Case PCL A Breakdown in the Enforcement of Management Control (p. 168) 13 May. v Questions 1. Analyze the challenges faced by PCL in reducing returned sets and NFF returns. 2. 2. Aside from the recommendations put forth by PCL, what other actions might improve the return rate of TV sets? 3. What lessons can PCL draw from its exercise in controlling the high rate of returned TV sets to inform its execution of internal control mechanisms in the future? CASE STUDY PCL: A Breakdown in the Enforcement of Management Control PCL was a leading European consumer electronics, The television market in China lifestyle, and healthcare company that had entered the Chinese market in 1985. While its consumer elec- It was no surprise that China, a country that produced tronics business grew steadily in China, the costs of 42% of the world's total shipment of TV sets, had a returned sets in its TV division amounted to 5% of strong TV market. Domestic manufacturers alone the division's total sales in 2008. Even more worry- accounted for three-quarters of its liquid-crystal dis- ing was that 37% of the returned TVs were of good play (LCD) TV market in 2009.* Driven by consumers' quality and had been returned without good reason. preference for large-sized TVs and by falling prices, PCL taskforces set up to study the situation found that China was forecasted to surpass North America as the control measures designed to handle returns were largest LCD TV market in the world, with sales reach- simply not being carried out by staff and third-party ing 29 million units in 2010, translating to more than after-sales service centers. What could PCL do to rem- 30% in growth year-on-year. The growth would be edy the situation? driven by consumers replacing their cathode ray tube (CRT) sets with LCD sets, especially in third- and fourth-tier cities." International brands faced fierce The consumer electronics industry competition from domestic brands, which enjoyed in China advantages in both cost control and distribution, and price wars were common as domestic brands lowered With a population of 1.3 billion and rising disposable their prices to increase their market share. Large retail incomes, China had become the second-largest market chains played a critical role in the retail market for con- for consumer electronics in the world. Analysts fore- sumer electronics in China, and competition for shelf casted a compounded annual growth rate of 9.8% space in such chains was fierce. Manufacturers became through to 2014 for consumer electronics, with grow- involved with the promotions, marketing, and supply ing demand for TV sets and computers in smaller cities chain management of these chain stores in order to and rural areas being the main driver."As the market build relationships with them.' Others opened their in the big cities had become saturated, market competi- own branded stores so they could have a direct hand in tion had moved increasingly to smaller cities and rural shaping consumers' purchase experience. areas. Sales of consumer electronics products in these markets were further enhanced by the government's subsidy program, which offered rebates for purchases 3 K. Zhang, "China TV Market to Enjoy Solid Growth in 2014," iSuppli (April 26, 2010), online at www.isuppli.com/Display-Materials- of consumer electronic goods in rural areas. Another and-Systems/ MarketWatch/Pages/China-TV-Market-to-Enjoy- government program that allowed consumers to trade Solid-Growth-in-2014.aspx (accessed June 20, 2010). in old electronic appliances for new ones in nine pro- 4 Ibid. 5 "Corning: China to Become World's Biggest LCD TV Market," Sino- vincial areas since 2009 had also helped to stimulate Cast Business Beat (April 14, 2010), online at www.tradingmarkets. demand. comews/stock-alert/glw_diek_corning-china-to-become-world- s-biggest-led-tv-market-910387.html (accessed June 20, 2010) "Overview of China's LCD Market," GfK Retail and Technology (March 29, 2010) online at www.gfkrt.comews_events/market_ "Consumer Electronics in China," Euromonitor (April 2009), online news/single_sites/005606/index.en.html (accessed June 30, 2010). at www.euromonitor.com/Consumer_Electronics_in_China (accessed 7 1. B. Von Morgenstern and C. Shu, "Winning the Battle for the June 20, 2010). Chinese Consumer Electronics Market," (September 2006), online 2"China Consumer Electronics Report Q3 2010," Business Monitor at www.mckinseyquarterly.com/High_Tech/Hardware/Winning_ International (2010), online at www.pr-inside.com/china-consumer- the_battle_for_the_Chinese_consumer_electronics_market_1855 electronics-report-q-r1905491.htm (accessed June 10, 2010). (accessed June 20, 2010). 168PCL: A Breakdown in the Enforcement of Management Control PCL Consumer Electronics - background retailer from whom they made the purchase within five PCL was a high-tech multinational company based in days or exchange it for a new one within 15 days. Europe. Since its establishment in the late nineteenth Retailers sent PCL sets returned by customers to the company's ASCs, which would decide whether to century, it had diversified into multiple industry seg- ments. The diversification strained its resources and, accept the return and repair them. If the defect was consequently, PCL reshaped the organization to serious, the ASC would send the set back to PCL's fac- tory for repair. focus on the healthcare and electronics sectors. In 2010, it had a sales and service presence and manu- facturing sites in more than 100 countries around Investigation the world. In response to the high volume of returned sets and PCL's consumer electronics division (PCL Con- sumer Electronics) was a global player in digital and high NFF returns, PCL's management appointed the product marketing manager of the TV division, who electronic devices, bringing the latest technology was also familiar with the return process, to look into and human-centered designs to the market. Its prod- the matter