708

Part III

Variations in Management Control

Casn 1i|-l

AB Tkonsrrn
"You will see from my report that the XL-4
project shows an excellent rate ofreturn on the
Skr 700,000 investment and is also a logical
extension ofour product developnent and
growth stratery here in Sweden. My
management and I strongly recommend this
project."
Anders Ekstrom, Managing Director AB Thorsten,
Stockholm (100 percent-owned subsidiary of Roget S.A.)

"Any extra XL4 which Ekstrom might sell in

Sweden can be produced in our existing plant in
Gent for no additional investment. Ekstrom is
not only very optimistic about the sales
potential, he is also underestimating the
manufacturing problems and costs he will face. I
recommend that you inform Ekstrom that it is in
Roget's best interest for him to import from
Belgium any XL-4 he can sell in Sweden."
Pierre Lambert, Vice President for Domestic and Export
Sales and Manufacturing, Industrial Products Group,
Roget S.A. Brussels

Roget S.A.
Roget S.A.1 was one of the largest industrial
companies in Belgium. The company was incorporated in 1928 by merging three smaller fiirns
that all produced industrial chemicals for sale
in Belgium. By 1981 Roget had expanded to
produce 208 basic and specialty chemical products in 21 factories, for sale throughout Europe.
Until the mid-70s, Roger was organized with
one large manufacturing division and one large
sales division in Belgium. A department of the
sales division was devoted to export sales. HowThis caseis adapted frorn AB Thorcten (A), (B), and (C) cases,which
were prepared by ProfessorsC. E. Summer end G. Shillinglaw and
are copyrighted by the Institute for Management Development,
Lausanne, Switzerland.
r"AB" and "S.A." are abbreviations used in Sweden and
Belgium that are sinilar
States.

to "Corp." or "Inc." in the United

ever, in the late 70s, exports glew so fast, and

domestic markets became so complex, that the
company created three main product divisions
(Food, Industrial, and Textile), each with its
own manufacturing plants and sales organization. In addition, the company created foreign
subsidiaries to take over the businesses in certain areas. For example, in Industrial Chemicals the company had two subsidiaries-one in
the United Kingdom and one in Sweden
(Thorsten), which served all of Scandinavia. At
the same time, the Domestic Department of the
Industrial Chemicals Division exported to the
rest of Europe. The United Kingdom and Sweden accounted for 9 percent and 5 percent, respectively, of sales in that Division.
Mr. Gillot (see Exhibit 1) was responsible for
profits from all industrial chemicals; Mr. Lambert was responsible for profits from domestic
operations (manufacturing and sales of industrial chemicals) and export sales to countries
where the company did not have subsidiaries or
factories; and Mr. Ekstrom was responsible for
profits in Scandinavia. The company utilized a
rather liberal bonus system to reward executives at each level, based on the profits oftheir
divisions.
This, together with a policy of promotion
from within, helped stimulate managers in
Roget to a degree not enjoyed by some of its
competitors. It also helped the company to retain key people in an industry where experience was of great importance. Many of the compauy's executives had been in the starch
chemicals business all of their business lives. It
was a complex business, and it took many years
to learn it.
Certain policies-rules of the game--governed
relationships with the subsidiary companies.
These policies were intended to maintain the efr-

Management
ControlSystems,@2001,lvlcGraw-Hill.
C.E.Summerand G. Shillinglaw,
prohibited.
CopiedunderlicencefromAccessCopyright.Fudherreproduction

Chapter 14

Multinational

709

Organiaations

Enusrr 1
Roget S.A* organizational chnrt

Vice Pregident
Research

Vice President
Engineering

Vice Resident
Finance

Senior Vice President

Industrial
Chemicals

Vice President
Domestic and Export
Operations

Senior Vice hesident

Textile
Chemicals

Managiug Director
Roget Ltd. (U.K.)

ciency of the whole Roget complex, while at the

same time $ving subsidiary managers autonomy to rr.r-nttreir own businesses. For exarnple, a
subsidiary manager could determine what existing Roget products to sell in the local market.
Export sales would quote the same price as they
quote agents in all countries. Of course, all
prices were subject to bargaining on both sides.

Second,subsidiaries were encouraged to propose

to division management in Brussels the development of new products.If these were judged feasible, new products lr'ere manufactured in Belgium for supply to world markets. Third, the
subsidiary managing director could build manufacturing plants if the investment in the local
market were adequately justified.

