Costs and Performance
Introduction Armco Inc. , is the sixth largest producer of stainless, electrical, and carbon steels and steel products in the United States, and the Armco Inc Midwestern Steel Division is its largest division. The largest subdivision of the Steel Division is the Kansas City Works which produces two products: grinding media and carbon wire rod. In January 1991, a new performance measurement system for Kansas City Works was implemented by Bob Nenni, the Director of Finance, with the aim of providing managers the best information that would better enable them to enhance company performance.
According to Mr. Nenni, the new system was designed so that managers would prioritize certain key objectives and not the numerous details provided by the old Operating Statistics Report that they have used in the past. The new system also aims to provide an improved basis for evaluating operating managers and manufacturing supervisors. This includes a balanced set of performance measures, including quality, schedule achievement, and safety, in addition to costs.
The cost reports were changed to include only those that are controllable by each individual operating manager.
Lastly, one of the most significant changes from the old system is the elimination of the Cost Above measure, therefore decreasing the cost detail in the new performance reports considerably. Although the new system intends to help the managers and increase their focus on relevant data, some are still complaining and dissatisfied because of the lack of information and lack of details that they have been accustomed to. Some actually prefer having the old system back, wherein monthly and annual trends are shown that allows them to compare actual costs with objectives.
According to one manager, the old report provided “the minimum amount of detail necessary”. Problem What is the optimal performance evaluation system for the Kansas City Works to adopt? If the chosen system is optimal, should it be implemented to other subdivisions of Armco, Inc. Midwestern Steel Division? Areas of Consideration (see exhibit 1) Kansas City Works should consider the following factors in determining what the optimal performance evaluation system to adopt. •Goals and objectives of the division •Purpose and operations of each department •The Incentive Program •Understandability and relevance. The Division as a Cost Center Alternative Courses of Action After taking into consideration the preceding factors, we now proceed to the courses of action that the division could take to determine the optimal performance evaluation system. 1. Return to the Old System (see exhibit 2) Advantages •Managers are familiar with the output of the system. This lessens discontent and frustration and enables managers to concentrate on their work rather than continually complain about the system. •The reports were given in a monthly or weekly basis which helps the managers take immediate action to solve specific emerging problems.
Disadvantages •Because it is detail oriented, managers may misappropriate the cause of the problem as a problem with the accounting system rather than a real problem with operations. •Too much detail may lead managers to focus on problems whose effects are short term, rather than details that look at the bigger picture and whose effects are long term. •The reports done are not in line with the goals of the division of undertaking activities that are the most value-adding to the division. 2. Implement completely the New System (see exhibit 2) Advantages This system not only caters to the top management but also to the middle to the lower branches of the company by providing a standard that serves the division as a whole, and not only to the standards for their specific department. •It provides a more objective way of measuring the performance of a department of the division. •By streamlining cost reports, it will include only the most relevant information needed by each manager to assess their division’s performance thus enabling them to locate the primary problems and eventually find a solution to the problems. By limiting evaluation of managers to the cost that they could control directly, which is the spending of their subordinates, unlike the costs of their whole department, they now have a wider scope of what they are responsible of above and beyond minimizing cost. Disadvantages •The system was not able to provide a performance measure for each individual, particularly the managers in the company. •Some of the key performance measures were not applicable to other divisions of the company. 3. Adopt a Modified System (see exhibit 2)
Advantages •This system not only caters to the top management but also the middle and lower branches of the company. •It provides a more objective and reliable measures of performance both in the division and individual performances. •Each division and individual will be able to assess their strengths and weaknesses in their performance to the company. •It provides a more objective way of giving compensations and incentives to the employees. •The system can easily adapt to unforeseen events. Disadvantages There is a possibility of resistance in the part of the managers thus resulting to delays and inefficiencies. •Additional opportunity costs may arise due to the fact that the employees need some time to adapt to the new system. •Evaluating each individual using specific measure which depends among their jobs could prove to be time consuming. Recommendation The group believes that adopting the modified system is the optimal decision for the division. The modified system addresses the remaining issues with the new system: 1) it minimizes the effect of uncontrollable factors on anager performance evaluation by separating those evaluation criteria that is not applicable to the manager’s respective department and; 2) it provides the basis for employee compensation by setting minimum requirements that should be met (general measures), and rewarding them if they manage to go beyond (specific measures). Along with addressing these issues, the modified system still manages to meet the objectives of the implementation of the new system, which is to provide a performance evaluation system that manages to focus manager attention on the most relevant problems thus adding the maximum value to the division.