so appropriate actions could be taken. He uct portfolio included color TV sets, DVD players, formed a task force that brought together the sales audio products, PC monitors, and PC peripherals. operation manager, the service manager, and the finan- PCL Consumer Electronics had a sales and service cial controller of the TV business. The team set out to presence in more than 50 countries and manufacture investigate the situation and uncovered a number of ing sites in France, Hungary, Belgium, Brazil, Mex- causes for the problem. ico, and Argentina even though it outsourced its Neither retailers nor ASCs had been trained in edu- production heavily. PCL Consumer Electronics placed cating customers about product performance or the cri- a strong emphasis on emerging markets such as teria for accepting returns. Retail stores usually used China and India. It entered China in 1985, and by 2008, its sales organization on the mainland had high-definition signals for product demonstrations, but grown to 550 people with annual sales of US$752 most consumers used cable TV at home. As a result, consumers often became dissatisfied with the picture million (See Exhibit 1). quality after they took the TV set home and would try to exchange it for a new set or simply return it. While Repairing the broken system PCL had established return criteria that were as strin- gent as those of its competitors, retailers and ASCs Returned sets often failed to execute them properly, accepting returns In 2008, the handling of returned TV sets cost PCL an without proper screening. average of US$6 million, equal to about 5% of its Chain retailers were significant players in China's annual TV sales. The costs covered freight from the consumer electronics market, and consumer electron- dealer to PCL's warehouse, repair, and refurbishment at ics companies could not maintain their market share the factory workshop. While PCL spent a hefty sum without selling through them. Because no interna- each year servicing returned goods, about 37% of the tional TV brand possessed unique product features or returned goods were no-fault-found (NFF) returns, technical advantages that differentiated its products in translating to a loss of US$2.2 million for PCL. NFF the market, the manufacturers' best option was to returns also included demo sets and slow-moving make concessions in their negotiations with chain goods that were not supposed to be returned (see stores in order to maintain good relationships with Exhibit 2). them and in turn receive higher visibility at the point of sale. PCL, for instance, cut its profit margins and The TV return process accepted returns of slow-moving models and demo sets in order to secure prominent display locations in the After-sales service for PCL's TV division was handled by stores. In addition, PCL salespeople had to meet sales authorized service centers (ASCs), which were third- targets and required the support of dealers to achieve party service centers authorized and managed by PCL's these targets. This made it hard for many salespeople after-sales service team. Under China's consumer law, to say no to unreasonable returns because doing so consumers could return a defective TV set to the might jeopardize their relationship with the dealers. 169Chapter 4 - Control System Tightness Moreover, they put little effort into investigating the returns, despite established approval procedures for returned goods. PCLl's after-sales service team, which was respon- sible for overseeing the ASCs, did not report to the TV division directly, but instead reported to the gen- eral manager of the organization, a line of reporting that reduced the incentive for the after-sales team to control TV returns or to monitor the third-parcy ASCs stringently. Not only did the ASCs fail to inspect the returned sets carefully, but they some- times faked their inspection records instead of rejecting the return of TV sets. The situation was further aggravated by the fact that PCL had no pun- ishment policy for fraud or incompliance on the part of ASCs. Action The team came up with a series of actions based on their initial assessment of the situation. The sales team's annual performance appraisals would be linked with TV returns and the cost of servicing returns, and this new measure was communicated by the TV sales director to all the salespeople. The service manager also communicated to ASCs a new policy whereby they would be fined three times the labor charge for each fake inspection record discovered. The project team forecasted that their plan would reduce the return rate to 3.5% and the NFF rate to 20% within two months, but their projection did not materialize. In fact, the NFF return rate went up to 40% after two months. Upon further investigation, the general manager and the production manager of the TV division discovered two reasons for the rising rate of NFF returns, despite their effores. First, the sales team was under enormous pressure to meet their sales targets, which was set at 132% of the sales of the previous year, a rate thar exceeded acrual mar- ket growth. In order to reach their targers, they put pressure on the dealers to increase their purchase volumes, leading to higher inventory levels and tighter cash flow. To counter the se problems, dealers negotiated with salespeople to accept returns and to allow exchanges of demo sets and slow-moving goods for new models. The second reason was that 170 the after-sales service team had failed to take puni- tive action against the ASCs for fake inspection records. There was little incentive for the service team to respond to the ASCs' transgressions, as it did not report to the TV division and its performance indicators were not linked to the amount of goods returned. Second try Dissatisfied with the outcome, the general manager of PCL Consumer Electronics appointed the service direc- tor, who reported directly to him, to lead the task force. The service