7LO

Part III

Variations in Management Contml

AB Thorsten

Initial

AB Thorsten was purchased by Roget S.A. in

1972. Since that time, Thorsten's board of directors had consisted of four persons: Mr. Michel
Gillot, senior vice president in charge of Roget's
industrial chemicals division; Mr. Ingve Norgren, a Swedish banker; Mr. Ove Svensen, a
Stockholm industrialist; and the managing director. Swedish law required any company incorporated in Sweden to have at least two out
side directors, and the Roget management felt
fortunate in finding two men as prominent as
Norgren and Svensen to senre on the Thorsten
board.
During the frrst four years of Roget's ownership, Thorsten's sales fluctuated between Skr. 5
and 7 million, but hit a low in 1976.2The Board
decided at that time that the company was in
serious trouble, and that the only alternative to
selling the company was to hire a totally difrerent management group to overhaul and streamline company operations.
On the advice of the Swedish directors, Mr.
Anders Ekstrom, a 38-year-old graduate of the
Royal Institute of Technology, was hired as
managing director. He had 16 years of experience as a production engineer for a large paper
machinery company and as division manager
responsible for profits in a large paper company,
Ekstrom joined AB Thorsten in January of
1977. Since that time, sales had increased to
Skr. 20 million and profits had reached levels that Roget's management found highly
satisfactory.
Ekstrom said that at the time he joined
Thorsten, he knew it was a risk:

In September of 1980, Ekstrom had informed

the Thorsten board of directors that he proposed to study the feasibility of constructing a
factory in Sweden for the manufacture of XL-4,
a starch-based adhesive chemical used in drying paper. He explained that he and his customer engineers had discovered a new way of
helping paper mills adapt the dryer sections of
their huge paper machines at very low cost so
that they could use )il-4 instead of competitors'
products. Large paper mills would realize dramatic savings in material handling and storage
costs and also shorten drying time substantially. Shortened drying tirne increases the effective capacity of a paper machine. It was Ekstrom's judgment that his innovation would
allow him to develop a market in Sweden almost as big as Roget's present worldwide market for XL-4. This product was currently being
produced in Roget's Domestic Department at
the rate of 600 tons per year, with none going to
Sweden. Ekstrom stated:

I liked the challenge of building a company. If I did a

good job here I would have the confidence of Norgren
and Svensen as well as of the Roget management in
Brussels. I felt that suscesding in this situation would
teach me things that would make me more competent as
a top executive. So I chose thisjob even though I had at
the time (and still have) ofrers from other companies.
2Most monetary amounts in this case are stated in Swedish
kronor (Skr).

Proposal

for Manufacture

of lil-4

At that meeting, Mr. Gillot and the other directors

seemedenthusiastic. During the next six months, we did
the analysis. My marketing director used modern market research techniques to estimate the total potential
in Sweden at 800 tons of)C-4 per year, using the custom engineered approach we wre proposing. We interviewed important customers and conducted triale in t,he
mills of three big companies whidr proved that with the
introduction of our machine designs, the large cost savings and capacity expansion would indeed materialize.
We determined that if we could gell the product for Skr.
1,860 per ton, we could capture at least one'half of the
market within a three-year period, or 400 tons a year.
At the same time, I called the head of the corporate engineering division ia Belgium and asked for his help in
designing a plant to produce 40O tons ofXI-4 per year
and in estimating the cost of tbe investment. This ig a
routine thing. The central stafT divisions are advisory
and always comply with requests for help. He assigned a
project manager and four other engineers to work on the
design of factory and machinery and to eetimate the
cost. At the eame time I assigned three nen from my
staff to work on the project. In three months this joint
task group reported that the necessary plant could be
built for about Skr 700,000. All of this we summarized
in a pro forma calculation lExhibit 2]. This calculation,

Chaptcr 14

E:qnrt

7tL

MultinationalOrganizations

]KL4z lhe Swedish Proposat

(in Skr.)