In order to avoid resistance to change in the implementation of the group’s recommendation of the modified performance evaluation system, Lewin’s three-step management model (see exhibit 3) can be used as a framework. First, the division must undergo the unfreezing step. This is the starting point of the change. It begins the process of detaching the members of the division from the old performance measurement system. This can be done through creating the need for change. The group has already assessed this necessity.
It can now be communicated through the units to educate them with the importance and relevance of the change. Support from the top management should also be acquired to affirm the validity of the implementation. The next step in the process is the change itself. Employee involvement should always be present to induce participation from them and thus reduce opposition. Involving people in the process will help generate feedback from them. This will evaluate the ongoing change process from the eyes of the worker.
The hands-on experience from the change will also assure them from any uncertainty that they might have. Finally, the last in the process would be the refreezing step. This will stabilize the foundation of the change. The new rules and regulations that represent the implementation should set the standard in the division. Every element comprising the goals of the change should be well-established. Incentives for following the new processes should be given to promote abidance. Feedback systems can be instituted to evaluate the change.
Support should also be consistent. With regards to the incentive and compensation that will be given to the different managers, the group would like to recommend a balance scorecard (see exhibit 4) to keep track of the performances of the managers. With this, the top management would be able to objectively measure the strengths and weaknesses of the each manager. In addition to this, the manager would be able to know what exactly are the things needed to be done by each manager in order for them to achieve the goals of the company.
Furthermore, a balance scorecard would be able to promote not only individual excellence but also a division as a whole. APPENDIX EXHIBIT 1: Areas of Consideration EXHIBIT 2: Features of the Different Systems Old System•“Cost Above” System – where the cost added per ton of steel at each production sated for the entire plant is indicated •Operating statistics report – provided a five year history, monthly and year-to-date actual performance and objective and variances from objectives from each of the factors that determined total Cost Above for each cost center. Performances of the cost center managers and their superiors were evaluated in terms of cost control and safety. •Cash incentive awards are based on a performance evaluation made by their immediate superior and ultimately the division president New System•The vision and goals of the organization were to be translated into key success factors which would be disaggregated into department individual objectives that would be compared with measures of actual results. Removal of the Operating Statistics Report- cost reports would include only those costs deemed controllable by each individual operating manager. •Removal of the Cost Above system – that production managers were no longer held accountable for all costs incurred in or allocated to their respective areas so they were no longer cost center managers; they are evaluated based on the spending of their subordinates. •Provide ten specific key performance measures that are the general basis of performance for the whole division.
Modified New System•It provides fewer key performance measures that are generally applicable to all departments of the division for a fair evaluation of their performance as a whole. The following are the key performance measures identified as general measures applicable to all departments: a. Tons per man hour b. Disabling injury index c. Total quality index d. Spending e. Maintenance Performance f. Sales price minus cost of net metal •Other performance measures (heats per week and cash flow) are specific only to certain departments. Hence, they are applied only to those affected departments. i.
Heats per week- relevant only to the melt shop (in cases of failure in this area, the performance measure of all other departments will be affected, making it difficult to identify the actual performance of those departments) ii. Cash Flow- cash flows for all four departments have differing nature. The types and costs of materials used per department are specific only to those departments. Applying a general standard may not reflect how efficient each department really is in managing its cash flows. •Product mix- since the product cannot be solely attributed to a specific department; it cannot be used as a performance measure.
The only relevant measures to be used are those that the managers can manipulate. Including otherwise will only further cloud actual performance (there being no perfect performance measure in reality). •In addition to general performance measure, there are specific performance measures which depend upon the nature of the individual duties of the employees within the company. •Because of the modified performance measures, it also provides for a more reliable basis for the incentive system. EXHIBIT 3: Lewin’s Three-step Management System EXHIBIT 4: Balance Scorecard