Case 7-3 Quality Metal Service Center In early March 1992, Raward Brown, president and chief executive ofcer of| ‘Quality Metal Service Canter (Quality) rade the flowing cbaervation ‘Though am asin with car at performance, ioe that we are cape achieving even higher lel ese and profs, Ceiering tho market x ‘adslon andthe tte of mpelen fel we might hve mined oot on sme (rows opportuni. [dont Foor cota ha inhiited sanaper fom ‘srrang oor goals earnsv growth nnd shov-tageretura on se, pare te th nduy ba 00 might kop that i ind wl lag corey ‘The Metal Distribution Industry ‘Youngstown, These supliers old thelr products in large ts, thereby optimizing the fficiencies arsocated with large production rans. Service centers sold their products to metal users in smaller lots ad on a shorten me besa "Tho metal lstribution industry wea generally eageded as a stare, highly ‘ompottive and fragmented industry. However, therewera amumber ofkoy tends Inthe metal industry that were enhancing eric caroré growth potantil, Steel Mill's Retrenchment In their efforts to become more competitive Usrough increased productivity, most of the major domestic tetas prodears had been sealing Dock product Tinos by dropping low-volume specialty products. Further they had eat back or sorvoe to customers by reducing sales fore sae and technical pore Pale line service centers, reengizing thet many customers preferred to deal with, only fw primary suppliers, had profited from thie trend by toaintaining wide product lines and increasing caster worvce. ust.n-Time tnventory Management | Given the high conto ownership and maintenance of iventory, most metal aoe attempted to redue the cat by lowering th lovela of a mater Bi inventories Cjustln-tie” aventary mansgemant) "This rented in trnllererdorquantitie and moe frequent deve, Mtalsorvin centers ‘had autora advantage over the ails here becrsse inventory waa tho ner co entors soak in ade ‘While tho service conte price was alwiye higher than buying from tho rll customers wer increasingly willing o pay th extra charge, They recog ‘ized thatthe savings they geerted fom lower inventories and handling | ha pepe y Yn Codi wth te nitro ay nen. Coppi Seto Cs‘hapa? toning and Courting Ane Empled 301 ‘oats, phi reduced semp and val of buolescence, would lower the otal costof {potting he metal into thelr production atom, Productivity Improvement and Quality Enhancement Quality and productivity had become overving issues with metal sors. They bad implemented. major quality and. productivity improvement programe simed at inoreasing both th repatatin oftheir products and the overall pro ltablty of operations. In their attampt to foeus on quality, end usors wore ducing the numberof suppliers with wham thy did businces and ware eon entzating their parchanna with Unoe hat ware bet abla o meet then specie ‘quality, availability, ond ceric quirements End veers fovnd tht loser r- lationhipa with fewer wuppliorsreslted in bottar quality confermanco and stronger tes between supplier tnd customer as each sought to maximize the Tnngitera Benefits of the elatonship Quality Metal's Strategy Quality Metals had been ertablishod acentary ago ea Joal mataledtribu- tor: Sino than, it had grown into a frm with natinel catributon, and ita in 1081 wore well ver $760 alan. Quality business strategy provided framework for the development of specie goals and objectives. According to Mr Brown throo fundamental objectives guided Quality ‘Objective 1: To Focus Sales Efforts on Targeted Morkets (of Spedalty Metal Users Quilty recognized that itcould compete much more eletively in specialty prod ‘ctlinesotitsown selection than in thebrosdar commodity earhcn stool marta ‘where price was the primary éotermining factor Conseguenty, Quality decided to dmisah ite participation in commodity product ues and redeploy Shae re sourees into higher technology metals, suchas carbon ally bara stainlgs