majority of empioyees around here. 6 For example, See S. Bekker, D- Fouarge, M・ Kerkhofs, A. Ro皿in, M・



that are based on realistic targets have a motivat-



ing effect. Setting realistic targets is particuiarIy



important in years of an economic sIump, like in



de Voogd-Hamelink, T. Wilthagen, and C. de Wol年7teJtd-raPPOrt:



recent years. When the target is apie ;n的e sky, the



V「aag marArbefd 2002 (Tilburg, August 2003, ISBN 906566 O623).



bonus wi= not work.



SaiesDepartment Newcarunjts



250



Usedcarsunjts



225



Newcarrevenues



5,900,000



Usedcarrevenues



Salesnet[1]



130,000



SalesnetmargIn



90 98



Usedcarnet/unit



1.29%



490



22 84,275



Warrantyexpense/usedcar



Servicenet[2] ServICenetmargin



a



375



 0



357



82



122,687



25.00%



2353%



401



165,922



8,350 7,400



Productivity b/a lnvoicedhourspercentage



 0



845,648



201,087



1,621



1,002



8,800



b



95



89



1,650



1,050



Capacity(numberofhours) C



815,367



191,819



Numberofcarshandied



invoicedhours



90,264



〇一・’￣



Numberoforders



Productivehours



-4



82,364



150,000



860,000



215,000



485



15



ServiceWorkshop



Servicerevenues



982



106,172



1,37%



500



Manufacturerincentives



107,154 70



89



1.44%



Newcarnet/unit UsedcarwarrantyexpenseS



8,204,856



3,504



115,639



225



2,906,335



94



112,135



5,000



221



5,298,521



96



8,446,166



125,000



Usedcarnet



93



2,978,644



9,000,000



Newcarnet



92



103



5,467,522



3,100,000



Salesrevenues



229



231



98



95



8,745



99



2378% 1,648



1,010 8,800



8,328



100



8,319



7,149



97



7,380



95% 95% C/a 84% 82%



95% 84%



PartsDepartment Partsrevenues Partsnet[3]



1,325,000 275,000



Partsnetmargin



1,318,879



20.75%



Partsrev,/invoicedhrsworkshop Inte「estExpenses[4]



Totalrevenues



245,000



11,185,000



100



375,000



Totainetmargin



3.35%



Newcarsinstock>90days Usedcarsstock(euros)



Partsinstock(euros)



475,000



135,000



95



367,210



10,342,324



98



50



175 232,487



3.47%



Newcarsinstock>90days



Usedcarsaveragedaysinstock



184



216,560



Newcarsaveragedaysinstock



Usedcarsinstock



256,562



19.86%



179



Newcarsinstock



Numberofbackorders



1,291,820



88



20.95%



10,580,412



TbtaInet[1]+[2]+[3]-[4] Inventory



100



276,312



331,334



3,20% 47



58



45



40



51



10



8



50



14



62



60



49



55



50 0



60



45



60



1



12



424,954



287,469



133,659



136,953



77



Chapter 2. ResuIts Cont「oIs



Exhibit 3 United States vs・ Nether-ands compa「ison of compensation plans used in ca「 deaierships 豊里コ



∴ussampie(1998)



Base



Formuia



Salary GeneralManagers



56.8%



NumberreceiVing PercentreceIVmg



$82,262



Av  ctoftotaIcomp g・p・ DartmentManagers ep Comp・PaCkagebreakdown



Sp附s



bonus



Base



3.9%



$136,724



49.8%



$35,757



Avg.pct"OftotaIcomp.



36.5%



n=238 95.2%



2.9% -110



36,2%



4.2%



nこ433 82.3%



$53,751



58.7%



$10,458



Sp珊S



bonus



$15,149



$4,585



0.4% n二3



100%



0,1% nこ1



14.8%



∈13,079



4.9%



C6,000



1.6%



C3,000



96.9% 17,5% 8,1% 5.1% [N=145]Avg.1bt.Comp"=C36,318(n=145)



98.7% -145



n二118 22.4%



18.0%



n_ 44.0%



毛56,029



6.3%



n=338 64.3%



54.6%



2.6% nこ9



n=49 19,6%



9.9% -323



Discretionary



bonus



[N=61]Avg,lbt・Comp.=C58,303(n=61)



96.9% n-61



n二1了0 68.0%



$36,449



Formula



Salary



58,2% 51,5% 18.9% [N=526]Avg.1bt.Comp.=$72,390(n=510)



NumberrecelVlng PercentreceiVing



Averageamount



Discretionary



bonus



[N=250】Avg.1t)t.Comp〇二$190,658(∩=240)



Comp.packagebreakdown



Averageamount



Nethe「Iandssample(2001〉



0.9% n-15



n_ 61,4%



n- 100%



∈35,745



15,6%



0,2% n二10



98.7%



10.3%



∈3,992



8.6%



0.3% n=30



6.9%



20.7%



C940



C457



2,7%



CASE STUDY Houston Feariess 76, lnc,



In late 200O, M.S. Lee, PreSident/CEO of Houston Fearless 76, Inc. (HF76), WaS COnSidering making a major change in the company,s sales incentive system:



peop-e and give them opportunities to be successful, but I a-so want the company tO get tO the next



ievel of performance. Are our structureS Set uP tO motivate them to do that?



We need revenue growth and consistent profitabiiity, a=d right now we don’t have them" l think our



primary prob-em reIates to sales, Which have siowed. Some of this is due to market conditions・



but l also thinkthat our saies effort and sales sup-



l think we have a range Of probIems" We,re cIearIy not doing enough to deveiop new markets, tO expand our existing markets・ Or tO deveIop syner-



gies among Our ma「kets" We have an obvious mis-



match between our COmPany Objectives and our port can be improved・ I want to take care of our



78



1.2%



Houston Fearless 76, inc. SaIes force incentives because ou「 commissions



In 1976, M.S. Lee, a former Houston Fearless empIoyee,



are based on sales, nOt PrOduct profitab冊y. We use



and two partners bought the Houston Fearless Photo Divi-



different compensation structu「es jor different



Sion. They named their company Houston Fearless 76,



PrOducts, and I have heard some grumbiing among



Inc., both to take advantage of the excellent reputation



the saIes peopie about equaiity, And our saIes fore-



the company had developed, eSPeCia11y in鮒m-PrOCeSSing



CaStS are inconsistent, Forecast accountab掴ty is



Circles, and to commemorate the year of their acquisition.



not st「Ong Since there is no downside for saIespeト



Mr. Lee later acquired a11 of his partners’shares.



SOnS fo「 overstating forecasts. This sometimes



CauSeS PrOduction planning probiems.



So we need to make some changes to improve



HF76 prospered in the 1970s and 1980s. In the 199Os, however, film-based product markets experienced a dra-



matic decline. Many corporate customers, including



Perfo「mance. We need better systems now more



those in the banking, healthcare, and movie industries,



than ever because we are entering some new ma「



Were mOVing toward digital production and record-



kets that are more competitive than those to which



retention technologies. Facing the declining market



We have been accustomed,



demand, SeVeral of HF76’s competitors had exited the



With these concems in mind, Mr. Lee asked his son,



乱m-PrOduct market. Mr. Lee believed, however, that “the demise of創m was greatly exaggerated:’He wanted



James (who joined HF76 in 1998 and later became head of corporate development and operations, and



Who was attending the University of Southem Califor-



nia Executive MBA Program), tO Critically evaluate HF76’s sales function and to revamp the sales incentive



Plan. M.S. and James Lee planned to present a proposal for change at the amual sales meeting to be held in mid-December 2OOO.



the company to cont:inue serving its traditional filmbased market, Particularly in good niche markets, aS it repositioned itself in faster-grOWing markets.



In the 1990s, Mr. Lee aggressively expanded in both the traditional film market and growing digital market



through a series of acquisitions, In 199O, HF76 acquired



Extek Microsystems, an imovator of film-duplicating technology that served a customer base similar to that ofHF76’s



Company history



in the micrographics marketplace. Extek’s operations were



integrated into HF76’s Compton facility. In 1997, HF76



Houston Fearless 76, Inc. was a privately held company



acquired Houston Intemational, Inc. which manufactured



headquartered in Compton, Califomia. Annual company



large-VOlume, SPeCialized te.g. long roll)餌m processors.



Sales were approximately $15 million. The company had



This division was renamed HF Intemational, but its opera-



120 empIoyees. HF76 was a worldwide leader in the



tions were not moved from its Yuma, Arizona, 1ocation. In



design, manufacturing, marketing, and service of high-



1999, HF76 acquired 8O% ofMekel Engineering, located in



quality micrographic products, Photographic創m and



Brea, Califomia, Which produced scamers that converted



PaPer PrOCeSSOrS, Photographic chemical handling



micro創m and micro宜che to digital format工ightweight



equipment, and photographic quality control accessories.



餌m and video cameras, heads-uP display units for fighter



HF76’s roots dated back to 1939 when H.W. Hou-



aircraft, and tra鯖c photo-Citation analyzers.



StOn, One Of Howard Hughes’s movie-making business



For over 3O years, HF76 also had a govemment divi-



PartnerS, founded a company around the development



Sion, Ca11ed HF North, that supported the US Air Force



Of the first automatic roll film processor. Most of the



through a variety of special prQjects that invoIved film



H.W. Houston Co.’s early customers were dosely con-



nected to the motlOn-PICture industry, Later in the



PrOCeSSerS, POWer distribution systems, mObile shelters, Climate control units, and po11ution controI systems,



1940s, the company went public and expanded into a



This division was Iocated at Beale Air Force Base, near



manufacturing company that produced a wide range of



Sacramento.



PrOducts, induding創m processors, hair-Clips, turbine



HF76 was also attempting to diversify its product line



blades, and radar. At one time it was one of the largest



by capitalizing on potentially sizable commercial appli-



manufacturing companies in the Los Angeles area. In



Cations of the pollution controI systems developed by HF



1950, the company merged with Fearless Camera Cor-



North originally for the US Air Force. These innovative



POration of Culver City and became known as the Houston Fearless Corporation. Later, however, the



POllution controI systems separated practically all



COmPany faced many problems, and it was forced to file



biohazardous waste. A production facility for these sys-



for bankruptcy and to liquidate its assets.



tems hadjust been started in the Compton location.



kinds ofwater contaminants, from heavy metals to toxic



79



Chapter 2. Results Cont「Ois



The company in 2000



HF76 product gross margins averaged approximately



28%, but they varied significantly across product lines



After the 1999 Mekel acquisitiorlJ HF76 was organized



and models. Relatively low profit margins (10-15%)



into four product divisions (see Exhibit l). Each divi-



were eamed on processors and po11ution controI systems.



sion operated as a profit center・ Corporate staff pro-



Duplicator sales were relatively profitable (30-35% mar.



vided support and coordination of activities" The



gins). However, HF76,s managers were selling some specific models of their older product lines at minimal, Or



pollution control business was being developed at the corporate level under the purview ofJames Lee.



even negative, grOSS margins. They did so because they



The HF76 culture was dose-knit, family-1ike, and



wanted to retain their customer base in order to earn



casual. M.S. Lee, the president/CEO’WaS a former local



profits on forthcoming replacement part sales, the mar-



“entrepreneur of the year.,, He was a strOng Central fig-



gins on which were usua11y in excess of4O%.



ure, but he was also perceived as being highly caring’



Industry performance benchmarks were di飴cult to



honest, and nurturing. Staff were given recognition



establish accurately because HF76,s smaller competi・



and periodic awards (e.g. parties, 1ogo merchandise).



tors were all privately held and their larger competitors



M.S. Lee described the company,s strategy as follows:



fe.g. Eastman Kodak’Be11 & Howell) were so large tha[



they could bury their HF76-relevant financial results in We now have products at d冊erent market stageS" aggregated financial statements. However, HF76’s



we have some emerging products, Particularly pol一 iution controI systemS and tra情c photo-Citation



ana-yzers. We have some POtentialiy high growth markets for some Of our scanner PrOducts. And we have a Iot of mature PrOducts, SuCh as our PrOCeSsors and dupiicators" Each market requi「es a d冊erent strategy. For



examp-e, for products in the emerging and growing



managers believed that their company,s performance was lagging behind that of its major competitors on all dimensions. For example, in 1999’HF76,s profit margin



(as a percentage Of sales) was only O.04%’While the



industry benchmark, aS given to HF76 management by a management consulting fim’WaS 5.7%. HF76’s



inventory tumover WaS 2.6 compared to the industry benchmark of 4.9. The HF Intemational division, Which



markets, We need our sales fo「ce to identify new



customers and new markets. For products in the



was operating at a loss’WaS Creating concem.



mature markets, Our Sa-es force should capitaiize



on our brand name and maintain as muCh voiume as possibIe in the niche market, PrObabiy through targeting Ioca- government and accounting fi「ms



and through specia- trade-in programS tO Stimuiate



the repIacement Of old machines.



The HF76 divisions each did their own manufactur-



ing. Most product lines had some standard products, or at least subassemblies. In these cases’HF76 would



build to inventory, based on demand forecasts. In the micro創m and motion-Picture飢m processing markets,



customers typically waited about 30 days for delivery



ofmachines that required some customization. Largely custom products were built after the orderwas booked’



and the wait in such cases could be several months.



HF76 suffered from the sales/OPerations frictions



common to many companies. Operation managers often complained that salespeople were not aware Of



the required lead times and that some of their rush orders imposed significant overtime labor costs. Sales’



on the other hand, COmPlained that they sometimes Iost orders because their operations department could not meet the required delivery schedule.



80



Marketing and sales e情orts All of the HF76 products’With the exception of replace-



ment parts’SOld for significant prices’SO they were capital equipment for the buyers. For example’a tyPical



new photo processing machine’One Of HF76,s Iow-end



products, SOld for approximately $60’000’and some of



the high-end products sold for several hundred thou-



sand dollars. Thus, the sales process usually invoIved more thanjust taking an order・ For many Of the prod-



ucts, the sales cycle was lengthy, a year Or mOre. In many cases, Particularly for the more advanced products, the salespeople had to serve as consultants’help-



ing their customers tO SOIve problems.



until the last few years, mOSt Of HF76,s sales were made through a network of dealers (sometimes referred to as “strategic partners,・) and independent sales repre-



sentatives. The dealers and reps provided HF76 with a professional sales effort’local customer knowledge’ and, in the case of the dealers’Sales of complementary



products and a service capability, With little or no fixed



costs. However, mOSt Ofthe dealers and reps did no proactive marketing; they merely responded to inquiries.



Houston Fearless 76, lnc.



Further, having the dealers and reps do the selling was



dealers to be more aggressive, They were planning to



expensive because HF76 had to Q暫er them significant



require the dealers to do some significant selling in order



price concessions (typically 40% off list price) or high commission rates (typically 7-10%). One active independent rep was also paid a fixed retainer fee. She was



to remain on the dealer list. In retum, theywere going to



PrOmise some exdusive territory protection. The scanner business (Mekel), Which had more high-



somewhat like an empIoyee, but with a lower salary



tech products with higher growth potential’uSed all the



and no benefits, and a higher commission rate. She also



sales channels. The company had two in-house salespeo-



had no obligation to serve HF76’s interests (e・g. market



ple. Jim Mancini sold throughout the United States. Ryan



development) if she did not believe that those e徹)rtS



Chase was responsible for Asia and Latin America. And



would lead to her own commissions.



some sales were made through dealers and independent



To provide a more effective and more company-



reps. one rep, Stephanie Eller’described earlier as being



focused selling effort and, SeCOndarily, tO Cut COStS,



on retainer, generated almost one-Sixth of Mekel’s total



HF76 managers were trying to build up the company’s



scanner sales in 200O. HF76 managers estimated that its



own intemal sales force. A11 of HF76’s competitors sold



customer base for scamer products numbered about



a11 their products direct to customers. For intemal



300-4OO, but it did not know the names ofall its custom-



§ales, HF76’s goal was to keep the sales costs (compen-



ers because some distributors did not share their lists.



§ation and expenses) to less than lO% oftotal sales, but



they did not always achieve that goal.



The tasks required to se11 the various HF76 products



One HF76 salesman, Mark Fogarty, WaS reSPOnSible



for selling pollution controI systems. Mark was a technical person with little sales experience. By late



varied signi丘cantly depending on a number of factors’



2000, HF76 had just gotten to the point that it could



induding the product characteristics’the market



build the pollution controI systems in any volume’and



conditions, and the company’s customer relationships.



Only one system had been sold.



Despite some redundancy (e.g. some of HF76’s sales-



One constant across all the divisions was that the



people for different equipment lines called on the same



salespeople were not, by themselves’aCtively develop-



cu§tOmerS), HF76 managers did not think that they



ing new customers. They generally relied on a list of



could organize the company’s sales effort entirely geo-



regular customers to contact and on company advertis-



graphically. Selling the HF76 products required consid置



erable technical knowledge, for example, about optics,



ing to interest customers. They then responded to tele-



micrographics, and software. Little of that knowledge



Phone and email inquiries. The in-house salespeople reported to Bob Smith (VP



was consistent across product lines.



Marketing), although in reality they worked relatively



The photo processing business (HF Intemational)



independently・ The salespeople were geographically



was mature. Most sales in this market involved replace-



spread across the country. For example’Brett Hutchins



ment of existing equipment and replacement parts, SO



(Houston Intemational) lived in Maryland; Matt Petilla



the potential customer base was quite we11 known. The US photo processing market had l’00O-1’500 potential



(micrographics) lived in St. Louis; Bob Smith lived in Atlanta. All of the salespeople traveled extensively to



customers, mOStly those who did wholesale photo fin-



meet with their customers. The salespeople had the



ishing (e.g. schooI portraits, Weddings)・ One HF76



authority to discount up to 5% off list price. Larger dis-



salesperson, Brett Hutchins’COVered the eastem halfof



counts had to be proposed to and approved by Mr. Lee.



the country. Sales in the western half were made through independent sales reps.



Assistants at both corporate and division levels provided support to the sales force. Among other things’



The micrographics and motion-Picture processing



they made some follow-uP telephone calls to customers’



markets (Extek) were also mature. Most of the micro餌m



maintained the databases, delivered the sales contracts



customers were local govemment entities, (Most corpo-



to production, designed the company’s advertisements’



rations had moved to digital storage of documents.) The



and set up the marketing shows. They also helped allevi-



vast m亘iority of sales in this market were made through



ate some of the salespeople,s weaknesses. For example,



a network of approximately 125 dealers, Only some of



one salesperson had no typing or computer skills. Thus,



which were active. HF76 had one salesman, Matt Petilla,



he needed more support in preparing sales contracts・



working in the micrographics and motion-Picture mar



Bob Smith managed the sales function primarily by



kets. Matt was also given the task of culling the dealer



monitoring the weekly sales reports. He also periodi-



list to a smaller number. HF76 managers wanted their



ca11y observed salespersons, behaviors on sales trips



81



Chapter 2. Results ControIs



and trade shows. About the evaluation process, Bob



but my big saIe took me two years of effort, The



noted: “I can distinguish go♀竺Performers from poor



year before last I sold only two scamers , ‥ ln my



OneS through the ways they de聖.vyith clients. But



forecasts, i wouidn’t mention the name of a com.



more directly, their performances are re血ected auto-



Pany if the probab冊y of the saie is less than 80鮪



matically in the reports of items shipped to their terri-



Or 90%. You often don’t get a soiid answer from



tory,’’Bob also noted that HF76 had not had formal



intemationaI customers until the last minute.



Performance evaluations in two years. He said言`we Can’t aff。rd raises, SO Why bother evaluating people?”



HF76 had gradually been computerizing its sales tracking systems. Previously, all tracking had been manual.



丁he old saies incentive plan



Up through 200O, all of the salespeople, eXCePt Mark Fogarty,1 were paid a base salary plus commission. The salespersons’base salaries Iooked relatively low,



SaIes forecasts



typica11y $40,000-$60,000, but the total compensa'



The sales personnel were asked to provide an annual



tion packages and their structure were industry com



Sales forecast at the beginning of each year. Then they



Petitive. Commissions were set at a defined percentage Of sales, meaSured as revenue from items shipped



Were aSked to update their forecasts on 30-, 60-, and



90-day rolling bases. The forecasts were important for



PrOduction planning purposes; for example, for deciSions about which parts to buy and what subassemblies to produce to inventory.



However, aCCOrding to Mr. Lee, the sales forecasts Were lnCOnSIStent:



Within the salesperson’s assigned territory. The com・



mission rate differed across salespeople on a negoti-



ated basis with specific attention paid to product Characteristics and market situation. Two salesmen,



Brett Hutchins and Matt Petilla, eamed a 4% commis. Sion. Ryan Chase eamed a 2% commission because he WaS relatively new in hisjob. Bob Smith eamed l% on



Fo「ecast accountabiIity does not rea=y exist in our



all company sales within the United States, Canada,



Current COmPenSation structure. There is no mech-



and Mexico, The actual commissions the salespeople



anism to prevent saIespersons from overstating



eamed were typically in the range of 50% ofbase sal-



forecasts or sandbagging. Thus, the saIespeopIe tend to be optimistic, and e冊cient production pIan-



ary, but they could be substantially more.



The sales assistants shared a small bonus pool if



ning sometimes becomes very di簡Cuit,



HF76 met its overa11 sales goals. In 1999, eaCh assistant



Bob Smith, On the other hand, thought that the sales



WaS given approximately $1,000. One assistant, Eva



forecasts were reasonably accurate. He noted:



Colton (Mekel), described her reaction to the bonus.



Last year our saIes goals were too tough. We worked



I had forgotten about the bonus. The $1,000 came



hard, but the market was soft, This year’s targets are



as atotaI shock , ‥ ifwe make thisyear’s goaI, and



more reaIistic, SO I think we’Il do better. But we can’t



right now we’re behind, it’= be great. But there is



COntrOi a看I of the results. Things happen. For exam-



not much I can do to help us getthere.



PIe, SOme Sales get heid up pastthe period end. This



year one of our big customers, OIin MiIis, Cut their budget at the Iast minute, and we did not get a Iarge



Order that we expected, On the other hand, We



A new incentive pIan being COntemPlated



SOmetimes get a “bluebird’’[a large order that was



M.S. Lee wondered what could be done to improve the



not forecast], We surely have to be out there working



COmPany’s marketing and sales efforts. He explained:



With our customers to know what is going to hapSome causes of our low p「Ofits and cash fiows are Pen, but even so we can’t controI everything.



Ryan Chase (Scanner Product Sales - Pacific Rim)



Obvious, SuCh as a deciining fiim-based product market and ou「 decision to invest strategica=y fo「



explained the forecasts from his perspective: I don,t have an annuai forecast because i,m reIatively new on the job, I have no basis for a forecast.



i guess if they forced me, I would forecas=O scanners peryear. I gOt iucky Iast year with saies of 14,



82



1 Mark Fogarty had been assigned to the job of marketing and sales Of pollution controI systems only recently, and he had not yet been



induded in the current incentive plan. However, he was Iobbying for indusion, and a decision on that had to be made soon.



Houston Feariess 76, lnc.



future gains, However, I beiieve that we are not fu=y



WaS SOmetimes in the company’s strategic interest to



expioiting market and profit op掌「tunities for either



make some of these sales. Should they report “phony’’



Our traditionaI products o「 our-neツ.PrOducts" ln Particular, Ou「 Sales force has not do=e What i want



gross margins to the salespeople to motivate them to sell these low margin products? Or should they weight



them to do, l want them to open new markets, tO



the commission payouts according to the ``strategic



Se旧n more profjtable markets, and to give us more



importance,, ofthe sale? Ifthe latter, how should strate-



iead time for better operationaI piannjng,



glC lmPOrtanCe be defined, and how should it be explained to the salespeople?



After a series of discussions, M.S. and James Lee COnCluded that they needed to make a major change in the company’s sales incentive plan to attempt to alter



behaviors in the desired ways. James observed: It was pretty cIear that the oid incentive plan was



The actual commission sIopes would be set for each



individual so that at lOO% of plan, eaCh salesperson could expect to eam in commission slightly more under



the new plan than they would have eamed under the old plan. This feature was considered essential for



not working, The commissions were exclusiveiy



securing the salespersons, easy acceptance of the



based on saIes voiume, WhiIe we tried to teIl the



change. However, the commission structure (see



Saies force which products were most profitabie, they seemed to be w冊ng to push saies at any cost



Or Price, They aiso were paying iittie attention to Other strategic goais, SuCh as the opening of new markets or accounts or improving the accuracy of their forecasts. This is pe「haps naturaI because



they were not evaiuated on those factors" In addition, the Iinkage between efforts and rewards was



unciear, Sales peopie received compensation for items shipped within their territory regardless of



Whetherthey were instrumental in making the saIes



Or nOt, So, OVera=, the old incentive pIan created distorted incentives.



Exhibit 2) would be quite di任erent. No commissions



would be paid for sales up to a minimum performance standard, de宜ned as 7O% of the annual gross margin



forecast. This feature was intended to allow for greater



PayOut leverage at high performance levels. Between



70% and lOO% of the planned annual gross margin, commissions would be paid at rates that were much



higher than would be the case if commissions were paid on all sales. That is, if commissions were paid on all sales, the commission rate (as a percentage of gross



margin) would be in the range of lO -12% onhigh mar-



gin sales and 3O-35% on low margin sales. Because of the leverage provided by the minimum performance standard, the actual commission rate paid on gross



Tb overcome the problems in the old system, M.S.



margins earned above the 7O% threshold could be



and James were considering a quite different incentive



raised to 3O-100%. For sales above lOO% of the annual



Plan that they thought would translate HF76 missions



gross margin plan, the sIope on the commission curve



and strategies into sales actions. They planned to leave



would be 25% higher than in the 70 -10O% range, tO



base salaries at current levels but were planning to



encourage the higher performers to develop new mar-



implement a new incentive plan consisting of three ele-



kets and customers effectively. No cap was placed on



ments: (1) a commission based on product gross mar-



the maximum commissions that could be earned.



gins, but with no commissions paid until gross margins



Salespeople were to be paid commissions on an annual



exceeded 70% of forecast; (2) a bonus based on fore-



basis, but monthly cash advances would be paid at a



cast accuracy; and (3) a bonus based on achievement of



rate of 8O% of annual plan to allow the salespeople to



individual management-by-Objectives targets"



smooth out their cash凪ow.



The o切ective of basing commissions on product



Tb encourage the salespeople to take their sales fore-



gross margins was to encourage salespeople to focus their effort where company profit potentials were



casts seriously, a SeCOnd element of the plan promised



an extra bonus based on the accuracy ofthe sales fore-



greatest. M.S. and James hoped that the salespeople’s



casts. The salespeople would eam an extra 5% ofbase



knowledge of product gross margins, COmbined with



salary if their total gross margins were within lO%



the incentive reinforcements, WOuld affect their sales



(plus or minus) of the annual gross margin forecasts.



behaviors bene丘cially.



M.S. and James Lee hoped that this “truth-inducing’’



One unsolved issue: M.S. and James had not yet



feature of the plan would motivate the salespeople to



decided what commissions they should pay on negative



reveal their best estimates of their market prospects



and low-grOSS-margin products. They thought that it



rather than be optimistic, aS had been typical in the 83



Chapter 2. Results Controis



Assessment was subjective and intended to lean in



past, Or COnSerVative’aS might be expected with the



new 70%-Offorecast minimum performance standard.



favor of the empIoyee" If top management deemed the



The third element ofthe contempla艇d new plan, the



salesperson,s perfomance in all of the defined areas as



MBO targets, WaS designed to facilitate communica-



satisfactory, the salesperson would be given an extra



tion and reinforcement of management desires and



5% ofbase salary. No changes were planned to the bonus system for



expectations in any of a variety of areas. The target areas and specific targets would be negotiated between



the sales assistants.



each individual and management. Typical MBO targets might include items such as the fo11owing: 'ミ adding a significant number of new customers;



こ∴ COOrdinating well with production;



Concems M.S. and James were preparing to present their proposal for the new sales incentive plan at the company’s



annual sales meeting, tO be held on December 13, ニ keeping annual travel expenses below travel



expense forecasts;



2OOO. However, both of them were concemed. They knew that changes of this magnitude could be made



ミ Strengthening ties with professional associations;



only rarely, SO it was important that this change be made correctly. They were offering to pay their sales-



ニimproving communications through effective use of



email;



men significantly more money. Would they be getting at least equivalent value in return? And even more



← learning and utilizing Microsoft O飴ce and other



software.



importantly, WaS this plan what the company needed to



push itselfto a higher level ofperformance?



Exhibit l Houston FearIess 76, lnc,, CO「PO「ate Organization chart, 2000



Co「porateDeveIopment



S.McLa「en



J.Lee



VP-Finance



Manager



CustomerService R.Prescott



Marketing/Sales R.Smith



Custome「&Technical ServiceManager



VP-Marketing



Personnel/Govemment ContractSupport



i



Operationsand



ExtekP「oducts



P,Kemedy



GeneralManager



84



」〇三」 Saies



MekeiTechnoIogy



D.G「een



Exec.VP/GeneraiManager



i        l Finance/Accounting



HFInternational



B.Scotts



VP/GeneralManager



HFNorth



P,Linder



VP/GeneraIManager



Exhibit 2 Comparison of oId and new commission structure



Commission PayOut ($)



70% of gross lOO% of gross margin pian margin pIan Saies doIla「s (Oid pIan) or gross margin dolia「s (new pian)



85



CHAP丁ER 3 Action, Persome看, and Cultural



ControIs



Results controIs are not the only form of control. Organizations can supplement or replace results c。ntrOIs with 。ther forms of control that aim to make it more likely that employees will act in the organization・s best interest.1 one such type of control, aCt証corl亡rO】s’invoIves ensur-



ing that empIoyees perform (do not perform) certain actions known to be beneficial (harmful) to the organization. Although action controIs are commonly used in organizations’they are not



effective in every situation. They are feasible only when managers know what actions are



fun)desirable and have the ability to ensure that the (un)desirable actions (do not) occur. Other forms of control, PerSOmeZ co庇roZs, are designed to make it more likely that employees will



perform the desired tasks satisfactorily o証hefr own because the employees are experienced,



honest, and hard-WOrking and derive a sense of selfrealization and satisfaction from performing tasks well. Related, C庇u「。 co庇rOZs exist to shape organizational behavioral norms and to



encourage empIoyees to monitor and influence飽ch o証er,s behaviors. Action’PerSOnnel’and



cultural controIs are part ofvirtually every management controI system (MCS). In some organizations, they are so important they can be said to be the dominant form of control・



Action cont「o看s



Action controIs are the most direct form of management control because they involve taking steps to ensure that empIoyees act in the organization,s best interest by making their actions



themselves the focus of control. Action controIs take any of four basic forms: behavioral constraints, PreaCtion reviews’aCtion accountability, and red皿dancy・



Behavioral const「aints Be庇vioraLeo鵬tra誼s are a “negative・, or, aS the word suggests’a uCOnStraining,章erm of action control. They make it impossible’Or at least more difficult, for empIoyees to do things that they



should not do. The constraints can be applied physically or administratively. Most companies use multiple foms of p互y扉caZ cous亡ra証亡s, in。uding locks on desks’COmputer passwords’and limits on access to areas where valuable inventories and sensitive infor-



mation are kept. Some behavioral constraint devices are technically sophisticated and often



expensive, SuCh as magnetic identification card readers and fingerprint or retina readers. In situations where a high degree ofcontrol is desired’SuCh as in facilities where radioactive materials are processed, SeCret SerVice agencies where 。assified information is gathered’Or CaSino



count rooms where cash is handled, the benefits of such sophisticated controIs outweigh their



cos亡S. But physical constraints are important in more everyday settings’tOO’SuCh as retailing.



For example, a Study by the Center for Retail Research indicated that theft by empIoyees is the second-largest sourcedf旬ventory shrinkage” - t:hat is’losses stemming from shoplifting, theft



by empIoyees, SuPPlier力endor fraud, Or aCCOunting errors. According to this stud扉n the year



to June 201O, retailers spent $26.8 b皿on (or O.34% of sales) on preventing theft.2 or’aS



another report suggested: `fb put retai- shrinkage in perspective, tOta- do一一ars Iost to shrinkage is aImost the same



amount as the totaI investment made each year by the entire Ca=adian retaiI industry in their lnf。.mation lt}Chno10gy (lT) departments and more than what retaiIers invested in



their Finance departments・ Un-ike lT and Finance spending however, Shrinkage provides no benefits to retaiiers and requires significant time and expense to identify’manage and



prevent,,, said Paul Beaumont・ Director of PwC・s Ca=adian Retail Consuiting Se「vices practice・3



Tb contro1 1osses in both store and warehouse environments’retailers use dosed circuit TV/



DVR recording systems, Observation mirrors, and ``tip lines,, to report incidents. Effective physical constraints are also increasingly crucial in the context of data protection and privacy concems faced by virtually all organizations’both private and public, that electronically store infomation about their clients’CuStOmerS, Patients’Or Citizens. In a survey



focused on the issue of data theft, the vast majority of respondents (84%) perceived data theft as a significant risk to their business’While more than half of the respondents (52%) thought



that the risk ofdata theft would only increase and become an even more serious threat. Further-



more, eVen though most data theft coverage focuses on the risks presented by extemal attackers, nearly two-thirds of the respondents (64%) suggest that empIoyees’Who inevitably have



access to company data in the normal course of business, are the most likely perpetrators of data theft.4



For example, Venerable HSBC,s Swiss private bank arm had to apoIogize embarrassingly to its clients, Whose data were stolen by a fomer employee who should not have had’but did retain, aCCeSS tO 。ient information.5 similarly, a US Internal Revenue Service (IRS) empIoyee



took home a computer thumb drive containing unencrypted data on 20’000 fellow workers’ where “the Social Security numbers, nameS and addresses of empIoyees and contract workers



were potentially accessible online because the thumb drive was plugged into the empIoyee’s



unsecure home network,” IRS commissioner John Koskinen said’adding that’αthis incident is a



powerful reminder to all of us that we must do everything we can to protect SenSitive data whether it invoIves our fellow empIoyees or taxpayers・・・ This IRS breach’Significant as it was in terms of poor controIs’nOnetheless was much narrower in scope than the security incident at



Target, the US retailer, Where hackers stole credit-Card information used by millions of shoppers; Or at Barclays’the large UK bank, Where confidential data of 27,000 of its customers (in。uding their eamings, SaVings’mOrtgageS, health issues・ insurance policies’PaSSPOrtS, and



national insurance numbers) were allegedly stolen and offered for sale by the hackers.6 The growing importance of such data systems risks cannot be overstated’aS SuggeSted by a correspondent at T庇Ecor10mfs亡:



untiI recentIy, for most businesses security was a question of buying decent iocks’doors



and windows, insta…ng CCTV’making sure that reception staff sign visitors in and out’and



trying =Ot tO -eave confidentia- papers in the photocopier. But attacks on their computer systems’be they by business riva-s, POlitica- activists, CriminaIs or foreign govemmentS,



are much harderto defend against - and can have farworse conSequenCeS than a physjcal break-in. A company can suffer a devastating b`ow to its reputation・ its inteiiect=al prop-



erty, Or its ab皿y to serve cuStOmerS - nOt tO mention its bank baiances" it may never Iearn



87



Chapter 3. Action, PersonneI, and Culturai ControIs Who has attacked it or why, Or how much information has been taken; SO it may never be sure if出has done enough to p-ug the -eak.7 Of course, the controIs evolve, tOO. For example, COmPanies can hireperle亡rC証o所esters to check



their data defenses. They also set traps, Called hon卯Ots, Which are bogus but convlnClng COmPuterS, netWOrks, Or乱es to lure hackers while revealing their presence and tactics. And organi-



Zations keep sensitive information in separate chunks with no single person in possession of them all, Which is a variation of the physical world’s segrega亡iort Qft7千句rm融on principle. In addition to, Or in lieu of; physical constraints, ad肌誼is亡ra轟ve corlS亡rC血ts can be used to Place limits on an empIoyee’s ability to perform all or a portion of specific tasks or actions. One



COmmOn form of administrative control invoIves the restriction of decision-making authority.



