PERFORMANCE MEASUREMENT SYSTEMS

How to answer the Question; Utilising insights from the relevant academic literature, critically evaluate the performance evaluation and reward system operated by Bay Industries. Provide suggestions for improvements.

Jim Quick, CEO of Bay Industries plc, was considering the performance of his three divisional managers who had recently made reports about their respective divisional performance. Within a week, he would have to guide a series of decisions on divisional and corporate strategy and, somewhere along the way determine each division manager's bonus. About half of the bonus was fairly automatically computed from profits and performance in comparison with budget, but the other half would depend on his evaluation. He was glad of the opportunity to apply his own judgement in the bonus-setting process, for he had never quite trusted the numbers to give a reliable reading on a manager's performance. On the other hand, he knew his unsupported judgements could be perceived as being arbitrary.

CONTROL DEVICES DIVISION

Ben Robinson had managed the Control Devices Division for three years and had done reasonably well, although profit in 2004 was down a bit from the previous year. The Control Devices Division made machine controllers for large specialized installations, as well as numerous small installations, in the chemical, paper, and petroleum industries. In the late 1990s, the division had developed and patented an electro-mechanical thrust transmission device that had allowed the division to achieve a large market share. In the last decade, electronic components had been added to maintain the company's competitive position. In his report, Ben Robinson had noted that competition had come from unexpected sources. Two months previously, the division had lost a large customer in Denmark. His European representative said that the division price should have been low enough to get the business and hinted darkly at some under-the-table deal by the winning German company. Since about one-third of the division's sales was in Europe, Quick wondered what the implications of this event might be. Robinson had said little about it except that it had adversely affected his bottom line.

COOKWARE DIVISION Colin Wood's report on the Cookware Division had shown remarkably consistent profits and a high return on investment during the two years he had been manager. The division made ceramic cookware that could go in the oven and on the table. Most sales were through mass merchandisers. The item was not branded and depended on good design and wide distribution to maintain its sales volume. The business was competitive, but Wood had shown a good sense of what would sell in each distribution channel and geographical area. He had previously been division director of marketing and had been promoted when his predecessor left to head a larger operation in another company. While listening to Wood, Quick remembered that the division's Christmas sales had benefited when a major competitor was shut down for two months to work on compliance with environmental protection standards. Quick was glad that Bay Industries had installed the necessary screening devices three years earlier. Wood noted in his report that two of the division's three melting tanks and most of the forming machines were ten years old and in need of replacement. In his long-term capital forecast, submitted in both 2003 and 2004, he had estimated that 30 to 40 million would be needed to provide the new equipment.

ELECTRONICS DIVISION Martha Hadley's report on the Electronics Division showed a disturbingly consistent low rate of profit. Hadley had taken over the moderately profitable division three years earlier. The division's main product had been an automatic-frequency-control (AFC) component that went into many radios and television sets. After joining the division, Hadley had designed a similar component that could be effectively used in cordless and cellular telephones. Sometimes it was built into the telephone, and sometimes it was part of the installation. The division's competition was mostly from large companies, but Hadley had been able to break into the phone market by having a six-month lead with a superior product. Hadley said that the only way to succeed in the business was to keep a jump ahead of everyone else. An example of that, she said, was when she had recognized earlier in the year that fast delivery was key to getting the order in about a third of the phone component business. Not only was speed important in some orders, but precise delivery time was required by almost all customers to keep their inventory down as many customers used just-in-time manufacturing systems. Hadley's competitors had regional warehouses, which allowed them to deliver overnight to most places. As a result she had arranged with an express service firm to deliver quickly and reliably, usually by air. Sometimes, when delivery was a week or more away, airfreight was not used, but the carrier's delivery could still be timed to within three hours. Hadley believed that the key was reliability and that the higher direct cost per shipment would be less than the cost of warehousing. Her volume was rising, but her costs had not gone up as much. Hadley estimated that her share of the radio AFC market was about 10%, and that her share of the newer telephone-frequency-control market was nearly 25% and would hold steady as the market continued to grow. She had invested in new equipment in 2004 to be able to service the growing phone market and capture economies of scale. BONUS Jim Quick reviewed the financial results of each division to see how the division managers' bonuses would come out. The 2004 bonus pool for these three managers amounted to 50,000, which was based on overall corporate profit. The bonus plan currently in force said that half of the pool would be distributed on the basis of points and half on the basis of the CEO's judgment. Points were awarded in two ways, both based on the percentage return on capita employed (ROCE). The first way gave one point for each percentage point that actual ROCE was above planned ROCE minus 5%. This method allowed a manager to receive a bonus even if the division did not quite achieve the planned results. (The plan figure was the result of a budgeting process that started in the divisions and ended with a discussion - sometimes like a negotiation - between Quick and each division manager.) The second way in which points were awarded gave one point for each 1% that actual ROCE was above the average of the previous two years.

As he pondered these results, Quick wondered whether they represented proper rewards for the results achieved. He also wondered whether the form of this part of the bonus system was as good as it could be. Because Quick was to use his own judgment in the second part of the bonus system, if he did not like the way the first 25,000 was divided, he could remedy the situation - at least partially - in dividing up the remaining 25,000.