Monoclean Ltd is a multinational company that manufactures and markets household cleaners in a batch process-manufacturing environment, and ABC is used to allocate overhead to production. Recently Monoclean has undergone a major structural reorganization to assist it to compete more effectively in Asia-Pacific region.
In the old structure, the Asia-Pacific region was divided into 12 business units along geographical lines. Each business unit had a managing director (MD) who was responsible for manufacturing as well as marketing and selling operations of the business units’ products. Each MD was evaluate remunerated on the business unit profitability, which was as reported in a monthly business unit profit statement. Managers within each business unit were evaluated and remunerated according to their personal, department and business unit performance.
About a year ago the number of manufacturing plants in the Asia-Pacific region were reduced from to 5. The 12 business units continued to exist, except that seven were now responsible only for the marketing and selling of product. Only five business units continued to include manufacturing plants, which were now responsible for supplying all of the business units the Asia-Pacific region. Each business unit with a manufacturing Plant has a manufacturing manager. While the MDs of those business units have ultimate responsibility for the marketing and sales operations and all other aspects of the business unit, in practice the MD does not interfere with the manufacturing manager, who is given full responsibility for manufacturing in the business unit. The MD is principally evaluated and remunerated on the profit generated from marketing and sales activities Marketing profit reflects actual sales revenues less standard manufacturing costs and actual sales and marketing costs. The manufacturing manager is evaluated on the profit from manufacturing profit consists of sales revenue less actual manufacturing Costs. There is also a manufacturing director for the region who has ultimate responsibility for all the manufacturing managers.
With the new company structure monthly profit statements are prepared for each business unit. In addition to these reports, a manufacturing profit statement is prepared for the region and a total-company profit Statement is prepared. The transfer price for goods transferred between manufacturing and marketing areas within the same business unit is at standard manufacturing cost. The transfer price for goods transferred between manufacturing and marketing, not within the same business unit, is at standard cost plus 5 per cent.
Some business unit managers have raised Concerns about some of the decisions that have been made since the restructure and wonder if the right incentives are in place. Some specific examples and issues follow:
• Marketing and sales managers are in the best position to influence the level of slow moving and obsolete inventory, through choosing whether to sell off these products or to allow them to be scrapped. In recent months there have been high levels of obsolete inventory. This affects the manufacturing profit statement. There is little incentive for marketing staff to sell off or manage slow or old inventory, as they simply purchase goods at standard cost from manufacturing as required.
• Inventory shipping and transportation is managed by manufacturing staff and the cost of this is charged to the manufacturing profit. However, the cost of these activities is heavily influenced by the deals that the sales force makes with their customers. Sales staff can negotiate three shipping and transportation options: the purchaser can pick up the inventory from Monoclean’s warehouse. The inventory can be shipped by Monoclean to a central warehouse of the customer, or Monoclean can transport the inventory to the customers’ supermarkets. Each of these options attracts different costs, which are treated as a component of the manufacturing profit.
• When there is a change in product or raw material sourcing, the business units that include manufacturing areas absorb the manufacturing variances from standard cost (favourable or unfavourable). This results in an adjustment to standard cost in subsequent periods and affects the profit of the marketing units. For example, if a favourable purchasing variance results from the activities of the manufacturing company, the transfer price will decrease.
• Another issue of concern is the role of the business unit MD in the capital expenditure approval process. It is the manufacturing director, not the MD of each business unit, who initiates all capital expenditure requests. Capital expenditure decisions affect business unit profits through the timing of cash flows, depreciation on assets, maintenance cost and so on.
Some business unit managers believe that there may be a problem in the alignment between business unit responsibility, transfer pricing policy, performance evaluation systems and management remuneration. The profits of some business units are below budget and, in the current competitive environment, head office management is concerned.
You are part of a management consulting team and have been asked by the regional finance director of Monoclean Ltd to prepare a report outlining any issues that may be working against effective performance measurement and incentive systems in the business units. In your report, identify Clearly any underlying problems and recommend a solution that considers appropriate responsibility centre type, transfer pricing policy, performance evaluation system and management remuneration package?