Abrams Company Case Analysis

Abrams Company Case Analysis

Executive Summary

Dear President and Chief Operating Officer, we have analyzed the management control system at Abrams Company as you have requested and reached the following conclusions regarding its efficiency and effectiveness.

Abrams Company currently operates in a saturated and price competitive market in which other factors such as quality, availability and efficient delivery are all pertinent to company success. Even though it's current management control system links compensation to operations to incentivise employees, various factors in the calculation of the bonuses may lead to demotivation or inaccurate budgeting.

Furthermore, the company lacks control systems in place to evaluate the performance of key success factors other than price, which can impede the maximization of company sales and cost reduction. In anticipation of the rise in demand in the AM market, we recommend that transfer pricing be set at cost of production per unit to eliminate internal disharmony.

Please refer to the analysis in the following papers for more details.

Situational Analysis

Porter's Forces

Industry competition: market is saturated and is highly price competitive, thus cost control is a key success factor in the industry

Buyer bargaining power: price competition in market suggests ease for buyers to switch, thus high buyer bargaining power. In order mitigate this threat, satisfaction of customer demands in quality, availability and quick delivery becomes critical success factors

Supplier bargaining power: actual threat is unknown, but it can be speculated that the price fluctuations among raw metal resources will impact ROI

Threat of new entrant: low due to market saturation and high capital requirement

Threat of substitute: substitutes for metal parts are unknown; demand changes are as a result of different part specifications related to new models of vehicles or equipment, thus technological innovation and efficiency of production plants are critical to success

SWOT Analysis

Strength

• Diversified structure allows for targeted and specialized marketing strategies
• ROI and sales targets as well as bonus compensations incentivises efficient and cost effective operations

Weakness

• Transfer pricing disputes and lack of unified resolution for internal transfers lacking market price comparison
• Internal disharmony between OEM divisions and AM division in parts sales; lack of goal congruence to operate towards company benefit as a whole instead of sole focus on own division
• Production exceeds demand, which causes high inventory most of the year and adds to storage costs
• Bonus points by hierarchy and high (25%) variation on actual bonus by superior discretion may demotivate employees
• ROI may not be accurate due to possible understatement or overstatement of assets, especially inventory
• Lack of other management controls related to key success factors

Opportunity

• Expected increase in aftermarket demand

Threat

• Fluctuations of raw materials cost will impact cost of goods sold
• Innovations in technology may disrupt current price competition and lead the manufacturing process

Strategy Summary

Abrams Company employs a diversified structure in its management of parts manufacturing and sales. It competes mostly on a cost basis. Quality and design, parts availability, and delivery services are survival and differentiating factors included in its competitive strategy.

Critical Success Factors Summary

• Just in time delivery to minimize parts inventory
• Innovative and dependable design for quality
• Cost effectiveness in price competitive market
• Availability of parts as a result of production planning and technological update
• Goal congruence and division harmony to ensure maximized company benefit

Management Control System Summary

• Return on investment target for each division based on budgeted profits (including allocations of division and corporate overhead costs and an imputed income tax expense) divided by actual beginning of year net assets (total assets - current liabilities). Actual ROI = actual profit divided by actual beginning of year assets. Cash and receivables are allocated based on sales revenue.
• OEM sales departments must meet annual sales targets, but marketing is responsible by each department and is not unified.
• Staffs participate in incentive compensation plan. Total bonus is calculated using fix formula based on earnings per share, then divided by the bonus points of each staff (ranked by hierarchy). Actual bonus could vary by 25% from calculated by superior discretion. Manager bonuses are also adjusted based on net effect of profit variance.

Problems with the Management Control System

• Issues with transfer pricing when no market price is available; usually resolved by divisions involved
• AM division treated as captive customer and OEM customers are favored against internal sales; AM division expected to convince plant manager of parts it needs to manufacture
• Inventory levels are high for most of year; mitigated by lack of production near holiday season

Recommendations for the Future

• As demand in the AM market will increase, OEM divisions should work more closely between the AM division as to not hinder the delivery and availability efficiency of the division in its competition for the rise in demand
• Internal transfer prices should be set based on cost of production to create an internal standard when no market rates are available to eliminate time lost during disputes
• Just in time delivery should be implemented to streamline the production to delivery process in compatibility with market demand as to eliminate excess inventory during the year
• In its ROI calculation, management may want to use yearly average to calculate net assets to provide a more accurate picture since it is mentioned that inventory is high in most of the year, except for yearend after low production during Christmas.
• It is not sufficient to only manage divisions based on sales targets and returns on earnings ratios; other methods such as inventory turnover and quality control procedures should also be used to manage the factors pertinent to company success