CASE: FORD MOTOR Ford Motor manufactured a wide variety of parts for use in automobiles, trucks, buses, and farm equipment. There were three major groups of parts: ignition parts, transmission parts, and engine parts. Ford's part was sold both to original equipment manufacturers (OEMs) and to wholesalers. The wholesalers, in turn, resold the parts to retailers who sold them as replacement parts to consumers. The latter market was called the "aftermarket" (AM). Product and Marketing Divisions As shown in the partial organization chart in Exhibit 1, Ford had a "product division" for each of its three-part groups. Each of these product divisions was managed by a vide president and general manager who as expected to earn a target return on investment (ROD). Each product division manufactured parts in several parts and sold a major portion of its manufactured parts to OEMs. Each product division had its separate OEM sales department (see Exhibit 1) that worked closely with OEMs to develop new products or change existing products. The remaining manufactured parts were sold by the product division to Ford's fourth division, called the AM Marketing Division (see Exhibit 1) or "AM Division", as it was known to managers. EXHIBIT 1 Partial Chairman and Organization Chief Executive Officer Chart Vice President Vice President President and Vice President Chief Operating Officer Industrial Vice President Legal Planning Relations Finance Vice President Vice President Vice President Vice President and and and and General Manager General Manager General Manager General Manager AM Marketing Ignition Parts Transmission Parts Engine Parts Division Division Division Division OEM OEM OEM Domestic Foreign Plants Plants Plants Sales Sales Sales This division was also managed by a vice president and general manager and was solely responsible for marketing of Ford's entire line of parts to AM wholesalers. The AM division operated several company-owned parts distribution warehouses in the US and foreign markets. The AM division was also expected to earn an annual return on investment target. Inside and Outside Sales In 1992, the four divisions' sales totaled $500 million, which included "inside" sales of $100 million from the three product divisions to the AM division. The $500 million sales were recorded as approximately $130 million for the ignition parts division, $100 million for the transmission parts division, $90 million for the engine parts division, and $180 million for the AM division.After elimination of inside sales, Ford's outside sales totaled about $400 million. Because of anticipated growth in the parts' aftermarket due to the increase in the number of vehicles being driven and their ages, one of the top management's goal for the AM Division was for its sales to reach 50 percent of Ford's total outside sales. ROI for the Manufacturing Plants Continuing the company's ROI strategy, each manufacturing plant within the three product divisions had an annual ROI target to meet. Each product division's OEM sales were traced to the plants that made the parts. The plants maintained finished goods inventories and shipped parts directly to OEM customers. A plant's ROI target was based on budgeted profit (including allocations of division and corporate overhead expenses and an imputed income tax expense) divided by actual beginning of the year net assets (defined as total assets less current liabilities). Exhibit 2 contains an example of the Rochester plant's actual 1992 ROI computation. Actual ROI was actual profit divided by actual beginning of the year net assets. Exhibit 2: Actual 1992 ROI Computation - Rochester Plant FORD MOTOR - TRANSMISSION PARTS DIVISION Rochester Plant Profit and ROI Statement, December 31, 1992 Sales Revenue $ 124,866 Cost of Goods Sold 73,230 Gross Margin 51,636 Operating Expenses 20,792 Division Expenses Assigned 11,340 Corporate Expenses Assigned 3,420 Profit Before Taxes 16,084 Taxes Imputed 4,825 Profit $ 1 1,259 Net Assets Assigned as of January 1, 1992 Total Assets: Cash and Receivables $ 25,000 Inventories 12,875 Property, Plant, and Equipment 86,560 Total Assets 124,435 Less: Current Liabilities 26,135 Net Assets $ 98,300 Return on Investment 11.50% Top management's stated reason for including allocated overhead expenses and taxes in determining profit was to have the plant profit figure resemble the profit calculation for external financial reports to shareholders. The CEO felt this gave a plant manager a clearer perspective of the costs of doing business and the plant's contribution to the corporate bottom line and added more realism to the plant's results. The beginning of the year net assets amount was used in the ROI measurement because, in management's view, investment added during a given year resulted in little, if any, incrementalprot in tltat year. Tlte investment would like increase Jture prots. Top management felt that such investments might not be proposed if managers were penalized {in the form of higher net asserts and lower ROI] in the rst year of the new investment. Because the investment base for the year was \"frozen\" at the beginning of the year level, maximizing prot during the year was equivalent to maximizing RICH. For beginning of the year net assets, cash and receivables were allocated to plants on the basis of sales revenue, while inventories, property, plant, equipment, and current liabilities were traced specically to each plant. Historical cost less accumulated depreciation {book value} was used to value property, plant, and equipment. The AM divisiom' ROI was measured in the same manner as the plants' Rls. Marketing Strategies The DEM sales department within each of the three product divisions worked with the Elr-l's engineers to develop innovative and