CASE ANALYSIS

ADAPTED FROM "PUENTE HILLS TOYOTA"

Puente Hills Toyota (PHT) was a privately held large Toyota dealership with annual sales of $85 million, annual profits of $1.8 million and a total of 145 employees located in southern California. PHT had won many awards including Toyota's President's Award for overall excellence in each of the prior 13 years.

Toyota allocated larger numbers of their best-selling models to their best performing dealers. Toyota evaluated their dealers in terms of their abilities to meet sales targets set for each geographical area. Amongst other evaluation criteria, customer satisfaction was obviously important in obtaining repeat sales and, hence, future profits. Customer satisfaction surveys were given to every customer who bought or leased a vehicle or had one serviced at a dealership. The responses to these survey questions were mailed directly to Toyota and aggregated into a customer satisfaction index (CSI) to which considerable attention was paid both by Toyota and dealership managers. Toyota sometimes reduced dealership vehicle allocations when CSI ratings fell below acceptable levels in three consecutive years.

PHT's organization structure was fairly typical in the industry. Reporting to the dealership general manager were a general sales manager, whose organization included both new and used vehicle sales, a service manager, parts manager and a director of finance (see Exhibit 1).

Dealership general manager was responsible for managing dealership net profits and return on capital. Each PHT's departments was managed as a profit center. Many indirect or overhead expenses, such as dealership administrative salaries and dealership advertising expenses, were assigned or allocated to the departments. Also, some infrastructure-related expenditures (e.g. rent) and some other expenditures over which the department managers had little or no control (e.g. insurance, taxes, legal and auditing) were allocated to them.

The profitability of PHT's department varied widely. As in most dealerships, new vehicle sales at PHT were only marginally profitable. Used vehicles provided a better profit source, as Howard Hakes, general manager explained:

"There is only an $800 difference between the window sticker price and dealer cost on most new vehicles, so there is not much margin. In used vehicles, we have a little more profit opportunity. We can sometimes take a trade-in for $2,000, put $1,500 worth of work in it and sell it for $6,000."

The service department was consistently PHT's most profitable department, with 15 - 20% profit margins.

Reporting of new and used vehicle profits required some allocation of expenses. All items of expenses were split 70% to new vehicles and 30% to used vehicles. Howard Hakes knew that this formula was somewhat arbitrary, for example some forms of advertising such as advertisement on Spanish television stations were solely aimed at selling used vehicles.

All interdepartmental transfers were done at market price. Thus, for example, when PHT's used vehicles were serviced in the PHT shop, the sales department paid full retail price for parts and labor. This policy gave the used vehicle manager some negotiating power in the service area. Paying full retail price ensured that internal used vehicle service jobs would not be given lower priority.

PERFORMANCE MEASURES AND INCENTIVES

Compensation of line personnel at PHT was high. Young salespeople could earn $6,000 - $7,000 per month if they hustled and followed up effectively with customers, while top sales personnel could earn $20,000 per month. Some service technicians earned over $10,000 per month. Performance-based incentives were a significant part of the compensation of all line personnel.

Incentives in the sales department

All personnel in the sales department were paid a relatively modest base salary plus incentive pay. The salesmen and assistant sales managers earned commissions on the deals they closed. The average commission rate was 20% and 7% of deal gross profit for salesmen and assistant sales managers, respectively. The general sales manager, used vehicle sales manager, and sales desk managers' bonuses were based on a proportion of departmental profit after overhead expenses but before taxes. The general sales manager and desk sales managers were paid a 2.25% and 1.2% - 1.5% of this amount for the total sales department profit, respectively. The used vehicle sales manager was paid 5% of this amount for the used vehicle department profit only.

Nonfinancial performance indices such as CSI and Employee Satisfaction Index were generally not taken in to account for bonus determination.

The bonuses, which were typically 250-300% of the sales employees' base salaries, provided a significant proportion of total compensation. The bonuses were paid monthly.

Incentives in the service department

The service advisors earned a base salary and bonuses of either 8% commission on customer-paid labor and parts or 6% commission on labor and parts paid for internally at PHT.

The service manager was paid a base salary and a bonus based on a percentage of the service department gross profit before overhead expenses - 3.75% if the gross profit was $195,000 or below in any given month and the percentage rose to 4% if the gross profit exceeded $195,000.

Gameplaying temptations

Howard worried that dealerships regularly "gamed" the CSI measures because they had become so important. In the quest for "perfect" ratings, customers were regularly "coached" on how to complete the questionnaire and sometimes were rewarded with a present, such as a full tank of gas, if they let dealership employee complete the questionnaire and send it to Toyota.

Management issues

Howard Hakes lamented that sales personnel were not effective at following up with customers who visited the sales department but have not yet decided to purchase a vehicle, as well as sales approached to customers who are driving an older vehicle that has recently been serviced at PHT. Service advisors regularly ignored explaining customers which service costs were likely to occur on their older vehicle in the coming years and encouraging them to visit the sales departments. Could incentives be provided to encourage follow-up and referral behaviors?

Howard also wondered what he should do about gameplaying temptation at PTH.

Despite these issues, Howard was confident that PHT was one of the best managed dealerships in the country.

a)Describe the Financial Responsibility Centers at PHT including the variations to the basic types of Financial Responsibility Centers. (4 Marks)

b)Evaluate the performance measurement and incentive systems used at PHT. (4 marks) What changes would you recommend, if any? (2 Marks)