Managers at a low organizational level may be allowed to approve expenditures of up to, Say, $1,OOO only, those at a higher level up to $5,000, and so on. Above those limits, the purchasing department is instructed not to place the order. The senior managers who restrict the decisionmaking authority in this way are trying to minimize the risk that resources are being disbursed



by empIoyees without proper approvals. However, this process of supervisory checks critically assumes that managers higher in the hierarchy are doing their job of checking and approving Well and/Or Can be trusted. Survey evidence suggests that this, Perhaps, Should not be taken for



granted and, thus, that the checkers also require checking. This is in evidence from the penultimate bullet point below taken from a recent occupational fraud survey‥8



二 Survey partlCIPantS eStimated that the typical organization loses 5% of revenues each year



to fraud. 余「 Occupational frauds can be dassified into three primary categories: aSSet misappropriations,



COrruPtion and financial state皿ent fraud. Of these, aSSe亡血sc[PPrOpr融10rlS are the most



COmmOn, OCCurring in 85% of the cases in our study, aS Well as the least costly, CauSing a median loss of$13O,OOO. In contrast, Only 9% ofcases invoIvedj訪伽c融state肌e所有α1td, but



those cases had the greatest financial impact, With a median loss of $1 million. Corrxption



SChemes fell in the middle in terms of both frequency (37% of cases) and median loss ($200,000). ㊧ Tips are consistently and by far the most common detection method. Over 4O% of a11 cases



Were detected by a tip-mOre than twice the rate of any other detection method. EmpIoyees accounted for nearly half of all tips that led to the discovery of fraud. 遼 Organizations with hotlines were much more likely to catch fraud by a tip, Which our data



Shows is the most eifective way to detect fraud. These organizations also experienced frauds



that were 41% less costly, and they detected frauds 50% more quickly. 呑 The higher the perpetrator’s level of authority, the greater fraud losses tend to be. Owners/



executives only accounted for 19% of all cases, but they caused a median loss of $500,000.



EmpIoyees, COnVerSely, COmmitted 42% ofoccupational frauds but only caused a median loss



Of $75,00O. Managers ranked in the middle, COmmitting 36% offrauds with a median loss of $130,000. 奮 Collusion helps empIoyees evade independent checks and other anti-fraud controIs, enabling



them to stea=arger amounts. The median loss in a fraud committed by a single person was $80,OOO, but as the number ofperpetrators increased, losses rose dramatically. In cases with two perpetrators the median loss was $200,000, for three perpetrators it was $355,000 and



When four or more perpetrators were invoIved the median loss exceeded $5OO,000. Another common form of administrative control is generally referred to as sepc[rC証on Qf d証es. This involves breaking up the tasks necessary to accomplish certain sensitive duties, thus making it impossible, Or at least di鯖cult, for one person to complete the entire task on their



88



own. There are many examples of separation of duties・ One common example invoIves making sure that the臆enPIoyee who makes the payment entries in the accounts receivable ledger is not



the employee wh(rreCeives the checks. If an empIoyee who is diverting company checks to a personal account has only the payment-entry duties - that is’OPening the mail and listing’



endorsing, and totaling incoming checks - CuStOmerS Will eventua11y complain about being



dunned for amounts they had already paid. But a person with both check-reCeiving and paymenトentry duties could divert the checks and cover the action by making fictitious entries



of retums of goods or, Perhaps, Price a句ustments.



Separation of duties is one of the basic requirements of what is known as証er旭coutro!,



which is the control-Oriented term used by the auditing profession. The effectiveness of separation of duties is limited, however, aS it cannot completely eradicate possible co肌sioれ, SuCh as



between those with the check-reCeiving and payment-entry duties. Although collusion requires empIoyees with malign intent to reveal their intentions to other empIoyees whom they seek to engage in the scheme as their accomplice’SurVey eVidence (such as in the last bullet point ofthe



list above) suggests that it does occur, and that it can pay o鮒Regardless’inadequate intemal



controIs heighten the risks of fraud and misconduct. Two-thirds of executives surveyed by KPMG admitted that when fraud and misconduct go unchecked in their organizations’it is



likely due to innde叫aとe証erJ調Z co庇roZs.9 Sometimes physical and administrative constraints can be combined into so-Ca11ed pokαyokes that are designed to make a process or systemJbo互)rOQflO A poka-yOke is a step built into a process to prevent deviation from the correct order of steps; that is’Where a certain action



must be completed before the next step can be performed. A simple mechanical poka-yOke example is the inclusion of a switch in the door of a microwave oven so that the oven cannot be



operated with the door open. Similar mistake-PreVenting poka-yOkes can also be built into some production and administrative processes. For example’airlines make their pilots use



融ot-PrOQfsoftware on laptops or handheld devices in the cockpit instead of letting them make



manual preflight calculations that are error-PrOne. The software does not slip up on the math and flashes a waming if an ouトOf-range number is entered’SuCh as a lO-tOn mistake in the weight ofthe plane or fuel load.11 In hospitals’greater uSe Ofcomputerized provider order entry



can substantially reduce costly and potentia11y harmful drug errors; a Study of the Institute for Healthcare Improvement in Cambridge’Massachusetts’found that processing a prescription



drug order through a computerized system led to a 48% reduction in the likelihood ofan error.12 Similarly, Signature-Verifying software can be used to authorize cash disbursements. Only after all the required signatures have been recognized by the software will the order be released or the transaction be approved. It is often di鯖cult to make behavioral constraints fooIproof, eSPeCially when the organiza-



tion is dealing with disIoyal, deceitful empIoyees. For example, despite reasonable safeguards’



a fomer secretary at Bear Steams’a nOW-defunct global investment firm’uSed disappearing



ink to write checks that her boss requested. After the manager signed the checks, She would erase the name of the payee and rewrite the checks for cash. In her eight months with the firm’



sh。 mad。 m。re than $800,000 vanish from her boss,s bank accounts.13 or at Ti触ny’s, the jeweler, a manager a11egedly stole, Very SIowly and systematically it seems’$1.3 million worth of



jewelry by checking out the jewelry for professional reasons - marketing purposes’Showing potential buyers, and so on - and then not retuming them’and by being careful to keep only



items that were valued under $10,OOO because Tiffany,s has a policy of investigating only missing inventory valued over $25,000.



Chris McGoey, a SeCurity advisor’be-ieves that other empIoyees at T冊any’s may have had suspIC-OnS `o=g before the investigation’but were afraid to speak up"雌i guarantee you that a



company like T描any’s has checks and ba-ances,,, he says・ ‖But it didn’t apply to her. PeopIe



89



Chapter 3. Actton, Personne!, and Culturai ControIs reported to her, and they had to 「eiinquish thej「 inventory to her, based on her say-SO,’’Eve掴



tbey had concems about why the jewetry she was checking out wasn’t being retumed, they mightdye been reiucta=t tO raise any red flags一仙nobody wants to rat out their boss,” he saidi14



P「eaction reviews Preact壬on rel,teWS invoIve the scrutiny of action plans. Reviewers can approve or disapprove the



PrOPOSed actions, requeSt mOdifications, Or aSk for a more carefully considered plan before granting final approval・ A common form of preaction review takes place during planning and



budgeting processes, Characterized by multiple levels of reviews of plamed actions and budgets at consecutively higher organizational levels (see Chapter 8).



Action accountab冊y Ac亡王o71 aCCO【上庇。b講ty involves holding empIoyees accountable for the actions they take. The implementation of action accountability controIs requires: (1) de丘ning what actions are accepト



able or unacceptable, (2) communicating those defined actions to empIoyees, (3) observing or



Otherwise tracking what happens, and (4) rewarding good actions or punishing actions that deviate from the acceptable.



The actions for which empIoyees are to be held accountable once properly defined are typically



COmmunicated through work rules, POlicies and procedures, COntraCt PrOVisions, and/Or COmPany COdes of conduct. It is common in fast-food franchises to prescribe and communicate through pro.



Cedures and clarify and reinforce through training how virtua11y everything should be done, including how to handle cash, how to hire personnel, Where to buy supplies, and what temperature to keep the oil to fry chips. At McDonald’s, for example, a memO from the vice chairman stated:



WhiIe we don’t want to limit your creativity, f「om an operations standpoint there are three



must-dos: 1. Sta什yourfry station a= day long.



2" Check times and temperatures three times a day, 3" Remember to salt your fries properly.15 Similarly, nurSeS uSe PreOPerative checklists to help ensure that they prepare patients thorOughly for surgery・ These checklists remind them to check on the patient’s allergies, drug-tak.



ing history, and time oflast meal.廿ain operators are provided with detailed sets ofprocedures



COmmunicated through safety rules and procedures handbooks that they must know and foト



Iow. The importance ofthe procedures is reinforced through training and examinations.



Sometimes the actions desired cannot be communicated in detail. In many operational audits, POSt audits of capita鵜investment decisions, and peer reviews of auditors, lawyers, doc・ tors, and managers, individuals are held accountable for their actions that invoIve prq厄ssiond



judgmerif. The desirability of the actions ofprofessionals generally cannot be clearly prescribed



in advance. Nonetheless, these individuals are held accountable for their actions under the Premise that they are expected to `act professionally.’



Although action accountability controIs are most e任ective if the desired actions are well



COmmunicated, COmmunication is not su鯖cient by itself to make these controIs e任ective. The a任ected individuals must understand what is required and be confident that their actions wi11



be noticed and rewarded or punished. Actions can be tracked in several ways. EmpIoyee actions Can be observed directly and nearly continuously, aS is done by direct supervisors on production lines" This is called d王rect s叩ervisZon or mo面or証g. They can be tracked periodically, SuCh as retail stores’use of undercover rrrystery shoppers to evaluate the service provided by store clerks,



They can also be tracked by examining evidence of actions taken, SuCh as activity reports or



expense documentation. Examining evidence about compliance with pre-eStablished action



90



Action controis and the controi problems



Standards is a key function of irlterrlC[Z c[【⊥d克(which we discuss in more detail in Chapter 14).



LechnoIogical advances have allowed greater monitoring in terms of both scope and frequency: l七ChnoIogy alIows品ne-and-mOtion studies to be carried to new Ievels. Severa=irms,



including Workday and Salesforce, PrOduce peer-reView software that turns performance assessments from an annuaI rituaI into a never-ending triaI, AIex PentIand of MI丁has



invented a ``sociometric’’badge wom around the neck that measures such things as your tone of voice, geStureS and propensity to talk or Iisten,巾mer Construction is using drones to monitor progress on a sports stadium it is bu‖ding in Caiifomia, Motorola makes termi-



nais that strap to warehouse workers’arms to help them do theirjobs more e鮒ciently-but



aIso to keep tabs on them.16



Action accountability is usually implemented with negative reinforcements; that is, With Punishments instead of with rewards. For example, emPIoyees late for their shift might lose a day’s bonus, and those who miss their shift may lose their bonus for the week. Truck drivers



Whose every move is tracked with a GPS device can be disciplined for driving unsafely or for taking extra time on their lunch breaks.17



Redundancy Re血rld肌ey, Which invoIves assigning more empIoyees (or equipment) to a task than is strictly



necessary, Or at least having backup empIoyees (or equipment) available, also can be considered



an action control because it increases the probability that a task will be reliably completed.



Redundancy is common in computer facilities, SeCurity functions, and other critical operations.



However, it is rarely used in other areas because it is expensive. Further, aSSlgnlng mOre than One emPIoyee to the same task usually results in conflict, frustration, and/Or boredom.



Action controIs and the controI probiems Action controIs work because, like the other types of controIs, they address one or more of the three basic controI problems. Table 3.1 shows the types of problems addressed by each of the action controIs.



Behavioral constraints are primarily effective in eliminating motivational problems. EmpIoy-



ees who might be tempted to engage in undesirable behaviors can be prevented from doing so. Preaction reviews can address a11 three of the controI problems. Because they often involve com-



munications to the empIoyees about what is desired, they can help alleviate a lack of direction. They can also provide motivation because the review of an empIoyee’s actions usually prompts



鴫ble 3,1 ControI probIems addressed by each of the action controI types



Typeofactioncontroi Lackofdirection Controiproblem MotivationaiprobIems Behaviora/constraints



Preact/onreviews Actionaccounねb〃ty



Pedundancy



Personailimitatjons



X



X



X



X



X



X



X X



X



91



Chapter 3. Action, Personnel, and Cultu「ai ControIs



extra care in the preparation of the expenditure proposal, budget’Or aCtion plan. Preacti 臆エeViews also mitigate the potentially costly effects of the personal limitations, Since a go



reviewer can add expertise if it is needed. The reviews can prevent mistakes or other harmf



actions from happening. Action accountability controIs can also address all of the controI pro lems. The prescriptions of desired actions can help provide direction and alleviate the types



persona=imitations due to inadequate skills or experience. The rewards or punishments he provide motivation. Finally, redundancy is more limited in its application" It is primarily effecti in helping to accomplish a particular task if there is some doubt as to whether the employ



assigned to the task is either motivated to perform the task satisfactorily or capable of doingso



Prevention vs, Detection Action controIs can also be usefully class誼ed according to whether they serve to preve融or de[c undesirable behaviors. This distinction is important・ Prevention controIs are’When they are eff



tive, the most powerful form ofcontrol because the costs and harm stemming from the undesi



ble behaviors will be avoided. Detection controIs differ from prevention controIs in that the form are applied申er the occurrence of the behavior. Still, they can be e館頂ive if the detection is ma



in a timely mamer and if it results in a cessation ofthe behavior and a correction ofthe effdets



the harmful actions. AIso, the promise of prompt detection of hamful actions is itself preven tive; it discourages individuals from purposefully engaging in such behaviors.



Most action controIs are aimed at preventing undesirable behaviors. The exception is acti accountability controIs. Although action accountability controIs are designed to motiva empIoyees to behave properly, One CannOt Verify whether proper actions were taken until e



dence of the actions is gathered. However, if the evidence-gathering is concurrent with t activity, aS it is with direct supervision and real-time monitoring’then action accountabili



controI can approach the desired state of prevention of undesired actions. For example’tru drivers are monitored by way of so-Called ``critical event reports,, generated by a truck’s compu ers, reCOrding things such as hard braking, aCtivation of the vehicle,s stability controI system’(l



other events that might indicate unsafe driving; and traders in banks are monitored by ``tran(



actions reports,,, which use aggregated data to spot insider trading and market manipulation11 Table 3.2 shows examples of common forms of action controIs dassified according to whe血



their purpose is to prevent or detect problems"



「略ble 3.2 Exampies of action controis classified by purpose



Source. K A Merchant, Modem Management ContIO/ Sys書ems.花xt and Cases (Upper Saddle RlVer, NJ’Prent(Ce Hall, 1998), P 31



92



Conditions determining the effectiveness of action controis



Conditions determi団ng the e情ectiveness of action controis



Action controIs cannot be used effectively in every situation. They are effective only when both Ofthe following conditions exist, at least to some extent: 1・ Organizations can determine what actions are (un)desirable; and, 2・ Organizations are able to ensure that the (un)desirable actions (do not) occur.



Knowiedge of desired actions Lack of knowiedge as to what aLCtions are desirable is the constraim that most severeiv limits the use of action contr。s. This knowiedge is often diffroult to bbtain. AIthough the actions required



Of employees on a production line may be straightforward to define relatively completely, the



definitions of preferred actions in highly complex and uncertain task environments, SuCh as 血ose of salespeople’reSearCh engineers, Or managerS’Often are incomplete and imprecise.



Most organizations do no亡have a good idea as to how empIoyees in these roles s九o面d best spend



Knowledge of the desired actions in feasible roles often can be established by analyzing



the action pattems in a specific situation or similar situations over time to learn what actions PrOduce the best results. For example’loan approval decisions in banks tend to be quite StruCtured. Over time’lenders observe which borrowers are likely to fail their loan payments. In so doing’banks can develop a loan approval protocol’delegate loan approval deci-



Sions, and monitor or audit the decisions in accordance with their adherence to the decision PrOtOCOl.



It is important that the actions for which empIoyees are to be held accountable are, in fact,



the actions that will lead to the highest probability of accomplishment of one or more of the Organization,s goals’Or at least the proper implementation ofthe strategy being pursued. In the



Same reSPeCt aS With results controIs’Which we discussed in Chapter 2, many Organizations



have actually found themselves encouraging empIoyees to take the wrong actions. This hapPenS・ for example’When policies and procedures are no亡kept up to date or are applied too tightly (see Chapter 4)’CauSing the action controIs to produce unintended side effdets, Which we



discuss in Chapter 5.



AbiIity to ensure that desired actions are taken Knowing what actions are desirable is not su鯖cient by itself to ensure good control; Organiza-



tions must have some ability to ensure or observe that the desired actions are taken. This ability Varies widely among the different action controIs. The effectiveness of the behavioral constraints and preaction reviews varies directly with the reliability of the physical devi⊂eS Or administrative procedures the organization has in place to



ensure that the (un)desired actions are (not) taken. Clearly, these devices and procedures are not always effdetive. For example, a rOgue CurrenCy trader at A雌rst Financial, Who had lost about $7OO million in foreign exchange trading, WaS Said to have “targeted every controI point in the



SyStem and systematically found a way around them.・, when called aside by managers for going OVer his trading limits’the trader complained that the computerized risk-mOnitoring system he



used to check his risk exposure during the daywas too cumbersome. He got away with it.19 Tb COVer uP his Iosses, the trader allegedly started selling bogus option contracts. This practice was not detected in a timely manne串ither’in part, because the responsibility for the monitoring and reporting of the trader’s foreign-eXChange risks was given to a junior, relatively inexperi-



enced staff member.20



93



Chapter 3. Action, Personnel, and CuIturaI ControIs



Examples such as these are consistent with the findings of numerous fraud surveys that sug-



gest that misconduct occurs and goes undetected not only because of poor intemal controIs (many of which fa即nto the category of what we call be庇VtOraZ coJZStratrZtS) but also due to mcmage肌eれt Ol,erride of the controIs. According to the occupational fraud survey cited above’



one-third ofthe reported cases could have been prevented ifthere had been better intemal controIs; but one-fifth could have been prevented ifmanagers had done a su飴cientjob ofreviewing transactions, aCCOuntS, Or PrOCeSSeS; and yet another one-紐h could have been prevented had there not been an override of existing intemal controIs.21 o卓O quOte anOther report’αcompa-



nies find that one of the greatest challenges in countering fraud is that unscrupulous manage-



ment may override otherwise effective intemal controIs.,,22 Action tracking also provides a significant challenge that must be faced in making αC亡ion



acco研融掘ty controIs effective. Usually some actions can be tracked even where employees’



actions cannot be observed directly" But this tracking is not always effective. The criteria that should be used tojudge whether the action tracking is effective are precision, Ot)jectivity’time-



1iness and understandability (as we also discussed in Chapter 2 in a results-COntrOI context). If



any of these measurement qualities cannot be achieved, aCtion accountability controI will not be e縦3Ctive in evoking the desired behaviors. prec扇。n refers to the amount of error in the indicators used to tell what actions have taken place. If action tracking invoIves direct supervision’Can the supervisors accurately distinguish



good actions from bad actions? If action tracking involves scrutinizing transaction records’do



those records reliably tell whether the proper actions were taken? For example’an initiative



aimed at tracking whether salespeople spend enough time on market development activities’aS opposed to direct sales activities’is doomed to fail until precise definitions can be developed as



to which actions fall into each of these two areas. Here is an example of this:



Eiaine Murszewski worked in customer service for more than 30 years. The job she found two yea「s after getting laid off was in customer service too’but he「 new empioyer moni-



tored her c10Seiy, faking the personaI touch out of the job, She said" The new empioyer’



kept track of the length of her phone caiIs’the amount of time she took between caIIs・ and the tjmes she wasn’t at her desk. /fa calIer was particu/atry d肪CuIt, She saidタ書he numbers



didnタ書re〃ec刷at〇 ・・Metrics are an empIoyee,s worst enemy’・, she said葛23



A similar precision failure of an action control exists within the context of the US Foreign Corrupt practices Act・ This act was intended to make `bribes, to foreign o鯖cials illegal’but it allowed亀cilitating payments, to Iower-1evel officials. The distinction between bribes and facil-



itating payments is not precise’however, CauSing concem for company o綿cers who cannot be



sure that their interpretations of the actions by company personnel in foreign countries will match those made by independent observers (such as a jury) at a later date in lawsuits of bribe allegations. O切ect王l,壇y Or absence of bias, is a concem because reports of actions prepared by those



whose actions are being controlled cannot necessarily be relied upon" PrQject- and sales-Ori-



ented personnel are frequently asked to prepare self-rePOrtS Of how they spend their time- In most cases, these reports are precise, aS the allocations may be in units oftime as small as by the minute. But the reports are not otyiective. If the personnel involved want to obscure the true



time pattems, Perhaps to cover a bad performance or to allow some personal time, it is rela-



tively easy for them to report that most of their time was spent on productive activities. Most companies use direct supervisors and intemal auditors to provide objectivity checks on such



reports, aS Well as, increasingly, advanced monitoring technoIogies as mentioned above. Without of)jectivity, management CannOt be sure whether the action reports reflect the actual actions taken, and the reports Iose their value for controI purposes.



94



⋮蒜1e t。噂皿Vlng闘町や



n肌e妬ness in tracking actions is important as well. Ifthe tracking is not timely, interventions



are n帆possible before harm is done. FurtheI., muCh ofthe motivational e任ect ofthe feedback is Iost whenthe tracking is significantly delayed. Aga主n, teChnoIogy has a11owed timeliness to be SOmetimes real time’Which is often decried by those being monitored as oppressing.



Finally, it is important that the actions for which individuals are to be held accountable are 皿derstandc謝e・ Although empIoyees presumably can easily understand prescriptions to arrive at work on time or to not steal’understanding and consistently acting in full compliance with



the detailed rules and regulations contained in procedures handbooks is obviously much more Challenging. Forensic investigations o庇en suggest that incidents and accidents are often due to



.軸螺両肘川n。亡



a lack of empIoyees, understanding of (and, hence, inevitably curtailed compliance with) all of the necessary procedures.



Implementing action controIs where one of these action-traCking qualities cannot be achieved wil=ead to undesirable e節ects. (These are discussed further in Chapter 5.) However,



like results controIs, aCtion controIs usually cannot be made near-Perfect, Or at least it would be PrOhibitively expensive to make them nea手perfect. As a consequence’Organizations use perSOnnel and cultural controIs to help糾some gaps. These controIs motivate empIoyees to con-



庇n山車暁



trol their own behaviors (perso肌eZ co虹roZs) or to control each other,s behaviors (c血urc[Z COntrOさs).



Personnel contro書s



Perso柵eZ co庇roZs build on empIoyees, natural tendencies to controI or motivate themselves.



Personnel controIs serve three purposes. First, SOme PerSOnnel controIs help clarify expectations. They help ensure that each empIoyee understands wha亡the organization wants. Second,



SOme PerSOnnel controIs help ensure that each empIoyee is able to do a good job; that they have



all the capabilities (e"g. eXPerience, intelligence) and resources (e"g. information and time) needed to do thejob. Third, SOme PerSOnnel controIs increase the likelihood that each empIoyee Will engage in selfmonitoring. Se昨肌o庇oring is an imate force that pushes most empIoyees to



Want tO do a good job, tO be naturally committed. Selfmonitoring is effective because most PeOPle have a conscience that leads them to do what is right’and they are able to derive positive



feelings of selfrespect and satisfaction when they do a goodjob and see their organization suc-



Ceed. Self-mOnitoring has been discussed in the management literature under a variety of labels, including融rt涌c motiγat王orl and kyr担y



Persomel controIs can be implemented through (1) selection and placement, (2) training, and (3) job design and resourcing. In other words, finding the right people to do a particular



job, training them, and giving them both a good work environment and the necessary resources is likely to increase the probabili亡y that the job wi11 be done properly.



Seiection and pIacement Organizations devote considerable time and effort to empIoyee selection and placement. A



large literature studies and describes how that should best be accomplished. Much ofthis literature describes possible predictors ofsuccess’SuCh as education’eXPerience, PaSt SuCCeSSeS, Per-



SOnality, and social skills,



EmpIoyee selection often invoIves refdrence checks on new empIoyees, Which many organiZations have stepped up in response to heightened worries over workplace securitywhile ensuring fair’inclusive and equitable recruiting practices.24 But beyond screening new empIoyees to



mltlgate SeCurity issues, Organizations primarily focus on matching job requirements with job applicants, skills・ For example’Home Depot’the large American retailer of home improvement



95



Chapter 3. Actjon’Personnei, and CuIturaI ControIs



and construction products and services’has an in-house computer system that contains the



names ofpre棄reened candidates who have the right skills and experience. This allows manag-



ersto fud q規範a・とandjdates qutckJy融en the need arises. B細山e au亡Oma[ed system also provides cues about what interview questions to ask’What answers to listen for, and even what



advice to give the interviewees.25



social media also has emerged as a mgivr background-Check tool for empIoyers, Where one survey indicates that over two-thirds of them decide against hiring afte血ding negative details



about the candidates. Meanwhile, though, many emPloyers surveyed said they are likely to hire a person if they find on social media that the candidate,s personality is a good fit within the company culture’has strong communication ski11s’is creative’and possesses a wide range of



interests, amOng Other presumably desirable traits.26



Employee selection can be expensive, but the benefit is to help find the best talent and to avoid hiring someone who is a “poor fit,, with the company・ One estimate for the United States is



that the cost per hire averages about $4’500’and the average time to fill ranges anywhere from



25 days (production positions) to 88 days texecutive positions).27



巾aining Training is another common way to increase the likelihood that empIoyees do a goodjob. Training can provide useful information about what actions or results are expected and how the assigned tasks can be best performed・ Training can also have positive motivational effect§



because employees can be given a greater senSe Of professionalism, and they are often more interested in performing well in jobs they understand better. Many organizations use formal training programs’both through in-COmPany training and by supporting in-Classroom continued education’tO improve the skills of their personnel. This



is important in all sectors because直r example’a global study of hospitals in developed co皿 tries found that competition, hospital size and independence’and professional management



and decision autonomy were amOng the most important factors that explain hospital performance.28 Factor§ SuCh as professional management and decision autonomy, however’require



training to help develop the skills for managers to perform we11. But training is also important at the worker level, Where some companies see ・・a mismatch in the labor market between what



businesses need and the kind of education young people are getting’,, said Nader Imani, Chief



executive of Festo Didactic, the stand-alone education division of Gemany,s robotics company FestoAG.29 Much training takes place informally’SuCh as through empIoyee mentoring. For example’ every month, neW aJld some existing franchisees for The Pita Pit’a quick-SerVice sandwich



chain with more than 240 locations across the United States and over 580 worldwide’aSSemble in Coeur dAlene, Idaho, for several days oftraining. However, Peter Riggs’Vice president ofThe



pita Pit, WantS tO make sure that the franchisees also share their experiences after the formal training is completed〇 ・Anyone can leam systems’・, he said; but then he hinted at the need to



continually transfer knowiedge among empIoyees’Which he saw as perhaps the most important



aspect of the training and the way it was provided.3O At Jaburg Wilk, a law fim in Phoenix, Arizona, junior co11eagues have two monthly mentoring meetings for 30 minutes to an hour each with a senior colleague, Which is seen as an effective way to help the junior colleagues improve their marketing and networking efforts to attract more SOPhisticated 。ients. Scott Allen, a COnSultant, nOteS that through mentoring’“yOu Will get insights [from the] one-On-One



face time that no market research report could ever give you; and if the mentor is luckwithat person] may even learn a thing or two froo].,,31 A similar approach is followed in other profer sional services firms. At Moneta Group, an investment adviser’its training program spanS丘ve



years and includes extensive coaching on business development because ``if we weren’t



intentional about replacing our top people who will be retiring in the next decade, Our COmPany’s ability to s也y independent would be in jeopardy,,, said Gene Diederich, the firm,s 。hi。f executive.32 ・ _・・



Firms also make growing use of social media for their training and coaching needs. “Social



leaming platforms,, are redefining the leaming experience by providing empIoyees with a virtual community to interact’engage, Share, and learn; and social media are used to establish a



dialogue with colleagues and instructors before’during’and after training sessions. These approaches expand the tradi亡ional classroom, Creating a culture of co11aboration and leaming



across multiple o鯖ces, job familie§, and teams.33



Job design and provision of necessa「y resources Another way to help empIoyees act aptly is simply to make sure that thejob is designed to allow motivated and qualified empIoyees a high probability of success. some organizations do not give all their empIoyees a chance to succeed. Some jobs are too complex・ Salespeople may be



assigned too many accounts to handle effectively. EmpIoyees also need a particular set of



resources available to them in order to do a goodjob. Resource needs are highlyjob-SPeCific, but they can include such items as infdrmation’equipment’SuPPlies’Staffsupport, decision aids, Or freedom from interruption. In larger organizations’Particularly, there is a strong need for



transfer of infomation among organizational entities so as to maintain亡he coordination of Well-timed’efficient actions and decisions. This latter point was illustrated pertinently in the



example ofThe Pita Pit above’Where the purpose oftraining’and the way in which it was delivered’also included and facilitated ways to allow transfer of knowledge, eXPeriences, and best



PraCtices. But there are circumstances where the situation is less conducive: Matt l也bi routineiy works 12-hour days as a driver for UPS, the U"S" ParCel company"丁he COmPany WOuid rather pay him and other drive「s ove「time instead of hjring more worke「s,



Talbi has no complaints about his pay. He makes $32・35 an hour’PIus benefits, and hasjob



SeCurity as a teamster [union membe巾But he wonders how much 10nger he can keep up the breakneck pace.傭There,s more and more push towards doing more with -ess workers,・,



Said leribi"償There are more stops’mOre PaCkages, mOre Pickups■ What,s happening is that We’re stretched to our Iimits and beyond.”34



Cuitural controIs Cr血raZ co柾roZs are designed to encourage mutual monitoring; a POWer皿form of group pres-



Sure On individuals who deviate from group noms and values. In some collectivist cultures, SuCh as Japan, incentives to avoid anything that would disgrace oneself and one,s family are ParamOunt. Similarly, in some countries’nOtably those in Southeast Asia, business deals some-



times are sealed by verbal agreement only. In those instances, the dominant social and moral Obligations are stronger than legal contracts. But strong cultural controIs produced by mutuaし



monitoring processes also exist within single organizations. Cultures are built on shared traditions’nOrmS’beliefs, Va量ues’ideoIogies, attitudes, and



WayS Ofbehaving. The cultural norms are embodied in written and unwritten rules that govem empIoyees, behaviors. Organizational cultures remain relatively fixed over time, eVen While goals and strategies necessarily adapt to changing business conditions. Tb understand an Organization,s culture’aSk long-time empIoyees questions like‥ What are you proud of around



here? What do you stand for? What does it take to get ahead? If a strong organizational culture exists’the seasoned empIoyees wi11 have consistent answers to these questions even when the



97



Chapter 3. Action’Personnei, and Cuitu「ai ControIs



answers are not otherwise codified. When that is the case’StrOng Organizational cultures can



prompt empIoyees to work together and be aligned・ It also implies, however’that despite the benefits of directibn狐d cohesiveness, StrOng Cultures sometimes can become a source of iner-



tia or create blind spots, Which can get in the way of needed change and adaptation in rapidly



Changing environments. organizational cultures can be shaped in many ways’both in words and by example’in。uding by way of codes of conduct’grOuP reWards’intra-Organizational transfers’Physical and social arrangements’and tone at the top.



Codes of conduct Most organizations above minimal size attempt to shape their organizational culture through what are known, Variously, aS COdes of conduct, COdes of ethics’Organizational credos’Or State-



ments of mission, Vision, Or management Philosophy. These formal, Written documents provide broad, general statements of organizational values, COmmitments to stakeholders’and the



ways in which management would like the organization to function. The codes are designed to



help empIoyees understand what behaviors are expected even in the absence of a specific rule; that is, they are to some extent Principle-based rather than merely rule-based. They may include



important messageS about dedication to quality or customer satisfaction, falr treatment of empIoyees and customers’emPIoyee safety, innovation, risk taking’adherence to ethical princi-



ples, OPen COmmunications and willingness to change丑be effective, the messages included in



these statements should be reinforced through both formal training sessions and informal dis-



cussions or mentoring meetings among empIoyees and their superiors.



