EXECUTIVE SUMMARY

Quality Metal Service Center has shown its resilience in the industry through its century old existence
banking on industry knowledge and high quality products. The company is doing well and would like to
maximize its potentials by looking into its control system. Analysis has shown that potentially profitable
projects may not be pushed through due to some inefficiencies in their performance evaluation and
incentives system. The company is currently using ROA as the sole criterion of evaluation. However, ROA
will be lower on companies with newer assets that those with older ones. This will lead managers to reject
proposals of new projects with large capital outlay. The Economic Value Added is a more appropriate
measure in this situation. In light of the application of the EVA, the issue with the Columbus District
manager will be resolved, and the proposed project should be accepted.
INDUSTRY ANALYSIS
The Metal Distribution Industry is highly competitive and fragmented industry which composed of fewer
companies because of the high costs of establishing and maintaining this kind of business. It is on its
mature stage that improved efficiency on production is the priority in order to beat the competitors in the
industry. End users still have different needs which are unmet by the market players. Processing
capabilities should then be improved by the service centers through obtaining processing equipment
necessary to meet the demand of the customers.
Nevertheless, the percentage of industrial steel products shipped through services centers had increased
dramatically due to key trends in the metal industry:
1.
Steel Mills Retrenchment
Service Centers is grabbing the opportunity when major domestic metals producers had cut back on
service to customers and reduced the product lines. They profited from this by offering wide product lines
and increasing customer service.
2.
Just-in-Time Inventory Management
Metal users are trying to minimize the cost of ownership and maintenance of inventory. Service centers,
recognizing this trend, partnered with the metal users in order to deliver on time to their customers the
inventories which are needed to the current production. This resulted to smaller order quantities and more
frequent deliveries.
3.
Productivity Improvement and Quality Enhancement
Product profitability and reputation are major concerns of metal users. This is achieved through partnering
with service centers who are able to meet their specific quality, availability and service requirements. For
these users, stronger ties between suppliers and customers resulted to better quality of the products
produced.
COMPANY POSITION
With regard to the aforementioned trends in the Metal Distribution Industry, Quality Metal is in a good
position compared to its competitors. Its corporate strategy is aligned with the current industry
observations. Moreover, with their updated marked database, they have adequate information they need
to identify the needs of their customers.

Internal Factors
Quality Metal targets markets more effectively through its corporate strategy of focusing its sales efforts
on particular markets which provide higher margins. In addition, QMs corporate strategy also allows the
company to have a better understanding of customers needs in different geographic region due to its
updated database, which is considered to be the most accurate in the country. This allows them to gain
knowledge of their customers and use this knowledge to develop techniques to increase market shares.
The company has excellent products and services to cater to the customers growing need for quality.
It has good relationships with its customers up to the point of assisting them in procuring just-in-time
inventory.
However, Since Quality Metal just focuses on some specialty users, it will lose other customers and
reduce the profits. Also, QMs current incentive scheme may lead to rejection of profitable projects due
to decreases in expected bonuses of District managers.
External Factors
The prevalence of the just- in- time inventory management allows service centers more opportunities to
expand its market since consumers will require small purchases of inventories in less lead time. Having
few competitors in this growing industry is also an advantage for QM.
On the other hand, even if there are only few competitors, competition is still stiff since customers allow
only a small range of suppliers which give them the highest quality products.
Competitive Strategy
Since the company is competing in a broad target and has the ability of lowering its cost due to
economies of scale and can produce high technology metals, it should use a combination of cost
leadership and differentiation strategy to be able to earn more than its competitors. Customers who
bank on quality need to know that QM offers the best, therefore, the strategy should be packaged as a
differentiation strategy. Moreover, differentiation creates brand loyalty to keep customers away from rivals.
In order to implement such strategy, the company should differentiate itself through its high quality
products and good customer relations. This includes having shorter lead times in order to fulfill customer
orders.
CURRENT ISSUES AND ANALYSIS
In examination of one district, a problem was raised regarding a new investment in equipment that would
further process products in that district needed by the customer which could have been processed in a
different district. However, further processing in another district would cause a longer lead time. Since the
companys competitive strategy is to provide good customer relationships, having this equipment which
would shorten the lead time would be to their advantage.
The following sections discusses the issues arising from the decision-making process of the district
manager.

Capital Investment Proposal

The capital investment proposal of the sales manager has pros and cons:
Pros:

The area within the Columbus District has a reasonable demand for processed inventory. Currently, the
company is unable to meet this demand. According to Elizabeth Barret, sales manager of the district, the
new processing equipment will be able to produce processed inventories which will satisfy the needs of
the customers.
The district will be entering a new market with lots of opportunities because of this asset acquisition for
the district producing processed inventories. Favorable earnings and positive sales growth for the district
will be achieved if there would be proper implementation and marketing of the product produced.
A capital investment with a low Payback Period of 4.5years, an Internal Rate Return of 21.8% and a Net
Present Value of $286,000 is attractive to a company because of these tangible benefits.
Con:
This proposal is disadvantageous to Ken Richards due to the unfavorable effect on its incentive bonus
because of the lower payout rate to be multiplied by his base salary which will result to lower bonus.

Performance Evaluation and Incentives

District managers are evaluated based on the Return on Assets (ROA) criterion. The larger the actual
ROA exceeded the 90% of the ROA target, the larger the bonus the district manager will receive. The
amount of the managers base salary also contributes to the size of the bonus. The regions performance,
in addition to the districts performance, also affects the bonus of the district manager.
It can be inferred from this scheme that bonuses are awarded on the basis of incentive profits in which
bonus increases in proportion to incentive profits. No bonus is awarded if incentive profits are less than
zero. The maximum bonus amount is 75% of managers base salary.
ANALYSIS OF ALTERNATIVES
There are three ways to evaluate the performance of an investment center - ROA, which is currently
being used by the company, Return on Equity, and Economic Value Added.
The advantage of ROA is that targets can be adjusted to focus managers attentions on key success
factors and also because every manager can be measured by the same metric. However, certain
circumstances causes managers to make decisions that are bad for their organization such as QMs
situation where the ROI target is not consistent with the entitys capital cost, in which case the investment
center manager will under-invest [sometimes over-invest] in assets. Moreover, the depreciation rate used
in calculating ROI is not the true economic rate of depreciation, in which case managers may make bad
decisions about both the maintenance and the acquisition of assets.

ROE is somewhat similar to ROA, except that liabilities are subtracted from the assets. This incorporates
an evaluation of how managers used leverage on their capital investments.
EVA, on the other hand, is a bit more complicated than ROE and ROA. However, it takes into
consideration all the costs including the cost of equity capital which is ignored in normal accounting. This
accounts for the true value of an investment decision to a firm.
RECOMMENDATIONS

Approval of the Capital Investment Proposal

Ken Richards should send the proposal by the Sales Manager to home office for its approval
since this will be beneficial to the company as a whole particularly the increase in market share
and favorable earnings. As you can see from the analysis section, pros of acquiring the asset
outweigh the cons. Thus, recommending the investment proposal to the corporate headquarters
is the proper thing to do.

Performance Evaluation and Incentives

Investments with relatively new assets will show a lower ROA than investment with older assets.
As such, QM should evaluate the performance of the investment centers based on the Economic
Value Added.