Presented by:Ishan AggarwalManju Chandel

Rajat Singla

Case HighlightsAbrams Company

• Manufacturer of variety of parts for use in automobiles, trucks, buses and farm equipment.

• Three major group of parts- Ignition, transmission and engine parts.

• These parts sold to OEMs and wholesales who in turn sold these parts as replacement parts to consumers.

Abrams Organization chartAbrams Company

Ignition parts Transmission parts Engine parts Aftermarket

OEM SalesPlants

Domestic ForeignOEM SalesPlants

OEM SalesPlants

Product divisionA vice president and a GMMeasured on ROI

Product DivisionA separate OEM department.Major sales to OEMsRemaining parts sold to AM marketing

division.

AM Marketing divisionSold manufactured parts to wholesalers.Operated several company owned parts

distribution warehouses in the US and foreign markets.

Measured on annual ROI.

ROI= Profit/ Assets at the beginning of the year

1992 Sales break upTotal Sales= $500 MN

• Ignition parts= $130 MN• Transmission parts= $100 MN• Engine parts= $90 MN• AM Division= $180 MN

High expected growth in AM segment due to high number of vehicles sold.

ROI calculationProfit- overheads- imputed taxesTotals assets – current liabilitiesFor each plant, a target ROI was calculated.

Each product division’s OEM sales were traced to the plants that made the parts.

Book value was used to value property, plant, and equipment.

OEM Sales performanceIndividual sales department for each of

product divisions.Worked closely with the clients to cater to

their needs and develop new products.Measured on an annual sales revenue target.Each of the sales departments had its own

customers.

Critical Success factorsOEM

Ability to design innovative and dependable parts meeting customer’s quality, performance, and weight specifications

Meeting delivery schedule requirements to minimize parts inventories.

Controlling costs

AM business Availability of parts Quality Price

Incentive Compensation planPlant managers- Based on profit varianceSales to AM division had no incentive for the

plant managers even if it contributed to positive profit margin variance.

IssuesTransfer pricing

Sales were made at market price.For parts not sold in market anymore, MP was

adjusted for inflation.For parts never sold as OEM, disputes

occurred which sometimes needed Finance manager’s interference.

AM division treated as captive customerOEM customers were given preference over

AM department.AM division had nowhere else to go. They

were not allowed to sell competitors’ parts.No incentive for selling to AM division.

Excessive InventoriesBoth product division and AM division

carried excessive inventories.

Goal CongruenceThe company’s management’s goal was to

increase the sales of AM division to 50% of the Abrams’ total outside sales.

For individual OEM sales team, the goal was to maximize the revenue from the OEM sales.

For plant managers, the OEM sales improved the bonus and also the OEM sales contributed to the ROI calculations also.

• Internal sales of parts were made at outside OEM market prices.• Inflation adjustment factor was used to determine prices after

several years.

• Problem:It occurred when the part transferred was strictly an AM part and there

was no current or former OEM market price that could be adjusted for inflation.

• Solution:The division which is transferring the part to AM can follow COST PLUS

PRICING.

• COST PLUS PRICING = Cost to manufacture + Profit Margin

• This profit margin can be decided mutually by the Manufacturing division and the AM division after consultation with the Vice President – Finance so that no dispute arises in future over the transfer price or the profit margin.

• So, the AM price in later years can be calculated by using the same COST PLUS PRICING method or using inflation factor to adjust the prices.

OEM Customer: Should be more Demanding

OEM Customer should be more demanding meaning that the divisions should try to fulfill the demands of OEM customers because these customers are the one’s who would drive the sales of AM division.

Remember, AM division is the After Sales market or the Replacement market for original parts.

Any customer who uses a particular car would ask for the Genuine Spare Parts only due to better reliability and long term benefits.

Return On Investment (ROI)ROI method should not be the sole criterion to judge

profitability.It should be supplemented by other measures like:Profit Margin = Net Profit/SalesReturn On Equity:  Net Income/Shareholder's

EquityAnd also Gross Profit Margin & Operating Margin.

Also, the AM division will have a huge ROI as compared to other divisions as there is no machinery, plant and equipment installed. It is just a trading firm.

Profitability AnalysisTransmission Division:Sales = $124000 Net Profit = $11200Net Profit Margin = 9.03 %

AM Division:Sales = $180000 Cost = $100000Net Profit Margin = Many times greater than Transmission

Net Profit Margin & ROI will be too high of AM Division as compared to other manufacturing divisions.

So, AM division is probably the most profitable division of Abrams & the demand of AM division should not be compromised with. It should not be treated as a Captive Customer.

Incentive SystemProblem:Incentive system is linked to the profit margin on sales

only to OEM customers.It does not include the sales to the AM division.So, the plant managers would have no benefit/advantage

to sell to the AM division as it does not increase their incentive.

Solution:The incentive should be linked to the sales to AM division.Margin on sales of AM division is high so the overall

profitability of the organisation would also improve.This will lead to a Win - Win Situation for all the 3

stakeholders which are AM division, Plant Managers & Manufacturing divisions and the company as a whole.

Excessive Inventory : Why??Improper demand forecastingIt should forecast the demand more adequately.

More number of workers employedTake a closer look at the actual number of

workers required so that the production does not suffer.

This is pointed out Vice President of Planning when he said:

“Thank Goodness, we have a generous vacation policy here.”

“At least, the inventories used to get down to a reasonable level at year end when the production volume is low because of a large number of employee holiday vacations”

It suggests that Planning is not accurate.

Demand Forecasting It is mentioned in the case that generally all the AM division &

the manufacturing divisions carried excess inventories through out the year.

Problem:Whereas, the manufacturing divisions did not favor the AM

division whenever competing demands were placed by the AM division & OEM customers may be due to the reason that the manufacturing divisions did not have stocks to sell to the AM division.

Solution:So, here the company should develop a proper Demand

Forecasting Strategy and producing only that much quantity which is required by the AM division & the OEM customers.

It can also follow the CHASE strategy.This will solve the problem of excess inventories to a large

extent.

Overhaul Inventory & Production System

It is very much possible that manufacturing divisions are closely working with the OEM customers(Ancillary Units) as these are generally long term contracts and it could fully understand the demand situation in a better way.

So, the problem of excessive inventories should not arise normally.

In such a case, the Manufacturing division needs to have a look at inventory management system.

It can follow the Lean Manufacturing or use Just In Time (JIT)

It should various other inventory control systems such as Inventory Turnover Ratio etc to check the accumulation of inventory.

Evaluation

The company’s management control system is not so efficient due to following reasons:The 3 product divisions’ OEM sales department

are separate leading to high inventory costs.AM being a marketing division has different

target to be met than the OEMs sales departments. AM has to meet annual ROI target. OEM sales departments have to meet annual sales

revenue target.Beginning of the year net assets are being used

for ROI calculation.

StrengthsManufacturing plants are profit centers.InnovationCost- EffectivenessQuality of productsService quality

WeaknessesHigh inventory costs due to separate 3 OEM

sales departmentsAM division is a profit center.Plant manager’s bonus not linked to selling to

AM division. So, he would prefer to sell outside.

RecommendationsCombine the 3 product divisions’ OEM sales

department.Reduce inventory.Make AM division a revenue center.Plant manager’s bonus should increase with

favourable gross margin volume variance caused by sales to the AM division.

Change ROI method