A recent study from the Institute of Business Ethics (IBE) estimated that fourLfifths of FTSE lOO companies had an explicit code of conduct or equivalent in 2OlO’increasing from only an



estimated one-third in 1993.35 But codes of conduct can vary considerably in form across firms. There are an increasing number of defensive’COmPliance-Oriented’Or legitimizing reasons to



establish or review a code, but a more meaningful motive proactively and regularly communi-



cates the organization,s distinctive culture and shared sense of purpose. The latter may invoIve developing the code to properly calibrate the organization,s rules-based policies with a more values-based approach to drive ethical decision-making. As such’Other than to comply with legal requirements’effective codes aim to shape a shared company culture and to protect or



improve the organization,s reputation. The most commonly cited values embedded in the codes are integrity, teamWOrk’reSPeCt’innovation’and client focus. In addition to general policy



statements, Which almost all codes of conduct necessarily elaborate, SOme COdes provide guidance on specific issues’SuCh as regarding confidential information, aCCuraCy Of reporting



(fraud), PrOteCtion of corporate property声nd dealing with gifts and entertainment. If such



guidance is in。uded’then the detailed behavioral prescriptions provide a form of action



accountability control because employees who violate the prescriptions can be reprimanded.



Many companies use e-learning modules to implement their code and have an ethics hotline and whistle-blower mechanisms to report Violations and misconduct・36



Do codes of conduct work? The evidence is equivocal. One study in the financial services sector found that:37 ミOver two-thirds of the firms in the survey had raised awareness ofthe importance of ethical conduct over the last three years’and roughly the same number had strengthened their for



mal code of conduct and the system for evaluating empIoyee behavior, but only two-fifths



said their firms had introduced career or financial incentives to encourage adherence to eth-



㊨ While respondents admitted that an improvement in empIoyees, ethical conduct would improve their丘rm,s resilience to unexpeCted and dramatic risk, half think that career



98



CuIturai controIs



PrOgreSSion at their firm would be difficult without being且exible on ethical standards; the



Same PrOpQrtion thinks their fim would be less competitive as a consequence of being too rigid in this area; and less than two-fifths think their firm’s financials would improve as a



result of an improvement in the ethical conduct ofempIoyees at their firm. A11 told’eVen though two-thirds of FTSE 350 respondents stated that ethics plays a part in



their company,s recruitment process, and over four-fifths stated that conformity to the compa-



ny,s code of ethics is included in contracts of empIoyment,38 the weakness remains that three珊hs also believe that’When push comes to shove, the code of conduct is not taken seriously.39



Overa11, the latter survey suggests that the most commonly cited factors that contribute to misconduct in the workplace were not only cynicism toward the organization,s code of conduct,



but also pressure to meet targets; fear ofjob loss if targets are not met; SyStemS that rewarded results over means; lack of understanding ofstandards that apply to thejob; lack ofresources to



get the job done without cutting comers, and a belief that policies or procedures are easy to bypass or override. The sum of these issues underlines the importance of the types of controIs We have discussed throughout this chapter.



Group rewards Providing rewards or incentives based on collective achievement also encourages cultural con-



trol. Such incentive plans based on collective achievement can come in many forms. Common examples are bonus, PrOfit-Sharing’Or gain-Sharing plans that provide compensation based on



OVerall company or entity (rather than individual) performance in terms of accounting retums, PrOfits, Or COSt reductions. Encouraging broad employee ownership of company stock, With



effective corporate communications to keep empIoyees infomed and enthusiastic, enCOurageS all empIoyees to think like owners" According to Sarah McCartney-Fry, member of Parliament and the A11 Party Parliamentary Group on EmpIoyee Ownership, there is a αgrowing interest in […] businesses [thatl are substantia11y or majority owned by its empIoyees, [because] co-OWned



firms appear adept at managlng lnnOVation and change and are underpimed by very high levels of productive empIoyee engagement享O Indeed, eVidence suggests that group-based incentive plans create a culture of負ownership,,



and =engagement,, to the mutual benefit of organizations and their empIoyees.41 specifically, a review of 70 studies over a 25-year Period found that both empIoyee ownership and profit-Shar-



ing programs improved empIoyee productivity, COmPany Performance, and company survivor rates"42 According to an empIoyee engagement study by the Corporate Executive Board・s Corpo-



rate Leadership Council’emPIoyees most committed to their organizations put forth 57% more



effort and are 87% less likely to leave their company than empIoyees who consider themselves disengaged. The study concluded that ``it should be no surprise then that empIoyee engagement, Or lack thereo白s a critical factor in an organization,s overa11 financial success.,43 Group rewards are discussed here as a type of cultural control rather than as a results con亡rol



臼s we do in Chapter 9) because they are quite different in character from rewards given for indi-



Vidual perfomance. With group rewards’the link between individual efforts and the results being



rewarded is weak, Or at least weakened. Thus, mOtivation to achieve the rewards is not among the Primary forces a航頂ed by group rewards; instead, COmmunication of expectations and mutual



monltOrmg are. That is not to suggest that group rewards cannot have positive eifects on motiva-



tion, eVen if only indirectly- Group rewards can encourage teamwock, On-thejob training of new empIoyees (when assigned to teams that include experienced colleagues), and the creation of peer



PreSSure On individual empIoyees to exert themselves for the good ofthe group. All told, […] for many organizations, teamWOrk is a fundamental bu脚ng biock in their culture, and is



a feature the CIPD [Chartered lnstitute of Persomei and DeveIopment] research showed 99



Chapter 3. Action, Perso=nel・ and Culturai ControIs



they wanted to keep" A-though persona- achievement waS reWarded’it was aiso seen aS



important tOidevelop a way of acknow-edging a=d promoting teamwork since good company results are nbt achieved by a sing-e person"書〇・・岬UKFast’a business-tO-business hosting



company, reWard is a device to reinforce team Cu-ture" Rather than giving high-Performing peopie individua- cash rewards’the money is poo-ed to fund a team event〇日These rewards create shared memories, he-p team bonding, increase aPPreCiation of peopIe’s d田erent personalities and reinforce the company’s va看ues of being supportive’Caring and fun・44



Other app「oaches to shape o「ganizational cuIture As mentioned earlier, Other common approaches to shape organizational culture in。ude intra-



organizational transfers’Physical and social arrangements’and tone at the top.



克ra-07官arl融王orla朝型fGrs or e肌pkyee rotc[亡io証elp transmit culture by improving the socialization of empIoyees throughout the organization’giving them a better appreciation of



the problems faced by different parts of the organization’and inhibiting the formation of incom-



patible goals and perspectives. pkysic。 arr肌ge肌eれ亡S (such as o鯖ce plans’arChitecture・ and interior decoD and socid c[rrOrlgemeJ暁(such as dress codes’institutionalized habits’behaviors, and vocabulary), Can also help shape organizational culture" Some organizations’SuCh as technology firms in Silicon valley, have created informal cultures’With open office arrangements and casual dress code§



that deliver messages about the importance of innovation and empIoyee equality. For example, Alibaba - nOt a Silicon Valley company’but one that accounts for more than three-quarterS Of china・s retail ecommerce - “Credits its awesome grOWth over the past 15 years to a uniquely



corporate culture and the visionary leadership of founder Jack Ma," replete with distinctive, cult-1ike features:



Both admirers and detractors a-ike credit the creativity and drive that got the company this far to AIibaba・s somewhat cuit-一ike espr,書。e co岬s - and the quirky Mr" Ma〇日Investors [must] decide what stomaCh they have for A-ibaba’s quirks - its governanCe StruCture gives



virtually a-1 powe「 to 27 board members’and very -ittle to ordinary sharehoiders・ They wilI



also have to have a high to-e「ance for sometimes bizar「e antics by senior managerS・ and a



corporate cu-ture that is more co-o仙than its wor-d-SPanning peers like Google and Face-



book. […l The Chinese company,s 22・OOO empIoyees’known as AIiren, aPPear tO be fueiled by adrena-in and inspired by Kung Fu nove-s〇日“Corporate cuIture is stil看Chinese・ [the] appraisa- system is that of a Chinese comPany’,, said Jasper Chan’formerly Alibaba’s sen-



ior corporate COmmunications manager, Who worked for the company f「Om 2007-12. Emp-oyees a「e CO=StantIy evaluated by managerS On their commitment to six core vaiues:



teamwork, ;nfegri書y, CuStOmer伽st, embrace change, COmmi書ment and passion・ “An empIoyee could have great Sales, they cou-d bring in a to= Of revenues’but if they don’t



score we旧n core vaiues, they could s剛ose theirjob,・・ she said"45 But many other “old-eCOnOmy,・ companies also possess’and are reputed for’their unique cultures. At Disneyland, emPIoyees are called ccIS亡members; being on the job is being onstage



toffthejob is Q輝age); a WOrk shift is ape加rmαれCe; and ajob description is a scr垂This vocabulary, Which is imparted on joining the company and is reinforced through training’SeParateS



Disney employees from the rest’brings them 。oser together’and reminds them that they are



pe血mers whose job is to help ful即the company・s mission-that is’that “every product tells a story,, and that ・・entertainment is about hope’aSPiration and positive resolutions.,,46



Finally, management Can Shape culture by setting the proper torle研he tqp. Their statements should be consistent with the type of culture they are trying to create’and’importantly’their



actions and behaviors should be consistent with their statements. Managers serve aS rOle



Effectiveness of personneI/cultural controIs



models and, aS the various surveys quoted earlier in this chapter suggest, are a determining factor in creating a c血ure of integrity in their organizations, Management cannot say one thing



and do another. That said, management SOmetimes sets the wrong tone by not responding appropriately to matters brought to their attention, SuCh as ethics concems or reports of misconduct.47 All too common, W柾stle-bfowers (empIoyees who draw attention to suspected mal-



PraCtice) are ignored, and so forth. Several studies, indeed, Paint a rather gloomy picture of tone at the top. For example, a SurVey COmmissioned by PwC suggests that while tone from the top is vital in developing and maintaining the ethical integrity ofthe business, nearly halfofthe respondents reported that leaders do not always act as role models in setting the right tone.48



Personnel元ultural controIs and the controI problems



Taken together, PerSOmel/Cultural controIs are capable of addressing all of the controI problems although, aS Shown in Table 3.3, nOt eaCh type of control in this category is effective at



addressing each type ofproblem. The lack-Of-direction problem can be minimized, for example, by hiring experienced personnel, by providing training programs, Or by assigning new personnel to work groups that will provide good direction. The motivational problems, Which may be



minimal in organizations with strong cultures, Can be minimized in other organizations by hiring highly motivated people or by assigning people to work groups that wi11 tend to make them a句ust to group norms. Persona=imitations can also be reduced through one or more types of



PerSOnnel controIs, Particularly selection, training, and provision of necessary resources.



「fabie 3,3 Controi probiems addressed by the various ways of effecting personnei



and culturaI controIs



Se/ectionandp/acement 7ねining



Jobdes/gnandpI℃VisIOn



X



X



X



X



Ofr)eCeSSaryreSOUI℃eS



X



X



Source. K. A. Merchant, Modem Management ControI?ystems. 7axt and Cases (Upper Saddle BlVer; NJ‥ PrentlCe Ha=, 1998), P 130



離ectiveness of persomeihuItura看cont「oIs All organizations rely to some extent on their empIoyees to guide and motivate themselves. Some corporate controI systems are dominated by personnel controIs. Wi11iam F. Cronk’ now-retired president of Dreyer’s Grand Ice Cream (since acquired by Nestle), Said at the time



that, “We consider hiring the most important decision we can make. We hire the smartest,



101



Chapter 3. Action, Persomel, and Cultural Controis most inspired people we can find, give them the resources they need, then get out of their way.”49 c亜ural controIs can also, by themselves, dominate a controI system・5O The best chance to create a strong culture, however, SeemS tO be early in an organization’s life whena founder can imbue the organization with a distinctive culture. Examples are the “cult-1ike’’



cultures created by the late Steve Jobs at Apple, Jack Ma at Alibaba, Jeff Bezos at Amazon, and Herb Kelleher at Southwest Airlines, just to name a few notorious ones.51 cultural con・



troIs often have the advantage ofbeing relatively unobtrusive. Employees may not even think of the shared norms or ``the way we do things around here’’as being part of the “control’’ system・ As such, Organizational cultures can substitute for other formal types of controIs. In



otherwords: A company’s culture is iikeiy to a什ect every aspect of how the organization operates and



how peopIe work, Research from the Chartered lnstitute of Persomei and Deve10Pment (CiPD) has consistently found that culture w川a什ect a business’s success because, un=ke strategy, ;t /s hard fo /mitate and can di施rentiate organjZations from肋eir com-



petifors. In the words of management guru Peter D「ucker, “CuIture eats strategy fo「



breakfast,,,52



As such, PerSOnnel/Cultural controIs can have distinctive advantages over results and action COntrOIs. They are usable to some extent in almost every setting, their cost is often lower than more obtrusive forms ofcontroIs, and they might produce fewer harmful side e鮒ects. Moreover, “soft’’personnel/Cultural controIs have also been shown to make “economic sense’’as surveys and evidence suggest that “it pqys to be nice to empIoyees.・,53 At the SAS Institute’the large’



Privately held software and business inte11igence systems company, emPIoyee loyalty is instilled with an unusual array of perks for its roughly 3,OOO headquarter empIoyees. These include a profit-Sharing plan; a free health clinic; daycare centers; Private o鯖ces for everyone; flexible



35-hour weeks; free sodas, fresh fruit, and pastries in the coffee-break rooms; and even a pia-



nist in the subsidized lunch and recreation room. SAS,s tumover rate has been about 4% for years, COmPared to an industry average of about 20%. Stanford University professor Jeffrey Pfeffer concluded, “The roughly $50 million per year that SAS saves with its Iow turnover pay§



for all the family-friendly stuff. And, While the free company dinic costs $1 million per year to operate, that is $5OO,OOO less than what it would cost the company if empIoyees were treated elsewhere.,,54 However, the degree to which personnel/Cultural controIs are e任ective can vary signifi-



can[]y across indjvidua]s, grOuPS’COmmunities’and societies. Some people are more hones〔 than others, and some communjties and societies have stronger 。es among their members. Cuト tures that are ・・too strong・・ can also be a disadvantage’eSPeCially when they need changing.55 culture change requires strong “culture carriers・」 rOle models who embody the new values -



and strong reinforcements’SuCh as changes in emphasis in the reward systems:



・・Take somebody who,s produced m冊OnS Of 「evenues but is sometimes a bit disruptive: how do you judge them against somebody who has Iower financiai pe「formance but is a great cu-ture carrier?,・ Co-in Fan’the co-head of investment banking at Deutsche Bank’ asks〇 ・・We used to have those debates" lbday, it,s not even a debate" The first group gets



knocked out of that year’s promotion p「ocess・,・56 And sometimes it requires a change at the top’SuCh as at Tbshiba’the Japanese electronics-



to-nuClear conglomerate, Where top executives played a role in a company-Wide accounting scandal invoIving at least Y152 billion ($1.2 billion) in inflated profits over a seven-year Period‥



in an 82-Page Summary Of its findings・ a Panel of externa- lawyers and accou=tantS detailed what it said were ・・institutiona一・・ accounting ma-practices and a corporate cuIture in which



Notes



empIoyees were afraid to speak out against bosses, push for increasingiy unachievabie proト its, ``There ex瞳ed a corporate culture at “foshiba where it was impossibie to go against the boss, wilI," the fePQJ.宣・ Said" Pressures to meet aggressive, Sho巾term profit targets - known



as ``the chalIenge" - eXisted from the presidency of Atsutoshi Nishida’Who headed the com-



pany from 20O5 to 2009・ Those pressures escalated as the company’s eamings deteriorated



in the wake of the globaI fina=Cia獲crisis and the March 2011 ea巾hquake and the Fukushima nucIear accident. “fop executives pressured empIoyees to achieve their targets with sugges-



tions that the company may withdraw from underperforming businesses such as teIevision if they were not met. […1 Hisao klnaka, Chief executive, StePPed down after making a 15-SeCond bow of contrition at a packed news co=ference in “fokyo, Saying that傭“foshiba had suffered what could be the biggest erosion of its brand image in its 140-year history.”57



Conclusion In this chapter, We PrOVided an overview of the most direct type of controIs’aC亡壬on corttγOZs,



which take any of several di縦uent foms: behavioral constraints’PreaCtion reviews, aCtion



accountability, and redundancy. Action controIs are the most direct type of management control because they ensure the proper behaviors ofthe people on whom the organization must rely by focusing directly on their actions. We also described persomeZ and c庇urαZ co庇roZs, Which managers implement to encourage



either or both of two positive forces that are normally present in organizations: Self- and mutualmonitoring. These forces can be encouraged in a number of ways’including effective persomel



selection and placement, training, job design and provision ofnecessary resources, COdes ofconduct,



group rewards, intra-Organizational transfers, Physical and social arrangements, and tone at the top. Personnel and cultural controIs, SOmetimes referred to as s草controIs, have become more



important in recent years. Organizations have become flatter and leaner. Managers have wider spans of control, and elaborate hierarchies and systems of action controIs (bureaucracies) have



been dismantled and replaced with empowered empIoyees. In this environment, Shared organ-



izational values have become a more important tool for ensuring that everyone is acting in the organization,s best interest.58



See, forexample, M. A. Abemethy, H. C. Dekker, and A. K.



5 ``Mass Leak of Client Data Rattles Swiss Banking,’’軌e



Schulz, `Are Employee Selection and Incentive Contracts



W七諏Street Jo事(rrlaZ (July 8, 2OlO), Online at on.w争j.



Complements or Substitutes,’’JourrlaZ Q/ Acco肌亡Zrlg



Research, 53, nO. 4 (September 2015), PP. 633-68. “Five-Fingered Discounts;’T九e Ecor10証s[ (October 23,



2010), p. 80.



3 (`Stealing Retailer,s Thunder: PwC Estimates Canadian RetailersAre Losing over $1O Mi11ion a Day to Shrinkage:’



PwC (October 31, 2O12), Online at www.pwc.com/Ca/en/



media/release/2O12-1O-31-Canadian-retailers-losingten-mlllion-a-day-Shrinkage.html.



COm/1mnNOUO. 6 αIRS EmpIoyee Took Home Data on 2O,000 Workers at Agency,’’BZoomberg (March 18, 2014), Online at bloom.



bg/1MjMWKM; See also ``Bardays Launches Investigation after Reported Customer Data Leak’,,耽e瑞narlC融 Ttmes (February 9, 2014), Online at on・ft.com/1J9wSdF.



7 “Manage Like a Spymaster,’’T庇EcoJlOmis亡(August 29,



2015), Online at econ.st/1Uqj8KK. 8 R印ort亡O亡兄e規正ons oれOcc 岬a亡ionα肝ra標d a肩Ab地se2014



4軌ropean Dam耽昨Survq′20ヱ2 (KPMG, 2012), Online at



GわbaZ Frand S弛め′ IAssociation of Certified Fraud Examin-



www.kpmg.de/docs/Central-and-eaStern-eurOPean-data-



ers, 2014), Online at www.acfe.com/rttn/docs/2014-



theft-SurVey-2012.pdf. See also負Business Warned of



reporトto-nations.pdf (hereafter 20J4 GLobaZ F「and Survey).



Enemy Within on Fraud and Cyber Crime,’’The F証a旭aZ



9切fccdve71eSS Qf FraL[d R巌Marlagement切f。rtS (KPMG



Hmes (November 23, 2015), Online at on.ft.com/11DkSwe.



LLP, 2009).



103



chapter 3. Action, Perso=nel’and Culturai ControIs



lO D. Stewart and R. Chase,掘s調ke-Proqfirlg: Des[g扇五g



E.r。rS Ouf (Portland, OR‥ Pr釦uctivity Press, 1995). pokaγOke is the Japanese term forfb妙γOQ手It was intro_



duced to the management literature by the Japanese quality guru Sigeo Shingo. 11 ・At Some Airlines, Laptops Replace Pilots, `Brain Bags,’’’



T九e W棚StreetJouma! (March 26, 2002), P. Bl・ 12 ・・Computer Systems Cut Hospital Drug Errors・,,施dpage T坤y (February 22, 2013), Online at www.medpagetoday"



com/HospitalBasedMedicine/GeneralHospitalI)ractice/ 37496, 13 ・・Bear Steams Ex-Staffer P獲eads Guilty to Taking Funds in



check Scheme,,,耽e W拙Sfreef LJourr証’(February 26’



26 “So。i。I Media Emerges as Major Tool for Background check of EmpIoyees: Survey’,, DM (September 14, 2014), online at dnai,in/Cn4m; “Survey: Social Media Back・



ground Checks, Policy Enforcement・”朋Dady Adγisor (Sep亡ember 4, 2014), Online at shar.es/1GNkle. 27 “Three Approaches to Pre-Screening Job Candidates’’’ERC



(July 14, 2013), Online at www.yourerC.COm/blog/POSt/



3-Approaches-tO-Pre-Screening-Job-Candidates"aSPX. 28 ・・How to Save Lives,,,丑e Ecor10m[st @ctober 23, 2010), P. 72'



29 See, for example, “German-Style Training for American



Factory Workers,,・ The V‘硯Street JourrlaZ (September 9’ 2014), Online at on.w争i "COm/11U4XsG. 3O “Improve Your EmpIoyee廿aining Sessions’"鎚s王rlesS Week



(February 2, 2010), Online at www.businessweek.com.



2002), p. C14・ 14 “How a Tiffany・s EmpIoyee Stole $1.3 Mi11ion in Jewelry’’’



31 ・・Mentors Make a Business Better;, Business Week (March



20, 2008), Online at www.businessweek.com.



Busincss Week Uuly 8, 2013), Online at www.bloomberg. com/bw/articles/2013-07-08/how-a-tiffanys-emPIoyee-



32 “Fim Shares Tips for Succession Planning’,,丑e W加工Street



J。um。Z Oanuary24, 2014), Online at on.w車com/1caDnQH. stole-1-doト3-million-injewelry.



15 ・・Memorable Memo: McDonald’s Sends Operations to War



33 “Skillsoft Selected as Gold Winner in Exce11ence in Social



Leaming by Chief Leaming O鯖cer Magazine," Business



on Fries,” The W拙Street JourrlC直December 18’1997)・



wire (September 26’2012)’Online at www.businesswire.



online at on.w料com/1xjJzSy・



com/news/home/20120926OO5748/en/Skillsoft-



16 ・・Digital Taylorism’,, T71e EcorlOm[st (September 12・ 2O15)’



selected-Gold-Winner-Exce11ence-Social-Leaming.



online at econ.st/lQqLUAM.



34 ・As Employers Push Efficiency’The Daily Grind Wear§ 17 ・・廿acking Wockers・ Every Move Can Boost Productivity- and



Down Workers;・ The Los AngeZes Times (Apri1 7’2013), stress,” The LosArlgeZes ’Z証es (Apri1 8, 2013), Online at w .



online at fw.to/yxImzOM・ 1atimes.com/1a-fi-harsh-WOrk-teCh-20130408’O,6413O37.



35 Codes QfCondrc亡: A Bc[rrier or Brec[軸rong坤r Corporo亡e



Be庇高oLlr? (PwC, 2013), Online at www.ibe.org.uk/



18 《・Driver Fatigue Cited as Cause of Crash that巾ured



u sera s s ets/SurVeyS/PWCCO de sofconductrep ort2 01 3 ・P df. comedian;, AP (August ll, 2O15), Online at bigstory・aP. uSeraSSeしb/叫1 VCry>/ r’WししuuしoU重し〉…-〉“一-r〉一￣￣￣ ￣￣ ’



org/urn:Publicid:aP・Org:dlbab7054636428c81e75ea540 36 ・・Business Codes of the GIoba1 200‥ Their Prevalence,



1繋輩三警誓菜輩薬輩諾 Memo,・, The War SfrectJournc岬bruary25’2002), P" C16. 37 A Crisis Qf(混ture (The Economist Intelligence Unit’2013),



霧謹霊諾崇豊謹言。8蒜謀議繋箋崇詐 22 Dr涌ng軸icaZ Growh New胸rkets, New C棚enges 39庇egr王tySurvの′20ユ3, OP.Cit. (Emst &伽ng llth GIobal Fraud Survey’2010); See also 4O “Employee Benefits: Share Ownership Schemes - Should . 《 〈… ′,,…r ,.〈_ハ言、∴つnlQ¥_1人手hp.p E7%  YouCoCo?,,,HR施ga加e (September l・ 2008)’Online a[ 匝egrity Sowey 20薦(KPMG Forensic’2013) - Where 57%



www.hrmagazine.co.uk. See also “Could the John Lewis



of the respondents reported that they付believe that policies



Model Work in Any Industry:, T庇7弛graph (November 14・



or procedures are easy tO OVerride,, as a root cause for man-



2014), Online at www.telegraph.co.uk/finance/festival-



agers and empIoyees to engage in misconduct - Online at



of-business/11229674/Could-the-LJohn-Lewis-mOdel-



www. kpmg" COm/CN/en/ Issue sAnd Ins ights仏rticle sPubli-



work-in-any-industry.html; and ``TSB Bank to Move



cations/D ocume ntS/ Integrity- Su rvey-2 01 3 - O -2O 1 3 0 7.pdf.



Tbwards John Lewis Model,,・ The Fin肌cia腫肌es (June 5,



23 ・・廿acking Workers’Every Move Can Boost Productivity and Stress;’op. cit.



2O14), Online at on.ft.com/1kN8dhN. 41 C. Rosen, J. Case, and M. Staubus’坤砂WlyE肌pZayee



24 “New Background Check Survey Reveals Security Issues



in the Screening Process,,, Securtr所をWctch (July 3’ 2014), Online at wwW・SeCurityinfowatch.com/arti-



cle/11545613/new-hireright-SurVey-highlights-POten- 42



tial-SeCurity-gaPS-in-the-SCreening-PrOCeSS. See also `Are workplace Personality Tests Fair?’・, The W拙S亡reet Jour-



坤september 29, 2014)’Online at on.Wgivom/1KHI7CY. 43



25 ``軸re a Lumber Expert, Click Here’,, For柵e (Apri1 3・



2(剛席. 267-70・



104



owrler誼p Js GoodJ扉軌siness (Boston’MA: Harvard



Business SchooI Press, 20O5). J. Blasi, D. Kruse, and A. Bemstein, J油e CompaγryQfOwn-



ers: The T油ot abo“t Stock Qpt{orrs佃d WlyEve7y動pZQyee



shou融耽ye TherrD (NewYork: Basic Books’2003)・ “The Role of Employee Engagement in the Return tO Growth,,,軌StrleSS Wee短August 13, 2010), Online at www. bloomberg.com/news/arti。es/201O-O8-13/the-rOle-Of-



CAS且



W itsky



Witsky and Associates, inc・



empIoyee-engagement-in-the-retum-tO-grOWth. See also



Reveals His No. 1 Leadership Secret;’forbes (Apri1 4, 2012),



“organizations in Central and Eastem Europe with High



online at www.forbes.com/forbes/2012/0423/CeO-COm-



EmpIoyee Engagement Are AchievinすBetter Business



pens ation-1 2-amaZOn-teChnoIogyj eff-bezos-getS-it.html.



Results, Says Aon Hewitt,,, PR Newsw謡e (Detember 3,



52 ``Reward Culture: Strong Foundations;’op. cit.



2012), Online at www.pmewswire.co.uk; and State Qf亡Jle



53 See, for examp獲e, αPeople Work Harder When They’re



Americ肌VMorkpZace (Ga11up, 2013), Online at www.gallup.



Happy, Study Finds,’’T庇財egraph (March 21, 2014),



com/SerVice s/ 1 785 14/State - ame rican-WOrkplace. aspx ・



online at www.telegraph.co.uk/news/health/10713606/



44 “Reward Culture: Strong Foundations,’’P`ry & Ber均缶s



People -WOrk-harder-When-theyre -happy-Study-finds.



(August 27, 2014), Online at www.payandbenefitsmaga-



html;負Virgin Pulse Named One of Bos亡On軌S誼ess Jour-



zine. co.uk/a rticle/reward- Cu ltu re -StrOng-foundations.



rlaZ’s Healthiest EmpIoyers,’’軌s証eSS Wfre (March 27,



45 ``Method in the Madness of the Alibaba Cult,’’The FinαnCidZ



T血es (September 7, 2O14), Online at on証・COm/WAoqTa.



46 See the company,s website, Online at corporate.disney. go.com/C areerS/Cu lture "



2014), Online at www.businesswire.⊂Om.



54 `An Idyllic Workplace under a tycoon’s Thumb:’The W硯 S亡ree上JollrnCIZ (November 23, 1998), Online at on.wsj.



COm/1sMFu7O.



47 See, for example, αTbne at the Tbp: Why Investors Should



55 See, for example, αSatya Nade11a: This Is How I,m Rea11y



Care,’’St「a亡eg[c瑞nαrlCe (March 2013), Online at www.



Going to Change Microsoft,s Culture’,, Busi71eSS血sic!er



皿anet.Org/docs/default-SOurCe/Sf/03_2013_king-Pdf.



Pdf?sfvrsn= O"



48 7加e力・O肌丑e T巾-廿d甲句mfrlg Words証oAcdon (PwC,



Uuly 15, 2014), Online at read.bi/lwpztta. 56 “Colin Fan, Deutsche Bank: `OMG, Colin’sVideo Has Gone Viral,,, The F王narlCiαi珊meS (October 12, 2014), Online at



2013), Online at www.ibe.org.uk/userimages/PWC_tOne_



on.ft,COm/1tlRYDc; ``Deutsche Bank Wams Traders in



from葵the_tOP_2013.pdf.



Video over Boasting and Vulgarity,7, The FinαrtCic{けfmes



49 Quoted in D. Ferguson, “Do Entrepreneurial Companies Lo§e Their Innovative Spark as They Grow Larger?’’Cc[Z BusirleSS (Fal1 1995), P. 12・



(May 16, 2014), Online at on.ft.com/叫1oqi・



57寝Scathing Report Says Toshiba CEOs Had Ro看e in



Accounting Scandal,’’The瑞nαrlC証n柵es (July 20,



50 In addition to the brief description of the Alibaba culture



2015), Online at on.ft.com/1KgFnZB; “Tbshiba Chief



earlier in this chapter, Southwest Airlines is another



Hisao Tanaka Resigns over $1.2bn Accounting Scandal,’’



poster child of a firm with an acclaimed corporate cuト ture. see, for example, G. Smith,伍An Evaluation of the



The Fincmc融Hmes (July 2l, 2O15), Online at on.ft.



com/1edzVbE.



Corporate Culture of Southwest Airlinesブ’’Measu高rlg



58 For further study and a recent academic perspective and



軌slrleSS Exce【ZerlCe, 8, nO. 4 (2004), PP. 26-33; and M.



overview of the control literature in the area of what we



Thomas, ``Strategic Principles at Southwest Airlines,’’



call personnel/Cultural controIs’See M. Loughry・ “Peer



Stra亡egfcDirect[orl, 31, nO. 8 (2015), PP. 10-12.



Control in Organizations;, in S. Sitkin’L. Cardinal, and K.



51 Many articles have been written about these and other leaders, but to mention one as an illustration, See `Ueff Bezos



B珂sma-Frankema, O即証如tZorlal Coutro! (New York:



Cambridge University Press, 2OlO), Chap. 11.



CASE STUDY Witsky and Associates, inc"



Brayton McLaughlin was a young associate at Witsky



In early June, Brayton was assigned to do time-and-



and Associates, Inc., a management COnSulting firm



motion studies at an o鯖ce supplywarehouse and distribu-



亡hat helped small and family businesses with a vari-



tion center located in Riverside, Califomia. Management



ety of issues, including strategy, OPerations’logistics’



needed accurate cost data to be able to negotiate profita-



and corporate govemance. Brayton had joined Wit-



ble contract terms in the forthcoming year. Theywere also



sky two years ago immediately after completing his



concemed that some of the warehouse personnel were



MBA degree.



not performing a11 of their activities e億ciently.



105



Chapter 3. Action, Personnei, and CuituraI Controis It was expected that Brayton would have to be on



A few days later, rather by chance, Pete mentioned



Site for approximately …p hours’at Various times since



Jeremiah’s surprise reaction to Priscilla Musso, Wit.



the center operated 24/7, tO Observe the proper mix of



Sky’s chief financial officer. After some reflection,



activities wil:h enough detail. Then Brayton would have



Priscilla suggested that they perhaps should check



to prepare and submit his report. As Brayton was also



the location-traCking data provided by Brayton’s ce11



WOrking on other prqjects, the due date for his report



Phone. Witsky paid the cell phone bills for the firm七



was the end ofJune.



Staff, and location tracking was one of the applica.



Brayton reported to Pete Mahlendorf, Witsky’s man-



tions that the staff was required to keep turned on'1



aging partner and the lead consultant on the job, that



The firm had never had an occasion to use these



he visited the warehouse and distribution center on



data, but Priscilla thought that it might be useful to



SeVeral days in June, both during the day and night



Iook at it in this instance. Pete and Priscilla checked



Shifts. He submitted his report on time and on budget.



the computer records and found, indeed, that Bray.



On July l, Pete got a phone call from Jeremiah Jones, OPerations manager at the Riverside distribution center. Jeremiah wanted to know when he could see



ton had been near Riverside only once in the month of June. Pete called Brayton into his o鯖ce and asked him to



Brayton’s report. Pete said that he had just received it,



explain the discrepancy. Brayton immediately broke



and he would send it right over. ButJeremiah expressed



down in tears. He explained that because of some per-



SurPrise that the report was丘nished. He told Pete that:



SOnal problems he was waybehind in his work. Tb tryto



As far as I know, Brayton only visited the warehouse once, and that was for a quite brief time,



How could he have finished his report? Maybe he WaS here when l was out, but I have not heard oth-



COPe, he took the shortcut of creating a report based



mostly on data he had found on the Intemet. He admit. ted that he had not spent the requlSlte tlme at the Riverside warehouse and distribution center.



e「S mention his presence either,



Pete checked again with Brayton, and Brayton assured him that he had completed all the needed work.



