You have recently been hired as Executive Assistant to the Board of Directors of Electro Inc. The financial statements of the company for the year ended December 31, 1986 have just been released and they are disappointing. After years of success as a "high tech wonder company", it appears that Electro has fallen on hard times.

The Executive Committee of the Board of Directors has taken the position that the company's financial difficulties have come about largely because of two projects - the Series A and Mercury. Some of the other directors are not so sure. They feel that, with some guidance from the Board, the company's management can "work things out" since they are essentially on the right track. The Board of Directors was determined to make some decisions at their March 31, 1987 meeting. In the meantime, they would consider two outside reports on the projects (See Exhibit 1 and Exhibit 2). The Executive Assistant would also be asked to comment at that time.

The Company

Electro Inc. was launched in 1974 in Calgary by James Cousins, an engineer. The company began by manufacturing touch-tone telephone converters and, later, telephone switchboards and other communications switching equipment for small and medium-sized businesses. As the company grew, more communications equipment was added to round out a Private Branch Exchange (PBX) line of products directed to the same market segment. It did not take long for Electro Inc. to acquire an image as a high technology wonder company. Sales grew from $12,000 in 1975 to almost $350,000,000 ten years later. This sales success was based largely on the company's ability to supply reliable, state-of-the-art communications products to the middle portion of the market.

As the company grew in size, it expanded geographically. While the Head Office, including sales management personnel, remained in Calgary, production was shifted to facilities in Toronto and Montreal. Manufacturing was later undertaken in Britain, France, and the U.S.A. Sales offices were located around the world as well.

Over the years, the most popular Electro products have been the Series X and Series Y analogue solid state switches. Electro has a worldwide installed base of over 100,000 of its PBX switches, mainly in the low to medium segment of the market. (This market segment is broadly defined as one having an installed cost of $100,000 or less per unit.)Of these switches, more than half are Series X or Series Y products. It has been company policy to "keep the customer happy" by supplying whatever Electro expertise and equipment might be relevant to the changing needs of the customer. This policy has been instrumental in allowing Electro to dominate its segment of the market.

Electro Inc. began as, and still continues to be, a company run by engineers, for engineers. To a large extent, its success can be attributed to the technology developed in its research laboratories. In fact, spending on research and development has approached 20% of sales in recent years. Much of the current research is directed to communications networks, intelligent workstations and generally to the technology necessary to make the "office of the future" a reality.

The Founder

The entrepreneurial spirit and drive of Electro Inc. originated with its founder. James Cousins is a brilliant engineer and salesman. It was he who insisted that the latest semi-conductor technology be used in all Electro products, even the most inexpensive ones. It was he who spearheaded the worldwide sales effort that earned the company an Export Canada award from the government. In spite of the present difficulties being experienced by the company, Mr. Cousins remains unshaken in his belief that remaining at the forefront of technology is the path that Electro Inc. must continue to pursue.

The Mercury Project

The impetus for the development of a micro computer compatible with the Personal Computer (PC) came from development work that had already been carried out by Electro Inc. In 1984, the company introduced a telephone/computer workstation to work in conjunction with its Series X and Y PBX products. It seemed only logical, therefore, to make the technology compatible with products being offered by the world's largest manufacturer of computers.

It would, the reasoning went, allow Electro into the mainstream of the office automation market more quickly. The particular attraction of this approach was that the micro computer, codenamed the Mercury, would be a Canadian product designed for world markets. After all, Electro already had a worldwide marketing network for its other products. In other words, the development, manufacture and sale of the Mercury Micro Computer (MC) would be immediately profitable while at the same time advancing the relevant technology for expansion into the office automation market.

The Electro Mercury MC was introduced in 1986. With its special monitor, built-in software, communications, high tech design and PC compatibility, it looked like a sure winner. Almost immediately, however, buyers began reporting that the special monitor, provided by an outside supplier, malfunctioned under sustained use. True to its code of customer satisfaction above all, Electro resolved the problem, but at a cost of approximately $1,000 to repair each of the more than 2,000 units that had already been sold.

Actual sales of the Mercury MC in 1986 were less than the sales forecast. Nevertheless, since the monitor problems have been corrected, Electro plans to manufacture and sell 5,000 Mercury micro computers in 1987.

