CASE STUDY

Denver Systems is a Chicago based company that manufactures aircons for the automobile industry. It has two main divisions:

AirCon divisionthe oldest division of the company manufacturing aircons for cars and utes. SuperCool divisionmanufacturing aircons for minivans and caravans.

Each division is headed by a division head, who runs his or her division as a stand-alone business within the general policy guidelines provided by the board of directors in the head office. Each divisional head agrees to achieve a series of targets: return on investment (ROI), market share and sales growth. These targets are developed each year as part of the annual budget-setting process. Intense lobbying takes place between each divisional head and the board of directors to determine the most suitable targets.

Each divisional head receives an annual cash bonus based on achieving the target divisional ROI. The company defines ROI as operating profit, before interest and taxes, divided by divisional assets (measured at original cost less accumulated depreciation). Divisional heads are each eligible for a cash bonus of $51,000 if they reach their divisional ROI target. If performance is above the target, share-based payments are awarded at the rate of 2,000 shares for every additional point over the target. Thus, if the ROI target is 5 per cent and the division achieves 7 per cent, the divisional head would be awarded 4,000 shares. These options are at the prevailing market price on the last day of the financial year and must be taken up within two years of the award. During the past year, the market price of the companys shares increased from $10 to $15. If the ROI target is not reached, there are no bonuses or share-based payments, and the divisional head must provide convincing reasons for the poor performance. Because of the performance measurement and reward system, the divisional heads are highly motivated to achieve, and exceed their ROI targets.

Jason Taylor has just been appointed as the new management accountant in the head office, charged with redesigning the performance measurement system. As his first task, he has obtained the financial data for the year 2020 and the latest forecast for the current year 2021, for each division, as follows:

Glenn Waugh, the division head of the AirCon division, is concerned that his market share, and hence his ROI, is likely to suffer next year, as his main competitor has recently purchased new plant and equipment with highly advanced technology to manufacture similar aircons. The technology used in his division is a decade old and may not be able to produce the new and powerful aircons that customers are demanding. Also, the current plant and equipment are giving him high maintenance and operating costs. He expects his divisional ROI to drop if he does not upgrade the plant and technology.

Waugh is contemplating a proposal to invest $3.25 million in new plant and technology. This will probably increase next years operating profit for his division by $250,000. Waugh has worked out that the new purchase will be able to meet the minimum required rate of return of 5% for all new investments at Denver

Question

Jason recommends the use of benchmarking and continuous improvement to improve overall company performance. Suggest how these could be incorporated into the performance measurement system at Denver. Provide some examples of performance measures to illustrate your answer.

Total Assets Sales Revenue Operating Profit ($'000s) DIVISON ($'000s) (S'000s) 2020 2021 2020 2021 2020 2021 SuperCool $3,150 $3,550 $292 $356 $1,883 $1,920 AirCon 3,300 4,980 575 773 2,930 3,288 Target ROI DIVISION 2020 2021 SuperCool 7.50% 9.00% AirCon 15.00% 14.00%