ROI &PERFORMANCE MEASURES & REWARD SYSTEMS

Auto World Ltd is a large and successful manufacturer of engines. The company consists of two divisions: The Outboard Motor Division and the Automotive Engine Division. 'Auto World' has recently acquired a new company which will become their third Division. The new Couch Division is a small manufacturer of lawnmower motors. It has been owned and managed by a sole proprietor for 40 years. The prior owner treated all employees as part of his family, the company was highly noted for the lack of a 'them' and 'us' attitude between employees and management, and there was free and open communication between all staff. The Couch is not a high performer due to the decline in the lawnmower market, and profits have slipped. However, the Auto World is known for its modern management systems and would like all managers at Couch to participate in the performance-related pay system that is currently used in the other two divisions. The profit-sharing plan applies to senior divisional managers only. It is based on placing 10 percent of Engine Designer's profits before interest and income tax into a pool, which is then shared by the senior divisional managers in direct proportion to their base salaries. The senior managers in the two original divisions (Outboard and Automotive) received bonuses of 11 percent and 12 percent of their salaries for the last two years before the acquisition of Couch.

The profits for the 1st-financial year following the acquisition of Couch Division are as follows

The profits for the 1st-financial year following the acquisition of Couch Division are as follows:

Outboard Automotive Couch

Sales revenue $31 600 000 $42 000 000 $9 500 000

Cost of Goods sold 10 000 000 24 000 000 4 500 000

Gross margin $21 600 000 $18 000 000 $5 000 000

Administrative costs 11 800 000 7 400 000 3 600 000

Marketing and selling costs 7 400 000 6 200 000 1 200 000

Total costs $19 200 000 $13 600 000 $4 800 000

Profit before interest and tax $2 400 000 $4 400 000 $200 000

The Senior management salaries included in the above costs, and divisional assets at the end of that year, are as follows:

Outboard Automotive Couch

Senior management salaries $4 000 000 $2 800 000 $1 400 000

Divisional assets 8 000 000 8 000 000 1 600 000

Before acquisition by Auto World, all Couch employees, including the senior managers, participated in a gain-sharing program. Under this program, the financial impact of improvements in labor productivity and delivery performance was quantified in each quarter, and 50 percent of this amount was accumulated in a pool. At the end of each year, each employee received an equal share of the pool. The scheme was discontinued when Auto World purchased Couch.

1.Rank the three divisions in the order of their performance, using ROI as a measure, in the first year after the acquisition

2.Determine the bonus pool that would be available in the first year, and determine the percentage bonus that each senior manager would receive

3.Discuss any behavioral problems that could arise among the top managers of the Outboard and Automotive Divisions as a result of the bonuses

4.Discuss how the Couch division managers and employees might behave from the changes in the performance-related pay system

5.Suggest any possible changes that could be made to improve Auto World's performance-related pay system to alleviate the problems identified above