tel, fluminumn,aieka alls, ianium, copper, and bras, which feed higher turns and had en-elfctiv competition, More than 60 percent ofa revenes ‘ware dave fom higher tochnalogy metals in 1902, compared with 29 percent inise2. Qualiy had made a long tren commitmant to high-tachnalogy metal uss ‘Thecompeny introduction of titaiim, a natural adjunct athe existing prod. uct line, wa indicative of th company’ stratogy of bringing new preduss to ‘the market to meet the neods of existing customers, Previously titanium was ‘ot rou avaiable on the distrbtar market. Quality planned to continue to iver into complementary higher-‘echnology products as new custamor ro. ‘gulromaata arse Objective 2: To Identity Those Industries and Geographic Markets Where These Metals Were Consumed ‘Toidentdy more aoourataly the major industries and geographies forego prod- ucts, Quilty developed the industry Seat metal usage data beso. Mr Brownmea Fat one The Mangas Cour! Baament belived that this database which waa continually refined and updated, was the {mos accurate in the country Its se enabled Quality to profi product con- ‘umption by industry and by geography Tals enabled the company tsnelyae ‘ntl market demand on a nationwide bata and to project potential sales on & market by-market boss, Asa result, Quality ad e competitive edge in deter- ‘ining where customers were loeted and what products they were buying. Ie ‘sed this information in elacting oetions for opening new sevice enters, ‘Objective 3: To Develop Techniques and Marketing Programs ‘That Would Inerease Market Share ‘To bild moat sare, Quality fred programs that assisted it customer i ‘implementing Jostin-iime investry management ayatems coordinated with thelr materils requirement panning programs. Tho company werked with cot {omer represcntatiesin purchasing, manofscturng, and quality aanrance {ltormine tein presnerequlremants for product specfentions, quantities, and {alvery echodalen. ‘Simulony,Qualiy emphasized value-added business by offering a wide range ‘of procoming serves fr fs eames, auch an saw cutting to specifi ies, ‘fame eulting into both astra an nenpnttern shapes, fattening, aurecs ring ing shearing, bending, edge conditioning, polishing, and thermal treatment ‘Beceuse of Quality volume, the sophisticated equipment requited for Chae Production ste wes operated at tower oat per Ualt than most eustomer ‘owned equipment. Organizational Structure Since the Great Depression, Quality had exporinood rapid sales growth and ‘ougraphical expansion In 1992, Quality operated in more than 20 locations, titudted in markete representing about 76 percent of metel consumption in the United States. Constant with thi growth was the necowsity to decentralize {ine functions. Thefiem curently had 4 regions, each of which had about 6 cee {mela fora total of 23 distro, Thare wero staff dopertmenta in finance, mar- Keting, operations, and human resoures. A partial organizational structure ftven in Exhibit ‘Typealy a atic manager hed under htm a warehouse superintndent a salen manager credit manager, « purchasing manager, and en ediinstrw tion manager (ixhibit 1). The decision-making authorities of Unoso managers ew doesribed bolow: ‘The Warshouse Supeitandent overs tragportatin lading and unloading, orage, nd prepatuction proce. "To Sloe Menger curio sal hat clues inside! aeeprsonk wha aba contact and take andere re tho pho, and un uli eu ‘Tha make vot ontamar coat ad cowlarge deal Suen pie and ds ‘oon terse ar gooralyerteishod bythe Distt Manogor ight ede ‘eat are le td wt nite el "Phe Credit Managoranoss tho ik of na cutomar acount, approves caer rails prada wins range nabbed by epoca auras, Sad enbrce customer callersChap? Menage Cnbaling At inp 308 EXHIBIT 1 Paria Orgunieational Chart Peas teem [= a “Nt! =| sete ser fe tite | sxe Vom frees 9 = |= |= ae | fe | ‘Tho Purchasing Manager aoquiesiaventry bom thereon washout, ‘oer