director was also given the authority to handle issues that did not usually fall within his scope of responsibilities in order to tackle the problem. Onee appuointed, the service director put together a new cross-functional team, with each member responsible for a specific area for improving the return rate and NFF return rate, as follows: # service director served as team leader; # service manager managed the ASC network; # chief financial officer responsible for the financial results of the team; # TV sales operation manager engaged in dealer management; # service financial controller performed service cost computation and analysis; # TV product manager concerned with process implementation and improvemsnt. The team set specific targets: # TV NFF return rate to be reduced from 40% to 20%; # TVreturn and exchange rate to be reduced from 5% to 3.5%; s total savings of US$1.13 million within six months. The service director also applied for some US$4,500 as a bonus for the eam, to be used for an ouring or teambuilding exercise if it could meet its targets. The general manager of the consumer electronics division endorsed the proposal and also incorporated the pro- ject targets into the bonus scheme of the team members such that they would lose their annual bonuses if the targets were not met. PCL: A Braakdown in the Enforcement of Managameant Control The team analyzed the situation and the following actions were drawn up to remedy the situation: # Given that both the sales team and the ASCs were failing to enforce the established criteria for accepting returned goods, PCL had ended up being more accepting of returned goods than its competi- tors. To manage the situation, the TV sales operarion manager was put in charge of rotating the regional sales managers and salespeople geographically in order to prevent the sales team from becoming too friendly with the dealers. # The TV sales operation manager and service direc- tor were put in charge of ensuring that no models that had been phased out for more than six months would be accepted for return. # The TV sales operation manager and service direc- tor were also put in charge of defining clear and sound criteria for the inspection and acceptance of returnad merchandise. # The TV product marketing manager and service director were put in charge of organizing training on the return process and criteria for all individu- als involved in making decisions in the return Process. The team quickly got to work, defining the criteria and monitoring measures to control the return process: & For goods that were defective upon arrival at the dealers' warehouses, PCLwould accept return only if they were functionally defective or there were serious cosmetic failures vis-a-vis PCLs standards for finished goods. For defective goods returned within 15 days after purchase by consumers, only functional failures would be accepted as grounds for return. Rerurned goods were to be accepted only after approval by cross-funcrional personnel. s HRerurned goods would be required to come in their original PCL packaging, with all the original ACCessories, & Models that had been phased our for more than six months would not be accepted for rerurn or exchange. PCL's regional service managers and engineers would also visit the top 10 ASCs for returned goods which together were responsible for 409 of monthly returns and provide training sessions with detailed working instructions to the ASCs. A new incentive and penalty scheme for ASCswas also drawn up, with the following mandates: # increased labor charges for inspection of rerurns; # penalties for NFF returns; # quarterly bonuses to those with the highest levels of compliance. On the sales team side, the TV sales operation man- ager worked closely with the TV sales directors to draw up a detailed rotation plan. Field salespeople were required to visit top dealers within their respec- tive regions on a weekly basis to solicit feedback and to implement follow-up actions. The plan was ful- filled after seven months and extended to 52% of the salespeople. The project team met every twoweeks for reviews as remedy measures were implemented. Immediate actions were taken to correct any weaknesses that had materialized and warnings were issued to those responsible for them. The team was able to adhere closely to the project schedule. Afrer six months, the NFF return rate was reduced to 13%, surpassing the team's target of 200, The return and exchange rates dropped to 3.2%, surpass- ing the team's 3.5% target. The team did not meet the target of US$1.13 million in savings, though it came quite close ar US$1.1 million, and thus the team was awarded its bonus. Epilogue After the hard work of PCL's two taskforces, PCL finally managed to bring the issue of the high return rate of its TV sets under control. The work of the two taskforces had revealed a major issue in enforcement within the organization. Even the best strategy or business plan could only be effective if it was prop- erly executed. What could PCL do to ensure that internal control measures would be enforced prop- erly to achieve organizational objectives in the future? 171 Chapter 4 . Control System Tightness Exhibit 1 PCL Consumer Electronics in China: Organization chart PCL Consumer Electronics China Peripheral & Service & Finance & Human TV Audio & Video Accessory Supply Chain Accounting Resource Exhibit 2 Flow of TV sales and returns Sales Team Dealers ASCs 1. Customer Returns Chain After-sales Retailers service team 2. Dealer Returns* Factory Salespeople Customers . Failed to inspect 3. Fake Returns the returned sets carefully Returned TV sets (US$6 million) 5 days money back (NFF =37%) 15 days exchange TV sales TV returns - ----- *Note: Dealer Returns = Demo sets + Slow moving disguised as TV returns This case was prepared by Grace Loo under the supervision of Professor Neale O'Connor. Copyright @ by The Asia Case Research Centre, The University of Hong Kong. 172