Quality Metal Service Center is a metal distributor, which sells to smaller users of metal

products than the big manufacturer/suppliers such as Bethlehem, Crucible, etc. Tobe competitive they
must have shorter lead time and all around better customer serviceto cover the extra cost of small lot
sales and make their product worthwhile tocustomers.Quality has three main strategic objectives. Their
first objective is to focus sales effortson targeted markets of specialty users. Quality metals focuses on
sales of specialtymetals and competes on differentiation of product rather than cost. This will help
themavoid commoditized good markets where they cannot compete based on price. They aimto
produce higher tech, higher return products and sell these to customers.
Thesemarkets of high tech metals have less competition and better profit margins. Their second
objective is to identify geographic markets where metals are being consumed.They use database
technologies to have accurate, up to date, sales forecasts on handand they service these needs by
preparing for orders before they occur, which willshorten lead-time and improve the benefit of their
services. They also use these toallocate products on hand by location and service each location in a
manner that worksbest for the regions customers. Their third objective is to develop techniques
andmarketing programs that will increase market share. Their fast lead time allowscustomers to adopt
JIT inventory avoiding high carrying costs and obsolescence. Asquality has saved costs on their own JIT
system through short lead time they can helpcustomers achieve this cost savings as well. This helps
customers to have the most upto date metal products available on the market as needed. In addition
they offered awide range of processing services. These modifications to products reduce need
for customers to have and use specialty tools, as well as cut down on time they need to complete job.
The management Control systems should support the implementation of these threemain
strategies through influencing management behavior to act in accordance withthese corporate goals
in maintaining a superior quality of service to the consumer.
Each of the four regions have a manager who is evaluated based on return on assetsand aims to
exceed a set goal of 90% of projected profit. Ken Richards, a districtManager is responsible to the vice
president of the Midwest division and has a set of functional managers who report to him. While many
of these functional managersoperate independently of head office, the purchasing decisions of each
division isinfluenced by the central database and the control in place that requires head officeapproval
on any capital expenditures in excess of $10,000 have to be approved bycentral management. This
makes the divisions heavily dependent on centralmanagement for investment decisions and they also
must trust that they are instructedon the best possible data for their area.
Within these regions the district manager are also evaluated on the ROA. Thismeasurement
allocation has a split of 75% weighted on district and 25% on region. Thismay cause dysfunctional
behavior where a manager may wish to act in the best interestof his district rather than the region or
company as a whole.
An example of dysfunctional behavior is shown when Ken Richards from the ColumbusDistrict is
reviewing a capital investment program. Ken is showing a large ROA over 30%and although taking more
projects could improve the corporate profitability he mayrefuse these projects if his compensation is
reduced by the current bonus program.
As shown in exhibit 3 central offices assessment through their database shows that hisdivisions
has demand for processed metal products. This will improve lead-time onorders further differentiating
their product, as well as fulfill objectives 1 and 2. Terms of the deal are shown which are better
summarized in exhibit 4 showing that all corporatecriteria are met in terms of payback period internal
rate of return and show a positiveNPV showing that at this discount rate, and assuming that a better
project is notavailable.
Also the manager must rely on central offices sales projections as if they are lower theycould
show a loss and an increased asset base quickly erasing any bonus they wouldhave received. This
dependence and added risk can cause the managers to be evenmore likely to turn down these
prospective investments.
As shown in exhibit five while this investment will improve profitability, even in the shortterm,
Ken will be motivated to turn down this project. While it causes him to increasecash flows by $40,000 it
will reduce his bonus by 6.28%. This will cause him to look atthe district financials and reject the project
although they benefit the company.
The cash flows in exhibit 4 also show growth throughout this investment period. The keyto fast
growth is to generate returns and further reinvest the returns into additional highyield projects. To
compete in this market and establish themselves as a growth firmQuality must generate high returns
wherever possible and reinvest this money to further their ability to grow as a company according to
their three main objectives.
Issues
Control over capital expenditures Limit of $10,000
Evaluation on ROA and Bonus Incentive program Counter intuitive
o ROA motivates managers to invest in positive NPV projects that will enhancefuture
cash flows;
o The Compensation plan is not motivating the managers to make thoseinvestment
decisions, rather to not invest at all as the payout rate would bedecreased for more
assets overplayed thus effecting bonus
Assets over-employed will increase change to profits and therefore reduceadjusted profits
and the payout rate charged to the base salary
Overall evaluation scheme is counterproductive towards organizationalobjectives,
managers motivations.
Bonus Plan Incentive deters managers from taking on investments that willrequire large
asset employment and may have positive ROA or EVA results
ROA as evaluation may work counterintuitive itself as, the Columbus division for example
with high profitability will be hesitant to invest in opportunities with alower ROA then their
Target ROA, that would benefit organizational cash flows otherwise

Recommendations
Management Control systems be made consistent with framework used for decisions about
capital investments.
Currently inconsistent, Managers do not have full authority
over investment decisions
ROA evaluation and Bonus plan is inconsistent with objectives.
Investment decisions should be made by division with less control
fromHQ if evaluated on that basis
EVA could be used for investment decisions
EVA proposes multiple advantages over ROA, EVA on
proposal willincrease
EVA supports the third organizational goal that the company
hasestablished to find techniques to increase market value
As EVA has a strong correlation with changes in the companymarket
value
Using EVA as an evaluation on investments could help
managersanalyze if it will help grow EVA, and therefore enhance
shareholder value

If they were to continue to use ROA as a basis for providing a bonus tomanagers, make it
consistent with how the managers are evaluated
o One suggestion: Remove assets over-employed from equation or add flexibility, so
that managers will not be penalized in their bonus on investment opportunities.