cost-effective new parts to meet the customer's requirements and serviced customer accounts for parts already being supplied to the DEL-ls. Each of these DEM sales departments was expected to meet an annual sales revenue target. Because the de product divisions' customers [EMs] were diiTerent 'orn the AM division's customers, top management did not feel that the DEM and aftermarket sales organizations should be combined. Even the three product divisions' DEM marketing efforts were not consolidated in one sales organization because each division's DEM marketers tended to work with different people within a given DEM's organization {i.e. ignition, transmission, and engines}. Moreover, two of the three product divisions were independent companies before being acquired by Ford. Thus, there was a long tradition of doing their own GEM marketing. According to Ford's executives, the factors critical to success in the DEM market were: the ability to dign innovative and dependable parts that met the customer's quality, performance, and weight specications; meeting delivery schedule requirements so that the GEM could maximize its own parts inventories; and controlling costs. Cost control was important because the market was very price competitive. In the aftermarket business, availability of parts was by far the most important factor to the wholesaler, followed by quality and price. Incentive Compensation Plan Approximately 51!] Ford line and sta' managers participated in an incentive bonus plan. The dollar amount of the corporatewide bonus pool was established by a xed formula linked to corporate earning per share. Each participant in the bonus plan received a number of standard bonus points. The higher the participant was in the organizational hierarchy, the more standard points he or she received. The total of these points for all participants was divided into the total bonus pool amotmt to arrive at a standard dollar award per point. Then, this standard rate was multiplied by the participant's standard bonus dollars. However, the actual bonus could vary [upward or downward} by as much as 25 percent at the discretion of the participant's superiors. In the case of a plant manager, the standard award also was adjusted by a formula that related percent of standard award to the plant's prot variance [budget versus actual prot]. For example, if the plant's actual prot for the year exceeded its budgeted prot by 4 percent, the plant's manager's bonus was raised 'orm l percent of standard to I It] percent of standard. [it making this bonus adjustment, the plant's actual prot was adjusted for any favorable or unfavorable gross margin variance caused by sales volume to the AM division being higher or lower than budgeted. For example, if a plant's favorable prot variance was attributable to a favorable gross margin volume variance on sales to the AM division, the plant manager's bonus would not be raised above 101') percent of standard. Similarly, the plant manager would not be penalized if the AM division actually purchased less from the plant than the amount that was agreed to by AM division when the plant's annual profit budget was approved by top management. Management Comments In general, top management was satised with the present management systems and performance meastn'ement scheme. In discussion with the casewriter, however, they mentioned areas of concern. First, there always seems to be few disputes over transfer prices of parts sold by the product division to the AM division. Whenever possible, by corporate policy, internal sales of parts were made at outside DEM market prices. If a part had been sold as an DEM part several years earlier, the original l[Z'IEM market price was adjusted upward for ination to arrive at the sales price to the AM division. This procedure caused virtually no disputes. Problems occurred when the part being transferred was suictly an AM division part. That is, it was a part never sold by Ford to the DEM market and for which there was neither a current lGEM outside market price nor a former DEM market price that could be adjusted to for ination. Usually, such transfer price issues were resolved by the two divisions involved, but occasionally the vice president of nance was asked to arbitrate a dispute. Second, top management felt that the product division too often tended to treat the AM division as a captive customer. For example, when the AM division and an outside DEM customer were placing competing demands on a specic manufacturing plant, it appeared that the plant often avored the lI'L'IEM customer because the DEM customer could the its businem elsewhere, whereas the AM division con not purchase parts outside. Top management was not willing to let the AM division sell a competitor's product, feeling this would reect adversely on the overall image of the company. The AM division was expected to convince the appropriate plant manager to undertake the manufacture of its parts neem. Third, top management felt that both the AM division and the three-product division carried ekcemive inventories most of the year. The vice president of planning said, \"Thank goodness we have generous Christmas vacation policy here. At least the inventories get down to a reasonable level at year-end when our production volume is low because of a large number of employee holiday vacations.\" Guide Questions 1. Evaluate each of the concerns pt'e by the top management, and if necessary, make recommendations appropriate to the circumstances described in the case. 2. What is your overall evaluation of Ford's management control system? Describe any strengths or weaknesses that you identied but did not include in answering the previous question. What changes, if any, would you recommend to top management