CASE S丁UDY 丁he Piatinum Pointe Land Deal



In early December 2006, Harry Hepbum, PreSident of



to achieve its 20O6 sales and profit plan. But what



the Southern California Division of Robinson Broth-



was worse, COrPOrate eXeCutives were recommend-



ers Homes, WaS faced with a sign誼cant cha11enge.



ing a sign誼cant downsizing of the division in 2007



The markets his division served had sIowed consider-



to wait until the housing market rebounded. Harry



ably. To sell its homes, the division often had to make



resisted this idea. He thought he had assembled a



Signi丘cant price concessions. But construction costs



great empIoyee team. The division’s performance had



Were COntinuing to rise, SO margins were getting



been outstanding during the good years in the early



SqueeZed. It was clear that the division was not going



2000s. He wanted to keep his team intact. But that



「O6



The Piatinum Pointe Land Deal



required finding a continuing stream of good prqiects



Exhibit l shows the organization chart for the



Southem Califomia division. This division, One Of



rthem to work on.



0ne promlSmg PrQject on the horizon was ca11ed



RBH,s largest, emPloyed approximately 120 people. In



latinum Pointe. It was a large prqject that promised to



2006, it was prQjected to sel1 637 homes, generating



rovide over $100 million in revenue and nearly $14



$235 million in revenue and $4O mi11ion in net income.



一’ .



mi11ion in profits in the 2OO8-11 time period. It would



keep a lot of empIoyees productively busy. Harry really anted to do the prQject. However, the financial prqiec-



Land acquisition



tions suggested that the prqiect would not quite eam



Land acquisition was a key function in the homebuild-



the returns that the corporation required for prQjects



ing business. RBH,s land acquisition personnel had to



with this level of risk. He contemplated preparing pro-



丘nd land on which the company could build homes that



jections that were a “1ittle more optimistic’’to ensure



could be sold at a good profit. The lag between acqulSl-



that the prQject would be approved.



tion of the land and sale of the final house built was typically three to丘ve years. Sometimes the permit-



The company



acqulSlt10n PrOCeSS itselfdragged on for years’With the



company宜ghting lengthy, emOtional battles with city



Robinson Brothers Homes (RBH) was a medium-Sized homebuilder. The company built single-family and higher-density homes’SuCh as townhouses and condo-



miniums. By 2006, RBH built almost 2,OOO homes per year. Because it was much smaller than the largest homebuilders who had economies-Of-SCale advan-



tages,1 RBH focused on building higher quality/higher price homes for first and second move-uP buyers. In



2006, the average dosing sales price for an RBH home was slightly more than $400,00O.



RBH,s stock had been traded publicly since 1995" The company had been highly profitable throughout the past decade, but finances were expected to be much



councils and other permit-granting organizations. On the other hand, SOmetimes land was acquired at “retail



price;, with all the permits already having been granted.



As a standard part of the land acquisition process,



RBH,s land acquisition personnel were required to prepare a detailed land acquisition proposal. These PrOPOSals provided detailed information on: ● the nature ofthe request; ㊨ the location; ㊨ entitlements; ㊨ infrastructure;



tighter in 2007 because of the homebuilding sIowdown



that had started in early 2006. The stock price had



declined almost 50% from the all-time peak in 2005. RBH,s organization was comprised of a headquarters staff located in Denver, CoIorado, and 15 divisions



㊧ PrOduct design; ㊧ market overview; ⑮ enVironmental considerations;



㊨ development fees and costs;



Iocated in most of the metropolitan areas of the Cen-



tral, Mountain, and Southwest areas of the United States. The headquarters staff was small, COmPrised



㊥ SPeCial assessments and homeowner association



dues (if any);



mainly of specialists in the areas of finance’aCCOunt-



㊨∴ SChool information;



ing, legal, information systems’Sales and marketing’



㊧ P重互ect milestones;



and customer service, and their staffs.



㊥ risk evaluations; and,



Each division was largely se11contained, With its own construction supervision, CuStOmer Care, PurChas-



㊥ 丘nancial prqiections.



ing, Sales and marketing, 1and development, land



Many of the detailed proposals were lOO or more pages



acqulSlt10n, and accounting staffs. The only m亘ior func-



in length and often included detailed maps’PrOduct



tion that was outsourced was construction. RBH’s con-



sketches, and excerpts from consultants’reports.



struction superintendents supervised the general



An important part of the proposal-Writing process



contractors who built the homes to RBH’s spec綿cations.



was a detailed evaluation of the prQject’s risk in four



1 For example, D. R. Horton, Inc.’the largest homebuilder in the



The risk in each area was evaluated subjectively into



areas: POlitical, development’market’and financial.



Unlted States, WaS building over 50,00O homes per year.



three categories‥ 1ow, mOderate’Or high. The risk



「O7



Chapter 3. Action, Persomei, and Culturai ControIs assessments in these areas were translated into a mini_



Michael,s experience suggested to him that higher.



mum intemal rate ofretu聖(IRR) requirements for the



density housing’rather than single-family detached



Prqiect, aCCOrding to the proce如re shown in Exhibit 2.



homes, WOuld provide the best use ofthis site. Over the



Many land acquisition ideas failed to progress亡O the



forthcoming several months, he fleshed out the idea



approval stage for any of a number of reasons, includ-



With the division and corporate specialists, Particularly



ing inadequate financial retums’eXCeSS risk in the per



in亡he areas of sales and marketing and construction.



mit-granting process, Or a mismatch between the needs



He also contracted for special studies from two outside



Ofthe market and the company,s capabilities. Ifthe pro-



COnSulting丘rms. One consulting firm prepared a report



POSals were approved by the division president and



detailing pl句ections ofthe costs needed to develop the



RBH’s cEO and CFO, the division president then pre-



Site. The other prepared a marketing study that pro-



Sented them to the Executive Land Committee of the



Vided pricing and absorption rate estimates based on



Board of Directors for final approval・ Only then could



analyses of competitive o任drings and forecasts of mar-



the monies be released.



ket trends in the geographical area.



The Piatinum Pointe site



homes in two formats: a triplex townhome and a six-



Michael wrote a detailed proposal for building 195



The Platinum Pointe site was identified by Michael Borland’the vice president of land acquisition for the



Southern Califomia Division. The Platinum Pointe site WaS Iocated in the Emerald Estates master planned COmmunity being developed by Jackson Development Company.



Jackson Development was recently formed by Tbm Jackson’Who had formerly worked as division president of one of RBH’s competitors. Michael Borland and



Tbm Jackson were long-time friends, back to their time



together as fratemity brothers at San Diego State Uni-



VerSity. Michael called Tbm soon after he leamed ofthe formation of Jackson Development. He looked forward to developing some prQiects jointly with Tbm.



Plex duster home. Other RBH divisions had produced Similar homes’but the format had not been previously



Offered in Sou血em Califbmia, and some modifications



Were made to appeal to southern Califomia buyers. The homes would range from l,628 to 2,673 square



feet and be priced from $445,000 to $705,000. The executive summary of the detailed proposal, With the required risk assessments and宜nancial pro-



jections, is shown in Exhibit 3.



Michael was disappointed when he saw the projected IRR for the prqject. It was only 21%, Which was below the minimum required for a prQject with this



level ofrisk - 24"5%. He decided to discuss the problem With Harry Hepbum to see what, if anything, COuld be done.



Michael discussed with Tbm several sites in the Plamed Emerald Estates community・ They finally set-



tled on a 21-aCre Site on the northeast comer of the



What to do?



master planned community. The proposed purchase Price was $22,500,OOO plus a profit participation by



Jackson Development in the amount of 50% above 9% net profit, With a soft cost allowance of 20%.2



Harry’tOO’WaS disappointed. He had hoped that the



Platinum Pointe prqject would provide a significant PrOPOrtion of the revenues and profits that the division



WOuld need over the next four-year Period. He still



Wanted to do the prQject. So he and Michael sat down 2 soft costs are cos亡S related to items in a pr(*ct that are necessary to



COmPlete the nonconstruction needs of the prqject, Which typically lndude such items as architecture’design, engineering, Pemits, inspections, COnSultants’enVironmental studies, and regulatory



demands needing approval before constru⊂tion begins.



to take another look at the detailed proposal. What modifications could they make to Iower the required



IRR or to raise the prQjected IRR to ensure that the project would be approved?



Chapter 3. Action, Personnei, and Cuiturai Cont「oIs



Exhibit 2 1RR requirements



Land acquisition opportunitiesr an吐the reIated product choices continue to expand for RoblnSOn Brothers Homes. Given



that risks can vary greatiy from oppo血njty to oppo山nity’guidelines to assess rlSk and the required minImum retumS



have been estabiished, The risks to be assessed are as foIIows:



1. Poi-tical/Entitlement - abiiity to achieve expected entitIements a=d timi=g; 2・ Deveiopment - Site conditions and abi=ty to accurateiy pro」eCt deveiopment costs;



3. Market - eXPerience with proposed product type, PrOduct price points, buyer types, Current market conditions both Current and future; 4. Financial/Financing - ab冊y to achieve projected results and obtain proposed financing.



Based on these factors, a minimum unieveraged旧R is to be estabIished" Risk ratings are to be assessed based on the Projects’specific characteristiCS" Each area is to be rated as Low, Moderate, Or Hゆ. A numericai vaiue is to be a請ached



to assessment as fo=ows:



The minimum lRR for the prpject is assessed as the sum of the ratings assigned in each ofthe four assessment areas,



しow



Politicai



5,0



Development



Market



6.5



5,0



5.0



Financial/Financing



110



Moderate



6,5



6.0 4.0



5.0



High



8.0



8,0



7,0 6.0



帥ibit 3 Piatinum Pointe investment proposal - eXeCutive summary (initiai draft)



The Southem Ca冊omia DiVision is requesting approval to acquire the 21 -aCre Site known as Platinum Pointe in CarIsbad,



CA.丁he slte Wiii yieid 198 detached and attached homes・ The purchase priCe is $22,500,000" The projected lRR is currently 21%, and the required iRR is 24.5%・ CIose of escrow is projected to occur ln June 2007"



PURCHASE The SeIier is Jackson Deveiopment Company, inc. The purchase price of the property is $22,500’000 for 21 net acres・



The purchase priCe is not tied to unit count. We are currentiy projecting construction of 123 tow=home units and 72 cluster units. The Master Deveiopment P-a= aPPrOVai is a ciosing contingency" Shou教d the Master Development Plan not be approved, We have the option to waive the condition or terminate the Agreement・ The ciose of esc「ow is targeted for



June l , 2007, We have the option to purchase two non-refundable nonappiicable 30-day extensions shouid our tentative tract map not yet be approved. ShouId the Seller cause a deIay that wouId prevent us from processing our entitiements ln a timeiy manner, We W川be g「anted the right to have the extensions without payment of the extension fee・ This pro」eCt incIudes profit participatiOn by the Sel-er for the amount of 5O% above 9% net profit’With a soft cost aIiowance of 20%" We have run muitip-e scenarios to inc-ude interest rate increases・ financing optio=S, COnst「uCtion deIays, and a siow



down in absorption. We are comfortabie that we w冊stay beIow the 2O% threshoId"



We have expIored the option of negotiating this deal with no profit participation. Jackson was open to negotiations where we would increase the iand price and move forward w-th no profit participation on the back end of the deai・ But



the increase in land price wouid decrease the projected lRR on the project. RISK EVAしUATION トPoliticai



The property is -ocated within the Emerald Estates Master Pian area. 1t is zoned PCD (Piamed Community Development). The Selier is preparing a detaiIed Master Deve-opme=t Plan (MDP) that w-iI be submitted to the City of Carisbad in eariy Ja=uary 2007. Our proposed project w川be part of that submissio=・ The SeiIer has been working with the City



throughout the creation of the MDP a=d has gained support of the project" if one contingency - PreServation of habitat forthe Westem SpeckIed lもad possibiy located in the area - Can be soIved’the SeIier projects that the guideiines w剛be approved by the City in March 2007" A neighbor claims that the site is habitat for the -road, but the E=Vironmenta。mpact



report has not yet been comp-eted〇一f the -foad issue is reaI, We W冊ave to piace a permanent habitat on the property



We think we can do this without iosing any buiidable iots" With the approvaI of the MDP our review by the Design Review Comm請ee w川be expedited" Our proposed pro」eCt w用be designated Fl-M (Medium ResidentiaI, 8 -10 duplexes/acre)・ Our current site pIan shows a totaI of 195 units・



which is approximate-y 9.29 dup-exes/acre. We have met with the Director of Development Services three separate times. We beIieve that our iatest site plan incorporates the City,s requests. We wiIi need to process a tentative map a=d to obtain approva- from the Design Beview Board for the site p-an and architecture. The tentative map is expected to be



received by May 2007, and al- appea- per-Ods are expected to expire before we cIose in June 2007" . OveraiI poIiticai risk is moderate.



> Deveiopment Site DeveIopmenf The site is current-y raw land, but it wii- be de-ivered as a mass-graded pad. The Seller rece一Ved the g「ading permit on



November 7, 2006, and has sta巾ed grad-ng. Grading w冊e compieted in Ja=uary 2007. The Seiler w帥COnStruCt aii offsite backbone sewer, Water, stOrm drain, dry u輔ty, Street improvements’and perimeter iandscaping・ The street and storm drain P-a=S are aPPrOVed’aS We-1 as the sewer and water pIa=S" Backbone utiiity pIans are currentiy being desig=ed. The



Seller w冊provide u冊y stubs to the site if we are abIe to give them fixed entry locatiOnS Prior to their instaIiing the



improvements" Otherwise, We W冊ave to comect to the systems" The EmeraId Estates master development infrastruc-



ture w冊not be comp-eted prior to our c-ose’but the SeIler w川SOOn begin the improvements. The improvements are being f…ded by the CFD [Community Facii-tieS Dist「ict]. Shouid the SeiIer fai=o make the improvements in the timeline Presented in the agreement a=d their faiiure to compIete the improvements affects our site specificaliy’We have the right to



(Con紡ued)



己旺



Chapter 3. Action, Personnei, and Cuitural Cont「ois



Exhibit 3 Continued assume responsib=ity for complction of the remaining Seiier work, and Seiier sha= reimburse Buyer at = O% of the third Party direct costs" in addition to cooperatjng with Buyer without iimitation, Seiler sha旧nsure that Buyer is abie to draw



against or obtain rejmbursement from the CFD for compieting the rema涌=g lmPrOVementS. As mentioned above, the CFD w用be funding the entire infrast田Cture for the site" The CFD has an approved Resolution of



intent. The Resolution of Formation went to City CounciI and was continued to January 12, 2007. The CFD is confident that the formation w川be heard at the January 13th meeting. The bonds wilI be soId in two issues. The first bond saIe, eXPeCted to be $30-35 miiiion wiii cover backbone infras血Ct=re, incIuding sewer, Water, StreetS, and stom drain. This is expected to occur in



March 2007" The second bond saie wiIi occur approximateiy six months later and wi旧nclude dry utiijties a=d landscapIng. The



CFD has toId us that the appraisai is underway and should be completed shorty They do not see any iSSueS With the appralSai meeting the 3‥1 coverage requirement. The bid package forthe first bond saie is compIete and w紺be subm請ed for City review



in January/February 2006. Furthermore, the City of Carlsbad is the lead agency and -S PuShing to get the backbone infrastructuI℃ COnStruCted・ The improvement pIans have been through muitjpIe pian checks and the tax rate wi= be appr(函mately 「.8%.



ln addition to the infrastructure, the CFD w川be funding certain impact fees, We are expecting to receive a $8,500



Pius credit per unit from the CFD to cover a portion ofthe fees・ The fees that w冊be covered by the CFD inciude webbed toed =zard・ drainage fees, Sjgnalization fees, SeWer and water comectjon fees, SuPPIementai water fees, and A山n PubIic Piaces fee・ Our in-traCt deveIopment costs are derived from a cost estimate based on our current slte P-an, Which was



PrePared for us by the Evensen Group. These costs言ncIuding fees and net of the pianned CFD reimbursement, COme tO $63’088 per unit. This total includes a 15% contingency on construction items and a lO% contingency on fees.



A sIte Visit was performed by an enviro=mental co=Sultant and previous Phase l report were aiso reviewed, Other than



the possibie Westem Speckled -road issue, there are no potentiai envlronmentai concems and no addjtional assessment appears to be necessary" A geotechnicai investigation concIuded that the sjte was suitabie for the intended use, The SeIler w川aiso be establishing a Master Homeowners Assocjation to maintain the perimeter and median la=dscaping. We w川create our own sub-aSSOCiation to ma輔ain our on-Site iandscaping detention basin and recreation fac踊es.



The Se=er w川be mass grading the we= and park sites and designing the park. We wi= be responsible for conStruCting the we= site improvements, eXCIuding the we旧tseif, and construction of the park, We have included $1 ,O m冊on for the park and weII site. The weII site improvements consist of a block perimeter wali, SOme landscaping



iron drive gates and drive approach"丁he park improvements are in the preiiminary planning stages and are expected to inciude landscaping, a tOt lot’Picnic tabies, Shade structures, Walkways and -ighting, and posslbie



restroom fac冊es. The costs of the park and weiI site w冊be initi訓y funded from equity in the short term but wiiI be



reimbursed through the CFD. The weli site wiIi be deeded to the Carlsbad Water District (CWD), and the park w紺be deeded to the City Of Carisbad. Both the weli site and the park w紺be maintained by each entity respectiveIy.



DiI℃C t ConstnノCtion



The townhome product consists of new pians that we have not built before and direct construction costs continue to rjse. However’the ciuster product is a modification of product our Phoenix Division has bu航before. The direct construc-



tion estimates we have used a「e derived from our actuaI costs in building the lO-Piex product in Ei Cajon, Which is



COming in at about $80 psf・ There we added an additional $10 psf to account for the -nCreaSed specs we are inciuding



in these new townhomes.



Overa= we conclude that the riSks associated with both site development and dlreCt COnStruCtion are moderate. ● Overa= deveiopment risk is moderate.



> Competitive AnaIysis/Ma「ket Risk We w川be bu淵ng two product types, a tripIex townhome a=d a six-Plex c-uster product・ The tripIex townhome ranges in



Square footage from l ,753 square feet to 2,442 square feet and wiIi be prjced from $445,000 to $595,000. We feel this PrOduct wili appeal to buyers who work in north San Djego County and second home owners (Weekend or seasonal) who are attracted to a low maintenance home with a larger yard・ The cluster w旧ange in square footage from l,628 square



feet to 2・673 square feet and be priced from $45O,000 to $705,000"丁hese pricing projections are the exact prjces recom-



mended from our marketi=g COnSultant, the Biackfieid Group. This is an upgrade version of a product that was very sucCeSSfui in Phoenix. 1t w紺be highIy amenitjzed. The master baths have been revised to meet the new ``wow” factor that is



PervaSive in this submarket" There is currently very littie competition for attached or mid-density product in the CarIsbad area・ We are currentiy unaware of any other 8 -1 O units/acre deveIopment projected within the Cify of Carlsbad at this



tlme, but we continue to monitor new development projects within the City. We have a compIeted marketing study by the BiackfieId Group that supports our product type and pricing. We are comfortable with the absorption recommendation from Blackfieid given the two very separate product lines. The models in our estimates are current看y sIated to open in Ju-y



2008. Our absorption wouid maintain 1 5 homes per month average as recommended by the Blackf'eId Group. But there



「12



The Piatinum Pointe Land Deai



Exhjbit 3 Conthued



馴Sk. The north San Diego County market has experienced a noticeab-e downturn in the last 12-18 months. 1f interest rates COnt血e to increase and if prjces in markets throughout north San Diego County continue to moderate, We may nOt be abie to maintain our absorption rate’Or We W冊ave to shave our margins,



' The rlSk associated wjth the market is moderate to high.



> Financjal/Fjnancing Risk Al。ndieat10nS are that interest rates w川contjnue to rise・刷e eve刷a冊erest rates j=CreaSe Substa刷Iy duwhg the



tife of this pr函, OUr P「Oduc出’I sti’l be posifioned ,n a mO′℃ a施rdab’e segment of the rrla繭. Give両he s廃of the transaction 648 mi/Iion at March 2009)タSOme form of outside capita, w冊e used・ Lot optjo= and or joint venture W冊e considered and Ieads to the moderate financjaI rjsk.



.胴nancla碗nc鳩胸r is mo朗fe gfro,)鵬prewfousfy 。fecussed po伽a, and deveIopment riske.



iRR I]EQUIREMENTS 虎sGO On the above analysis and assessed risk, the lRR requirements are as foiIows:



lbtalSalesBevenue: Profit($): Profjt(%): EquityRequired二 HomeSizeTripIex二



$112,050,000



$13,707,000



12.2% $8,722,000 2・151sfweightedaverage



HomeSizeCiuster:



2,126sfweightedaverage $93/sfweightedaverage



DirectCostsl十iplex:



DirectCostsCluster:



$82/sfweightedaverage $531,667/unitweightedaverage $571’667/unjtweightedaverage



BaseSaIesPriceTriplexこ



BaseSalesPrjceC山ster:



BaseSalesPriceTripIex:($tsf)



$247.17/sfweightedaverage $268"89/sfweightedaverage



BaseSalesPriceCluster:($庵f)



IRRLeveraged: IRRUnieveraged: 丁O-「ALPEAKEQUiTY



41.4%



21・0%(Required24,5%)



$11,809,000



113



CASE S丁UDY ’’ EyeOn Pharmaceuticals, 1nc,



In early 2016, Frank DeMartino, Senior vice president



Surgery and for the care ofhard, SOft, and gas-Per



Of Science and耽chnology at EyeOn Pharmaceuticals,



able lenses, and a few dermatoIogical produc



Inc.’re皿ected on his concems about the challenges his



Despite contmumg Price pressure from the chea



COmPany faced in controlling its research and develop-



generic drugs entering the market, EyeOn reven



ment (R&D) activities:



and profits nearly tripled over the period betwe



2OO5 and 2O15. In 2016, EyeOn sold products ino¥ R&D is the most criticaI part of EyeOn’s business.



80 countries, and worldwide sales totaled almost



The company wiIi thrive onIy if we are effectjve at



billion.



deveIoping new breakthrough products. in manag-



EyeOn used a traditional product-1ine organiza(i



ing the research function, We have to address



StruCture. Reporting to EyeOn’s cEO were the man



three d輔cuit but important issues. First, We have



ers of each of the product lines, and the managers



to decide how much to spend on R&D. Then we



Science and耽chnoIogy (Mr, DeMartino), Finance a



have to decide how to a=ocate the resources



Administration, Intemational, and Legal.



among the various p「OgramS and projects. And,



finaily, We have to ensure that the resources are used e什ectively. How we address these issues



determines how productive our research activity



Wiii be. I am especia=y concerned about the third issue - how to cont「oI the use of our resources. i don’t



think we do a very good job of measuring our p「o-



ductivity. At the time we are spending our resources, both money and time, and even for SOme time after they have been spent, it is very diト



ficuIt to te= how productive we are being and have



been" We couId be missing some important information about probIems we might be having. I feeI



We ShouId do some thinking about this issue and



What we can do to improve the tracking of our P&D PrOductivity.



The R&D organization R&D was critical to the maintenance of EyeOn’s rate



growth. Over 25% of 2O16 sales were from produ released injust the past five years. The company’s R&D department was headed by



Prakash Kumar, Who reported to Mr. DeMartino. T department included 35O people - 290 scientists (80



Whom had PhD degrees) and 6O support staff. Thep



POSe Of the R&D organization was to develop new, m ketable eye-Care PrOducts that would fuel t COmPany’s growth. EyeOn’s board of directors esta



1ished broad research policies based on the long-ter



Strategies of the marketing divisions, but the boar



depended heavily on Mr. DeMartino and Dr. Kumar PrOVide the guidance and direction necessary to en§u e任ective research activities.



The company and its products



Mr. DeMartino and Dr. Kumar complemented eac Other well in terms of knowledge and experience.



EyeOn Pharmaceuticals, Inc. (EyeOn) focused on the



DeMartino had an in-depth knowledge of EyeOn’



OPhthal皿ology segment of the pharmaceutical mar-



PrOducts and markets because he had advance



ket. It developed, manufactured, and sold a wide



through血e sales organization. Dr. Kumar was



range of products for the diagnosis and treatment of



chemist.



OPhthalmic disorders; that is, those used in the treat-



ment ofdefects and diseases ofthe eye. The company



The R&D department was organized in matrix for With eight key senior directors (plus staff support



marketed both prescrlPtlOn and nonprescription



reporting to Dr. Kumar. On one dimension ofthe matri



drugs, a Wide variety ofproducts for use in ophthalmic



Were four medical specialty groups: OPhthalmoIogy



「14



EyeOn Pharmaceuticais, lnc・



optical, dermatoIogy’and basic research" Personnel in



commercial applications. Scientists designed and



these groups specialized in particular types ofdiseases.



tested new drug compounds against the characteristics



The basic research group was distinguished from the



of the diseases they were studying both in test tubes



other血ee medical specialty groups in that its work



and later in live animal subjects. For most new drug



took place early in the drug development cycle



concepts, these screening and testing activities would



鮎scribed below). On the other dimension of the



last from two to five years.



matrix were four preclinical science departments:



When the compounds moved into the discovery



皿icrobioIogy, Chemistry, tOXicology, and pharmaceuti-



phase of development’EyeOn management assigned



cal sciences. Personnel in these departments were



the effort a development program number. This num-



experts in one of these scientific fields. Each research



ber identified the effort until the product entered the



ram and prQject was managed by a medical spe-



clinical phase of testing. In 2O16, EyeOn had a total of



ty expert. The preclinical science personnel were



ll development programs underway, 4 each in oph-



gned to programs and prqiects when needed. They



thalmoIogy and optical’and 3 in dermatoIogy.



en had more than one assignment at any particular



A successful culmination of the discovery phase of development was marked by the identification of a



The personnel on the research staff had needs and



compound that showed promise. Such compounds



characteristics that were different from those of



were moved into the optimization phase of develop-



mployees in other parts of the EyeOn organization"



ment. This phase usually involved one to two years of



anagers in the R&D department had to be sensitive to



studies of how the compound might act in the body.



ose differences. The senior director of the basic



Scientists would study how the compound was



esearch group explained:



absorbed, distributed, metabolized and excreted in



animal subiects. They would do some expIoratory testWe,re not an organization comprised of conformists, and we don’t want to be" The other companies



can have those peopIe" Good researchers are unique・ They are creative a=d inte冊gent’and



aithough they ca= be aloof a=d seemingIy disengaged, theywiIi work theirta=s o竹When they get on



a project they like, But theirfeeiings are easily hurt" it’s very easy to k川ideas. We have to be careful



because if we use punishment, discouragement or penalties for faiiure, We may neVer get anOther idea"



ing of toxicity (i.e. harmful side effects) and stability



(i.e. length of time the drug retains its effectiveness when stored). By the end of this phase of development,



the scientists would prescribe a preliminary chemical



formulation and make a preliminary packaging decision (i.e. mode of delivery and size of dosage).



Drugs continuing to show promise were moved into



the preclinical phase of development. This phase invoIved better contro11ed laboratory experiments to validate the results of the expIoratory tests conducted



in the optimization phase of development- The preclinical phase of development usually lasted about 6-12



Product deve看opment cycle The product development cycle in pharmaceutical companies such as EyeOn was Iong’tyPically totaling up to



months. The drugs that continued to show promise were釦ed as IND (Investigation of a New Drug) candi-



dates with the US Food and Drug Administration



15 years for a totally new drug and from. 3 to 5 years for



(FDA). At this point, a reaSOnably complete composi-



a simple product. Often the cycle started with some



tion and speci宜cation existed’and a manufacturing



basic research designed to provide a better understand-



procedure suitable for the preparation of dinical sup-



ing of the underlying biochemistry of the disease pro-



Plies was in place.



cesses at the molecular level. In 2016, EyeOn had five



Once the IND was filed, the prqiect moved into the



basic research programs underway’all in the area of



clinical phase of development. This phase invoIved tox-



ophthalmoIogy‥ in皿ammation, immunology, glaucoma’



icity and stability testing of a longer-term nature than



diabetic retinopathy/cataracts’and drug delivery.



had been done previously. The testing was performed



When a new product concept was fomed’the prod-



on live su切ects: first normal human subjects and then



uct development cycle was said to begin. Development



diseased human sut)jects. During this testing, the sci-



consisted of a number of relatively distinct steps. First



entists would make judgments of the safety and e筒-



was the discovery phase of development’the purpose



cacy of the drug candidates and make final decisions



of which was to identify compounds with potential



about the dosages and modes of delivery to be used.



115



Chapter 3. Action, PersonneI, and Cuiturai Controis The clinical phase of development generally lasted



available for controI purposes because the investments angl



between five and eight yea卦When a product entered



in basic research were longer-term and riskier. As Mr.



the clinical phase of development, a Prqject number



DeMartino explained:



WaS aSSigned. This number would stay with the effort until the product received FDA approval or the e鮒ort



WaS abandoned. In 2016, EyeOn had a total of3O active



What’s important高conducting research is to keep achieving progress on a daily basis, When it take§ ten years to deveIop a product, yOu Can’t wait untii



PrQJeCtS. A drug that passed dinical testing was創ed as an



NDA (New Drug Application) with the FDA. The FDA approval process took from one to three years.



Approval was needed before the drug could be mar-



tomorrow to get the work done,丁he importan(



questions are: Are we doing everything we can to ensure that we are being productive eve「y day? And how can i teiI if we十e being productive?    " ¥上 l高宮・ -



keted in the United States. However, the product could be sold in many other countries after it had passed



Drug investments and payo情s



dinical testing. Exhibit l shows an overview ofthe product develop-



ment cyde" The times shown in the exhibit for completion of each of the phases in the cycle are for development of major drugs. For fairly simple drugs and optical devices, the times were considerably Shorter where INDs were often創ed within 12 months,



and clinical testing took between 12 and 18 months.



New product development invoIved high-risk invest-



ments for potentia11y lucrative payoffs, Across the industry, Only about l of every lO,000 compounds



investigated in the early expIoratory research stages eventually proved to be commercially successful. The PrObabilities offailure of a typical compound in each of the phases of the product development cycle were



approximately as follows:



A shift in emphasis Through most of its history, EyeOn had relied heavily



Phase



ProbabilityofFailure



Discovery



90%



On Other pharmaceutical companies not invoIved in OPhthalmic markets as sources of new product ideas,



Optimization



EyeOn scientists would screen compounds developed



Prec=nical



from these companies, and if they showed promise,



EyeOn would license the compounds and introduce tailored forms of them into ophthalmic markets. Com-



POunds screened in such a manner were entered into the product development process in the preclinical Phase of development because the properties of the COmPOunds were already understood.



In recent years, however, EyeOn management had been shifting their R&D efforts to emphasize more basic research・ As the ophthalmic markets had grown,



Other pharmaceutical companies had entered some of EyeOn’s market segments. These companies were less



PrOne tO Offer EyeOn their newest compounds. Thus, the research focus had been evoIving toward larger-



SCale, longer-tem Studies of more complex and sophisticated diseases of the eye. This is because EyeOn already had a broad product line covering most niches in the eye-Care market’and to meet the company,s



Clinical FDA&Patent



50%



25%



70% NegiigibIe



The payoffs from the research were highly depend-



ent on the magnitude and duration of the competitive advantage that EyeOn eI互oyed when the new products



Were developed. Some drugs were breakthrough prod-



ucts that provided significant advantages over the com-



Petition in large market segments. Others were either minor modifications of already-eXisting EyeOn products or were aimed at small market segments. Some-



times competing firms developed altematives to COmmerCia11y successful new drugs in periods as short



as two to three years, While on other occasions EyeOn PrOducts were sold for 20 years or more with little or no



COmPetition, As Mr. DeMartino noted:



aggressive growth targets, neW breakthrough products



From my perspective, it’s not very important



Were needed. The inevitable shift toward more basic



Whether a product costs $30 mi=ion or $60 m冊On



research made management even more concerned



to deveIop. When we are working on a drug that wiil



about having measures of research productivity



give us severai bi=ion do=ars in saIes over 15 years



「16



EyeO= Pharmaceuticals’inc.



and a 75 percent gross margin’OVerSPending a



By February, all EyeOn empIoyees were required



little on research doesn’t matteLmuch as Iong as



to develop, in consultation with their immediate



the drug gets created.      重・ ・



supervisor, PerSOnal objectives for the year. The



company did not require the use of a standardized The timing ofthe development e任orts was critical. If



e development of a particular drug was pursued too 両he company could be subject to a high probabil-



of failure and/Or Significant extra development enses and, if problems were found after introduc。, POSSible lega=iability expenses・ If the develop-



t was pursued too late’the result would be a



form or format for documenting these objectives, but the ol)jectives had to be written down, and this document had to be signed by both the empIoyee and the SuPerVisor.



During the year, budget updates were prepared on a quarterly basis consistent with the planning schedule. The budget analysis process, 1ike the annual planning processes’WaS Very informal because’aS Dr・ Kumar



explained:



Plaming and budgeting EyeOn u§ed a well-developed set of management sys-



tems to help manage its R&D effort. Planning and dgeting was done on an annual cycle’Which took



lace from mid-July to mid-September. Planning was



We do not expect the scientists to act Iike businessmen when they plan new product activity" We want to encourage them to deveIop new ideas without many constraints, and they don't like a 10t Of PaPerWOrk.



an iterative process. Mr. DeMartino and Dr・ Kumar



Indeed, bne research program manager explained his



began the process by setting program and pr。ject



dislike for paperwork requirements:



obectives and priorities and by outlining an overall budget for the R&D department. In establishing these guidelines’they met with EyeOn directors and top-



level managers to ensure that they had a good under納れdinq ofmarket trends and the amount of resources



e company was willing to spend on R&D. Then direcand managers in each medical specialties group



We work onIy on programs with payo惰s so poten-



tia=y large that a monkey can run the figures showing that the investment is worthwhiIe. The t「ick is to



make the new product wo「k, nOt tO try tO figure out



that a new breakthrough therapy for gIaucoma wi= Pay Off. 1t wiii!



and each preclinical science department determined



Mr. DeMartino had two main concems about the



the labor hours and resources required to satisfy pro-



planning process. First’he wondered if too much detail



ject and program objectives. This process was accom-



was still being required. Second’he wondered ifrequir



plished through a series of meetings between directors and managers.



