Diploma In Management Adani Group Management Control System

Falcon INC Performance Evaluation System

Submitted to : Prof. Parag Rijwani Submitted by : Shalin Shah

Falcon Inc

Global Appliance Industry: A Glimpse

A consolidated industry with less than 10 companies controlling 50% of the total market. Slow growth pace hence making competition tougher Three major segments: Low price, Mid price, Very high price Major players:Electrolux,G.E,Maytag,Whirlpool etc.

Falcon Inc: A Brief Profile

A Publicly held U.S Co A Global player in home appliance industry Wide range of products including refrigerators, kitchen appliances, washers, dryers etc. Presence in all three segments low price,mid price and high price Three foreign subsidiaries in Mexico,Denmark & Japan

Falcon Inc: A Global presence

Falcon Inc Subsidiaries

Mexico Product Refrigerators

Denmark High priced kitchen Appliances

Japan Low cost laundry machines Japan U.S Low cost

Production Sales Differentiator

Mexico Mexico Growing demand

U.S Denmark No competition

 Question 1
Under the current performance-evaluation system (PES) at Falcon, how would you assess the financial performance of the division managers in Mexico, Denmark, and Japan? Which manager should be awarded the highest bonus, and which should be awarded the lowest bonus?

Current PES: Each Subsidiary is responsible for budgeted US Dollar profit.

Year 2004 Budgeted Profits( US $ ) Actual profits ( US $ ) Difference

Mexico 14,910,000

Denmark 8,282,640

Japan 20,420,825

14,937,721 27,721

9,691,788 14,09,148

17,839,177 (2,581,648)

Highest Bonus

Lowest Bonus

 Question 2 Using the approach outlined in Appendix A, calculate the nominal and real changes of exchange rates for Mexico, Denmark and Japan during 2004? In light of your calculations what revisions if any would you make in the 2004 dollar budgets at the time of tracking them? How would you assess the financial performance of the three country managers of Falcon? Which manager should be awarded the highest bonus? Why? Evaluate appropriateness of the three country managers responses to the changes in exchange rates?

Nominal and Real exchange rate

Exchange rate (LC per US $ ) 2003 2004 Mexico 10.72 10.985 Denmark 6.88 6.47 Japan 119.8 111.8

Real Exchange rate

Mexico: 10.72*1.05/1.023 Denmark : 6.88*1.043/1.023 Japan : 119.8*1.0225/1.023 11.00 7.014 119.74

Presently Budgets have been evaluated by 2003 exchange rates and performance of 2004 by the rates prevailing in 2004. A common metric should be used for subsidiary evaluation, Hence 2004 budgets should be recalculated by using 2004 exchange rates. If ROI method used to evaluate the performance of managers. Mexicos ROI:14937721/149100000*100=10% Denmark's ROI:9691788/20706600*100=47% Japans ROI:17839177/510520625*100=3% Hence Denmark should be awarded highest bonus and Japan the least

 Question 3: If ROI, rather than profit margin were used as the performance measure would the performance ranking of three subsidiary be different? Describe the advantages and limitations of using ROI as a performance indicator? Would you consider ROI as a superior measure?

Advantages & Limitations of ROI

Comprehensive measure: Anything that affects financial statements is reflected in this ratio Simple, easy to calculate and understand Can be used to compare performance of different units Increase in ROI may reduce overall profits Ignores cost of raising capital

 Question 4 : Evaluate the appropriateness of Falcons use of the beginning of the year exchange rate for budget setting, and average-of-the-year rate for budget tracking. Describe the approaches for preparing country managers to better respond to inflation and exchange rate changes

Falcon believes that the operating part of foreign exchange risks should be born by subsidiary However subsidiary managers should not be held responsible for the same and common metric should be used for comparison Tools such as hedging of currency should be used so as to safeguard forex risks Beginning of the year exchange rate does not represent the correct conversion factor. Rather the applicable forward rates prevailing in the market for next year should be considered Further, falcon should implement appropriate treasury function for hedging their exposure and that treasury should be responsible for the profit / loss due to exchange rate fluctuations. Subsidiaries should not be held responsible for exchange rate fluctuations unless they are being given authority to hedge their exposure.