The Series A Project

The Series A was a personal project of Mr. James Cousins. He could see the trend toward large scale integrated transmission and switching of voice (analogue) and computer (digital) information. He also recognized that Electro Inc. had, by choice, confined itself to the low to medium end of the market for communications products (as defined earlier). And, finally, he felt a personal thrill at the prospect of having his name associated with the development of new, state-of-the-art technology that would lead the world.

The result was an announcement, in June of 1985, that Electro Inc. had begun development of the integrated communications centre of the future. Using the latest digital technology, the Electro equipment would be at the centre of an all encompassing information network, directing everything from telephone calls to the computer mainframe. The project was code-named Series A.

The proposed installations would be expensive, probably selling for approximately one million dollars per installation. Only the very largest corporations and, perhaps, governments and major universities would have use for equipment of such sophistication. James Cousins saw this as an opportunity. After all, this was the very segment of the communications market in which Electro Inc. was not active. If the company was to continue its significant growth into the future, it must have products to offer in this market.

Mr. Cousins recognized that competition in this market would be more intense. Electro would have to compete not only against the major computer manufacturers but also against all of the companies that supplied equipment to the telephone utilities throughout the world. He felt, however, that inasmuch as it was Electro that had initiated the development, the company had about two years as a "window of opportunity" between the time the Series A project became common knowledge and the time the other companies became serious competition. The true extent of the competitive position of Electro would, however, not be known until all of the competing products were available and actually being sold in the marketplace. The decision having been made to proceed, a development budget of $25 million, exclusive of any capital costs, was allocated to the project.

Provide a written report for your discussion at the next Board meeting, including issues, and a quantitative and qualitative analyses for each issue and recommendations for each issue with respect to the two projects and the management of the company as a whole.

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Exhibit 1:EXECUTIVE SUMMARY OF FINDINGS RE: MERCURY PROJECT

By: I.M.A. Consultant

Principal Findings

1) My tests indicate that the Mercury Micro Computer (MC) is entirely compatible with the Personal Computer (PC) for all commonly available software. All other functions of the Mercury MC performed within specification.

2) In my opinion, the Mercury MC can be produced equally well at

either the Toronto or the Montreal assembly facility.

3) No additional money is available to the Mercury project, either for increased levels of R&D or for advertising.

4) The following information is related to the financial aspects of the production and sale of the Mercury MC in 1987:

a) The unit selling price to the dealer network should be $2,800.

b) For internal purposes, assembly functions for the Mercury MC have been broken down into Equivalent Work Units (EWUs).

c) 30 EWUs are needed to assemble one Mercury MC at the Montreal assembly facility. 20 EWUs are needed to assemble the same machine at the Toronto assembly facility.However, because the Toronto assembly plant is more automated, the cost of one EWU is $49.05 in Toronto while the cost of one EWU in Montreal is $8.50.

d) Due to various constraints, a total of only 120,000 EWUs is available in the two locations combined.

e) Target production of the Mercury MC in 1987 is 5,000 units; 1,000 units to be produced in Montreal and 4,000 units to be produced in Toronto. It is conceivable, however, that a more desirable combination may be possible.

f) The cost of material is $851 per unit in either facility.

g) The Accounting Department expects to be able to recover the following costs from each Mercury MC that is sold:

Mercury MC development costs $500

Faulty monitor correction costs $200

h) Overhead allocations per unit are:

Variable overhead (based on estimated EWUs) $100

Fixed overhead (based on allocation formula) $350

i) Using the figures from the 1987 production schedules, the average contribution margin per unit will be $1,113.

j) For purposes of planning, it is the Total Contribution Margin (TCM) that should be maximized.

Exhibit 2: SUMMARY REPORT ON THE SERIES A PROJECT

By: I.C. Yu

Three of the most important aspects to be considered in assessing the management control of a project are generally thought to be 1) time, 2) cost and 3) quality.

This summary will consider each in turn for the Series A project.

Comments:

a) Following the anticipated completion of the systems testing of hardware/software, it is now estimated that at least a further 6 months of preparation will be necessary before production can commence.

b) As at December 31, 1986, the systems testing of hardware/software was exactly 6 months behind schedule.

c) As at December 31, 1986, the testing of individual software components was only 2/3 complete.

d) According to the original schedule, production of the new equipment is scheduled to begin in June of 1987.

e)The Series A project was first made public in June of 1985.