End.
of
Year
0
1
2
3
4
5
6
7

Plant

56
34
SoLes Voriable Contributionl
Ton
Worhing Pricel
Costl
(col.3-4)
Ton
Capi.tal
Ton

-?00,000 -56,000+
-2,000* 2,000
-7,000* 1,850
1,850
1,850
1,860
1,850
+150,00Or+65,000+ 1,850

1,ofi)
1,000
1,000
1,O00
1,000
1,000
1,000

1,000
850
850
850
850
850
E50

Number
ofTons

200
800
400
400
400
400
400

rc

78
Total
Contribution
bol.5 * 0

Promotion
Costs

130,000
200,000
i265,OO0 75,000
3,[0,000
50,000
3410,00O 60,(X)0
34O,0oO
50,o0o
60,000
340,000
340,000
50,000

Tuesl

Net
Cash Flows
(1+2+7-8-9)

(36,000)
20,000
76,000
76,000
75,W
145,000
145,0fi)

-756,000
103,000
153,000
216,000
215,000
2l5,OOO
145,OO0
360,0Oo

tTheee workiag cepitrl iDvestrnent amou.Dtaare Det of t! 6ealita.

iTaxeo are calculated after depreciating Skr, 700,000 over a 5-year period oa straight-lioe baeis.
tSales value, net ofappropriate taxes, asouming plant will b closed at end ofeeven yeare.

together with a complete written explanation, was

mailed to Mr. Gillot in early April 1981. I felt rather excited, as did most of my ataff. We all know that in0roduction ofnew products is one ofthe keys to our continued
growtlr and profitability. The yield on this inveetment
wae well above the mininum 8 percent egtabliehed as a
guideline for new inveetment by the Roget vice president of finance, We algo knew that it was a good analysis, uoing modern tools of management. In the cover letter, I asked that it be put on the agenda for the next
Thorsten board meeting.

The minutes of the next board meeting held

in Stockholm on April 28, 1981, quoted Ekstrom's remarks as he explained the proposal to
other directors:
You will see from the summary table [Exhibit 2] that
this project is profitable. Gentlenen, it seeme clear from
theoe figures that we can justifr tbis investment in Sweden on the basis of sales to the Swedish market. T'he
group vice president for finance has laid down the policy
that any new investment shoulal yield at least an 8 percent return. lbis particular proposal erceeds that aubstantially, using a very conservative seven-year life. My
management aud I etrongly reco--end thia project.

Ekstrom later recalled Gillot's reactions in

his role as chairman of the Ttrorsten board:
Gillot eaid that it seened to him to be a clear caee. He
aeked positive guestions, nainly about the longer-term

likelihood that we could sell mme than 400 tons a year,

and about how we would frrance any further expansion. I
explained that we in Sweden were vety firm in our judgment that we would reach 400 tons a year even before
one year, but felt constrained to shoq, a consenrative estimate of a three-year transition period. We aleo ehowed
him how we could finance any furttrer erpansion by borrowing in Sweden. That is, if Roget would furnish the initial capital, and if the 400 tons goal were reached
quickly, any further expansion would easily be financed
by local banks. ltre two Swedish directon confirned this.
Ttre board voted unanimouely to constnrst the plant.

I)isagreement

about the lil,4

Proposal

About a week later, Gillot telephoned Ekstrom:

I have been through sone additional discussions with
the production and marketing people here in the Domeetic Department. They thint the engineering design and
plant cost is accurate, but that you are too optinistic on
your sales forecaet. It looks like you will have tojustifr
this more.

Ekstrom said:
I pushed him to eet up a meeting the following week.
firis waa attended by nyseUand my marketing and production directore from Sweden, and four people from
Belgium-Gillot,
Lavanchy (director of rnanufacturing),
Gachoud (director ofsales), and Lambert (vice president
for domestic and export), That was one of the worst

7L2

Part III

Variations in Managem.ent Control

meetings of my life, It lasted all day. Gachoud said that

they had sales experience from other countries and that
in his judgment the market potential and our share were
too optimistic. I told him over nnd over how we ar:rived at
this figure based on our custom engineered approach,
but he just kept repeating th.e over-optimistic argument.
Then Lavanchy said that the production ofthis product
is complicated, and that he had difficulties producing it
in Belgium, even with trained workers who had long experience. I told him I only needed five trained production
workerg and that he could send me two men for two
months if he liked, to train Swedes to do the job. I impressed on him that they could oversee manufacturing
for ue in Sweden until we learn, if they ditl not have confidence in Swedish tecbnolory. He repeated that the difficulties in manufacturing were enormous.
Lavanchy then said that since the whole world market
for Roget was only 600 tons a year, it was inconceivable
that Sweden alone could make 400 tons. Gillot ended the
meeting without a decision, and said that he hoped all
concerned would do more investigation of thia subject. He
indicated that he wotrld think about it hirnselfand let us
know when another meeting would be held.

