Abrams company case Anaysis


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This case is about Abrams Company. I have done brief analysis of this case. I am uploading this case only for Management students...

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Abrams company case Anaysis

  1. 1. ABRAMS COMAPANYCASE 5-4 ABRAMS COMPANYQue. 1: Evaluate each of the concerns expressed by top management, and ifnecessary, make recommendation appropriate to the circumtences describedin the caseThe Abrams case is about using profitability measures to evaluate profit centers. The case alsoreflects a long academic debate in the US-literature about ROI problems. In EU companies it ismore common to evaluate PCs with Income measures like RI and EVA. This case covers thetree main problems in controlling profit centers: 1. The ROI behavior 2. Transfer pricing disputes 3. Operational trouble shoutingIt is very difficult to find a relevant and fair capital base for the ROI measure. Abrams usebook value for fixed assets which inflate the ROI measure as the assets age.The age and mix of assets also differs among divisions which give unfair measures. It is alsoeasy for the divisions to manipulate the capital base at the end of the year. ROI based bonusmay rob the future, who want to invest in assets if that reduce the bonus.I recommend this company to use RI or EVA instead of ROI and to control the investmentsseparately using NPV and capital turnover measures. The bonus should be based on thebudgeted income level, the RI target.The problem with the inventory level can not be controlled with ROI management. If thecompany change to RI/EVA it will be possible to to negotiate relevant inventory levels in thebudget process. High inventory levels can also be managed with differentiated capital chargesPrepared by: Milan Padariya, 63-MBA(Pharma) Page 1
  2. 2. ABRAMS COMAPANYthat will create high interest costs. The best way to control operational tasks is to us nonfinancial measures such as inventory turnover.Use non financial measures to control the inventory levels. If it is an strategic issue you canconnect this measure to the bonus system.Que. 2: What is overall evaluation of Abrams management control system?Describe any strength or weakness that you identified but did not include inanswering the previous question. What changes, if any, would you recommendto top management?In general, Abrams Company adopts the lowest cost, differentiation, market focus and ROIstrategies to accomplish the organization’s goal. Furthermore, In order to implement thestrategies the firm establishes its own management control systems.Evaluation of Abrams’ Management Control System:The current measurement system of the company is ROI. The ROI target is set based onbudget profit divided by actual beginning of the year net assets. Actual ROI is calculating byactual profit divided by actual beginning of the year net asset. The advantage of the AbramsCompany ROI system is it does not consider the investment added during the year, becausethe investments provide little effort to the year, but more benefit to the future. However, theROI measurement system has some weakness, such as defer asset replacement, short-termfocus at the expense of long-term.The incentive compensation plan of Abrams Company is bonus plan, and it calculateaccurately based on an equation, and it seems equal for all members. In addition, someadjustments also are made associate with the performance of the managers. The performance ismeasured by compare of actual profit and budget profit. However, all the measurement isPrepared by: Milan Padariya, 63-MBA(Pharma) Page 2
  3. 3. ABRAMS COMAPANYassociate with data, sometimes the performance will be influence by variance elements, such as,economic environment, the demand level, material price, cost of labor, and governmentpolicy, so the measurement need to improve in some areas. The dollar amount of corporatebonus pool was established by a fixed formula linked to company earning per share. Thisincentive compensation plan can be considered as a reward system. Using this method thecompany can increase or maintain motivation.STRENGTH :-The company has a clear management structure.-The company has employed a bonus plan for employees.-The AM Marketing division will input products form the other three divisions, and sell it todomestic and foreign market, it helps the company save cost when it input internal.WEAKNESS:The Abrams Company has three totally independent divisions, and the three divisions are lack ofconnection. They purchase their materials separately, and they carried excessive inventoriesmost of the year. Also, inside sales sometimes need a negotiation on price, the may lead to lowproductivity.SUGGESTIONS TO PERFORMANCE MEASUREMENT SYSTEM:1) ROI: can be used combination with other performance measures to avoid the limitations ofROI. The company can establish a non-financial performance measurement system such asthe balanced scorecard .With a good performance measurement system, the incentivecompensation plan will be improved.(2) EVA ( Economic value added): can be used instead of ROI Suggestions to transferpricing… A transfer price fixed by the top management in compliance with the AM divisionand the other divisions involved which could be revised when it is out of date. This fixed pricePrepared by: Milan Padariya, 63-MBA(Pharma) Page 3
  4. 4. ABRAMS COMAPANYcould be adjusted due to inflation. There should be an internal policy on it. Therefore, topmanagement should implement a cost-based transfer prices because when competitive pricesare not available, transfer prices may be set on the basis of cost plus a profit markup.RECOMMENDATION:The non-financial performance measurement system should be established. Thebalanced scorecard is a good choice for company measure performance. With a goodperformance measurement system, the incentive compensation plan will beimproved.Prepared by: Milan Padariya, 63-MBA(Pharma) Page 4