As compared to plans for the development prQjects,



plans for the basic research programs were easier to prepare because they used few resources from the pre-



ing numbers about the research activities made the



managers and scientists conservative in presenting their ideas. Given the company,s need for good ideas’



he thought it was important that no administrative barriers to ideas be erected,



clinical science departments. Thus’Very little cross-



organizational coordination was required. Most



Measurement and reporting



development prQjects required the assistance of all, Or



at least most, Ofthe preclinical science groups, SO many



Accounting in the R&D department was done on a full



meetings between the managers of the medical spe-



absorption cost basis. Direct expenses・ both labor and



cialty groups and the director of Pre-Clinical Sciences



materials, Were Charged to specific programs and pro-



were required to ensure that resources were allocated



jects. Labor was charged on the basis of time sheets completed weekly by R&D personnel. Costs not specifi-



appropriately and, if necessary’that steps were taken 〔O PrOCure additional resources.



After the plans were prepared’Dr. Kumar reviewed 〔hem and made suggestions and a句ustments as neces-



cally identifiable with a particular prQiect or program



were allocated monthly on the basis of direct labor hours.



sary. Then the plans were consolidated and compared



EyeOn produced an extensive set of cost reports.



with the overall targets. Sometimes further adjust-



Many of the reports were on a prQject, PrOgram, Or



mentS Were neCeSSary・



medical specialty basis. They showed costs by line item 「17



Chapter 3. Action, PersomeI, and Cultu「al Controis



COmPared to budget. These reports were available on a



1ncentive plans



monthly basis. Another set of喋POrtS Showed expenses



aggregated by cost center. The R&D department was



EyeOn used two formal incentive plans offchng cash



divided into 75 cost centers. The cost reports were sum-



awards for good performance, One for scientists and



marized by type of medical specialty and by type of P量Pjec亡or program. The program/Prqiect cost accounト



One for senior-level managers. The sc e:r証s白JICe融ve



pZ肌was introduced in the R&D department in 2013.



ing system provided the information necessary to mon-



Four cash awards of $25,000 each were made annually



itor the flow of resources to medical specialty areas,



for technical exce11ence. The awards were split between



research versus development, and long term versus



SCientists doing basic research and those invoIved in



short term.



development activities,



The prQject/PrOgram and cost center reports were



Candidates for the scientist award were nominated



Sent tO the managers responsible for the costs. The



by senior directors in the R&D department. The candi-



managers reviewed the reports, but they were not



申しi¥間刷 五両hいい =当用¥血圧



dates’accomplishments were judged by a seven-PerSOn



required to explain variances. This was because most



COmmittee which included four working-1evel scien-



Ofthe variances were caused by changes in the scope or



tists, tWO director-level managers, and one person from



timing of the prqject/PrOgram, and such changes were



OutSide R&D (e.g. from corporate marketing). The com-



almost always preapproved by Mr. DeMartino and/Or



mittee assigned the awards based on ``perceptible con-



tributions or unusual problem-SOIving capabilities



Dr. Kumar.



EyeOn management recognized that the cost reports were useful for measuring the inp種でs to the



R&D processes, but they were not useful for measuring the productivity of the R&D activity because they did not re血ect any o叫匹ts. The outputs, Which might



Which are perceptible to fellow workers.’’



The ma珊gemen高nce砧ves were provided through



a company-Wide program which provided stock options and bonuses to managers down to the director level of



the firm. Each year an incentive award pooI was



be measured in terms of profits generated or value



assigned to the R&D department based on a predeter-



Created, WOuld not be known for years. The signifi-



mined percentage of EyeOn profits. This pooI was allo-



Cant lag between the investments in R&D and the



Cated by R&D management to R&D empIoyees included



retums generated ensured that traditional account-



in the plan in coIjunction with the annual performance



ing measures, SuCh as retum on investment, Were nOt Very meaningful except in very long measurement



For purposes of assigning the awards in the R&D



department, R&D empIoyees were classified into



windows.



Tb date, Mr. DeMartino and Dr. Kumar had focused



three categories of achievement: (1) distinguished



their atten亡ion on the deparment’s consolidated丘nan-



Performance (DP), (2) superior performance (SP), and (3) good solid performance (GSP). (A fourth cate-



Cial summary (actual versus plan) and on the major



R&D achievements of the year. In the last few years,



gory called “Needs Improvement’’was also used on



these achievements were as follows:



OCCaSion, but, aS Dr. Kumar observed, “these colleagues don’t get to stay very long:’) Table l shows the



2013



2014



2015



approximate percentage of people who were class誼ed



in each category of achievement and the bonuses that iNDsf=ed



NDAsfiied



3



6



ResearchpubIications



25



4



3



5



3 CategOries.



19



COuld be expected in an average year in each of the



17 “i古bIe 「



Patentapp=cationsfiIed Patentsindicateda=owable Patentsissued



5



15



9



8



7



8



5



6



4



Categoryof



DP They realized, however, that none of these indicators was a totally reliable indicator of forthcoming com-



mercial success.



118



PercentSo



Achievement



SP



GSP



AverageAward



EvaIuated



、 and are no responsfve 〔O changes血〔OCfaJ唇fd料



mOVlng eCOnOmy; ㊧ Centralize power in the organization and stifle initiative;



㊥ Separate planning (thinkers) from execution (doers);



㊨ Cause too manycosts for too fewbenefits; and so on.



The more moderate critics make a number of suggestions for improvement involving (relatively minor) mod脆cations to traditional planning and budgeting processes, SuCh as updating



Plans more frequently (roZ航g pZ肌processes) and using re庇ive pe所,rmanCe S亡肌dards and S均ec亡fve pe加rmc[rlCe eVαfua轟orlS rather than relying exclusively on fixed budget targets and



Pre-agreed incentive formulas. But some of the critics go further, impIoring managers to abandon traditional budgeting and to move bの。Jld bL‘dge血g・37



One of the budgeting-abandonment success stories cited by many critics is that of the



Swedish-based Svenska Handelsbanken, Which eliminated budgets in 1972 and has never looked back to reintroduce them. Svenska Handelsbanken has no annual budgeting process, and it produces no budgets; instead, it evaluates the bank’s and its managers’performances by



COmParing them with measures of competitors’performances on key performance dimensions,



SuCh as retum-On-CaPital, COSt-tO-income ratio, and profit-Per-emPIoyee. Whereas Svenska Handelsbanken has been successful in managing the firm without budgets, it must be noted that most firms are not in an industry with such homogeneous entities as banking. Therefore, many firms do not have such good relative performance data avai量able to them. Moreover,



Svenska Handelsbanken sti11 has to engage in many of the standard planning and budgeting elements described above to ful創I all the other purposes, Other than motivation, SuCh as plan-



ning, COOrdination, and facilitation of top management oversight. The critics are correct, however, that many fims’plaming and budgeting processes are inef-



fective.38 Designing and implementing plaming and budgeting systems is complex and di鯖Cult. The purposes for which the systems are needed often conflict, neCeSSitating some di鯖cult tradeoffs.39 Business conditions are prone to shift’yet it is di鯖cult to adapt plans and budgets



quickly. In any case, it is sometimes counterproductive to set performance targets because they Can focus empIoyees unnecessarily narrowly, and they can encourage unethical risk taking or



eamings management (as wi11 be discussed further in Chapter 15).40 The spirit of the beyond-bndge血g management model can be seen perhaps more as a man-



agement philosophy rather than a mere issue ofplanning and budgeting, Or Plaming and budgeting alone. Its key aim, instead’is to increase the adaptability of organizations. Companies



that fallow the beyond-budgeting principles tend to have simple organizational structures (or aim to simplify them), flat hierarchies (or aim to make them flatter, less hierarchical), and flexible pee手to-Peer netWOrks used to provide and exchange the benchmarking data and share best



PraCtices. They operate with an assumption that organizations, like natural systems, are CaPable of selforganization and selfregulation. Their managers do not require negotiation of fixed Performance targets’aS is done in a亡raditional budgeting system. Allocations of resources are



event-driven, nOt Calendar-COnStrained. Allocated resources are not treated as entitlements that must be spen亡・ Unconstrained by a fixed and outdated plan, emPIoyees strive to improve



311



Chapter 8. Piaming and Budgeting their performance relative to their peers or some other benchmark. Creativity and rapid response to cu蓬Omer needs and unpredicted events are encouraged. HoweveI’, there秘‘e nO ``quick fixes’’when it comes to improving an organization’s adaptability



and responsiveness in highly competitive, unCertain, and turbulent environments. Tb improve



the design of a planning and budgeting system, Or anything that presumably takes its place, managers must be aware of all of the purposes for which the systems can be used and wisely Choose the combinations of system elements that best serve these purposes in their settings. The beyond-budgeting ``management model’’has been developed and refined as its use has



spread to several organizations around the world.41 That said, many Organizations continue to



consider budgets as indispensable,42 although many of them also continually struggle to make them more e任ective.43



The key di綿culty is to get the needed flexibility while maintaining the features ofplans and



Planning that stem from drawing managers away from fighting day-tO-day fires, enCOuraging



them to think about the future, and helping them shape that future. But as useful as plans and Planning can be, When they becomej‡m亡ed on a single number or target, they can hinder rather



than help and even become detrimental. Even the best laid plans must allow for some, Or eVen any, Carefully considered a句ustment and flexibility to respond to any of a number ofchanges in



N otes



the environment. This can be done, aS SuggeSted earlier, and as the setting requires, through updating budgets more frequently, uSjng su吐jective performance evaIuations, rOlling forecas亡S,



and possibly other means, SOme Ofwhich we discuss in later chapters, eSPeCially Chapter 12. A



SurVey Of over 50O senior finance professionals by Deloitte, however, SuggeStS that striking this balance is inevitably di綿cult, aS gleaned, for example, from the following two points:44



加塵grαting pね柵Jlg, bndgedng andjbrecas血g - 37% of respondents admitted to a failure to



I See,允rexaⅡ



証ng S即リサ((



2 In additionto



PaPerS by Blo



uring Manag



online at eco1 3 See, forexar



align their planning, budgeting and forecasting effectively. In these circumstances there is a risk that the activities of the organisation will be misdirected, lack focus, alignment and cohesion. Us証gjbrecc厨ing properly - 61% of survey respondents recognised the importance of fore-



CaSting as a way of compensating for the static nature of budgeting. However, there is a fa11ure to appreciate how forecasting can enhance corporate agility and specifically a lack of



The W(調S亡「e



COm/10帥R 4 “Planning a



(2010), Onlln(



5 “Zara’s Secrel



Fbrbes (Oぐto七



understanding of how it fundamentally d推ers from planning, budgeting and target-Setting. As we said at the start of this chapteI’, SOme Of the organizational benefits of planning and



budgeting come from the processes of developing the plans. For plans and budgets to serve a



6 SeealsoM.[



P α競れ【ng諒



(New York: R 7 Quoted fror



useful role’then’the issue is not 14,he崩er to prepare a plan or budget, but 7tow.45



(March 7, 20 8 Inlarge,dlVe busines§eS th



often referre



Conclusion



The indlVidu the corporatl



Planning and budgeting systems are potentially powerful management tooIs that serve multiple PurPOSeS. They provide a way of converting managers’visions into an organized set of tactics that



are empIoyed throughout their organizations. They provide a standard that can be used to judge



Organizational success or progress" And they have many behavioral implications, SuCh as regarding the effbrt invested in thinking about the future and commitment to achieve performance targets.



Many ofthe criticisms ofplaming and budgeting systems, SuCh as those made by devotees of



10 See, forexa



Budgeting PI



Cha nged,’用



(2002), pp∴



P. Schuster,



the so-Called bのりれd-b Jdge血g movement, focus on the組aws of negotiating performance tar-



(He idelb erg,



gets. It is true that allowing target negotiations has drawbacks. The negotiating processes are



11 See, forexal



COStly, Particularly in management time. Hence, firms are willing to engage in the processes relatively infrequently, 〔ypically annually. Thrgets that are丘xed that far in advance can easily



become obsolete, Particularly in fast changing environments. Moreover, allowing negotiation Of targets can also enhance gameplaying, SuCh as the reluctance to share private information to



312



to as ``(strate(



9 20」2B種dg帥



M. Young, “l



Evidence fr(



ra7γ Acco肌(



12 20」2B標dge亡 pp. 3,与・



Notes



be able to create budgetary slack and to maximize incentive payouts associated with achieving



the targets. Still, negOtiating targets has its advantages, aS this chapter has described. Although annual budgets haVe been criticized for inducing gameplaying behaviors and for being incapable of meeting managers’needs in rapidly changing environments, eVidence suggests that they



remain in widespread use and continue to play a crucial role in coordinating and motivating empIoyee actions and behaviors.



However, just because an organization prepares a plan does not mean that it is engagmg m



useful plaming. Frequent criticisms voice that strategic planning is overly bureaucratic and absurdly quantitative. Often plans are prepared but not used; theyjust take up shelf space. For Plans to be effective, they must match the business conditions the firm is facing so that they can be used as a near-COnStant guide for employee actions. The plans should also assign responsibil-



ity and accountability for performance. This is an important role for budgets. Budgets turn Plans into performance targets that a任ect employee motivation, Particularly because the tar-



gets are often linked to performance evaluations and rewards, Which we discuss in the next Chapter, and which must be implementedjudiciously as well to have good e任ect.



Notes I See, for example, 20]2 Budget証g, Forecas由ng,伽d動d乱 ing S工JrVey (Quantrix, 2012).



2 In addition to the original academic articles and working PaPerS by BIoom, Van Reenen, and co11eagues, See “Meas-



uring Management,” TJte EcorlO扇s亡(January 18, 2014),



online at econ.st/1b4aTUl. 3 See, for example, ``Companies Get Budgets All Wrong;’ T71e WdrZ S亡ree亡JoIJrmZ Uuly 22, 2013), Online at on.w争i.



COm/1OfjJaR. 4 “Plaming a Budget (Davis Case Study),’’H肌es ]00



(2010), Online at www.thetimesIOO.co.uk.



13 See also T. Libby and R. M. Lindsay, ``Beyond Budgeting or



Budgeting Reconsidered? A Survey of North-American Budgeting Practices,’’MarlC[ge肌e庇Acco肌房ng Research,



21, nO. 1 (March 2010), PP. 56-75. 14 “The Quanti丘ed Serf,’’op, Cit. See also A, Locke, “Goal-



Setting Theory and Its Applications to the World of Business,’’Academy Qf Ma朋gemerlt Execl‘[ive, 18, nO. 4



(November 2004), PP. 124-25. 15 ``Grow, Grow, Grow,’’軌e Economist (April 17 2010), P. 13.



16 For a recent series ofpapers on the issues oftarget ratchet-



ing, See J. H. Evans, `A Forum on Ratcheting and Incen-



5 “Zara’s Secret to Success: The New Science of Retailing;’



tives,”耽eAcco肌血gRevie男89, nO. 4 Uuly2O14), P. 1195;



Forbes (October 14, 2013), Online at onforb.es/16ZsH74.



C. Aranda, J. Arellano, and A. Davilla, ``Ratcheting and the



6 See also M. D. Mumford and M. Frese, The Payc心ofogy Qf



Role of Relative嶋rget Setting,’’The Acco[仙南g Revfet4;



現〔刷れ諒g誼O7官α証如亡ioれS: ReseαrC九αnd AppHca亡王ons



89, nO. 4 Ouly 2014), PP. 1197-1226; R. J. In4jejikian, M.



(New York: Routledge, 2015).



Matejka, K. A. Merchant, and W. A. Van der Stede, “Eam-



7 Quoted from ``The Quantified Serf,’’T九e EcoれOmisf



(March 7, 2015), Online at econ.st/1GZAcbw.



ings Tatgets and Annual Bonus Incentives,’’耽eAcco肌でi7章g



Rev[e叫89, nO. 4 Uuly2014), PP. 1227-58; R. J. In句ejikian,



8 In large, diversified corporations, the question as to which



M. Matejka, and J. D. Schloetzer, ``丁hrget Ratche亡ing and



businesses the corporation should (and should not) be in is



Incentives: Theory, Evidence, and New Opportunities,’’



Often referred to as “(corporate) divers㌍c誼orl Strategy.’’



The individual stra亡egies for each of the businesses that



the corporation has decided to pursue are, in tum, referred to as ``(strategic business unit) compe証fve sfra亡egies.’’



9 20ユ2 B可se血g, forecas血g, Cmd PZ肌証ng SzJrV勤OP, Cit., P. 5.



10 See, for example, P. A. Ryan and G. P. Ryan, ``Capital Budgeting Practice of the Fort皿e lOO: How Have Things Changed;’Jour71d QfBl上Siness arld Mcmageme庇, 8, nO. 4



柵eAcco肌血gRe高e1生89, nO. 4 Uuly 2014), PP. 1259-67 17 See, for example, “Burger King Chief Takes Aim at McDonald’s,’’軌e FfrlarlCiaZ Hmes (August 26, 2014),



Online at on.ft.com/1tHvCIY; ``Hedge Fund Manager Bill Ackman Seizes 7.5% Mondelez Stake,’’The瑞n肌cfaZ 丁i肌es (August 6, 2O15), On宣ine at on.ft.com/1DsumCk. 18 20ユ2 BIJdge亡irzg, Forecasting, a71d P!cⅢm血g Surγey, OP.



Cit., p. 8.



(2002), PP. 355-64. See also U. G6tze, D. Northcott and



19 Ibid.,P.6.



P. Schuster, hlVeSt肌e庇AppraisaZ: Met九ods餌d ModeZs



2O “VoIvo Aims for Profit Margins at Top of Heavy-Equip-



(Heidelberg, Germany: Springer, 2015).



11 See, for example, J. J. Gong, W. A, Van der Stede, and S. M. Young, “Real Options in the Motion Picture Industry:



ment Industry,’’Bfoo肌be7g (September 22, 2011), Online



at www.bloomberg.com.



21 ``Continuous Improvement as a Business Strategy: Target



Evidence from Film Marketing and Sequels,” CorltemPO-



Setting (Corus Case Study);’Times JOO (2010), Online at



「oryAcco【側面gResec[rCh, 28, nO. 5 (2011), PP. 1438-66.



www.thetimeslOO.co.uk.



12 20ユ2Bndge血g, Forecas血g, arldP妃伽血gS研V勤OP. Cit.,



pp・3,5・



22 J. Welch, Jac亙S亡raig加重・Om油e G虹(New York: Warner Business Books, 2001); G. Hamel, Leading丑e Revo庇fon



313



Chapter 8. PIanning and Budgeting



(Boston, MA: Harvard Business SchooI Press, 2000); S. Kerr and S. Landauer言`Using S虫etCh Goals to Promote Organizational Effectiveness and-Per雪印al Growth: Gen-



era看Electric and Goldman Sachs,’’Academy QfMcmc[geme庇放ec[l[iγe, 18, nO. 4 (November 2004), PP. 134-8.



O7官C肌[2;C証ons cmd Society, 24, nO. 2 (February 1999),



pp・ 125-37.



33 20]2Bl」dge亡ing, forecc[誼ng, andP血m血gSurγ切OP. Cit., p.与.



34 Ibid., P.13.



23 ``Grow, Grow, Grow,’7 0P. Cit., PP. 12-13.



35 Ibid.,P. 7.



24 As mentioned earlier in this chapter, Edwin Locke and



36 Ibid.,P.3.



Gary Latham are renowned researchers in the area of



CAS各 Royal W



37 See, for example, J. Hope and R, Fraser, Beyond Budgeト



goal setting theory. For a recent re組ection by them on



ing: How M肌agers Ccm Break Freefrom fhe AJl皿d Per-



research in the target-Setting area, See E. Locke and G.



JbrmaれCe Ttap (Boston, MA: Harvard Business SchooI



Latham, “Building a Practically Useful Theory of Goal



Press, 2003); B. Bogsnes,加pZeme証血g BeyO融Budget-



In early Febrし



Setting and Task Motivation: A 35-Year Odyssey,’’A肌er子



irlg: UrlZocking丑e Pe所orm肌ce Pote柾iaZ (London: John



Wiley & Sons, 2008). For an academic perspective, See S.



Europe at Roy



C復職Pycho!og王sち与7 (2002), pp. 70与-17,



budget for the】



25 See, for example, K. A. Merchant and J. F. Manzoni, ``The



C. Hansen, D. T. Otley, and W. A. Van der Stede, “Recent



Achievability of Budget Targets in Profit Centers: A Field



Developments in Budgeting: An Overview and Research



Study,’’The AccoIm訪1g Re高ew, 64, nO. 3 (July 1989),



Perspective,’’Jou「rlCZZ Qf Mcz朋ge肌erl[ Acco章川面g



Of strategic unl



PP. 539-58; and K. A. Merchant, “How Challenging



Research, 15 (2003), PP. 95-116; T. Libby and R. M.



arose not onl



Should Profit Budget Targets Be;’M伽agemerlt Accour正



Lindsay, “Beyond Budgeting or Budgeting Reconsid-



resulting in lc



ing (November 1990), PP. 46-8.



ered? A Survey of North-American Budgeting Practices,’’



recent COrPOra



26 “Tesla Wams Vehicle Sales Target at Risk;’Ifle F玩arlC融 丁主mes (August 5, 2015), Online at on.ft.com/1W2HaVR. 27 See also M. Jensen, ``Corporate Budgeting Is Broken: Let’s



Fix It,’’Harvclrd Bl(Siness Re高ew (November 2001),



MarlC[ge肌e庇Accourlting Research, 21, nO. 1 (March



2010), pp.与6-7与. 38 “Companies Get Budgets A賞l Wrong;’op. cit. 39 S. C. Hansen and W. A. Van der Stede, “Multiple Facets of



tegic outlook f《



Strategy・



Since the la



Organic food



PP. 94-101; and M. Jensen, “Why Pay People to Lie?,’’



Budgeting: An ExpIoratory Analysis;’Marlage肌e所Accou柾



growth at we



丁he W拙S亡ree亡JoIJrnCIZ (January 8, 2001), P. A32.



irlgResea7ch, 15, nO. 4 (December 2004), PP. 415-39.



growth began



40 L. Ordonez, M. Schweitzer,A. Galinsky, and M. Bazeman,



``Goals Gone Wild: The Systematic Side Effects of Over-



5%, thereby n tions. Worse,



Performance Measures: Empirical Evidence from Amual



PreSCribing Goal Setting,’’Academy q手MczⅢge肌e庇



ment to believl



Bonus Plans of Loss-Making Entities;’MclⅧgeme庇Sc子



Perspec証ves, 23, nO. 1 (2009), PP. 6-16,



28 See, for example, M. Matejka, K. A. Merchant, and W. A,



Van der Stede, ``EmpIoyment Horizon and the Choice of



erlCe, 55, nO. 6 Uune 20O9), PP. 890-905. 29 See, for example, W. A. Van der Stede and T. Pa獲ermo, “Scenario Budgeting: Integrating Risk and Performance,’’



瑞nczrlCe & Mαmgemeγ江, nO. 184 (January 2011),



PP. 10-13. See also N. Frow, D. Marginson, and S. Ogden,



“Continuous Budgeting: Reconciling Budget Flexibility



in the market



41 For more information, See the Beyond BI上dge亡irlg Ins庇L[te,



Online at bbrt.org (accessed December 2015). 42 Libby and Lindsay, “Beyond Budgeting or Budgeting Reconsidered?’’Op. cit. See also B. Ekholm and J. Wallin,



“Is the Annual Budget Really Dead,’’耽e軌rOpe伽



level of uncert Of negative gr《



OPing an alte account a “wl



Acco【Jrlt王rlg RevIet生9, nO. 4 (200O), PP. 519-39; T. Libby



nues. But to



With Budgetary Control,” Accou庇Zng, Org伽fzc[tious仰d



and R. Lindsay, “Beyond Budgeting or Better Budgeting?’’



needed the su



Socie助35, nO. 4 (May 2010), PP. 444-61; “Managing in



S亡rα亡egic FirlarlCe (August 2007), PP. 47-51.



the Fog,’’T心e EcorIO証st (February 26, 20O9), PP. 67-68.



43 J. Orlando, ``Thrning Budgeting Pain into Budgeting



30 20ユ2BIJdgedrlg, Forecasting, CmdP!伽n血g S【JrVey, OP. Cit.,



Gain,’’S亡rc江egic Ftrtcmce (Mar⊂h 2009), PP. 47-51; ``How



p.12. 31 There is an extensive stream ofresearch in the area of



JourrmZ QfAcco【J庇arley (February 20, 2014), Online at



budget participation going back nearly half a century. For



a study that speaks to some ofthe benefits discussed here, among many other studies too numerous to list here, See



to Better Connect Planning, Forecasting, and Budgeting;’



shar.e s/ 1Gxnwf. 44血tegraとed Pe頑〕rmanCe Ma朋gemerlt (Deloitte, 2014),



Online at www.planbudgetforecast.com/report.



M. Mah量endorf, U. Schaffer, and O, Skiba,くAntecedents of



45 For an academic study on the use and usefulness ofbudg-



Participative Budgeting: A Review of Empirical Evi-



eting (in times of economic crisis, for example), See S. D.



dence,’’in M. J. Epstein and J. Y. Lee (eds.), Advances諒



Becker, M. D. Mahlendorf, U. Scha任er, and M. Thaten, “Budgeting in Times of Economic Crisis:’Co庇empora7γ



Marlageme庇Acco肌t誼g, 25 (2015), PP. 1-27. 32 T. Libby, “The influence ofVoice and Explanation on Per-



formance in a Participative Budgeting Setting,”Acco肌ti喝



Acco肌亡ZngResearch (2016), in press,



utive Board.



Royai Wes



In the sevenl



Netherlands l trading natio



ried new and the far-flung



Caribbean a] this trading a



and unloade( lined the Ri「



warehouses



trader oftha( Sanen teame



Laan, tO trad



314



CASE S丁UDY



Royal Wessanen NV



In early February 2009, Sjoerd Schaafsma, CFO



The then-neW COmPany WaS Called Wessanen &



Europe at Royal Wessanen, WaS POndering on the



Laan.



budgetfor the remainder of20O9 as well as the stra-



By about two-and-a-halfcenturies late扉n 2008, Royal



tegic outlook for 2010 and beyond. An era with a lot



Wessanen NV developed into a group with operations in



Ofstrategic uncertainty laid ahead. The uncertainty



seven countries in Western Europe and North America.



arose not only from the global economic∴Crisis



Royal Wessanen NV was listed on the Midcap Euronext



resulting in lower revenue growth, but also from



stock market in Amsterdam. Revenues were fl.6 bi11ion



recent corporate decisions to change the company’s



SPlit 4O-6O over Europe and North America’reSPeCtively.



Strategy・



(See Exhibit l for a combined overview of the revenues



organic food had shown a very satisfying amual



and EBIT ofWessanen by business and location.) Wtssanen had a two-tier board structure. The Board



growth at well above lO%. Since 20O8, however,



consisted of the chief executive officer (CEO), Chief



growth began to sIow and had stabilized at less than 5%, thereby no Ionger meeting corporate expecta-



American operations. The CEO also acted as president



Since the late 1990s, Wessanen’s main market of



financial officer (CFO), and president of the North



tions. Worse, the economic recession led manage-



Of the European activities. Under the Executive Board,



mentto believe that 20O9 was likely to show a decline



there were two leadership teams: One for the European



in the market for organic food. Because of the high



and one for the North American markets, reSPeCtively



level of uncertainty, and not ruling out the possibility



(see Exhibit 2).



Of negative growth, Mr. Schaafsma considered devel-



In the second half of 2008, reVenue groWth dropped



OPing an altemative forecast for 2009 to take into



from lO% to below 5%. Key challenges were to keep



account a “worst-CaSe SCenario’’of declining reve-



growing the top line while protecting margins. Stalled,



nues. But to effectively pursue this, he knew he



or even declining, grOWth became a serious business



needed the support and commitment ofthe fu11 Exec-



reality. The existing strategy set out to cope with these



utive Board.



cha11enges focused on three di縦rentiating capabilities:



寧 Strong and focused brands and excellent branding



Royal Wessanen NV In the seventeenth and eighteenth centuries, The Netherlands was one of the world’s most prominent



Skills;



s Best-in-dass distribution services; 曾 Excellence in category management.



trading nations, With a huge merchant fleet that car-



ried new and exotic materials between Europe and



the far-flung ports of the Far East, the Americas, the



2009 - a year Of transformation



Caribbean and Africa. Amsterdam was the hub of



In February 2009, the CEO left the company. A member



this trading activity where many of the ships docked



of the Supervisory Board filled the CEO position



and unloaded their cargoes into the warehouses that



c[d in柁rtm, While the search for a new CEO was on. At



lined the River Zaan. One of the owners of those



that time, a radical change in the global strategy was



warehouses was Adriaan Wessanen, a renOWned trader ofthat time. In 1765, the 41-year-Old Mr. Wes-



announced to increase the company’s focus on the Euro-



Pean market and concentrate on its leading brands in



Sanen teamed up with his 31-year Old nephew, Dirk



Organic foods. In Europe, Wessanen aimed to become a



Laan, tO trade in “Mustard, Canary and other seeds.’’



負one-SyStem,, company with considerably more



315



Chapter 8. Pianning and Budgeting harmonized brands and centralized sourcing. The plan



and concentration of activities resulted in an expected



請謁5幻亡母で塑誼盤超す守亜重樺す虚Iとち魂藤並仁緩雷冬冒l馳糊彊-



血霊妙壷1電場で盛り筏五0歴∠霊,6虎必o分立ロ型擢ガ慣重態a車￣



Sisted of four ent王ties, nameIy Pahos㌻ I.iberty Rich〔er,



f70O miH王on by血e compIetion of血e divestment pro-



Ttee ofLife, and American Beverage Company (ABC).



CeSSeS (Exhibit l). That said, it would also result in a



TWo business lines - Organic and Frozen - Were tO COnStitute the core of the company’s operations in



Europe. First, Wessanen Europe was a dedicated player



Strengthened balance sheet due to an improved debtequity ratio and lower working capital. The new strategy of less diversi宜cation also intro-



in organic food with a strong presence primarily in the



duced a stronger dependency on a few core markets,



Benelux (including, Chiefly, Belgium and the Nether-



both business- and location-Wise. HoweveI., StOCk mar-



(FDs), and co



lands), the United Kingdom, France, and Germany. The



ket analysts pointed to the risks associated with such



Wtlrdt’s Cor



Strategy for this business line consisted of a so-Called



COnCentration especially due to the large uncertainty in



These corpora



“multichannel approach with channel-SPeCific solu-



the development of the organic food market which had



targets (see



tions.’’Wessanen Europe’s two sales channels were



not yet taken up much space in a typical consumer’s



grocery stores on the one hand, and Health Food Stores



grOCery Cart.



(HFS) on the other hand, With channel-SPeCi宜c solu-



tions ranging from Wessanen-OWned brands to private labels. Innovation was key at this time. New brands



Piaming and controI



Were launched and existing product ranges were



Tb enable the Executive Board and the management of



extended or changed with high frequency, With mixed



budget year (t



the operating companies (OPCOs) to manage and con-



(亡十2;t十3).



levels of success, however, aS is common in宜ercely



trol the organization, Wessanen’s intemal govemance



was referred to



COmPetitive consumer product markets.



StruCture WaS based on a performance framework that



updates were



COnSisted of annual budgets and a monthly and quar-



Strategic plan



invoIved in the distribution and marketing of snack



terly review cycle. A11 planning and performance



both the threa



foods. The Wessanen brand in the Benelux for this was



reporting was done in Hyperion, an Enterprise Perfor-



Beckers. Private labels were distributed and sold



mance Management (EPM) tool from Oracle.



Frozen Foods, the second main business line, WaS



through the Dutch-based Favory Convenient Food



Group, a joint venture with Rabo Private Equity. The



Budgeting was essentially a bottom-uP Planning



updates were



with substanti



activities of the companies in Germany and Italy - Karl



PrOCeSS, Which was guided by the Executive Board with SPeCific targets on the three KPIs that formed the back-



Kemper and Righi, reSPeCtively - Were deemed low on



bone of the reporting in this company: Net Sales (and



The budget



POtential synergies with the Benelux frozen food oper-



by comparison to prior periods, the expected growth in



imately six we



ations. For this reason, they were sold.



Net Sales), Eamings Before Interest and Taxes (EBIT),



year. As partof



and Working Capital.



the local mana



In the latter half of the year, the American Panos brands and Liberty Richter were sold, tOO. The sale of



Net Sales were essentially Gross Sales adjusted for



required for bu



ness challenges



廿ee of Life was announced in December 20O9, 1eaving



discounts. Net Sales were also sometimes referred to as



gets. Mr. Scha



ABC the main operation to divest in the United States. In



the “Tbp Line” or simply “Revenues.’’



had αan informa



the summer of 2009, however, irregularities were dis-



EBIT was calculated from Net Sales by subtracting



tant performan(



COVered in ABC’s books, reSulting in a restatement of its



Cost of Goods Sold (COGS),1 Marketing, Advertising &



folio, PrOduct po



accounts. During that period, the local management



Promotion costs, and Sales, General & Administrative



quality of the pc



team was restructured and a recovery plan to regain



COStS (SG&A). What is broadlyknown as SG&A induded



PrOCeSSeS,’’



PrOfitability was established. The turmoil, however,



many detailed line-item accounts, Often referred to as



meant that ABC’s divestment plans had to be put on hold.



“0Verheads’’although not all ofthese costs were宜Ⅹed.