Ekstrom returned to Stockhohn and reported

the meeting to his own staff, and to the two
Swedish members of his board:
They, like I, were really disgusted. Here we wer, operating with initiative ancl with excellent financial techniques. Roget rnanagement had often made epeechesin
which they emphasized the necessity for decentralized
profrt responsibility, and for authority and initiative on
the part of foreign subsidiaries. One of my men said that
they seem to talk decentralization and act like tin gods
at the same time. Mr. Norgren, the Swedish banker on
Ttrorsten's board, expressed surprise. I considered this
carefully. It is sound business for AB Thorsten, and XL-4
will help to build one more growth company in the
Swedish economy. Somehow, the management in Brussels has failed to understand ttris. I dictated a letter to
Mr. Gillot telling him that I didn't know why the project
was rejected, that Roget has a right to its own reasons,
but that I was prepared to resigrr as a director. It is not
that I an angry, or that I have a right to dictate decisions for the whole worldwide Roget organization. It is
simply that if I spend my time studying policy decisions,
which are not appreciated by parent company management, then it is a waste of my time to continue.

Finally, Ekstrom stated:

While I certainly wouldn't bring tJrese matters out in a
public meeting, I think those Belgian production and
sales people simply \ilant to build their empir.e anrl make

the money in Belgi'm. firey dont care about Thorsten

and Sweden. We have the ideae and initiative, and they
take them and get the payoff.

Further

Study

Mr. Gillot received Norgren's letter in late May

1981. He then contacted Messrs. Lavanchy, Gachoud, and Bols (V.P. finance, Roget) and told
them that the Swedish XL4 project had become
a matter of key importance for the whole Roget
Group, because of its implications for company
profrts, and for the morale and autonomy of
subsidiary management. He asked them to
study the matter very carefully and report their
recommendations in one month. Meanwhile, he
wrote Ekstrom, "Various members of the Corporate Headquarters are studying the proposal
very seriously. You will hear from me within
about six weeks regarding my frnal decision."
Lavench5/s Rsponse
A month after he was asked to study the XL-4
project more closely, Lavanchy gave Gillot a
memorandum explaining his reasons for opposing the proposal:
At your request, I have reexamined thoroughly all of the
cost figures that bear on the XL-4 proposal. I fintl that
mpnufacture of this product in Sweden would be highly
uneconomical, for two reasons: (l) overhead costs would
be higher, and (2) variable costs would be greater.
As to the first, we can produce XL-4 in Gent in our
existing plant with less overhead coet. Suppose that
Thorsten does sell 400 tons a year so that our total
worldwide gales rise to 1,000 tons. We can produce the
whole 1,00O tons in Belgium with essentially the eame
capital investment we have now. If we produce 1,000
tons, our fixed coets will decrease by Skr. 120 a ton.3
that means Skr. 72,000 in savings on production for domestic and export to countries other than Sweden (600
tons a year), and Skr. 120,000 for worldwide production
including Sweden (1,000 tons). Second we could also
save on variable costs. If we wene to produce the extra
total fixed cost in the Gent factory was the equivalent of
Skr. 180,000 ayear. Divided by600, this equals SLr.300 a
ton. Ifit were spread over 1,000 tone, the average fired cost
would be Skr. 180.

Chapter

Enusrr 3
End
of
Year
0
1
2
3
4
o
6
7

Plont

lC-4:

74

Multindtiorrol

The Belgian Proposal

23456
Scles
Worhing Pricel
Copitol Ton

*64,0,00*
-10,000* 2,000
-10,000* 1,850
1,850
1,950
1,950
1,850
+74,000 1,850

(in Skr.)

