AMERICAN STEEL CORPORATION Next class: Formosa Plastics

American Steel Corporation: Context An integrated steel producer with annual sales in 1993 of about $4.5 billion. Numerous divisions: Headquarters (St. Louis ) Warehouse Sales Division operated 21 field warehouses throughout the US half of sales were steel products (rod, bar, wire, tube, sheet, and plate) purchased from Mill Products Division disappointment in the performance of the Warehouse Sales Division Mill Products Division

Warehouse Sales Division: American Steel Corporation New Performance Measurement System Decentralize the management of the division each branch warehouse manager responsible for the divisions activities in his or her geographic area. compete with other producer-owned warehouses as well as with independently owned warehouses. purchased their steel products from the Mill Products Division at the same prices charged to independently owned metal supply warehouses.

Warehouse Sales Division- American Steel Corporation: Issues Performance Measurement System Evaluate in depth the new incentive system. How, if at all, would you modify it? ROI What role should the new investment center incentive plan play in decisions such as Denvers lease-versus-own issue? Behavior with ROI as a performance measure

Warehouse Sales Division- American Steel Corporation Performance Measurement System responsibility to make the division grow, both in sales volume and ROI [return on investment], subject only to approval of the divisions annual profit plan and proposed capital expenditures by corporate headquarters. implementation required on the balance sheet

Effective Performance Measurement System

Warehouse Sales Division- American Steel Corporation Compensation Plan Components: 1. Base Salary determined on dollar sales volume of the districts in the prior year; the higher the sales volume, the higher the range for which the manager becomes eligible. actual salaries will be established by the Divisions general manager, salary ranges will be reviewed periodically in order to keep them competitive with those of other companies in the metal supply warehouse business. 2. Growth Incentive the manager will earn $500 for every $100,000 of increased sales over the prior year (i.e., 0.50 percent of any sales increase)

Warehouse Sales Division- American Steel Corporation Compensation Plan Components 3. Return on Investment Incentive an incentive will be paid in relation to the size of investment and return on investment. No incentive will be paid to a manager whose branch earns less than 12 percent pretax ROI. 50% of divisions earn less than 12% No increase in incentive payment will be made for performance in excess of 50 percent pretax ROI. No payment will be made in excess of $50,000, regardless of ROI performance. Sliding scale of performance

Warehouse Sales Division- American Steel Corporation

Effective Performance Measurement System Given the goals of the company which alternative incentive will motivate the desired behavior? Process participatory and easy to understand by employees feed back provided Incentives congruent with reward systems – pay performance link various types of compensation (e.g. salary, bonuses, options) attainable performance levels responsibility and control is considered (overall vs. divisional)

Effective Performance Measurement System Given the goals of the company which alternative incentive will motivate the desired behavior? Alignment with Organizational Goals assesses progress toward organizational goals and objectives - promote intended behavior (critical success factors) Measures unlikely a single measure or even several measures will effectively assess performance a mix of financial and nonfinancial metrics absolute vs relative measures includes both short and long term metrics measures are observable (objective vs. subjective) limit ability to manage/manipulate outcome measures

Warehouse Sales Division- American Steel Corporation Given the goals of the company which alternative incentive will motivate the desired behavior? Process Incentives Alignment with Organizational Goals Measures

Warehouse Sales Division- American Steel Corporation Own vs Buy Im sure that the incentive compensation plan you put in last year is fair, but I didnt know whether it adjusted automatically for the difference between owning and leasing, and I just thought Id raise the question. …he said that hes getting a lot better return on investment in his district because hes in a leased facility

Warehouse Sales Division- American Steel Corporation Own vs Buy Lease vs Own is a financing not operating decision Current system appears to penalize managers in the short run who move to newer facilities As capital decisions are infrequent, the incentive system should not be designed with capital decision as a primary issue Suggest a process to deal with the impact of capital investment (e.g. upward adjustment in base)