diets, and ose cmpasin, Drs bavefeeom ops exh ‘aide apples. However sntr management has eetablihadEsinomie Order ‘Quantity guidlines fre purcawe ef nvotoy and etalk re siocked ino Alice waraboste ely ne! Sead nate to jy e Within ha ‘veal znsrun he Purchasing Managat hae aor ta chee ups {id aoatnte ea term, althoogh payment supple art handled telly a tha home of. ‘Cyitalexpenitaresn exon of 10,000 anal cepa lensing dacions oul corporate approval Responsibility Allocation and Performance Measurement _ He District managers were reaponsibe for aang prodetrmined return on set (ROA) level, which ware agoed toa hn Bogining of th yor. The Towing items were included in Ue ase base fr ROA caeulationa304 rane the Mangonent Conta Brsiroment 1, Land, warohense buildings, an equipment wore included in the eset base at green bock value 2, Loared buildings and equipment (except for leased trucks) were included fn the suse base ot the cepstlized Jame value (Lease trucks were nol capitalied athr, lease expenses on trasha ware reported es an operating expense) 8. Average inventory in unit, was calelated, The replacement coat, sed on caren yooh, were eerie for he its ince inthe asset bas 4. varage eceintsresiable balance or the poviod was included inthe asset bbe, (Canh vea excluded fom distri asset; tho amounts were {svi} 5. Ava general rule, ncooute payable was not deducted from the asset base. However, an adfatoent was made if the negotiated credit period was treater then Ine company standard of $0 days I thi ccoured, "fered in Wentorg” a omtra-astet account, was deducted from the amount of the Inwantory value for the period in excos of the 30-day standard. This wes ‘equivalent ta reduction of inventory antct corresponding to the exces ‘eat period or example, if dati nogotiated a ret period f 0 days, then the inventory expenditure was removed from the assot bas for 20 ‘aye, However penslty wae not sated ifthe negotiated credit period ‘was lees the the S0eday company standard. Income before taxes, foreach district, was calculated in cordance with generally acspted neonunting prinsple, except for cost of wales, which was ‘allt bases on current inventory replacement valucs, Rxpensea were sep [rated into convollable and noncontrellable categoriog. Controllable expenses Included wach seme e8 warehouse labor and ealos commissions; oncontra- lable expenses included rent tte, and property taxes, "No corpratsoverhoad expenses were allocatd to the districts. A few you carla the ompany had considera a propoel to lleatecorprate overheads {othe distriste. However, the propoeal ad bean rejected onthe grounds thatthe “lloation bes” ware arbitrary and at rach expeneo could nat be contelld atthe district level, Performance Evaluation and Incentives ‘The incentive bonus for dite managers was based on frmula tha tied the ‘bonus to meeting and execoding 90 perant of hair HOA targus. Exhibit 2eon- {tains the detailed procedure aed to calculate the incentive bonus. The elec Ietionn determine an applicable payoot rat, which was then multiplied by tho Antrct manages base salary t yield the amount of th bonus award. Thus, ‘the size of the bonus depended on (1) the amount of the manager's bee elary ‘nd (2) how far 90 percent ofthe ROA target wk exseeded; hee wes ‘mom bone ameunt. ‘The bons of «district manager was also affctd by hiv or her regions performance, In 1992, 7 perant ofa district masager’s bonus was based ot Aistrict porfummance, and 28 preant was based on his or hor rogio’s poror- ‘mance, The bonus of the district manager’ steiT was based solely on the ‘performance of hat district.Chapter? Maarngend Courting Aout pd 305 EXHIBIT 2 tacentive Caleulation Procedare “Si Momsen wt bono org ih peal om {Bes cts em Set 4 "at ndreloed Die ROA gi Cee pes Sip 2 le roe oper in 90 a gel ct cbectve “che MMR PORS— COW lone)» renee. “fue 5 wlll es Onl Spb ayaa HTN Sap faye anagerstasesaby bonus