Lakeshore Manufacturing (mining industry) is a vertically integrated company that mines,

processes, and finishes various non-precious metals and minerals. Lakeshore has decentralized

both on a geographical and on an operational basis. For example, Exploration and Development,

which includes all mining operations, has been designated a strategic business unit (SBU). There

are multiple divisions within this SBU, such as North American Exploration and Development,

South American Exploration and Development, and other divisions. Similarly, Refining, which

has often been located near the mines, is another strategic business unit and is divisionalized by

geographical region. Lakeshore has a clearly stated management control system that includes

long standing policies on transfer pricing, performance evaluation, and management

compensation. Transfers are made at full cost plus a markup to approximate net realizable value.

Lakeshore's primary operating divisions (such as mining) are required to fill internal orders

before servicing outside orders. Each division has full responsibility over setting prices and sales

targets as well as monitoring costs. Also, divisional managers have decision-making authority

over fixed investments (capital equipment) up to $0.5 million as long as the investments can be

internally financed. For any investment exceeding $0.5 million, final approval must be given by

the SBU and head office. For performance evaluation purposes, Lakeshore uses two basic

measures to evaluate managers. First, it uses budgeted income, and second, return on investment

(ROI). Divisional managers develop their budgets in line with goals set centrally for the

organization. All budgets must be approved by the SBU and central executive before final

acceptance. Net income includes headquarters' allocations based on a percentage of divisional

sales. ROI is calculated as net income divided by total assets. As with the budget target, the ROI

target has to be approved. Although the weighted average cost of capital for the company is 12%,

each division negotiates its target ROI according to past performance and perceived risks and

uncertainty in the environment. Progress toward the budgeted income and ROI targets are

evaluated on a quarterly basis. Lakeshore's bonus compensation scheme was extended to its

divisional managers last year. The bonus consists of a "50/50 cash plus deferred payment"

scheme that is measured each quarter. For example, if a division manager exceeds budgeted

income and ROI targets for the division, then the manager is awarded a bonus, 50% of which is

paid immediately in cash and50% of which is invested in "phantom shares" that can be redeemed

three years hence, given continued good performance. The total value of the bonuses range from

10% to 100% of regular salary, depending on how well managers do their level in the

organization. Actual amounts of bonuses earned in any given year depend on the centrally

calculated bonus pool, which is defined as a percentage of overall company income. Some of the

divisional managers have been unhappy with the bonus compensation scheme. They felt they

were at a disadvantage because of their lack of control over their prices (due to the nature of the

external market), and their inability to achieve the growth in the ROI required by central

headquarters. The division managers believed that a shift to residual income would help, but

Lakeshore's CEO rejected this, feeling that residual income would not allow comparison of

divisional results. The results of three of these divisions are shown below. As well, the managers

of the Primary Operating Divisions wanted the restrictions on the internal versus external sales

lifted so that they could achieve better results than they were currently experiencing.

Division A

Division B

Division C

Budgeted Net Income

$195

$1974

$905

Actual Net Income

$158

$1978

$1030

Budgeted Total assets

$1410

$8855

$7078

Actual Total Assets

$1209

$8811

$7055

Target ROI

14.20%

22.4%

12.8%

what are recommendation for this case?