 Question 5 : Assume that for each of the past five years, the Japanese subsidiary has reported lower than budgeted profit margins and ROI in dollar terms. If adjustments are made for the real exchange rate changes however its performance in each of those five years turns out to be better than the revised budget. Would you recommend closing Japanese subsidiary? Why or why not?

Real exchange rate has significant effect on competitive positions. A decline in nations real exchange rate makes its exports more competitive and vice versa. Eg:1$=10 yen earlier 1$=8 yen now Hence Local currency profits would reduce Now if real exchange rate is 1 $=9 yen the performance of company would improve

We do not suggest for closing of Japanese firm on below reasons - Japanese firm has achieved better cost target and saved on production costs in JPY. - These costs are not exposed to US currency as production in local market only - However, due to conversion factor only the production cost in US currency looks higher. - Further, Japanese firm has achieved higher sales in USD currency ( sales is in USD only) as compared to target. - However, due to conversion factors the sales and profitability is impacted and looks trim - Japanese firm has outperformed in both the responsible area i.e. in sales and cost of production. However, only because of exchange rate policy adopted in PES, shows Japanese as poor performer. - Hence, we do not recommend for closing of Japan Sub. rather recommend for change in PES.

 Question 6 :Describe the strengths and weaknesses in current PES for foreign Subsidiaries. What changes in PES would you recommend :
Existing System : Strength : All subsidiaries are at par for evaluation purpose and all are measured by profitability in USD which is ultimate aim of the business strategy Easy to understand by manager and they are clear of their goals. Systems are followed strictly and no benefits / exception being considered on case to case basis. Weakness : Exchange rate differences are contributing to the performance of the manager which is not within their control. Managers should be evaluated for the performance within their control. Denmark subsidiary is responsible only for revenue within Denmark and has only one right to procure the product is from US Falcon. Hence, they are not responsible for the cost still charged for the same.

 Existing System : Weakness contd.. - Japan is responsible for low cost manufacturing as well generating revenue in US market. Japan is producing in local currency but selling in US Currency. Hence, there is mismatch in exchange rate fluctuation between revenue and costs. - Mexico has revenue and cost both in domestic currency. Still they are evaluated on converted exchange rate in USD. Further, the budgeted exchange rate and average exchange rate is different on which the performance of the subsidiary is impacted.

 Suggested Performance Evaluation System :

- All three subsidiaries operate in different territory and with different goals. Hence common yardstick should not be used for PES. We suggest following PES for each subsidiary : 1. Mexico : - Responsible for cost of production and revenue generation. - Both revenue and costs are in local currency Hence, Mexico should be evaluated on ROI basis in local currency. The target should be provided considering the exchange rate effect in USD and to take care of interest of shareholders of US

2. Denmark: (suggested PES) - Goods are supplied by US only and no other purchase option - Responsible for revenue generation in Denmark for US products and revenue in local currency - Hence, Denmark should not be responsible for Costs as it is not within their control. Denmark should be treated as Revenue Center in local currency. Corresponding manufacturing plant in US should be considered as Cost Center fro production of goods. The profitability / revenue target should be decided based on the exchange rate between two countries The transfer of goods from US to Denmark should be hedged in advance to avoid the exchange rate differences.

2. -

Japan: (suggested PES) Goods are produced in Japan as low cost production facility Responsible for selling goods in US with exclusive rights Hence, Japan should be considered as an Investment Center Further, Japan has foreign currency exposure in Revenue and local currency only in production costs.

Japan should be given full authority to produce and sell goods and also do the hedging of their sales The budget should not be prepared based on closing exchange rate of the previous year. But should be prepared based on one year forward exchange rate prevailing in the market. Japan sub. Should be given authority to hedge their revenue at that forward rates. After above, delegation of authority japan should be evaluated on ROI basis in US currency.

Thank you