paabe 5p 5: Sones mare on eb inert Po hearers es i226, bans Sapa Tetons een rporen rere ol ie neximom ons ee ere ‘Meeting with the Columbus District Manager ‘few days after speaking with Mr Brown, the casowritr visited Ken Richard, ‘hediatrict manager forthe Columbus Serves Center Me Brown recommended him as one f the company’ brightest end moet tuccoaafl dateet manager, ‘The district had boen highly escasnel in recent years eonsiatenty earn well above 80 percent ROA (peta. "For 1992, Ken Richards targeted gure for operating profit was 60.8 mit ion targeted aseta ware et st $10 zion. He lt thet aa ROA of 88 prcant ‘was reachable, considering historical performance and market opportunities ‘As of March 1002, Ken was reviowing a capital investment proposal forthe purchase of new processing equipment, which he had recived from hi sles ‘anager (xbbita and), Before submitting the proposel vo carporatoheai- (uorters for approval, Ken wanted to make sure tht the new investment Srould have a fevercbe eet an his incentive bonus for 1002. Using 19°2 profit and astt targots as the benchmark, hs eompared hs incontive booas for 1992 with and without the new investment. Thess elealtions are shown in Exhibit 6 Questions * Te the capital investment propel described in Bxhibit 3 an atrective one fr Quality Metal Service Centar? ‘Should Ken Richards send that proponal to home ofc for approval? 5. Comment on the general useflneat af ROA ta the basi of evaluating ds Slt manage performance, Grad the perfomance rears bo mate sore effective?306 Pet One Th Manguent Court Biman EXHIBIT 3. Afemorandum ‘Anil i wae cated by ating Eaings ater Tves ceo or deprecavon, wis ‘Stowd iy thesctineyens-dgs method and rot Worng apt ester, wich ‘xzuned ung our sandard 908 aera incerta growth The restant end-of-year cath ows, ath ett apts of 15% (chs ate ead ic Feques on projects in sar ik o A i Key . has into pres ans meio homaanir neem wedi. sitmit thes proposal tothe home office for consideration. Please Ket me Know if you have any. a odin SO 4 In deciding tho investnent base for evaluating managers of investment foctar, the general question i: What practices will motivate the district ‘managers to vee their ante moat efficiently and to eequire the proper fount and kindof new exeta? Prasumebly, when his retarn on assets it being meassred, the district manager wal ty to increas his ROA, and we erie tt the actions he takes toward this end bo eetions that ae in che hott interest ofthe whole corporation. Given this generel line of reasoning, cvaluate the way Quality computes th “investment bas” for its districts, For each asaotcetogory, disease whether the bass of measurement used by ‘the company isthe best fer the purpoas of meaning datits return on a seta What ere thelikely motivational problema Uantenul risen sucha 636 {en? What con you rcemmend to oveoume auch dyeintionl effets?Copter Meaning end Contig At Emplned 307 EXHIBIT 4 Columbus Disriot Procesing Rquipment Proporal 7h ht i005 956 197 98 1959 aon ge ee Ba AT TE oo ay a Ga G39 ee a Co ee ee eee sata ero gran 69g Gp go 99 to. wy Gp ss 7 BSS SS A i ee ' TID 2” 30 3s 36400 as 5 38° 300 i205 3003 es foo Sass 08) HEM a) 0 8) investment vorkngeipial 5020)" (155) @5) AG BG) GO) 55 sere ration ERS 5. While computing district profte for perfrmanoe evaluation purposes should there be chazge for incur taxes? Should corporata overheads be allocated to dntrits? Should profs be computed onthe baie of historical ‘ts or onthe bass of replacement costs? Evaluate thea ies fom the tandpoint of their motivational impact an th dstrit manngers 6. Evaluate Quality’ incentive compensation system. Dees the presen ystam motivate district managers to make decisions which are consistent with the Sraiegy ofthe fem? If not, make spectfe recommendations Srprove the system,200 raone The Monge Col Brant EXHIBITS. Incentive Bonus for Columbus District Manager for 1992