Question Includes all information given in the case.

Overview

Ladbrecks is a major department store with 50 retail outlets. The companys stores compete with

outlets run by companies such as Nordstrom, Macys, Bloomingdales, and Saks Fifth Avenue. During

the early nineties the company decided that providing excellent customer service was the key ingredi-

ent for success in the retail industry. Therefore, during the mid 1990s the company implemented an

incentive plan for its sales associates in 20 of its stores. Your job is to assess the financial impact of

the plan and to provide a recommendation to management to continue or discontinue the plan based

on your findings.

Incentives in Retail

The past decade has evidenced a concerted effort by many firms to empower and motivate employees

to improve performance. A recent New York Times article reported that more and more firms are of-

fering bonus plans to hourly workers. An Ernst and Young survey of the retail industry indicates that

virtually all department stores currently offer incentive programs such as straight commissions, base

salary plus commission, and quota bonus programs. Although these programs can add to payroll costs,

the survey respondents indicated that they believe these plans have contributed to major improve-

ments in customer service.

Companys Background

Ladbrecks was founded by members of the Ladbreck family in the 1880s. The first store opened

under the name Ladbreck Dry Goods. Growth was fueled through acquisitions as the industry con-

solidated during the 1960s. Over this hundred-year period, sales associates were paid a fixed hourly

wage. Raises were based on seniority. Sales associates were expected to be neat and courteous to

customers. The advent of specialty stores and the stated intention of an upscale west coast retailer to

begin opening stores in the Midwest concerned Ladbrecks management. Building on its history of

excellence in customer service, the company initiated its performance-based incentive plan to support

its stated firm-wide strategy of customer emphasis with employee empowerment. Management

expected it to result in further enhancement of customer service and, consequently, in an increase in

sales generated at its stores.

Incentive Plan

The plan was implemented in stores sequentially as company managers intended to examine and

evaluate the plans impact on sales and profitability. Initially, the firm selected one store from a group

of similar stores in the same general area to begin the implementation. By the end of 1994, 10 stores

had implemented the plan. In 1995, 10 more stores implemented the plan, bringing the total to 20 out

of a total of 50.

The performance-based incentive plan is best described as a bonus program. At the time of

the plans implementation, sales associates received little in the form of annual merit increases, and

promotions were rare. The bonus payment became the only significant reward for high performance.

Each week sales associates are paid a base hourly rate times hours worked. In addition, under the plan

sales associates could increase their compensation by receiving a bonus at the end of each quarter.

The contract provides sales-force personnel with a cash bonus only if the actual quarterly sales gen-

erated by the employee exceed a quarterly sales goal. Individualized pre-specified sales goals were

established for each employee based only on the individuals base hourly rate, hours worked, and a

multiplier (multiplier = 1/bonus rate). The bonus is computed as a fixed percentage of the excess sales

(actual sales minus a pre-specified sales goal) by the employee in a quarter

Using the information on sales and expenses for a typical store, provide an analysis of the ad-

ditional store profit contributed by the plan. Assume that it costs 10% a year to carry the added

inventory.

Employees Bonus = 0.08

(Employees actual sales for quarter

employees targeted sales for quarter)

Where employees

targeted sales for quarter

=

Employees

hourly wage

Hours worked in quarter 12.5

Senior managers regarded the incentive plan as a major change for the firm and its sales force. Man-

agement expected that the new incentive scheme would motivate many changes in employee behavior

that would enhance customer service. Sales associates were now expected to build a client base to

generate repeat sales. Actions consistent with this approach include developing and updating customer

address lists (including details of their needs and preferences), writing thank you notes, and contacting

customers about upcoming sales and new merchandise that matched their preferences.

Consultants Task

Management decided to call you in to provide an independent assessment. While the company thought

that sales had increased with the plans implementation, the human resources department did not know

exactly how to quantify the plans impact on sales and expenses. It suspected that employee salaries,

cost of goods sold, and inventory carrying costs, as well as sales, may have changed due to the plans

implementation. You, therefore, requested information on these financial variables.

Sales Analysis: Because each of the 20 stores implemented the plan at different dates, and store sales

fluctuated greatly with the seasons and the economy, you could not simply plot store sales. Instead,

for each of the 20 stores, you picked another Ladbreck store as a control and computed for 48 months

the following series of monthly sales:

Percent Change in Sales =

[(Plan Store Sales in Month t Plan Store Sales in Month t-24)

(Control Store Sales in Month t Control Store Sales in Month t-24)] 100

The plans implementation was denoted as month 25, so you had 24 months prior to the plan and 24

months after the plan. Averages were then taken for the 20 stores. If the control procedure worked,

then you expected that the first 24 months of the series would fluctuate around zero. T Month 25 is denoted as the rollout month, the month the incentive plan began.

Percent 100 Total 10,000,000 6,300,000 3,700,000 800,000 2,900,000 Sales.... Cost of goods sold Gross profit.... Employee salaries Profit before fixed charges. 63 37 8 29