Chapter 23. Explain why and how companies decentralize.

Chapter 23

Explain why and how companies decentralize

Companies decentralize as they grow Split operations into different divisions or

operating units Top management delegates decision-

making to unit managers

Advantages Disadvantages

Responsibility Center

Manager is responsible for:

Cost center ?

Revenue center ?

Profit center ?

Investment center

Explain why companies use performance evaluation systems

When companies decentralize, top management needs a system to communicate goals to subunit managers

Financial measures tend to be lag indicators Management also needs lead indicators Tendency to focus on short-term

achievements

Describe the balanced scorecard and identify key performance indicators for each

perspective

Management must consider both financial and operational performance measures

Measures should be linked with company goals and strategy

Financial measures are only one measure among many

Uses key performance indicators

COMPANY GOALS

CRITICAL FACTORS

KEY PERFORMANCE

INDICATORS

Examples of critical factors and corresponding KPIs

Operational

efficiency

Employee

excellence

Financial profitabili

Market share

Yield rateTraining

hoursRevenue growth

Customer satisfactio

How do we look to shareholders? KPIs:

◦ Sales revenue growth◦ Gross margin growth◦ Return on investment

How do customers see us? Customer concerns: KPIs:

◦ Customer satisfaction◦ Market share◦ Number of customers and repeat customers◦ Rate of on time deliveries

At what business processes must we excel? Three factors:

◦ Innovation ◦ Operations◦ Post-sales service

How can we continue to improve and create value?

Three factors:◦ Employee capabilities◦ System capabilities◦ Company’s climate for action

Balanced scorecard

perspective

(a) Number of customer complaints ?(b) Number of information systems upgrades completed ?(c) EVA ?(d) New product line development time ?(e) Employee turnover rate ?(f) Percentage of products with online help manuals ?(g) Customer retention ?(h) Percentage of compensation based on performance ?(i) Percentage of orders filled each week ?(j) Gross margin growth ?(k) Number of new patents ?

Key performance indicator

Balanced scorecard

perspective

(l) Employee satisfaction ratings ?(m) Manufacturing cycle time ?(n) Earnings growth ?(o) Average machine setup time ?(p) Number of new customers ?(q) Employee promotion rate ?(r) Cash flow from operations ?(s) Customer satisfaction ratings ?(t) Machine downtime ?(u) Finished products per day per employee ?(v) Percentage of employees with access to upgraded systems ?(w) Wait time per order prior to start of production ?

Key performance indicator

Use performance reports to evaluate cost, revenue, and profit centers

Report financial performance of responsibility centers

Cost center Revenue center Profit center

Management by exception Should focus on information, not blame Some variances are uncontrollable

Use ROI, RI, and EVA to evaluate investment centers

Performance measures:◦ Return on investment (ROI)◦ Residual income (RI)◦ Economic value added (EVA)

ROIROI??

ROIROI ?? ??

Profit marginProfit

margin

Capital turnoverCapital

turnover

ROIROIOperating incomeOperating income

Total assetsTotal assets

Residential

$63,700$63,700

$196,000$196,000? %? %

Professional $162,400$162,400

$406,000$406,000? %? %

Profit marginProfit

margin

Operating incomeOperating income

SalesSales

Residential $63,700$63,700

$580,000$580,000? %? %

$162,400$162,400

Professional

$1,100,000$1,100,000? %? %

Total assetsTotal assets

Capital turnoverCapital

turnoverSalesSales

$580,000$580,000Residential

$196,000$196,000??

Professional

??$1,100,000$1,100,000

$406,000$406,000

ROIROIProfit

marginProfit

margin

Capital turnove

Residential

10.98%10.98% 2.962.96? %? %

Professional

14.76%14.76% 2.712.71? %? %

Compares division’s operating income with minimum operating income expected given the size of the division’s assets

Minimum acceptable income

Minimum acceptable

income

Minimum acceptable

income?? Total assetsTotal assets

Promotes goal congruence better than ROI Incorporates management’s minimum

required rate of return Can use different target rates of return for

divisions with different levels of risk

Special type of RI calculation Considerations:

◦ Income available to stakeholders◦ Assets used to generate income for stakeholders◦ Minimum rate of return required by stakeholders

Total assets

Current liabilities ? %

Measurement issues

Short-term focus

Chapter 23. Explain why and how companies decentralize.

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