The budget「



based on Hyperi



Evaluating 2009, it seemed that after two di綿cult



Working Capital conformed to its usual accounting



bled the Corpor



years, including poor growth, CEO tumover, and fraud



definition, including inventory, aCCOuntS Payable旬en-



to roll up thefin



in the American operations, Wessanen had tumed a



dors), and accounts receivable (debtors). Working Capi-



COmer and was back on track with a clear strategy going



tal was tumed into a KPI by dividing it by the last three



POrate Perfom Point reportin



forward. The company had transformed from a widely



months of Net Sales that was extrapolated for the year



overviews froⅡ



diversified conglomerate with many house brands,



by multiplying it times four. This method was chosen



COmmentary Hl



l As was customary in accounting terms, reVenueS minus COGS was



ysis on the cha sumed risks an(



COCktails, SnaCks, and bioIogical food, tO a mOre focused



COrPOration concentrating chiefly on the European



Organic and frozen food markets, The reorganization



316



also separately reported as Gross Margln.



in their forecas(



Royal Wessanen NV and introduced in the budgeting process of 2009 to get



In early November ofeach year, the MD and FD of



the best possible match betwee打the working capital



each OPCO presented their budget to the Executive



Closing position of a specific quarter,創igned with the



Board. It was not unusual within Wessanen that corpo-



re§PeCtive Net Sales, and taking into account seasonal-



rate “upped’’the initially proposed targets by the OPCO



ityeffects (see Exhibit 3).



managers" In the end, however, the targets were set in



Each September,バCorporate Guidelines for the Prep-



aration of the Royal Wessanen Budget,, were issued to the managing directors (MDs), financial directors (FDs), and controllers of the OPCOs by Dick van der



agreement with the Executive Board, COntaining what they believed was the ``optimal’’amount of stretch.



OPCO managers, however, COnSidered their targets “challenging’’in most of the years.



Wardt’s Corporate Accounting & ControI Department.



The targets for Net Sales, EBIT, and Working Capital



The§e COrPOrate guidelines communicated the top-1evel



Were uSed for the bonus schemes of the MDs of each



targets (see Exhibit 4). The guidelines also set out the



respective OPCO. Specifically’the annual bonus pay-



PrOCedures and timetable for t:he budgeting process as



ments ofMDs reflected their OPCO,s actual results rela_



Well as the specifications for use of Hyperion. Technical



tive to these targets, induding minimum, On-target and



information about interest rates, CurrenCy rateS, taX



StretCh target levels. Bonus payouts were calculated as



rates, and capital expenditures were also provided. The



Shown in Exhibit 5. The minimum target level was set at



time horizon for the planning process covered the



9O% of the on-target level, Whereas the stretch target



budgetyear (亡+ 1) as we11 as the two subsequent years



level was set at llO% of the on-target level. The three



(t+ 2; f + 3). Plaming for the second and third years



Performance targets were weighted 20-40-40 in the



WaS refdrred to as the存Strategic Update.,, The strategic



bonus scheme; that is’20% of the bonus potential was



updates were designed to corroborate the espoused



based on target achievement ofNet Sales, 40% on EBIT,



Strategic plan and to inform corporate management on



and 40% on Working Capital. Target achievement on



both the threats and opportunities for the coming years,



each performance measure was independent from tar-



induding their potential e紙3CtS On P&L and cash flows



Ofthe OPCOs in light of their strategic plan. Strategic



get achievement on any of the other two performance measures. In other words, target aChievement on each



updates were reported (and entered into Hyperion)



Perfomance measure was strictly cumulative in the



With substantially less detail than the detail that was



determination of the overall bonus payout. Seventy per-



required for budgets.



Cent Of an MD’s incentive pay was determined in this



The budget had to be prepared in a period of approximately six weeks during SeptembeトOctober of each



Way喜that is, based on meeting the targets, and hence,



determined formulaica11y. The other 30% was based on



year. As part of this process, Mr. Schaafsma met with



an MD’s “individual performance;’which was assessed



the local management teams to discuss the m句Or busi-



Sut2jectively (see Exhibit 6).



ness challenges on how to establish the required tar



The base amount ofthe incentive pay was IO% of



gets. Mr. Schaafsma noted that these meetings usually



annual salary. The maximum bonus for MDs was set at



had “an informal character and were all about impor-



25% of salary or 250% of the incentive pay base



tant performance drivers, Such as the customer port-



amount. Thus, for the formulaic part of the incentive,



肌o, PrOduct portfdio, OPerational excenence and血e



at target performance, an MD eamed 7O% of lO% of



quality of the personnel invoIved in the local business



salary・ On average, incentive awards at Wessanen



processes・’’



The budget was reported via two formats. One,



amounted to between 5% and lO% ofsalary. As is customary in most organizations, the remuneration com-



based on Hyperion including all the financial data’ena-



mittee (a committee ofthe Supervisory Board) reserved



bled the Corporate Accounting & Control department



the right to cap or change incentive payouts on a discre-



to roll up the financials of the different OPCOs to a cor-



tionary basis, but this was done only rarely.



porate performance overview. The other was a Power



During the budget year, OPCOs had to submit



Point reporting format which included the main



revised forecasts each quarter to provide the Executive



overviews from Hyperion, but also allowed for more



Board with a latest estimate of the prQjected financials



commentary・ Here the OPCOs had to report their anal-



y§i§ On the changes to prior years and both the pre-



for the year. These forecasts were reported next to the budget, Which was considered the ufixed plan:’This



sumed risks and upside potentials that were embedded



was all done in Hyperion in order to provide the com-



in their forecasts.



pany its αintegrated), EPM for which the system was



317



Chapter 8. PIaming and Budgeting designed・ The reforecast for the third and fourth quar-



on the FIC. The results were communicated to Internal



ter (done at the end of the secohd quarter, Or end of



Audit and the Executive Board. A summary was cOm-



what they ha



June) also required an update fof the如bsequent two



municated to the Supervisory Board. For any identified



gories. These



years on the three KPIs. In September, then, COrPOrate guidance was established for the upcoming year’Which



was the starting point for the upcoming budget discus-



controI weaknesses, an aCtion plan was put in place by



management. progress on these action plans and fol-



low-uPS On any intemal audit issues were reported and discussed during the QBRs. A risk and control databa§e



Monthly, aCtual financial perfomance was reported against the budget-tO-date and the latest forecast-tO-



was kept to keep track of all the reported risks and



had a fixed



were deem POtential g



ing, andpr



the top lin



improvement or寝mitigation,, plans.



The WCC provided empIoyees with a set of moral



ther reduci



hour conference calls between the Executive Board,



and ethical guidelines for how to do business and how



s ut)j ug ated



Mr. Schaafsma, and the respective OPCO,s MD and FD・



to achieve results in an appropriate manner. It included



Much more extensive face-tO-face discussions took



Wessanen,s Mission, Core Values, Business Principles,



ParameterS



and Guidelines. The Guidelines dealt with several top-



der Wardt



date. Variances were discussed monthly during half-



place among the same group of people each quarter in



order to vet the performance of the previous quarter



ics, induding information security’insider trading’



and the forecast for the remainder of the year. This



gifts and favors, bribery and corruption. The WCC also referred to Wessanen,s whistle-blowing policy, fraud



was ca11ed the Quarterly Business Review (QBR). Mr. Schaafsma commented:



accountmg P



in Hyperion



Ward analyz



policy, SuStainability policy and applicable authority limits.



Our QBRs are not just “talking shops・’’We require



the OPCO managers to make detailed 「eports in



Chailenging times (ea「ly 2009)



shipping. As it



eastry last for two hours, and they are ``honest’’-



Tb get the management support he knew was required,



Put down a ta



sometimes bruta=y honest・ We discuss perfor-



Mr. Schaafsma urgently requested a meeting with the



mance on the financials, based on reporting formats



new interim CEO, The CEO supported the idea to



preparation for these meetings■ These meetings



in Hyperion, but we also d「ili deep into nonfinancial



perfo「mance indicators to discuss and grasp the



current state of the business, These nonfinanciais



develop a cost-Cutting scenario that would ‖stress test’’



a possible drop in revenues of lO%. The idea had been floated before in 2008 by the former CEO. At that time,



can have to do with credit notes, CuStOme「 COm-



however, the implementation was not pushed through.



p-aints, Sick-Ieave percentageS and empIoyee turn-



But by this time around, the economic situation had



over, Any and a一一exceptions are flagged up and fair



deteriorated more than it had then, SO Mr. Schaafsma



game for discussion. Ou「 QBRs are, however・ nOt



felt that it was now-Or-neVer tO PreSS On With the idea:



just about operationai perfo「mance" We also use



them to discuss, and decide as app「OPriate’the



Look血g back, and happy about having convinced



launch of new brands; tO eValuate progress On PrO-



the new CEO, l knew that a= eyes were trained on



jects; tO aSSeSS key investments and/or to raise



other issues we suspeCt may be Iurking in our



me to take charge of what turned out to be a fre・ netic process to imp看ement a ``hurricane proof”



OPCOs, Al看told, the QBRs a=ow us to spend some



scenario, I was happy to have joined forces with



・・quaiity time" with our OPCO managers …



Dick [van der Wardt, VP Corporate Accounting & ControI]. The two of us together, With our teams’



Finally, tWO Other components of Wessanen’s inter



worked hard to get this done as swiftIy as possibie"



nal control and governance structure were the com-



韻 schaafsma expl



丁he in¶ueno



clear here. 1



understood



eve車軸印Ⅵ



nario that l



jeopard由n(



Sateguard l



Time was running short, though, because revising



heads, The



the Wessanen Company Code (WCC). The FIC provided



an annual plan made little sense the further they were



approach, (



a clear overview of the control activities applied to the



down into the year. This was March 20O9. The primary



the manag



most important process-level risks of the main business



objective was to keep EBIT at budget level while antici-



functions. The purpose of these control activities was to ensure e任ective and e鯖cient operations, reliable



pating a drop in revenues of approximately lO% relative to the original budget. Given that Net Sales



financial reporting, and compliance with laws and reg-



prQjections were revised down, and given that EBIT



pany-Wide Framework of Intemal Control (FIC) and



ulations. In May of each year’the OPCOs were required



to perform their amual controI selfassessments based 318



targets stayed the same’that implied that budgeted



costs had to come down.



OPCO MD



ance with th葛



come back w levels. Durin talks with th



RoyaI Wessanen NV Mr. Schaafsma,s team developed a model based on



impact of the many tough decisions that had to be



What they had determined to be血e relevant cost cate-



made. Examples of the actions taken were the renego-



gories. These categories induded all e童enditures that



tiation of vendor contracts’Salary freezes, and leaving



had a fixed component in them, but at the same time



VaCanCies open. In some cases, eVen layoffs were on the



Were deemed to have minimal negative impact on



table’Which made the process in one or two of the



POtential growth in Net Sales. The marketing, advertis-



OPCOs rather painful for those invoIved. Mr. Schaafsma



1ng, and promotion budgets were ring-fenced to protect



Observed:



the top line. During this period, management・s atten-



tion was primarily focused on Net Sales and EBIT. Fur_



How the teams handied this cha=enge varied



ther reducing Working Capital was, While important,



CiearIy between those who had dealt with this



Su助ugated to the focus on Net Sales and EBIT.



The financial modeling taking into account these



ParameterS WaS done in dose cooperation with Mr. Van der Wardt who facilitated the technical management accounting part of the process by working out the details



before and those who had ijttle or no experience Wjth cost cutting" Interestingly, and fortunate看y to a



degree・ many Of our managers had been groomed in successful companies, and made great ca「eers,



du「ing times of mainiy growth・ They had gotten



in Hyperion and Excel. Messrs, Schaafsma and Van der



used to `the-Sky-is-the-1imjt, sorts of attitudes,



Ward analyzed all cost accounts per country primarily in



They were now facing a new reality・ For them, the



the SG&A category, and contemplated new targeted cost



rather hard-nOSed meddIing from Corporate came



levels on a line-by-1ine basis. For example, they scruti-



as somewhat of a surprise,



nized travel, Car fleet’PerSOnnel, advisory services, and



That said’Mr" Schaatsma gathered from the discus-



Other expenses related to costs such as warehousing and



Sions with the vast majority of the management teams



Shipping. As it turned out’On mOSt aCCOuntS血ey simply



that the purpose of the exercise was, all things consid-



Put down a target to reduce the spending by lO-2O%.



ered’quite well understood and its necessity not



They also reviewed all Capital Expenditure (CAPEX)



doubted, at least not in conversations with him・ =Maybe



prQjects. For new prqjects, they kept those that they



there is some truth in the proverbial wisdom that



deemed offered a su鯖ciently compelling business case



`necessity is the mother of …;,, he mused.



to improve EBIT. Most ongoing prQjects were continued.



The Executive Board was very serious about the pro-



The last thing they wanted to do was to upset high-



CeSS - they considered the space for negotiations as



皿PaCt Change programs that focused on improving



longer-tem PrOfitability. An example of one of the ongo1ng Prqiects was the European rollout of the ERP system. Based on the modeling and analysis, guidance was



WOrked out for the local management teams. Mr. Schaafsma explained:



The influence of our newiy instailed interim CEO was Clear here. He’but also the other board members,



understood cIearly that action was required. However; they were resolute in their desire to see a sce_



nario that reflected the economic crisis whiie not jeopardizing potential growth. Their idea was also to Safeguard the margins, by 「educing SG&A and oveト



heads. The CEO feIt strongIy that this was the right approach’and somehow reckoned that it wou-d keep



the management teams in the OPCOs on board, tOO,



quite limited. For most OPCOs’the負hurricane proof,,



SCenario was completed after only one round ofdiscusSions and negotiations. In other cases’the cost saving



Plans developed bythe OPCO,s did not meet the Board,s



expectations. In these cases, Messrs. Schaafsma and Van der Wardt guided the management teams of the respective OPCO to reach the savings in alternative accounts and asked them to stretch further, thus requir-



ing an additional round to converge on an agreed plan.



The numbers were compiled in Excel outside of



Hyperion. With the new numbers now available, however, tWO issues had to be addressed. First, it was not dear how’and as what, tO uPIoad the revised numbers



into Hyperion. The Hyperion version that the Corporate Accounting & Control department was running COuld not accommodate two budgets. An upIoad, therefore, WOuld require an override of the original budget



OPCO MDs and FDs were asked to discuss the guid-



With the newly developed scenario. If the original



ance with their respective management teams and to



budget was not replaced’the only way to proceed



COme back with plans to meet the targeted lower cost



WOuld be to report the altemative scenario outside of



levels. During this process’Mr. Schaafsma had lengthy



the system by way of an ``extra,, set ofbooks. But evalu-



talks with the local management teams to discuss the



ating actual results versus the latest forecast and two



319



Chapter 8. PIaming and Budgeting the second halfofthe year to try to grow this business in



budget versions across two systems seemed almost like “too much of a good thing,’’sighed Mr. Van der Wardt,



Exhibit2 0



the face of negative “publicity’’from the discontinued



brands, Which had by themselves, however, helped to



The second and possibly more cbntentious quandary



WaS Whether to change the targets in the OPCO manag-



streamline costs.



The divestments in North America had been



ers’bonus schemes. After an already tough reporting for



most cost line-items even against the original budget,



delayed.廿ee ofLife was eventually sold, but later than



the Executive Board decided to drop the original budget and to宜x the altemative ``hurricane proof’’scenario



Planned, The fraud case that had surfaced in ABC in the summer of 2009 required a restructuring, Which



into the systems and bonus schemes. “The original



delayed the timing by which this business could be



budget was history,’’said Mr. Schaafsma. “It was now



even put up for sale,



hurricane season, and the correspondingly named `hurricane scenario’became the new plan for 2009.’’



The future



Fiscal Year 2009 0Perational results came in cIose to



the hurricane budget. It helped that reorganization



Mr. Schaafsma and Mr. Van der Wardt contemplated on



COStS Came in lower than expected. These costs were



how they could possibly better translate business



related to re-Organizing the legal entity structure fol-



uncertainty into altemative scenarios of the budget:



1owing the split of business lines into Organic and Fro-



Shouid we deveIop these altemative scenarios



zen. Moreover, 1ocations had been rejigged yielding



beforehand rather than during the year? Wouid there



further e鯖ciencies. On the other hand, SOme layo紐汗o



be enough support in the operating companies to do



help reduce overhead had caused one-Off staff-related



this even if there was no ``hurricane’’coming?



redundancy costs. Advertising and promotion expenditures also were substantially higher than forecast. This



What they obviously could not know is whether the



WaS mainlybecause the interim CEO and Mr. Schaafsma



budget would have been met even if it had not been



felt the need to boost the retained frozen food brands in



reset … but would that have been a good thing?



Exhibit l Keyfigures, FY 2008 and FY 2009 (in C mi=ion), Royai Wessanen NV



Structure2008



WessanenEu「ope(BioIogicai



Structure2009 Revenues Food)



France Beneiux UnitedKingdom



Continued



WessanenEurope



FrozenFoods Germany



itaIy



FrozenFoods



FoodGroup



ABC



Non-allocated



Benelux:Backers



∈493



∈120



∈ 90



2009



2008



∈ 501



C123



さ てO2



∈703



Ebit 2008



C  3-



C  3



e 41



∈ 2



∈ 30-



e 725



7b書alCon書inued



2009



∈ 2



∈ 14-



C 8-



∈ 44-



∈ 37



Exhibit 3 Wo



許諾KariKempeiミミミゝ NorthAmerca AmericanBeverage Company(ABC) PanosBrands LibertyBicher FrozenFoods



PanosBrands TreeofLife



TreeofLife



7bfaIDidcont/nued



SouI℃e, Royal Wessanen NV, AmuaIReport 2009, PP 12-13



320



∈ 30



C36 e817



C883



Discontinued C 35



∈35 C802



2009



2008



2009



乞 2-



∈3 e「



∈ 872



2008 ∈1-



モ3 C」「



e  3



e14



New Wo「kln



Exhibit 2 Organization chart, Royai Wessanen NV Supervisory Board Four (non-eXeCutive) members



Executive Board



CEO (PreSident Europe), CFO, President North America (NA)



European Leadership l七am



President Europe and CFO Europe (Mr. Schaafsma)



Exhibit 3 Working capitaI as percentage of sales - neW definition for the 2009 budget, Royai Wessanen NV



IActuai Month Third Party Net SaIes + Prior 2 Months Third Party Net Sales)*4



321



Chapter 8. Pianning and Budgeting



Exhibit 4 General budget guideIines for the 2009 budget, RoyaI Wessanen NV 臆臆臆臆臆〇二〇、臆 Autonomous,SalesGrowth



in%



Europe



Branded



7-8%



NorthAmerica



Distribution



5-7% 7-8%



7-8%



Branded



BasedonROS>10% BasedonROS>10,5%



巨BI丁



Distribution



BasedonROS>5,5% BasedonROS>2.3%



Exhibit 5 Financial targets incentive calcuiation scheme RoyaI Wessanen NV



Exhibit 6 Distribution of incentive payment, Royai Wessanen NV



TSC’s person



Viding dust cont Cations. The sy



Which generate



PaSSed the cle; 15 years TSCr



PrOfits from clil



Exhibit l sh



tem COmPOne]



This case was prepared by Professor Wim A. Van der Stede (London SchooI of Economics) and Dimitri Kruik (Erasmus University Rotterdam). Copyright ◎ byWimA. Van der Stede and Dimitri Kruik.



322



Other system c



ized product



depending on



CASE STUDY 丁he Stimson Company



Henry Stimson, PreSident/CEO ofThe Stimson Company,



the application, and the desired methods of emptying



a small engineering company and manufacturer of dust



the dust bags. The other components, SuCh as main



controI systems and equipment, eXPlained the problem:



and branch pipes, hoods and conveyers’had to be cus-



tom-designed to fit the customer,s equipment and



We have a considerable amount of tension present in our professional staff now’With most of the dis-



satisfaction focused on the project budgeting sys-



tem, Everybody has strong feeiings on the subject" The project Ieaders and operations peopIe feeI



that the original estimates made by the saies engineers are not very reaiistic and, therefore, nOt Very



usefuI for pIanning workloads and schedules" The Saies engineers, On the other hand’feeI that a iot



Of the budget changes are motivated onIy to pro-



Plant layout.



TSC managers preferred to sell complete systems, meaning that company personnel would handle thejob



all the way from design through installation and test. TSC was the dominant supplier of such systems to the



paper industry in the Northwest region of the United



States, but company managers were begiming to consider diversifying both into other industries and into



other products that would utilize their engmeermg expertise.



duce a zero variance, and that there is not enough thought or effort invested to try to meet the budget"



Project management The company



Because a large proportion of TSC’s revenues were



derived from a limited number of large-SCale prQjects,



The Stimson Company (TSC) was founded by Henry



prQject management was very important to the com-



Stimson,s grandfather. The company was privately



pany・ Two roles in the organization were specifically



held, With the Stimson family sti11 contro11ing nearly all



prQject-Oriented: Sales engineers and prqiect leaders



ofthe stock. In 2015, annual revenues were approxi-



(see organization chart in Exhibit 2). The sales engi-



mately $15 million, and the company had just under



neers were responsible for the initial customer contact,



130 fu11-time empIoyees. In the recession of the late



analysis of the problem, definition of the system con-



2000s, TSC’s丘nancial position was weak, but under



cept, Selling, Original job cost estimating, and pricing.



Henry Stimson,s leadership the finances had strength-



The p垂ect leaders were responsible for the detailed



ened to the point where the company had no long-term



technical development aesign) of the prQject and the



debt and was eaming modest profits.



management of the job from time of order entry to



TSC,s personnel had a particular expertise in pro-



completion. Throughout the remainder of this case’



viding dust controI systems for general industrial appli-



PrQject 14321 will be used to illustrate the functioning



cations. The systems filtered the air from machines



of these roles and the company’s management systems.



which generated dust or particulate air pollution and pa§Sed the clean air back into the plant. In the past



Project 14321



15 years TSC had generated most of its revenues and profits from dients in the paper industry・



In 2014, TSC was asked by the Oregon Paper Corpora-



Exhibit l shows a picture ofa core dust controI sys-



tion (OPC) to submit a proposal for a complete dust



tem component: the separator. Separators and some



controI system for the converting area of a toilet葛PaPer



other system components were more or less standard-



processing plant. The machines in the converting area



ized products, although they varied somewhat



took tissue paper from the mill’rO11ed it into Iogs



depending on the type of dust generated’the size of



96 inches wide, Slit it into widths of 414 inches’and



323



Chapter 8. Piannjng and Budgeting



packaged it for sale. OPC was interested in a dust controI



the estimate. The contingency was done on an entirejob



deslg掴:し



system because it would reduce Imintenance on the con-



and not on an individual component unless the risk was



1ng‡ 「ep丁い、



verting machines, make a less dusty product’and keep



high on a particular section of the job, Pe血aps because of



thaし¥1〇五」



the plant safely within federal safety standards.



lack ofinformation about it. The contingencywas intended



TSC submitted an estimate for the entire job, but for



to protect TSC from cost uncertainties. It was not affeded



their own intemal reasons, OPC asked that the prQject



by what the market would bear. However, SOme eXtra reV・



be broken into two phases. Thus, TSC submitted a



enue dollars might be added ifTSC managers felt the com-



phase I proposal for part of the job. This proposal was accepted and TSC began the work. The request for a



Pany WaS in a strong compe血ive position.



proposal for phase II, a job which eventually was assigned number 1432l, followed as expected.



The proposed price of $3,197,640 for the Phase II



work was presented to OPC. It was accepted on November 12, 2014, and that is when the prqject was



standard



assigned number 14321・



standard



ProposaI Project kicko情 For a11 potential jobs where the customer was consid-



ered serious about adding equipment, the sales engi-



On November 13, the prQject kickoff meeting was held.



neer prepared formal estimating sheets. These required



The primary purpose of this meeting was to transfer the



detailed estimates for each element of direct cost, built



responsibility for the job from the sales engineer, Jona-



up by pounds of material and hours of labor for each



than Hemmer, tO the prqiect leader assigned to the job,



system component. These units were converted to doト



Sarbiv Kumar. AIso in attendance at the meeting were



1ars by multiplying by standard costs’Which the



Steve Davis (proposals manageD, Bob Stimson (design



accounting department updated every six months, and



manager), Bruce McIntosh foperations manageI), Mike



by getting quotes for special materials or service.



Giordano (plant manageI), Gary Blasiar (a separator spe-



Tb get to aj珊Z-COS亡eStimate, OVerhead was applied



cialisO, and Mary Fiore Oob cost accountant). Most of the



based on pounds of material or hours oflabor. Account-



discussion at the two-hour meeting was on technical sub-



ing personnel updated annually the 16 overhead rates’



jects, SuCh as about what触er media and fan size were



eight each for variable and fixed overhead categories.



required, and the expert team provided their inputs.



example, a



The price was determined by adding a profit percent



After this meeting, SaI可iv, the pr匂ect leader, Planned



Plete with



onto the full-COSt eStimate. The company’s goal was to



the prQject, broke the tasks into wo水orders starting with



more like



maintain a lO-15% net profit margin on sales (before



the design work, eStal)lished the schedule’and began the



foremen亘



tax). Because time was often limited, Jonathan Hem-



process of coordinating manpower and material needs.



most OPtl



mer, Sales engineer, uSed a rough rule-OfLthumb based



on dollars per required volume of air (cubic feet per



Project cont「oi



minute) to estimate the total cost and price for Prqject 14321. For the breakdown in costs, Jonathan compared



ControI ofthe prQject was an ongoing process, With fre-



this job with a similar, large job completed the year



quent communications required between Sa坤v, the



before. Steve Davis, PrOPOSals manager’eXPlained:



prQject leader, and personnel in both OPC and the various TSC work areas: design, OPerations, and installa-



COmPlete wa§



tion. Each month, Sanjiv was required to assemble a



Report showe



First of all, yOu have to reaIize that these estimates



invoIve a lot of guesses, This project is now being instalied, but portions of the new OPC buiiding a「e



being remodeied’and the work is not yet finished. Their equipment is not in Iocation・ So with this as



with many other jobs, We had to estimate it based on their drawings・ For more or less standardized com-



POnentS, SuCh as separators, those do not cause a big problem. But fo「 customized components’SuCh



monthly repo



Job Status Report which showed the percent physical completion at the end of the month and the predicted dollar variance to completion for each element of cost.



This report was built up from the work order level and



COmPOnent and



summarized by the prQject leader to the level of detail



to - COmPletion:



provided in the original prQject budget. The estimates of percent complete were an impor-



summarized va ances to date fo



tant part of the controI process because they directly



The pr句ecI



a絶頂ed the percent of the budget used for comparison



Shortly after l



Tb protect the company against these prQject uncer



with actual expenditures to date and’therefore’the



job cost accou



tainties, Sales engineers typically added a “contingency’’to



variances. In estimating the percent complete in the



nations of cos



as branch iines, the estimates are onIy guesses.



324



The Stimson Company de§ign area’Sa坤v used drawings as his gauge. Draw1ng§ rePreSented a relatively smaIfelement ofwork, and



that work did not norma11y stretch t証over several



reporting periods" It was generally not difficult either to estimate how long the work represented by a drawing



Should take or tojudge whether that work was done.



appearing during the month and of any obvious errors



fe.g. expenses incurred but showing zero percent com-



Pletion). She was trying to determine whether an actual problem existed or whether’for example, the



Variance was merely a timing problem or was the result



Of a recording error. Any large input errors were cor-



In the fab area, Sa坤V relied on inputs from the fabrica-



tion department. Based on their experience and accumulated records’the fabrication department broke down the



WOrk orders into individual operations and established



Standard for each work order. Then they looked at how



cent complete on each work order. Sa坤V believed their



estimates were generally quite good, better than he could



Around the lOth working day of each month, a COmPany-1evel financial review meeting was held with the key managers in attendance‥ Henry and Bob Stimson,



Standard hours fdr each operation to come up with a total



much they had accomplished and calculated the total peト



rected before the financial statements were produced.



Charles Cowsill・ Bruce McIntosh’Kristina Boyd and



Steve Davis. About 30 minutes of this meeting was devoted to a review of the top 6 to lO prqiects, Which



typically covered about 80% of the costs incurred dur-



ing the month. Mary Fiore would present a summary of



make’but he noted that errors could occur on occasion:



the prqject variances with the explanations provided by



For instance’they may say their fabrication is so



the prQject leaders. The discussion would focus mostly



many PerCent COmPlete on a given work order but l



On OVera11 performance, nOt the specifics ofthejobs.



know we have aIready shjpped aIi of jt. Orthe records



mayshow oniy 50% ofthe materia- on ajob has been



Budget adjustments



Withdrawn’but they are indicating lOO% fabrication.



A number of budget adjustments were made for prQject Field installation was a bigger problem, Sjnce TSC "’as on」y begjnning 〔he estab]ishment of standards for installation. Sa坤v had to rely on the estimates of instal-



1432l. A押endix A expIa血s the rationale and general proCedure for budget a卸stmen亡S. The fo]lowing are two iIIustrative examples ofbudget a匂ustments for prQject 14321:



Iation foremen who were generally optimistic. For



example, a foreman might say that he was 99% comPlete with a work order when the reality was perhaps



A" BIow-back dampers In December and January’WOrk proceeded on pr(桓t



more撮e 85%. Since Sa坤v often worked with new



foremen, it was impossibIe for him tojudge which were



14321, mOSt重y on prQject design. On January 23, 2015,



Sa坤v Kumar submitted a budget a勘stment for $7613 mOSt OPtimistic and which were re工atively pessimistic.



for the in。usion of three blow-back dampers. Nomally,



岨e foremen were able亡O tell SaI垂v which items on the blow-back dampers had to be specifica工ly called out in



awork order were complete, SO Sa坤v had some infor



mation on which to applyjudgments on the estimates.



血e budget, Since they were unique and required a certain amount oftime to be fal)ricated- HoweveちSales engineer



The Job Status estimates were input to the computeち



and the portion of the budget detemined by the percent 伽plete was compared with actual costs



ing a11ocated亡he dollars for the blow-back dampers to M



(Main Line)’instead of separa亡ing them under V (VAIve9



to date. Three



nthly reports were produced. The Detailed Job Cos亡



Or SOme Other designation. But because the blow-back



dampers were shown in the drawing as part ofA anani-



rt showed a comparison of actual costs伍nd labor



fold)’Sargiv released them on an A wo血order. (He later ) wit旺action ofbudget ftotal budget multiplied by



nt complete) fdr variable cost categories only. The



ary Job Cost Report summarized variable costs by Onent and showed variance-tO-date and forecasト



mpletion. The Job Cost Fully Accounted Summary marized variances by component and showed vari_



admitted that he should have gone back to sales engineer



ing and requested that the blow-back dampers be shown



aS Part Of the manifold.) On the job cost report, these



Choices made A Iook bad and M Iook unnaturally good. Sa坤v observed, howeverJhat “Even with th。S。 d。ト Iars allocated to the manifold・ the sales engineering



ances to date for variable cost’餌I costブand net profit.



estimate was extremely low",, It did not include enough



The pr垂cts were monitored by accounting staffl Shor[ly after the reports were produced’Mary Fiore,



POunds for the three blow-back valves. Based on actual drawings’Sa坤v submitted the budget a担stment.



」Ob cost accountant’aSked the prQject leaders for expla-



nations ofcost category variances greater than $2,500



Even after the budget revision, however, When fab actually built the dampers’the actuals were way off



325



Chapter 8. Piaming and Budgeting budget. Sanjiv guessed that the material requirement



actuaIs wouId come in cIoser to 140,OOO po…ds.



Calculation done in design frorrmctual drawings failed



But we are predicting this job wiIi come in at about



to include scrap, Or it may have“been,based on metal



165,000 pounds. Not onIy is the materiaI way off, but



Cuttings of sizes of sheets that did not exist. These dif-



instaiIation on last year’s job took 2,300 hou「s, and



ferences between estimate, design, and fab showed up



We’「e now forecasting 2,800 on this job. The p看at"



as budget variances because a budget a句ustment could



form wiiI make a di惰erence, but not 500 hours,



not be made after work was started. Jonathan Hem-



I agree that in comparison with what was actua=y



neering to discuss the anticipated va「iances to



attempt to develop corrective action,



grand scaIe that was eventuaily drawn up" l



n︰



happened, design shouid have met with saies engi-



OuS Shortcoming, We certainly didn’t think in the O



my contention that the manifoid was over-designed and thus over-bu冊for this appiication, Before this



have anything specific in mind, and that’s an obv主 d



bu冊, the materiai estimate was iow, Howeve「, it’s



We did inciude some hours for the piatforms in the originaI estimate, although i admit we didn’t



量書寡漢○○寡



mer, the sales engineer, COmmented:



know how to expIain the extra 25,000 pounds of



material, There must be some over-designing. But Our OriginaI estimate for fab hou「s was 3,864, a[d



On the latest cost sheets we’re 「uming at about



3,OOO hours, That’s obviousIy to the good, and it’s



B, P漢atforms



On June 16, a SeCOnd formal meeting was held. Design had progressed to the point where it was possible to te11 OPerations that they could look for speci缶c work orders



not consistent with the materia1 0Verrun.



Scope changes/budget revisions



a句usしnle冊



monthS点画



When a scope change required the customer price to be



On a SPeCific schedule, In attendance at this meeting



renegotiated, a budget revision was also required.



Were Sa巾iv Kumar, Bob Stimson, and Bruce McIntosh.



Appendix B describes this price renegotiation and



The next day, because ofwhat he learned at the meeト



budget revision process in general and the rationale for



ing, SaIjiv submitted an adjustment which increased



invoIving the sales engineer in it. The fo11owing are two



the budget by $38,17O, the details ofwhich are shown



examples ofbudget revisions for Prqiect 14321.



in Exhibit 3. SaI可iv elaborated on the largest item,



Which individually caused a $39,910 increase:



A, Move co=ectors



In order to estimate accurateiy, We Can’t extrapoIate



In February, after the manifold was released for fabri-



directIy from past data. We need to Iook more



Cation, Sanjiv, the prQject leader, PrOVided OPC some



On June 24



CioseIy at what’s required from the current job" Last



additional information about where the collectors



OPC insisted



year we buiit a very simiiar co=ector and used that



would be located on the roof and the static and wind



ard, eVen th



as a gauge for estimating. But this co=ector required



loads that would be imposed on the roof. OPC decided



try standar



a minimum of four piatforms that weren’t in the esti-



that these loads were unacceptable and asked that the



be made



mate … I think sales engineering basica=ytook their



COllector be shifted 150 feet north and to the grade



total job



estimate from their oid estimate, But not only did



level of the building, Even though TSC was we11 into



erS PrOteS



they overiook the pIatforms, We OVerran their origi-



PrOduction at that point, an aCCePtable altemative for



a pnCem



nal estimate. They shou獲d have looked at the actu-



the collectors could not be found. Substantial modifica-



however,



aIs on thatjob and not rep「oduced a bad estimate,



tions were required to incorporate the existing mani-



around $4



Jonathan Hemmer explained from his perspective: We have to use last year’s job as a guide. Both coi-



fold with some additional piping that had to be installed. This necessitated a re-eStimate of the job, agreement on a new price, and revision ofthe budget.



iectors have 18 hoppers, The configuration is siightIy



Jonathan Hemmer, the sales engineer, WaS reSPOnSi-



d珊erent, and the size of the OPC coIIector is a little



ble for negotiating the price change. OPC accepted the



SmaIler, l checked against the actuals on看ast year’s



PrOPOSed price increase of $203,50O, and Jonathan revised the budget to reflect the needed changes.



job when that job was about 98% complete, and the SeParatOrS Were lOO% compiete at that time Based



A short time later, SaI可iv also submitted two a句ust-



On that check l estimated we shouId come in at



ments which increased the budget by just under



about 135,000 pounds of materiaしAliowing for some



$47500 because the亀nal drawings showed thejob had



additionaI bracing and reinforcing, I fo「ecast the



expanded beyond where sales engineering had丘gured.



