Case 25.1 Harwood Medical Intruments PLC

This case asks you to evaluate an new bonus plan that was designed to specifically address the perceived shortcomings of a previous plan.In particular you should consider:

• The purpose of changing the system
• The calculated bonuses for the managers
• How well the new plan is working

Case 25-1

Harwood Medical Instruments PLC^*

Harwood Medical Instruments PLC (HMI), based just outside of Birmingham, England, manufactured specialty medical instruments and sold them in market niches that were becoming increasingly competitive and price sensitive. The company was organized into nine divisions each run by a general manager. Over the years HMI had grown both organically and by acquisition. Six of the divisions had been acquired by HMI within the past decade.

All of HMI's divisions sold medical products to hospitals, laboratories and/or doctors, so the need for product quality and reliability was high. The divisions varied significantly, however, in terms of the degree to which their success depended on, for example, development of new products, efficiency of production, and/or customer service.

Bonuses for division managers were paid semiannually. Up through the year 2006, the bonus amounts were calculated as two percent of division operating profits.

HMI's managing director, Andy Guthrie, worried that the operating profit measure was too narrowly focused. He had been reading articles about performance measurement and decided to implement a more balanced scorecard. In November 2006, just before introducing a new bonus plan, Mr. Guthrie explained to his chief financial officer that he was willing to pay out higher bonuses than had been paid historically if improved performance warranted doing so.

The new plan provided a base bonus for division managers of one percent of division operating profits for the half-year period. This base bonus was adjusted as follows:

1. Increased by 5,000 if over 99% of deliveries were on time, by 2,000 if 9599% of deliveries were on time, or by zero if less than 95% of deliveries were on time;
2. Increased by 5,000 if sales returns were less than or equal to 1% of sales, or decreased by 50% of the excess of sales returns over 1% of sales;
3. Increased by 1,000 for every patent application filed with the UK Intellectual Property Office;
4. Reduced by the excess of scrap and rework costs over 1% of operating profit;
5. Reduced by 5,000 if average customer satisfaction ratings were below 90%.

If the bonus calculation resulted in a negative amount for a particular period, the manager received no bonus. Negative amounts were not carried forward to the next period.

Results for two representative HMI division for the year 2007, the first year under the new bonus plan, are shown in Exhibit 1. The Surgical Instruments Division (SID) sold a variety of surgical instruments, including scissors, scalpels, retractors, and clamps. The Ultrasound Division (Ultrasound) sold and serviced ultrasound probes, transducers, and diagnostic imaging systems. In 2006, the total annual bonuses of the managers of SID and Ultrasound were approximately 85,000 and 74,000, respectively.

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EXHIBIT 1Harwood Medical Instruments PLC

^*Copyright by Kenneth A. Merchant.

Case 25-2