Home Appliance (HA) builds coffeemakers and battery-powered small tools. For a long time, HA held a reputation for strong, durable, and reliable appliances. This reputation began to decline, however, when increased competition forced HA to cut costs, and this was handled poorly. For a moderate period following the cost cutting, as long as they were able to take advantage of their reputation, HAâs sales remained relatively steady. This effect then all but disappeared. The loss of reputation, coupled with increased overseas competition, caused HAâs sales to plummet sharply.
On January 1, 2014, HA began a massive effort directed toward rewarding for quality. In the two years that followed, sales failed to go up, but remained steady at around $10 million per year. A significant amount of money was spent on testing equipment, increasing inspection, setting up a statistical process control system, reworking or throwing out defective items, and paying incentives. The results of the effort are presented in the following table:
Also on January 1, 2014, HA organized into three divisions: electronic circuits, coffeemakers, and battery-powered small tools. Electronic circuits were used by the other two divisions, and 100% of its production was transferred at full cost plus an 8% markup (this is the standard practice in the electronic components industry) to coffeemakers and battery-powered small tools. All rejections made by coffeemakers and small tools were treated in the quality control system as internal failures, but most of the time they were not reported simply because electronic circuits replaced them immediately in the production lines. Each division had a bonus pool with 50% based on quality performance and 50% based on financial performance. The 50% based on financial performance is equal to 20% of the divisional residual income (the minimum required rate of return is the ROI of the worst-performing division). The 50% based on quality performance is calculated as: (Internal Failures as % of sales â External Failures as % of sales) Ã HAâs net profit. Given the results of last year, the manager of the coffeemaker division asked the top managers to review the current compensation system, because he was having the feeling that his division had been subsidizing those âlazyâ fellows of electronic circuits. He supported his claim with the following:
Instructions: Form groups of two or more students to complete the following requirement. Calculate the bonus paid to each division. Explain to the upper management if the money is being spent effectively and if the claims of the divisional manager are correct.
Quality Costs as a % of Sales for the Years Ended: 2013 2014 2015 External failure costs 8.20 2.40 1.15 Internal failure costs 2.80 4.00 3.40 Appraisal costs 2.00 3.20 3.39 Prevention costs 1.20 2.60 2.79 Total quality costs 14.20 12.20 10.73 Battery-Powered 2015 Electronic Circuits Coffeemakers Small Tools Net profit $ 500,000 $ 700,000 $ 660,000 Investment $2,500,000 $7,000,000 $6,000,000 External failures 0% of sales 1.2% of sales 2.4% of sales Internal failures 5% of sales 2% of sales 3.2% of sales Appraisal costs 0% of sales 5.2% of sales 3.1% of sales Prevention costs 1% of sales 7% of sales 4.2% of sales