326



Wi= be, So



The Stimson Company



e血s occurred after TSC had received the addi-



al money from the customer, SaItjiv had to adjust



budget. He explained:



Status at August 2015 From the begiming, PrQject 14321 had had its share of PrOblems as reflected by the numerous budget adjustments and budget revisions. The Summary Job Cost Report for 14321 at July 31 showed a small unfavoral)le total variance



Where the manifold le什o情and where the main pipe



versus the budget at the estimated 43% complete, CauSed



began, l may report the costs against the manifoid,



mainly because of the problems in the collec亡or part of the



Whiie the saies engineer had figured the budget in the



separator component. SaI直v Kumar described the current



main, The sum totai forthe manifoid and main may be



PrOblems and his remammg COnCemS:



the same, but we would show a variance for each. We also had a p「oblem with the totaI do=ars



budgeted. This is oniy specuIation, but what may have happened here is that saIes engineering fig-



ured we couidn,t ask the customerfor aIi of the dol-



iars for the change and they decided that TSC WOuid absorb part of the cost.



A gross estimation error has just recently surfaced" The budget for ``Material-Sundry’’in the S (SePara-



to「) component is $41,865. We have ai「eady spent



OVer $45,000, and our forecast to complete is in excess of$67,500, It couid be argued that we shouId have recognized this probIem earlier, but this is also a notabIe exampIe of poor estimating. i’m gojng to



Jonathan Hemmer was not aware of this budget a句ustment at the time but he commented on it several



months later:



l wish Sanjiv had let me know what was happening" There is nothing worse than knowing after the fact



that, for example, yOur manifoId is lO,000 pounds OVer budget, lt may have ended up that way any-



have to adjust the budget upwards in this area.



We couId aiso have more troubie with the budget for management hours. Each addition to project SCOPe Or eXtenSion of the project schedule extends the number of 「eporting periods and increases



management time. Since the company has grown, We have progressed from just ``doing’’a project to



`くmanaging” a project, but the budgets haven’t



Way, but we can’t provide suggestions or leam from



refIected this. On a large project, management time PrOb!ems if we don’t know about them.



can be 20%-22% of the total design budget, but



B. Pipework supports



the originaI budget for 14321 ai看owed onIy 4%-5%.



On June 24, anOther budget revision was necessary.



mates for getting painting and pneumatic piping



In addition, l’m a iittIe worried about the esti-



OPC insisted that the pipework did not meet their stand-



done on this particuiar project. We’re not as good



ard, eVen though TSC maintained that it met the indus-



as we couId or shouid be at estimating othe「trades,



try standard. OPC managers felt that the change should



SuCh as printing, Piumbing and eIectricaI, and I’m



be made at no cost to them, Since they gave TSC the totaljob without soliciting competing bids. TSC managers protested. The disagreement was finally settled with



aprice increase ofjust $15,000. The total cost estimate, however, Which went through as a budget revision, WaS



around $42,500. Sapjiv Kumar commented: This revision is a good example of a major probIem we



not sure there are enough do=ars in there to get the job done 〇〇〇 And fina=y, We COuld aIways run into



SOme PrOblems in instalIation, Since the budget changes had increased the planned



COStS muCh faster than the price had been negotiated upward, the prQject’s planned profit margin had slipped



from an origina1 11% to less than 6% (see Exhibit 4), a



have with saIes - their budget changes are often pain-



level considered below the company’s desired range of



fu‖y siow. in this case, We had known for months that



between lO% and 15%. The margin would slip even



the budget needed revising, and I had to keep prod-



lower if the budget had to be a句usted upward any fur-



ding them to make the change, These expected



theI; and SaItiiv seemed to think it would have to be. Steve



Changes can often span severaI repo巾ng periods, and



Davis Iooked back at the job and summarized his feelings:



it creates confusion as to whethe「 we shouid be report-



jng against the budget or what we expect the budget W航be, Sometimes the revision takes so Iong that the



WOrk is done before the revision comes through.



I don’t think this was a particuIa「ly d櫛cuitjob. I stiIi



feeI that in an overa= sense our originai estimate WaS aCCurate, although I wi= agree that there were



numerous discrepancies in the components. At this 327



Chapter 8. Pianning and Budgeting



point’howeve「, it's even hard to tell that. We may be



seeing va「iances because cchservative estimates



of percent COmPlete are making t胎jobs Iook worse than they 「eaIly are" Design and fabrication seem tO



看ike to hoid back a few percent aS a hedge against



something going wrong Or just the unknown. But more importantly’What seems tO be missing



is a commitment to bring ajob in at the minimum cost possib-e" lf we invoIved the various grouPS in setting the budgets’the numbers would be so



super-COnSerVative that they would be meaningIess, We’d either be pianning p「ojects at a loss or



we,d be prici=g OurSelves out of the market. Not alI of the budgets set by sa-es eng-nee「一ng are tight"



They shou-d be a target tO Shoot for; an incentive for



霊宝霊宝豊露悪禁書誓書易巨剛 tuted a budget adjustment proCedure to allow the pro-



ject leader to change the budget to reflect a realistic standard, but with the following constraints: 1 , No budget a句ustments were allowed once workwithin a labor category (e.g. design, fal〕rication’insta11atioh)



was started within a job section te.g・ SeParatOrS, main)



exhausterS), With the exception of general job costs.



2. No budget adjustments were a11owed unless the adjustment totaled at least eight hours and lO% of the total hours in the work order.



3, All budget adjustments had to be approved by the OPerations manager.



superior performance, SO We are mOtivated to search for creative solutions to our prOblems" We’ve



got to get this commitment internaIized because standards of performance aren’t avaiIabie for eve-



rything we do" We’re not trying to punish anybody’



but the company does have to exist, after a="



Appendix B Budget revisions If for any reason the customer price had to be renegotiated, SuCh as for a scope change or customer-CauSed cost overruns (e.g. schedule delay)’the sales engineer wa§ notified to prepare a budget revision. This involved a re・



estimate of costs, uSing the same Estimating Sheets used



Appendix A Budget adjustmentS



when the prQject was proPOSed’and a renegotiation of



over time, many Changes were likely to be made to the



price. When the price change was agreed upon, the new



system as it was origina11y planned and estimated.



More information would be gathered as to the precise customer requirements’SuCh as for the layout of the



exhaust piping, and as company persomel reviewed the technical design, SuggeStions would be made to improve performance or cut costs.



c。St eStimate was entered as the revised prQiect budget・



Even though at the time of most of these budget revisions, the prQiect leader,s detailed knowledge far exceeded that 。f the sales engineer on the job, because they had been following progress daily’it was seen as desirable to



invoIve the sales engineer in the budget revision because:



In addition, While the sales engineers were conSid-



1, More realistic estimates were likely・ The sales engi-



ered excellent at estimating the total cost of a job, Very



n。erS had been exposed to a broader range ofjobs, and



often their estimates for specific phases of a job (e.g.



they had begun to accumulate a database of standards



main, eXhausters) were very inaccurate’OVereStimated



for recurring operations that could facilitate the esti-



for some parts and underestimated for others’and the



mating process. They were also more skilled at prepar



dollars in the budget would have to be moved between



ing estimates at the concept stage; i.e. before detailed



components. The custom elements of the systems, SuCh



drawings and speci丘cation sheets were availane.



as branch piping, PreSented the greatest estimating uncertainty. Some definitional problems also existed’aS



the boundary between components WaS nOt Clear. A project leader might build on a branch line work order what



a sales engineer estimated as part ofthe main piping. The job budgets were intended to reflect the compa￣ ny’s best estimate of what it should cost to do the work



2, It was a goOd opportunity to develop the sales engineer/CuStOmer relationship because it was a chance to



meet without a new sale being the explicit intent. In addition, it would provide a relationship conti皿ity for



the customer as the sales engineer may have made agreements regarding the specifications of the system that were not put explicitly in the written agreement.



described. This was because while the prQjects were in process, the budgets were important tooIs fdr planning and control, and after a job was completed, budgets which proved to be accurate were use餌as an aid for



estimating future similarjobs. As the prqiect unfolded, 328



3, It was a good leaming opportunity for the sales engineers. By getting out in the field and seeing how the prQject was progreSSing’they could leam’both



technically and in their estimating.



Exhibi= Anatomy of the Stimson lype C Separator 臆_.暮



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0 互白け



護国翼菜園園



Co=ectecfdust。 O O



o



Optionai bagging SyStem for dustless,



0niine emptying Without 「otary value



Or Other powered



equipment



○プap{♀∞・P-a⋮i⊃ga⊇富里dgの⋮g



Exhibit 2 Organization structure



hibit 3 June 1 7, 1980 budget adjustment - Projec=4321 lncrease (Decrease〉 in Budget



hibit 4 PIan and forecast for Project 14321



$3,1 97,640



$3,426,248



$1 ,287,352



$1 ,300,568



$ 353,750



would血e strated? Ho



during the



CASE S丁UDY Multiple Versions of the Plan



Anthony who was m



It was a Sunday. The first day of the annual Strategic



On the call, Sharon explained that she had received



Planning retreat of the Board of Directors of Anderson



the newest budget submissions from the business



Industries, Inc. had fina11y arrived.



units just before leaving the o飴ce on Friday after-



Anthony Rizzo, a yOung financial analyst, had



noon. wanting to get a head start on next week’s



been working for Thom Thomson’Anderson’s



work, She began her review of the company-Wide roll-



recently-aPPOinted chairman/CEO’for the last six



up on sunday morning. Initia11y, eVerything looked



months. He had been given the assignment to present



fine, but she noticed that a few ratios were a little o鮒



the newly developed Corporate Restructuring Pro-



One was the operating expense ratio, SO She wanted



gram to the Board. Anthony was both excited and



to inform Anthony before his presentation to the



Board. Sharon and Anthony discussed some of the The Corporate Restructuring Program was one of



most likely explanations for the exceptions’but lacked



Mr. Thomson,s key management initiatives’largely



the data to reach any conclusions. Sharon commented



because Anderson had frequently been criticized for



that the budgeting process tended to be somewhat



having unusually high expenses. Composed of 83 pro-



iterative this early in the cycle, SO She almost regret-



jects, the program was complex, With many moving



ted her decision to take a quick look on Sunday morn-



parts. However, a key element of the program was to reduce expenses by $100 million while maintaining



ing. Nevertheless’Sharon and Anthony both knew



current revenue levels, thus providing dramatic



them to be concemed that real slippage had occurred.



improvement in a key metric known as the operating



Focusing on Anthony,s presentation’the potential



expense ratio (operating expenses/revenues). Manage-



impact was clear. To meet the targeted operating



that some very ambitious goals had been set causing



ment viewed this expense reduction goal to be a



expense ratio, either revenues would have to increa§e



stretch, but they also considered it necessary’and they



by $25 million, Which was unlikely given the current



wanted to build credibility by demonstrating the company’s ability to meet an important goal. The Board of



economic∴COnditions, Or the expense reductions



would have to increase by an additional $15 mi11ion,



Directors was aware of the program and its obje⊂tives,



which was slightly less than 2% of total company-



but Anthony,s presentation was intended to provide



Wide expenses.



much deeper insight.



After speaking with Sharon’Anthony asked if the



The prior week had been unexpectedly easy. Because



hotel could provide him with space to work・ He was led



of Mr. Thomson,s desire to avoid any surprises, all of



to the hotel engineer,s o鯖ce, a Very Small o鎖ce deep in



the presentations had been finalized by Wednesday,



the guts of the hotel. There’he got back on the phone



and the dry run took place on Thursday" On Sunday,



with Sharon, and they considered the altematives. The



Anthony planned to arrive at the hotel early to have a



focal point ofAnthony,s presentation could be impacted



chance to check the meeting room before the presenta-



in a small, but still material, Way; they could only spec-



tion. The meeting was to start at 2‥OO p.m.’and



ulate about the reasons for the change in prQjections;



Anthony was one ofthe first presenters.



and they could not reach Mr. Thomson. Further’time



廿affic was light, and Anthony was well ahead of



was very short. Should Anthony simply proceed with



schedule. Upon arriving at the hotel, he checked to see if



the presentation as previously approved’Should he try



his room was available. He leamed that he could not



to incorporate the new prQjections into the presenta-



check in for a few hours, but the front desk delivered an



tion, Should he “hide,’the slides showing numbers and



urgent message asking him to call Sharon Carpenter,



try to丘nesse his way around the issue, Or Should he be



Anderson,s head of financial plaming, aS SOOn aS POSSible.



upfront about the uncertainty in the numbers? How



332



Vitesse Semiconductor Corporation



WOuld the Board react if uncertainty was demon-



Board, but that Committee meeting ran longer than



Strated? How would Mr・ Thomson respond静surprised



expected. Mr. Thomson rushed to亡he Board Meeト



during the Board meeting?         - ‥



ing, flanked by a few ofthe Audit Committee mem-



Anthony tried again to speak with Mr. Thomson, Who was meeting with the Audit Committee of the



bers, getting there just in time for the scheduled Start.



CASE S丁UDY Vitesse Semiconductor Corporation



n the semiconductor industry, Picking the right



1ndustry background



&D investments and then turning those investents into successful products largely determines



uccess. To help with that decision process atVitesse



emiconductor Corporation, Marty McDermut (CFO) and Patty Heinen (manager of Financial 1anning and Analysis) had spent the last several Onths developing a business model designed to



ut R&D successes at Vitesse in the proper perspecl¥’e. The model showed that the company would



Firms in the semiconductor industry face some unique



Challenges. Significant R&D spending is necessary to drive future revenues and profits. Because new products



have limited life cycles, Chip manufacturers must continu-



OuSly develop new products to replace revenues from



declining products. In order to grow, they must accelerate



new product growth or improve the retums that the new



Products generate. Most of the spending is focused on



Chieve its Iong-term gOals only if R&D prQjects



applying and extending existing technoIogies, but occa-



enerated at least 35% returns. They proposed mplementing a minimum IRR hurdle rate of 35%



Sionally investments are made to try to develop ground-



Or R&D investments.



Inthe first resource allocation meeting after they



ade their proposal, however, Marty and Patty ere disappoin亡ed tha=he senjor management eam had just approved one par亡jcufar R&D pro尋.to build a new Carrier Ethernet product, With



forecast that was much lower than the desired 洲RR. Mar亡y and Pa〔ty trjed亡O make亡he case galnS白nves[工ng jn thjs prqjecらbu亡they 」ost the



breaking technoIogies that might open new maIkets, Semiconductor chips are components in customers’



PrOducts, SO Chip design is guided by the technoIogical



advances and changing requirements of those customers. Marke〔jng and sales persomel work cIosely wjth



existing and potential customers to understand their needs. “Design wins’’are often secured before chips are



fully developed and available for sale. At the design-Win POint, CuStOmerS design the chips into their products, SO the c埋) manりfacturers begin to have an jdea abou亡how much revenue and profit a specific prqject wi上I generate.



Some risk sti11 exists even after a design win. The



333



Chapter 8. Planning and Budgeting CuStOmerS Can drop a product, miss a product cycle, Or



In 2006, SOme former executives at Vitesse were



even introduce new technoIogy too early. Vitesse miti-



indicted for backdating stock options. The charge§



gates its risk by collaborating cIosely with customers.



were resoIved with a $3 million settlement with the



Revenues from new products ramp up slowly. Using Vitesse Semiconductors’product lines as examples: Chips



SEC. Although there was no guilty verdict or admi§Sion



Of guilt, the scandal was distracting and expensive.



SOld to phone carriers to include in their routers and



About that same time, the telecom industrybegan to



SWitches typically have a lOYear life cycle, With revenues



Shift to packet-based Ethernet networking technolo-



Peaking in years 5, 6, and 7. Chips designed for enter-



gies. Vitesse brought in a new management team that



prise-level networking devicesl have shorter, quicker rev-



included Marty McDermut as its CFO. The new team



enue cycles, but revenues typica11y still do not peak until



Shut down development of many legacy products and



three years after the product is introduced. (See Exhibit l



focused its R&D spending on the development of a new



for Vitesse’s carrier and enterprise revenue cycles.) Oper



line of products based on Ethemet technoIogies. The



ating margins are lower in the first few years of a prod-



move was risky, aS Marty explained:



uct’s life cycle because the R&D expenses are recognized



There were no new products for three to fou「 yea「s,



immediately, Whereas the revenues come later. Many new products are fo11owed by ``derivative’’



PrOducts that build on the earlier technoIogy but are SOmehow improved in subsequent iterations, for exam-



Ple, With more features, better performance, lower POWer COnSumPtion, and/Or lower costs. It is not unusual for a new product platform to generate four to six deriva-



and Vitesse had to continue servicing its signifjcant debt ioad at the same time that revenues from its existing legacy product iines were deciining. The Strategy ki=ed ope「ating margins for a wh=e



because a= the new products were at the same eariy stage of the be=-CurVed revenue cycle,



tive products. The first product is typically the least prof-



The shift to Ethemet tumed out to be a good decision,



itable because of the high initial development costs, but



and by 2O13, the investment began to pay off. Marty and



PrOfit often increases with each derivative. When a new



the rest of the new management team successfully



PrOduct platform is launched, the rough plan for deriva-



explained the tumaround story to Wa11 Street analysts



tive products is outlined in a “product roadmap.’’



by categorizing Vitesse’s products as new, mature, Or



new techl



Curre[



Chip costs decline over time. The most dramatic cost



end-Oflife, and by demonstrating strong revenue growth



In 2013,「



reductions take place between the first and second year



from new products. Revenues from new products dou-



ally on R(



Of production. Yields, Or the proportion of chips that



bled in 2012 and were prqiected to double again overthe



are found to perform properly, tyPica11y improve with



next two years, tO apPrOaCh $60 million by 2014.



VOlume and experience and can increase by as much as



The communications industry was seeing exponen-



50% in the second year ofproduction. Costs are often



tial growth on public and private communications net-



reduced further by lowering material costs and by



works. These networks included those used by



transferring processing and testing functions overseas.



long-distance, local exchange service providers and



Vitesse Semiconductor



aries, 20勺



was foru



R&D凄



Wireless service providers (“Carriers’’), aS Well as spe-



PrQleCtS t



Cialized networks, SuCh as those used by Internet ser-



CeSS. Eve



Vice and over-the-tOP (“OTT’’) content providers.



PrOduct



Vitesse Semiconductor Corporation, headquartered in



Driving the tra描c growth was the rapid adoption of



ally. (Se(



Camarillo, California, designed and marketed advanced



data-intensive applications and services such as web



PrOCedu]



Semiconductor chip solutions for the growing network



access, Web-delivered content, Internet Protocol (``IP’’)



and communication industries. Founded in 1984, Vitesse



Video conferencing and telepresence, IP television and,



COntinued to innovate in response to its customers’



more recently, CIoud storage, CIoud computing, and



and theく



it before Prqie( reSPOnS〔



demands for more data and more sophisticated devices.



Software-aS-a-Service (“SaaS’’) by Enterprises. Power-



The company was known for engineering excellence and



ful mobile devices like smartphones and tablets that



Pline wa



developed several industry leading technoIogies. Vitesse



rivaled and often exceeded the capabilities of desktop



BPRs in(



StOCk was traded on NASDAQ under the symboI VTSS.



machines also consumed these types of services. In the



M arketi]



not too distant future, the industry expected that a



Part, by'



majority of devices, aPPliances, SenSOrS, maChines, ter-



enue an(



minals, Vehicles, aS Well as public and private power



no clear



distribution systems (“Smart-Grid’’) would all be



」eCtS, Or



1 Enterprise-1evel networking devices are used in large companies



Or enterPrises. The word enterprise implies multi-Site, multi-SerVer



applications. Cisco is an example of an enterprise customer.



334



_ ‥        Vitesse Semiconductor Corporation



to these ever-eXPanding worldwide commu-



consistent with short- Or long-term business plans. Gen-



networks, leading to what is commonly



erally, PrQjects were expected to have a 4-5 times ROI2



as the Intemet of Things (“IdT’’). While all



or positive NPV at a 20% discount rate’Which was



nt, this expanding conglomerate of networks



thought to be dose to the cost of capital for Vitesse.



mon challenges: how to provide service



Marty acknowledged, however, that this rate was



nchronization and timing, and security.



somewhat arbitrary; 20% was a commonly used hurdle



ess the cha11enges, PaCket-based Ethernet



rate, but it was not based on any current analysis spe-



g technologies increasingly formed the basis these new applications and services. Long Enterprise networks, Ethernet was expandy in both Carrier and Industrial networks’



cific to Vitesse. The positive NPV guideline was not



dosely adhered to in the BPR processes, either. Everyone understood that new prQjects usua11y returned less



than future derivatives, eVen though that was not



1der technoIogies. In addition, SO-Ca11ed vir-



explicitly stated or quantified with a lower hurdle rate.



technoIogies that started in Ethemet-based



Most of the scrutiny during the BPR process was on the



a centers were making inroads into Enter-



marketing and engineering design data’nOt On the



Carrier Ethemet networks, PrOmlSmg eVen



financial data.



ient network resource utilization. Even in



Process Control, Smart-Grid Energy Distri-



The current issue



ansportation and Automotive networks’the



ansition from proprietary legacy networks to Ethemeトbased networks was taking place.



1 portions of the Carrier, Enterprise and IdT



were expected to be rebuilt based on these 01ogies over the next 5 to lO years.



In 2013, Vitesse was er互oying strong revenue and profit



growth driven by R&D investments from prior years. However, the number of new product launches had slowed down signi丘cantly in 2012, from an average of



3O new products to less than lO. Management knew that the company had a few αgrace,, years during which it



Business Plan Peview Process



would continue to realize growth driven by the increas-



ing revenue stream of current products. But a board



itesse spent approximately $40 million annu-



member asked Marty if the current portfolio of R&D pro-



D. CIose to 60% of that spending was for sal-



jects could be expected to drive long-term reVenue



va§ fnr nrher T)rOject_SDeCi丘c costs. and 2O%



se of shared resources, SuCh as engmeermg Only the “other prqiect-SPeCi丘c costs’’could



d w蘭hout taking drastic皿eaSureS With long-



equences, SuCh as layoffs.



sets and spending were allocated to specific



rough the Business Plan Review (BPR) proy product derivative was considered a new



nd went through the BPR process individu言xhibit 2 for excerpts from the o鯖cial BPR



document.) Marketing initiated the BPR,



growth at the rates that were forecasted in the long-term business plan. It was a good question・ Marty explained’



P「ojects are apprOVed one at a time, but someone



needsねbe ○○ncemed糊肋的e b脚pわ的吟的e financiai impIications of the compiete product porト



foiio. 1n this industry you can make big decisions that dig big holes" You might be OK for a few years・



but if you don’t have enough new products in the Pipeli=e, yOu WOn,t be abie to sustain g「OWth.



The difficulty was that the BPR process was some-



tlre eXeCutive team was required to approve



what disconnected from the company’s business model.



PrQject could move forward.



Vitesse’s business model assumed that new, yet unde-



s were initiated throughout the year, Often in



fined prQjects would be introduced regularly to replace



to a customer’s need. Some financial disci-



revenue from obsolete prQjects. However, the prQject



designed into the pr(加Ct Selection process;



selection process did not guarantee that revenue from



uded detailed revenue and cost prQjections.



selected prqjects would be su綿cient to meet those long



department performance was evaluated, in



term revenue goals. The 4-5 times ROI and 20% hurdle



hether or not new products delivered the rev-



rate was not informative. Marty and Patty wondered if



profit prQjections in the BPRs. But there was nanclal measure or criteria for selecting proor ensuring that a prQject’s financials were



2 ROI was calculated as the 15-year Cumulative gross margin divlded by R&D investment.



335



Vitesse Semiconductor Corpo「ation



‘Cted to these ever-eXPanding worldwide commu-



consistent with short- Or long-term business plans. Gen-



1OnS netWOrks, leading to what is commonly



erally, PrQjects were expected to have a 4葛5 times ROI2



led to as the Intemet of Things (“IdT’’)・ While alr



0r POSitive NPV at a 20% discount rate’Which was



endent, this expanding conglomerate of networks



thought to be close to the cost of capital for Vitesse.



common challenges: how to provide service



Marty acknowledged’however, that this rate was



籾SynChronization and timing’and security・



somewhat arbitrary; 20% was a commonly used hurdle



address the challenges, PaCket-based Ethemet



rate, but it was not based on any current analysis spe-



)rking technoIogies increasingly formed the basis



cific to Vitesse. The positive NPV guideline was not



liver these new applications and services. Long



dosely adhered to in the BPR processes’either. Every-



nt in Enterprise networks, Ethemet was expand-



one understood that new prQjects usually retumed less



apidly in both Carrier and Industrial networks’



than future derivatives, eVen though that was not



cing older technoIogies. In addition’SO-Called vir-



explicitly stated or quan捕ed with a lower hurdle rate.



ation technoIogies that started in Ethemet-based



Most of the scrutiny during the BPR process was on the



data centers were making inroads into Enter-



marketing and engineering design data, nOt On the



and Carrier Ethemet networks, PrOmising even



financial data.



e鯖cient network resource utilization. Even in



trial Process Control, Smart-Grid Energy Distri-



The current issue



n, Transportation and Automotive networks’the



nt transition from proprietary legacy networks to



itous Ethemet-based networks was taking place. antial portions of the Carrier’Enterprise and IdT



orks were expected to be rebuilt based on these



echnoIogies over the next 5 to lO years.



rent Business PIan Review Process



In 2O13, Vitesse was er可oying strong revenue and profit



growth driven by R&D investments from prior years. However, the number of new product launches had sIowed down significantly in 2012’from an average of



30 new products to less than lO. Management knew that the company had a few =grace,, years during which it would continue to realize growth driven by the increas-



ing revenue stream of current products. But a board



13, Vitesse spent approximately $40 mi11ion annu-



member asked Marty if the current portfolio of R&D pro-



nR&D. CIose to 60% ofthat spending was for sal-



jects could be expected to drive long-term reVenue



20% was for other prQject-SPeCific costs, and 20%



growth at the rates that were forecasted in the long-term



for use of shared resources, SuCh as engineering are. only the ``other prQject-SPeCific costs’’could



duced without taking drastic measures with longconsequences, SuCh as layoffs.



D assets and spending were a1located to specific



cts through the Business Plan Review (BPR) proEvery product derivative was considered a new



uct and went through the BPR process individu-



business plan" It was a good question" Marty explained, Projects are aPPrOVed one at a time, but someone needs to be conce「ned with the bigger picture, the financia=mp-ications of the compiete p「Oduct port-



foIio. In this industry you Can make big decisions that dig big holes. You might be OK for a few years’



but if you do亜have enough new products in the pipeline, yOu WOn’t be able to sustain growth"



(See Exhibit 2 for excerpts from the o鯖cial BPR



edure document.) Marketing initiated the BPR,



The di鯖culty was that the BPR process was sOme-



the entire executive team was required to approve



what disconnected from the company,s business model・



fore a prQject could move forward.



vitesse,s business model assumed that new, yet unde-



rQjects were initiated throughout the year, Often in



fined prQjects would be introduced regularly to replace



。nSe tO a CuStOmer,s need. Some financial disci-



revenue from obsolete prQjects. However, the prqiect



was designed into the prQject selection process;



selection process did not guarantee that revenue from



§ induded detailed revenue and cost prQjections.



selected prQjects would be su航cient to meet those long



keting department performance was evaluated’in



term revenue goals. The 4-5 times ROI and 20% hurdle



bywhether or not new products delivered the rev-



rate was not infomative. Marty and Patty wondered if



and profit prQjections in the BPRs. But there was 1ear financial measure or criteria for selecting proor for ensuring that a prqiect’s financials were



2 ROI was calculated as the 15-year Cumulative gross margin divided by R&D investment.



335



Chapter 8. Pianning and Budgeting they could develop a more useful benchmark to guide 鴫ble l Revenue-nOrmaiized business modeI PrQject selection decisions and皿ake sure that invest-



P&LModei



ment decisions were consistent￣With.the company’s



long term business model. Was there a straightforward



ModeI



Revenue



Minimum



100%



Mid



100



1O-year inco



High



100



inve stments



100



Way tO COmmunicate whether or not a prQject was



CostofGoods SoId



acceptable?



38-43%



43



41



39



(See the IRR



Pany Wanted



GrossMargin



5T-62%



57



59



to be evenhi



61



and estimated



lRR target deveiopment



R&D



Marty and Patty’s solution was to calculate the IRR



SG&A



on R&D project spending that was assumed in



25-28%



15-19%



Operating income



Vitesse’s Iong-term business model. Then they could



28



19



15-21%



10



27



25



17



16



15



to 43%-47%



Results of



20



Patty thought



compare the IRR they calculated from the model to



e nlighte ning.



the IRRs that the current portfolio of R&D prQjects



was forecast to generate, If the IRR assumed in the



Eventually, the R&D manager provided the needed



business model was dose to the IRR of actual pro-



information. He estimated that 6O% of total R&D spend-



the current B



ing was direct spending on prQjects. Patty was able to



actual IRRne



achieve the model’s revenue goals. Perhaps more



Verify that these numbers tied, mOre Or less, tO the total



Patty went



importantly, the IRR calculated from the model could



R&D spending reported on financial statements.



jects, they could infer that they were on track to



Cantly higher



become a functional hurdle rate for future R&D pro-



Patty used two different models for the timing ofpro-



jects that would link prQject selection to Iong-term business goals.



ject investment. In Model l the entire investment takes Place in Year O, the year before the investment began gen-



expected, the I



The IRR calculations were based on several assump-



erating revenue. In Mode1 2, the investment is incurred



below Pattyis t



20% inYear -1, 70% inYearO, and lO% inYear l.



derivative. (S



tions. Patty began with Vitesse’s revenue-nOrmalized



as forecasts t



PrQiec亡Irtvest肌eJl亡Ti肌ing Es亡[mate:



business model, Shown in Tbble l.



Platfom IRRs.) roadmaps, the



Patty wanted to calculate the IRR on the model’s



direct R&D spending, nOt tOtal R&D spending, Since



Yea「:



-1



Only the direct spending was used in the BPR process.



Mode=



100%



Unfortunately, however, that information was not



Modei2



readily available.



20%



0



1



Platfom, and Exhibit 5 forI



70%



10%



Recommen



She asked the R&D manager to estimate the per-



Centage Of R&D that was direct spending. R&D per-



Tb calculate IRR, Patty also had to make some



Marty and Patty



sonnel had been resistant to collecting information



assumptions about how prQject revenue was distrib-



executive teaus



for the IRR calculation. They did not want to spend a



uted over time. Patty followed current prqiections and



lnCreaSe mlnlm



lot oftime gathering data ifno one was going to use



assumed that 56% of prQject revenue followed the



that a minim皿



it. The senior vice president ofR&D told Patty, “Unless



quicker enterprise revenue distribution pattern, and



ness modelwasI



We uSe the IRRs to drive behavior, it’sjust a collection



44% of prQject revenue followed the slower carrier rev-



essary to achi



Of pretty pictures.’’Marty and Patty did not disagree;



enue distribution pattern. She weighted revenue pat-



recommended t



they hoped their analysis would indeed change



tems accordingly, tO develop a blended lO-year reVenue



derivative at a ti



behavior.



d i stribution.



be approved, bu target. Martybく



Prqiec亡Rel,e皿e T書肌ing Es亡[mc[te:



to sayno tobad Year:



Enterprise



Carrier



Biended



1



2



30%



0%



75%



NormaiizedtolOO% 336



100%



30%



17%



3



75%



50%



55%



4%



78%



12%



4



50%



50%



64%



17%



5



6



7



8



nue foreca§tS in



30%



100%



72%



14%



Marty also su 10



9



evaluated agaim



100%



61%



16%



100%



44%



14%



50%



50%



22%



10%



22%



5%



5%



the 30%



higher hurd】



On a PrQ]eCttOC(



13%



how to deliver tl



3% markets, Or incr(



Vitesse Semiconductor Corporation



Patty subtracted the investment from the revenue



Response



Ch year and calculated the IRR on血e resulting -year income stream. she conduded thaでR&D prqject



Vitesse’s CEO and marketing team were intrigued by



estments should yield IRRs between 35% and 40%



the analysis. The actual IRRs of some prQjects sur-



achieve the profit prQjections in the business model.



Pr主sed them. Their sense of a prQject,s retum had been



e the IRR model in Exhibit 3.) Obviously if the com-



largely informed only by anecdotal results, SO they



y wanted profit growth rates, the IRRs would have be even higher. Patty used the same methodoIogy



Were interested to leam that’amOng Other things, One



large and popular prQject was not as financially suc-



d estimated that target IRRs would have to increase



CeSSful as they had prev王ously believed, But even



43%-47%亡O aChieve 20% profit growth.



though everyone understood the analysis and its impliCations’nO One Seemed in any hurry to formally adopt



Suits of the analysis



the 35% IRR 〔arget as a new prqject hurdle rate.



tty thought that the results of the analysis were



Carrier Ethemet p「oject



ightening. The target IRR she calculated was signifi-



The first test came when a BPR for a new carrier Ether-



tlyhigher than the 20% hurdle rate that was used in



net product landed on Marty,s desk. This was a new



Current BPR process, and often higher than the al IRR new products were generating.