Varidbl,e Contributianl
Ton
Costl
(col.3-4
Tont

1,380
1,380
1,380
1,380
1,380
1,380
1,380

713

Orgd,nizatians

620
470
470
470
470
470
470

Number
ofTons

200
s00
400
400
400
400
400

78
Total
Cont rib ut in n Pro mot ion
Coste
kol.5*6)

124,000
141,000
188,000
188,O00
1E8,000
188,000
188,000

130,000
75,000
50,0oo
50,000
50,mo
50,000
50,000

Tws

10
Net
Cash Flowa
(1+2+7-8-9)

(3,000)
33,000
69,000
69,000
69,000
69,000
69,000

s4,000
-13,000
23,000
69,000
69,000
69,000
69,000
143,000

*Working cspital ainounts are Eet of tar credits.

tVeriable cost per ton
=SKr. 1,380
=
Manufactruing
930

Shipping from Belgium tn Sweden=

=
Swedisbimport tlut5r
=
Total variablecost

60
_199
1,380

400 tons in Belgium, the total production of 1,000 tons a

year would give us longer production runs, lower average setup costs, and larger raw Dlaterial purchaBes, tbus
allowing maBs purchasing and material handling and
lower purchase prices. My accounting departnent has
studied this and concludes that our average variable
costs will decrease from Skr. 960 e ton to Skr. 93O. This
Skr, 20 per ton difference meatrs a savings of Shr.
12,000 in Belgian domeetic production and a saving of
Skr. 20,000 for total worldwide production aesuming
that Sweden takes 400 tone a year. Taxes on these
added profits are about the same in Belgium and
Sweden-about 50 percent of taxable income. In conclusion, a new plant shoultl not be built. Ekstrom is a
bright young man, but he does not know the adhesives
busineee. He would be caught up in costly production
migtakes from the very beginning. I recommend that
you inform the Thorsten management that it is ir the
Company's interest that they muet buy ftom Belgium."

Bolste Response
The same week, Gillot received the following
memorandum from Erik Bols, Roget's financial
vice president:

I am sending you berewith eetimatee of the working capital requiremente if Roget increaees its production of
XL-4 in our Belgian plant from 600 to 1,000 tons a year
lExhibit 31. Initially, we will need Skr. 54,000, for additional inventories and accounts receivable. By the end of
the aecond year, this will have increased to Skr. 74,000.
Ttre working eapital qmounts shown in thie erhibit are
based on the applicable law which permits bugiaegses to
deduct 60 percent of iacremental inventory costs from
taxable income. I have also looked at Lavanch5/s calculations for the fixed and variable manufacturing costs,
and am in full agreement with them. In conclueion, I see
no reaeon to spend Skr ?00,000 to build a factory in
Sweden when we have exceee capacity in our Belgian
plant which can produce the incremental tons at lower
cost and with lower manufacturing risk.

Gillot's Response
In early July 1981, Gillot Bent a letter to Ekstrom indicating that the XL-4 proposal was
turning out to be more of a problem than he
had anticipated. He included copies of the
memos from Lavanchy and Bols. He said he
was not yet in a position to grve final approval.

7r4

Part III

Variations in Monagement Control

He said he would let Ekstrom know his decision

as soon as possible.

4.
Ekstrom'e

lhoughte

Ekstrom expressed some impatience with the

way things were going:
I have other projects that need developing for Thoraten,
and this hind of long-range planning takee much tise
and energy. Also, just keepirrg on top of the normal operating problems ofthe business we already have takes up
a lot of my time. Sometimes I feel like tellirrg them to go
and sell XL-4 themselves.

5.

6.
Queetione
1. Using the numbers from Exhibit 2, what
is your estimate of the NPV (at 8 percent)
for the Swedish proposal. Also, what is the
6-year IRR?
2. What is the NPV (at 8 percent) and IRR of
the Belgian proposal in Exhibit 3?
3. What are the key arguments for and
against the alternatives presented by the

7.

8.

contending parbies from Belgium and

Sweden?
Is ever5rthing that is being expressed by
Ekstrom and the Belgium management
above board? What are the respective
hidden agendas that can be anticipated
for each party, and in what way do they
coincide? In what way can they be
expected to diverge?
Ifyou were in Gillof,s shoes, would you
support the Swedish or the Belgian
proposal? Why?
Ignoring your answer to question 5, if the
plant were not built aud the products
were shipped from Belgium to Sweden,
what transfer price would be appropriate?
lVhat are the competitive advantages of
Roget S.A.? What is Roget's stratery in
the industrial chemicals business? Are the
management control systems designed to
support this strategf
What changes in the management control
systems would you necommendto Gillot?