Patty went on to calculate the IRR for all new prodS and platforms currently on the market. The calcu-



OnSWere based on actual revenue and costs as well



forecasts taken from platform roadmaps. As



PrOduct that’if approved’WOuld be Vitesse,s first entry



into this aspect of the Carrier Ethemet market. Marty and Patty were both in the BPR meeting and argued against i亡s approval because the prqject did not have a



POSitive NPV even at the 2O% hurdle rate, let alone the more meaningfu1 35% hurdle rate. Even future deriva_



ected’the IRRs of new platfoms were always well



tives were expected to be low margin, falling below the



OW Patty’s target, but the IRRs increased with each



35% IRR target.



ivative. (See Exhibit 4 for one example: Ethemet tfom IRRs.) Patty also calculated IRRs for entire dmaps’the weighted IRR for every derivative in a



tfom, and several fell below the 35% target. (See ibit 5 for IRRs of a11 current platform roadmaps.)



Marketing pushed back, arguing that it was necesSary tO aPPrOVe the prQject for “strategic reasons.,, If



Vitesse did not enter this aspect of the Carrier Ethernet market now’they argued, Vitesse would miss an entire



generation ofproducts. It was necessary to take a loss in the short term, SO they could build a customer base and



COmmendation



keep the door open for more profitable derivatives in the



tyand Patty took their results to the marketing and



think it was unreasonable, but she did not want to



Cutive teams and made a strong recommendation to



approve the BPR as it had been presented. She explained:



future. patty understood this argument and did not



ease minimum prqject hurdle rates. They argued



a minimum 35% IRR tied to the company,s busi-



l wasn,t compieteiy against moving forward with



model was required. This higher IRR rate was nec-



the new Carrier Ethernet project, but i thought that



ry to achieve long-term PrOfit plans. They



marketing shouid take another iook at the numbers



mmended that instead of approving one prQject



and commit to higher revenues (and profits), Their



VatlVe at a time, entire platform roadmaps should



forecasts are typica=y too conservative, And since



PPrOVed’but only if the platfom met the 35% IRR



et. Marty believed that management had to leam yno to bad investments. arty also suspected that marketing low-balled reve-



marketing claimed that earnings from future derivatives wouId justify the initiaI 10SS On the project, i



thought they needed to document that. i wanted to



See a rOadmap,



forecasts in the BPR because their performance was



As the discussion continued it became evident that



uated against the BPR revenue targets. Marty hoped



no one was willing to ki11 the prqiect. In addition to the



higher hurdle rate would compel everyone invoIved



Strategic reasons for approving the prQject, marketing



prQject to commit to higher retums and to figure out



argued that engineering resources were not totally fun-



to deliver them’either by reducing costs, expanding et§, Or increasing the number of derivatives.



gible. Di飾erent groups had different expertise, and the



engineers who would be assigned to this prQject could 337



Chapter 8. PIanning and Budgeting



not be redepIoyed immediately to other prqjects. Marty



sure they were lOO% accurate. And even assuming the IRR targets were accurate, Marty and Patty knew that there might be legitimate strategic reasons for pursu-



increase the prcject’s IRR. Marketing agreed to study



ing a prQject. If so, COuld those be quantified? Certainly



the issue, but they made it very clear that they were not



a new prQject could not be expected to meet the same



committing to a higher revenue forecast in the BPR.



hurdle rate as a later iteration. That was understood by



iii﹂叩i州﹁同州



and Patty eventually concede虫but they insisted that



the marketing team at least serioudy consider how to



Exhibit 2



everyone in the organization. Marty and Patty won-



Concems



dered how they could include those considerations into



the decision process with an objective measure.



Marty and Patty were disappointed that the prQject was



Marty and Patty conceded that IRR target might not



approved even though it did not meet the IRR bench-



be appropriate as a hard cutoff for prQjects, but they



mark that they had worked so hard to develop" It made



still believed it was a useful tool that could add disci-



them evaluate whether or not the IRR benchmark was useful as a tool to assess prqjects. The IRR calculations



Pline to the BPR process and could better position Vitesse to meet both its short- and long-term financial



relied on forecasts and assumptions, SO nO One COuld be



goals・



W



Exhibit l Carrier and Enterprise Revenue Cycies



W



0 0   0 0   仰   2 0



%  %  %  %



G白∵a十二封h.仁子k上m乱d



※蒜重篤蒜 轟



①つとo>〇回とeOd○○}に〇〇〇〇回



338



ibit 2 Excerpts from the BPR procedu「e document



VSC Procedure VQPR-1001 i●● ● ’



fen書



e fo=owing而ormation provided by the Product Marketing Manager (PMM) sha= be presented using the tempiate



arket conditions and target customers uaiitative descriPtion of the product and opportunity



ted on a scaie of l-5:



a. Bevenue and Profit b Qua航y of Forecasting Methods (Siiding scaIe with BPR ievei O-2)



CI Strategic Aiignment d. Customer Needs



e Standards or Compliance Issues fl CompetItive Anaiysis



i. Risk Management 」 Market ChanneIs & Key Contacts



k Management Suppo直 上 Resource Availab冊ty



! - i l 長 竿 書 ¥



g. Product Positioning h. Key Requirements & PrIOrities



’1教. 、 1職場   一志も



二」 里      長ヨ賢



m. Core Competencies



n. Dependency Management O. SWOT anaiysis



CtOrS Of revenue (CuStOmerS, unit voiumes, ASPs and timing of ramps) can lead to resuits that miss or exceed p「edic-



ns by a factor of two or more. Optimism in forecasting tends to make most products miss rather than exceed their als. The presenter of a BPR is responsibie for forecastjng the target revenue within reasonabIe limits of accuracy.



339



Chapter 8. PIanning and Budgeting



Exhibit 3 iRR modei



P&しModel



Model.



Revenue



100%



COGS



GM



43,0



R&D



34%



ROI



2.04



Modeil Minimum, ModeI2



Mid,Mode=



37%



d,Modei2



H H



gh,Mode11



gh,Mode12 Breakeven



Breakeven



340



$7.36



33%



2.19



35% 41%



NPV



2.19 2,44



$8.61



$8.39



26%



1.63



$2.99



1,63



(3,24)



$10,36



2.44



$2.23



(17)



$5.86



$6.91



39%



25%



(3,36)



2.04



(16)



(3.00)



(10.50) (3.24)



2,14



(11,76)



(11.34)



1 7.02



0.46



2.21



0.59 (15)



0.79



2 9.92



7.02



27,0



16.0



17,0



7.27



7,27



2,29



7.52



10,27



4



8,14



9.16



8.43



10.62



10.62



(16) 1.65 5,42 7,66 (11,34) 0,03 5,42 7.66



8,14



8,43



10.27



7,52



20,0



3



9.92



44.0



25.0



15.0



0



30.6



61.0



17,0



-1



74.6



39,0



27.0



10,0



Breakeven



100.0



59.0



19.0



15-21%



iRR



Hgh



41.0



28,0



15-197%



Opinc



Mid



100.0



57,0



25-287%



SG&A



M



100.0



57-62%



Minimum,



Mjnimum



8.71



8.71 6,29 6.29



9,16



9.48



9.48 9.80



9.80 7.07 7,07



5 了,74



7,74



0,0



6 5.60



5.60



7



8



2.80



2.80



2.80



2.80



9 1.68



1.68



8.01



5,79



2,90



2,90



1.74



8,01



5.79



2.90



2.90



1.74



8.28



8.28 5.97 5.97



5,99



5,99 4,32 4.32



3.00



3,00



3,00



1.80



3,00



1.80



2,16



2.16



2.16



2.16



1.30



1.30



10



China. Hi themselve



CASES丁UDY “ VisuSon, Inc.二Business Stress丁esting



growth dro



cal ultrasou



decade. Ce called hand-



On the evening of Friday, October lO, 2008, Linda



flow and VSI’s own access to financing as much as cus-



tO grOW mu



Ott sat alone in her o鯖ce contemplating the year to



tomer demand. As Linda pored over the numbers and



industry an



COme. Linda was the founder ofVisuSon, Inc. (VSI), a



COnSidered various scenarios, She wondered whether



accounted f



Sma11 manufacturer of medical ultrasound equipment,



Jon皿ight be right.



reached §a



and the only CEO the company had ever had. Linda



01der technoI



re且ected on the meeting she had had that aftemoon



world were e



With Jonathon Foley, VSI’s CFO. At the meeting, they



Uitrasonography



reviewed the company’s results for the third quarter



Medical devices for ultrasound imaging (ultrasonogra-



just ended and discussed prQjections for the rest of 2008 and for 2009. The last item on the agenda - the



Phy) use high-frequency sound waves to generate



for at least th



Company



look at 2OO9 - dominated their discussion and now



graphical representations of soft tissue, OrganS, and blood flow. This often can be accomplished non-inva-



VSI manufacI



OCCuPied Linda’s thoughts.



Sively through the application of probes, Called tran§-



Plant in Apple



Sales were at a record high in the third quarter of



ducers, tO the surface of the patient’s skin. In some



Wide through



2008. Furthermore, the company’s book of confirmed



important applications, tranSducers are inserted into



The firm beg2



Orders provided ample assurance that the fourth quar-



body cavities or even into blood vessels to produce beト



Cializing and



ter, and 20O8 as a whole, WOuld continue VSI’s estab-



ter images. Modern ultrasonography equipment is



ualization al!



1ished pattem of double-digit growth (see Exhibits l-3).



CaPable of producing moving 3-D images of internal



academic res(



But there were dark douds on the horizon. The Dow



body structures in real time. With the use of so-Called



After sevei



Jones Industrial Average hadjust dosed at 8,451, nearly



Doppler technoIogy and coIor display, the speed and



Ⅱedglin8正調



20% below its level of a week before and down 4O%



direction of且uid flow can be accurately measured and



bridge Manu



from a year ago. Of more direct importance to VSI, the



displayed. Ultrasonography is generally a less expen-



COntraCt man



February collapse of the auction-rate SeCurities market



Sive form of radiology than magnetic resonance imag-



ultrasound IT



PrOduced some delays in orders and collections, While



ing (MRI) and computed tomography (CT). In contrast



turing expert



many US hospitals, VSI’s largest group of customers,



to CT and X-Ray imaging, ultrasonography does not



own. Bainbril



SCrambled to replace their auction-rate debt with alter-



expose the patient to potentially harmful radiation.



move up丘0Ⅱ



native sources of capital. Both Linda and Jon believed



Consequently, ultrasonography has developed into the



the more pro



that this one problem had reduced sales growth for the



most common form of radioIogy for some areas ofmed-



Phy systems.



year by several percentage points from what they had



icine. CardioIogy and obstetrics/gynecoIogy, for exam-



WOn aPPrOV乙



PrQjected at the same meeting a year ago. Both Linda and Jon agreed that a wider credit crisis would nega-



Ple, PrOVide important applications for ultrasonography. By 2OO8, the global macket for ultrasonography equip-



tively impact 2009 sales, but there was no historical



ment was dominated by four large medical device manu-



former head



PreCedent on which to base a reliable forecast.



factures that were themselves divisions of global



Pendent fim



Linda worried about the near-term impact on eam-



COnglomerates. Industry analysts estimated that Philips



Principal re



ings and the long-term Strategic impact of a sIowdown



Healthcare, Siemens Healthcare, GE Healthcare, and



retained as [



While VSI prepared to release its丘rst entirely new prod-



Tbshiba together controlled approximately 80% of the



As a new



uct platform in several years. The new platform



worldwide market. But the medical ultrasound market



larger firm



accounted for nearly 30% of VSI’s research and devel-



remained quite dynamic and innovative with more than a



focused on (



OPment budget plus more than $10 million in capital



dozen smaller competitors vying for the remaining share.



PrOPrletary



expenditures over the last two years. Jon, however, had



In addition to new and niche competitors from North



tage. VSI ta



Cautioned against “fixating on sunk costs,” as he put it.



America and Europe, neW entrantS into the global ma正et



丘rst six yea



He believed the company should be focused on cash



Were emerging from other parts of the wo血d, Particularly



medical pra



342



tion, Visute( forming VSI



Game Shop, inc. reason for the failure, named the department and/Or



Once the prQiect shipped, the PM was also responsible



individual(s) responsible, and prescribed corrective



for compiling a billing packet that the billing depart-



action. CARs linked to an individual“empIoyee became



ment sent to the customer for approval and payment.



Part Ofthat empIoyee’s permanent record.



Bills, and in some cases even the bi11ing processes,



Kevin also managed a World Wide Knowledge Base



Were tailored to each customer. For example, One CuS-



that gave empIoyees around the world access to the



tomer did not allow overages, SO they would not sign a



most recent work instructions, Checklists, forms, and



PO until the prqiect was completed. The PO, Shipping



POlicies. He discouraged empIoyees from sending outdated emails or storing outdated instructions on their



document, and invoice were all sent to this customer at



PCs. Often when CARs were issued, the failure was at



industry, many CuStOmerS Were nOt billed when the



least partially addressed by updating instructions in



the Knowledge Base. Kevin believed in knocking out



Prqiect shipped, but were given a period of time to review and approve charges after the prQject was



failure modes with smart controIs, Or, aS he explained,



Shipped. The period of time allowed varied by cus-



“I minimize discretion so that a process cannot con-



tinue until the right choices are made. I try to force



the same time. In a practice somewhat unique to the



tomer. Kevin noted, “Sometimes it’s as di描cult to bill



the thing as to build the thing:’



things to be right.’’



Accuracy and timeiiness issues B輔ngs and revenue recognition



Billing accuracy and timeliness had become increas-



G§I prQject managers (PMs) were responsible for man-



ingly important as the company matured. Kevin was



aging customer prQjects from start to finish・ Their



COnCerned that GSI’s reputation for billing was not up



responsibilities induded bi11ing. Most PMs had no



to par with its reputation for delivering quality prod-



financial or technical background. All were high school



ucts, and billing problems were causing frictions with



graduates, and some also had a college degree, uSua11y



important customers. Partly because of the丘nancial



in a liberal arts丘eld. The best of the PMs were smart



generalists who were able to juggle multiple priorities.



reporting and intemal control requirements of the Sar-



banes-Oxley Act of 2OO2, mOSt CuStOmerS Were nOW



In addition to the PM, a tyPical prQject invoIved at



requesting better invoice accuracy. In addition, aS GSI



least eight employees, mOSt Of whom had a technical



grew, its need for working capital also grew, SO it was



SPeCialty such as video compositing. PrQjects required



imperative to get invoices delivered and receivables



quality controI persomel as well, uSually two focused



COllected as promptly a§ POSSible.



On the incoming stage of the prQject and two or three



Friction with large customers had revealed some



focused on the outgoing stage. Quality controI checks



bi11ing issues, and there was additional evidence that



Were built into the process. GSI’s policy was that no pr匂ect was to be started



PrOblems existed, The PM’s accrual estimates could be



Wildly inaccurate, and there were often several months



Without first securing a purchase order (PO) from the



Of accrued revenue sitting on the books. In late 201O,



CuStOmer, The PMs regularly violated that policy, how-



GSI had over $5 million of working capital “trapped in



ever, With tacit approval from corporate. As one PM



accruals older than 60 days;’almost twice GSI’s aver-



explained, ``[The big customers] are temperamental.



age monthly revenue.



We don’t want to upset them.’’Even starting a prqiect



with a PO in hand did not soIve a11 the billing problems. Not all the prQject contingencies could be foreseen, and



The improvement process



OVerageS above the amount specified in the initial pur-



David was assigned the task of improving the bi11ing



Chase order were common in the industry.



system. He was given dear prqiect goals: aChieve 98%



Revenue was recognized when it was eamed. PMs



accuracy in accrued revenue calculations and reduce



WOuld estimate the amount they would eventually bill



accruals to a maximum of 30 days of sales. If David’s



for the work that had been done to date and enter it as



PrQject was successful, the accrued revenue amount would decrease from over $5 million to $1.3 million.



accrued revenue. Once the prQject was billed, the amount changed from accrued revenue to an account



In early 2010, GSI management had a brainstorming



receivable. Each PM was responsible for tracking time



session to identify the issues. They found that a lot of



SPent On Prqiects, Changes to the prqjects, and overages.



COntrOIs were mi§Sing. As a result, SOme billings were



243



not being turned in. Many that were tumed in were



David accepted that customer behavior could not be



inaccurate. Sometimes customef言were double billed.



COntrOlled completely, but he also believed that PMs and



PMs were a major cause of the prot丸ems. This was



managers could do more to try to influence customer



understandable, aS Kevin noted, “They are busy peo-



behavior. PMs could try to insist on getting a customer PO.



Ple. Sometimes they don’t get all the details right.’’



They could also try to get authorization to bill for parts of



Tb understand all the root causes of the problem,



a job instead ofwaiting for the entire job to be complete.



in large part



Performance assessing the



The Billin



David built a `亀ult tree’’(see Exhibit 2). The purpose of



For example, One BU was able to persuade a customer to



BU’s billing



the fault tree was to diagnose the problem in enough detail so that the solutions would follow from the detailed



Pay for intemational dubbing before the Japanese ver Sion, by far the most technical and time-COnSuming dub-



into a O-tO-4・



diagnoses. David’s fault tree exercise exposed nearly lOO



bing task, WaS COmPlete. This shortened the bi11ing cycle



CauSeS Ofthe inaccuracies and revenue accrual build-uPS.



On this job from over a year to just four months.



These issues could be categorized as system or process issues, CuStOmer issues, and management issues.



Management issues Perhaps the biggest issue was that many GSI PMs did



System/process issues The billing system had several flaws. Billing paperwork



COuld only be submitted once a week, and reports could take upwards of lO minutes to download onto a PM’s



COmPuter. There was also no redundancy in the proCeSS. A single empIoyee’s vacation could hold up the entire company’s billing cyde.



Theoretically, these issues could be addressed with



Changes to the system, but both the billing and IT departments were resistant to change, David thought that billing department resistance stemmed both from



familiarity and comfort with the existing system and, PrObably, fear ofjob loss. Bi11ing department personnel



had also been bumed once by the IT department when it tried to force a new alpha version of a system on



them. This system was untested and full of bugs, SO hard feelings had been created. The IT department had



always given billing prQjects Iow priority. Historica11y, the IT focus had always been on systems designed to



improve operations. Financial systems had always been an afterthought,



not track prQject changes and simply did not tum in



A perfect s SOld was al into a grade



2" Adjusted n



accrued things randomly. For example, they would



ae⊂ruals/(3



declare certain tasks as having been completed, forget What they had done in the prior period, and then bill for



them again. David discovered several causes of this problem. GSI did not have a set of written bi11ing instructions, and manymanagers did not know how to use the billing tooIs



available to them. In general, PMs did not understand the importance of correct and timely billing, and often Were nOt aWare that there was a problem; they assumed



A week 13-Week ave WaS a句咽ed



Sped鉦toさ approval de



allowed the



bi11s before a句usted nu



by subtracti



SeVeral months of accruals were the norm. Managers Were also not terribly motivated to spend time on billing.



They were much more focused on production. The prob-



lem was aggravated during the busy season when some



managers complained that they were already in the O鯖ce until past ll p.m. every night making sure orders



Were Shipped. Forced to choose between spending time



On Shipping or billing issues, they chose shipping.



While some ofthe problems could be seen as failures



example, ifa accrued, but



Weeks to app accruals wo



allowed one Or fraction th



from a perfe



grade. So us WOuld prod眠



improving the process, rather than focusing on specific individuals’failures. He provided training sessions that



GSI’s policy was that nothing could be shipped without



included instruction on billing and time management,



a PO, but some customers refused to issue a PO. They



and he added detailed billing instructions to the World Wide Knowledge Base.



Wanted to make changes along the way and have the



1, Percent of



bi11ing paperwork in a timely manner. Some just



Of specific individuals, David decided to focus on



Customer issues



(described bel



3, Percent ofs



bill from GSI reflect what was actually shipped. Even Where POs were used, they often quickly became obsolete as changes were made to the work orders. Some



BilIings Scorecard



Shipped without a grade bysub



CuStOmerS insisted on a lengthy review process before



Tb focus attention on billing performance, David devel-



they would approve a bill even though the order had



OPed a new ``Billings Scorecard,’’a monthly report that



already shipped. Some prQjects shipped over a long



tracked each BU’s billing performance. David hoped the



Period of time, uPWards of one year, but customers



Billings Scorecard would provide increased visibility



This measure w



WOuld not accept a bill until the final stage ofthe prQject



about billing performance. Many PMs, and even their



A perfect score



WaS COmPlete.



bosses, had not cared about billing-related performance



WOuld mean th



244



result by 4,



4, Percent ofaccr



VisuSon’inc・: Business Stress lesting



efore December when the budgets were fin車zed and en approved by vsI七board of directors.



刷e engineering was navigating the approval pro-



ess and manufacturing was developing cost estimates,



inevitably suggested, fdrcing negotiations and revisions.



岨gh most distributor agreements were renewed



ach December as part of the quota commitment proS5ysales worked with the distributors throughout the ar. In addition to monitoring current sales activity and



Orked through a formal review and evaluation process



l[h each distributor of the partnership,s performance ’erthe previous year. At the same time, the distributors



up of deparment budgets to higher organizational levels. But in the budgeting review processes’Changes were



fell to sales to begin working with the distributors.



hleVements toward quota’the sales department



SPreadsheet produced by the Accounting Department. The design of the spreadsheet largely automated the ro11-



The budgeting review effort was intensive, but the pro-



CeSS WaS nOt OVerly cumbersome because vsI,s managemen亡COnSisted of fewer than 2O individuals. Finally, in



December, VSI,s execu亡ive committee, and then the



board of directors, aPPrOVed the consolidated budget. Managemen亡Of cash and working capital was a criti-



Cal issue fdr this small・ raPidly growing company. vsI



management and its bankers agreed that the fim should O‘-ided feedback on developing sales leads for the com_



gyear・ Tbgether with the distributors, Sales would for



late plans to support these sales efforts with VSI monstration and training staff as well as evaluation



typica11y hold six weeks of operating expenditures in its



CaSh accounts. In an effort to be responsive to the needs Of its distributors and customers’VSI maintained a pol-



icy of holding 30-40 days, forward sales in finished



uipment. sales would also begin providing distribu-



S With advanced marketing infomation conceming thcoming offerings in order to elicit feedback on ti。pated voIume and market pricing. Though most tribution and sales agreements induded confidentiaト



Clauses’the distribution network was a valuable



rce of competitive intelligence regarding expected



tures and pricing by competitors. This information COmbined into a preliminary sales forecast provided



e budget committee by mid-August of each year. n the basis of the preliminary forecast from sales their own planning effort for any new products,



ufacturing developed and submitted a draft labor get to human resources (HR). The o血er deparト ts also submitted sta鯖ng requests at this time, but



manufacturing labor budget was the most critical. WaS reSPOnSible for developing the staffing and



ing schedule for the coming year. As part of this eSS’HR reviewed the salary and wage surveys it



hased from consultants to ensure that vsI kept With the competitive labor markets. salaries and



eS Were a significant cost category for vsI. This mation was critical for developing department agers’merit pay budgets for the coming year as well



r refining the direct labor budget. The most inten-



Phase of the budget process took place each mber. By this point in the year, the volume ofsales roduct mix for the coming year was relatively pre-



goods inventory. Finished goods accounted forjust more



than 40% of the total value of inventory, With the remainder split about equally between work in process



and raw materials. At the other end of its operating



CyCle, VSI,s accounts receivable balance hovered between 6O and 80 days oftrailing sales. In an effort to



mmmlZe net OPerating capital, VSI maintained accounts Payable and accrued liabilities at the highest levels pos-



Sible while still taking advantage of all available trade



Credits for prompt payment. Likewise, eXPenSeS Were Only prepaid when required. Nonetheless’its Iong oper-



ating cy。e and high growth rate required VSI to finance



this growing investment in working capi亡al through



Short-term borrowing against the value of its accounts



receivable and inventories. Thus, before any budget COuld be considered viable, it required review and approval by the finance department.



Anywhere from one-third to one-half of the managers’cash compensation was tied to achievement of



O巧ectives set by the executive committ。。 and th。 board at the start ofeach year. For firsト1evel managers,



One-third of cash compensation was considered “at-risk’,, with the level rising to 50% for Linda. For



mOSt managers’aChievement of budget o亘jectives was



Weighted 5O% in importance for determining the annual bonus. The remaining 50% was based on achievement of other quantified goals and/Or a Suhective evaluation of perfomance.



ble. Combining the updated sales forecast distrib-



by the sales department at the beginning of the h with salary’Wage, and staffing infomation pro-



by HR, department managers developed detailed ts for their departments using a standardized



The new cha=enge The budget that Jon Foley delivered to Linda earlier in



the day was based on an assumption of lO% revenue 345



Chapter 8. Pla=ni=g and Budgeting



growth for 2009 (see Exhibits 6 and 7)’a level that had



been considered quite conservative just a month ear1ier, It included plans to boIster Asia/Paci宜c and Latin



elective procedures’further reducing all hospitals’rev-



enues and spending. Consequently’analysts were



beginning to speculate about a decrease in capital



American sales support by hiring more account manag-



spending by US hospitals of as much as 14% in 2009.



ers and sonographers and by devoting additional dem-



Yet, it was unclear how capital spending on radioIogy



onstration equipment to these markets. While it



a任ected. As the bulk of sales in the domestic market



engineering and marketing planned to begin the FDA



were replacements for older technology, many CuStOm-



510(k) process for approval of the new hand-Carried



ers could defer purchases.



ultrasound (HCU) platform targeted for release in



Customers had already shifted purchases to later in



2010. Recently, the HCU market had grown faster than



the year during 2008. Linda and others at VSI feared



the cart-based segment where VSI currently competed.



that this pattern could become more pronounced due



Analysts were forecasting an acceleration of the shift



to the developing recession" With limited workforce



toward greater use ofHCUs. Linda and the board were



flexibility, VSI would be forced to choose between



eager to enter this new market segment.



building inventory early in 2009 or risking stocking out later in the year. Fortunately’the sales mix was



management perceived that they would face tight



expected to remain essentially fixed’aS it was driven



resource constraints. Manufacturing headcount and



by customers, clinical requirements rather than by



manufacturing compensation were budgeted to grow



financial factors.



by only 6.4% and 9.0%’reSPeCtively. Capital expendi-



tures were actually budgeted to fall significantly as the firm more fully utilized existing capacity・ Additional



investments were expected to accompany the new HCU platform introduction in 2010. By far the most signifi-



cant growth in operating expenses would come from expansion of the sales sta埠with total compensation



VSI,s fate could be determined by how well they managed cash and by their ability to access bank financing.



He felt that a11 plans should be built upon an assumption of reduced gross debt levels and improved debt



ratios. He suggested that they ``prepare for the worst



from new product introductions in subsequent years.



of the working capital accounts.,, Jon argued that com-



Growth in engineering head count of 12% and engineering compensation ofjust over 15% was in equal



mitting to plans for growth was risky and that umodest



functions.



However, While the strategic importance of growing into new markets and keeping ahead of the technoIogy



cuts now [could] avert severe cuts later.’’While Linda



had come to rely on Jon,s financial expertise’her



trusted friend and collaborator, Simon Lee, had pri-



vately criticized the CFO as overly cautious and Peter Beeson had on more than one occasion dismissed him as `just a bean counter・’’In contrast, Tbm Nelson, VSI’s



COO, Who had worked with Jon at Bainbridge’neVer



made a significant proposal without having Jon first vet the numbers.



would not change, COntinuation of the market,s and



Linda knew that deferring planned investments’let



VSI,s high rates of growth could not be assured. The US



alone cutting back, WOuld limit the company,s capacity



domestic market was dominated by private not-for-



for growth in 20O9 and beyond. Recognizing that any



profit hospitals, Which rely in part on endowments like



⊂OurSe Of action would create some controversy Within



those of some private universities. The nearly 40% fa11



the management team, She wondered how exposed VSI



in equity market values was sure to adversely affect



was to a decrease in sales, Which might be imminent. How



such investment portfolios. Govemment-OWned hospitals were already anticipating funding shortages



great a downtum could the company endure without having to make the sort of deep cuts that would choke off



because the sIowdown was reducing tax revenues. In



future growth? And might VSI,s own survival be threat-



addition, the crisis was likely to reduce demand for



ened if market conditions became really unfavorable?



346



N



icy of “deferring expenditures and wringing cash out



deemed necessary to support growth in the other three



Exhibit 2



words of caution, Jon believed that in the short term



investment required to maximize the potential growth



count and compensation expense within finance was



Net incoI



prepared for the 20O9 budget’She considered his



and hope for the best,・, and advocated beginning a pol-



product line. Finally, the roughly 12% growth in head-



E xt rao rd



As Linda reviewed the spreadsheet Jon Foley had



by slightly less than 40%. This was considered an



parts justified by growth in manufacturing capacity and the installed base and by development of the new



Income [



器国師皿



expense in sales and marketing budgeted to increase



income sl



generally’and sonography in particular, might be



included no plans for major product releases in 2009,



With the assumption of lO% growth’mOSt first-level



Exhibitl l



ibi= income statements



串estatement



 二_". 2008(estiT碧ted〉



Revenues(net)



$59,766



Oostofgoodssoid



Grossmargin



27,269



7,566



Operatingincome



6,811



773



Ne自ncome



886



653



2,626



1,416



3,738



=零壁壁



6,673



3,279



4,046



1,384



帥aordinaryitems(netoftax)



5,856



4,933



3,955



l[COmebeforeextraordinaryitems



8,705



7,028



4,728



5,751



2,013



9,581



5,611



1,060



I[COmebeforetax



24,513



6,646



7,458



冊erestexpense



血



7,921



5,744



Generaiandadmjnistrative



22,930



28,188



10,663



2006



$47,443



24,806



24,003



紺‖[g



2007



$52,994



20,224



32,498



Ope「atingexpenses



恥D



9monthsended9/30/08



$44,227



2,570



ー



919



2,630



ー



1,707



年型土壁



=。壁壁型



聖堂



敵hibit 2 Baiance sheets



Baiancesheet



2008 (estimated)



Currentassets



Oash



$5,930



Accountsreceivable(net) l[VentOries



9monthsended9/30/08



$5,448



12,898



6,767



Prepaidexpenses



12,153



25,652



Non-CUrrentaSSetS Property,PIant,andequipment 6,323



_哩



20208 Otherassets



totalassets Currentliab冊ies



壁乙1坦



Notespayabie



14,860



4,496



Accruedliab紺ties



Currentportionoflong-termdebt



No[-Current=ab=ities



Tota川ab帥ties Owners’equity



22,516



339



Long-termdebt



22,865



348



22,371



Commonstock



AddittonaIpaid-jn-CaPitai



Retainedeamings TotaIowners’equity



Tofa=iab冊tiesandequity



29,251



堕型



339



28,083



遡



聖堂些 3,516



6,210



239



111



2,146



1,906



339



16,154



687



_」坦2乙



189



4,546



_」遡



25,512



13,448



189



4,546



18,147 22,882



壁土聖堂塗



339 12,083



17,180



20,777



塾量三壁



2,466



3,960



339



189



4,546



23,348



12,685



9,470



19,568



20,255



189



4,546



24,516



4,423



433



○○旦生皇室



塾迎壁



2,397



21,938



19,167



2,988



368



2,357



1,431



19,472



21,583



15,152



12,040



253



2,437



Totalcurrentiiab=ities



4,348



14,640



384



1,611



○○旦皇塑



堂垂堅



9,093 4,770



21,922



17,752



$50,454



$4,178



10,238



24,108



3,522



Accountspayabie



Taxpayable



26,945



4,209



2005



5,371



1,800



○○旦L墜喧



20,592



4,282



11,436



24,494



26,531



2006



$4,701



6,000



1,835



27,625



Lessaccumulateddepreciation



$5,258



6,216



〇三土壁塑



Totaicurrentassets



2007



189



4,546



16,440 21,175



$34,624



Chapter 8. Pian=ing and Budgeti=g Exhibit 3 Statements of cash flows



Statementofcashfiows     ‥



OPERATiONS:



Exhibit 4 2008(estimated)  9monthsended9/30/08  2007   2006



$3,738



$2,570



$2,630



$1,707



Netincome



Adjustmentstoreconcile: Depreciationandamortizatjon



AccountsreceivabIe Inventories



5,182



(1,462) (767)



Prepaidexpenses



Taxpayabie



15



Accruedljabiljties



(189)



(75)



463



(115) 40



Cashfiowfromoperatingactivities



3,813



(1,146)



(628)



(35)



73



4,275



(1,198)



(216)



(230)



AccountspayabIe



3,836



(717)



129



_」全曲



_旦星型



251



__星型



5,734



(601)



(180)



443 128 240



4,405



lNVESTiNG" AdditionstoPP&E



6,509



Acquisitionsoftechnoiogylicenses



5,845



〇二L室塑♀



Cashf10WuSedforinvestingactivities



FINANCiNG:



14,860



8,398



11,510



5,978 1,519



1,430



7,364



7,409



12,040



5,482 1,321



6,803



9,470



Borrowingofnotespayabie



RepaymentsofnotespayabIe Lon-termborr



(12,040)



g OWmg Repaymentoflong-termdebt Cashdjvidendspaid



Cashflowfrom(usedby)fjnancing Netincrease(decrease)incash Cashpaidforincometaxes



Cashpaidforinterest



348



2,481 $673



(8,910) (339)



(9,470) (254)



2,346 $190



(339)



2,231 $557



(6,210) (339)



2,921 $523



2,481 2,346 2,231 __生き塑1 一重1、621 重工」三三 $1,287 $791 $1,054 〇〇〇」退塾 」堕 」壁坦



it 4 VisuSon, inc.: Organization cha直



Exhibit 5 Budget timeIine



Nov Dec Dec Jan Feb Mar Apr May Jun Jui Aug Sep Oct Nov Dec



P    lndustryAnalystReports 至           PSNA



---○○田-○○---〇十一一--〇十〇〇〇〇-



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