Falcon INC Performance Evaluation System

Diploma In Management Adani Group Management Control System

Submitted to :Prof. Parag Rijwani

Submitted by :Shalin Shah

Falcon Inc

Global Appliance Industry: A Glimpse

A consolidated industry with less than 10 companies controlling 50% of the total market.

Slow growth pace hence making competition tougher

Three major segments: Low price, Mid price, Very high price

Major players:Electrolux,G.E,Maytag,Whirlpool etc.

Falcon Inc: A Brief Profile

A Publicly held U.S Co

A Global player in home appliance industry

Wide range of products including refrigerators, kitchen appliances, washers, dryers etc.

Presence in all three segments low price,mid price and high price

Three foreign subsidiaries in Mexico,Denmark & Japan

Falcon Inc: A Global presence

Falcon Inc Subsidiaries

Mexico Denmark Japan

Product

Production

Sales

Differentiator

RefrigeratorsHigh priced

kitchen Appliances

Low cost laundry machines

Mexico U.S

Mexico Denmark U.S

Growing demand

No competition

Low cost

Japan

Question 1

Under the current performance-evaluation system(PES) at Falcon, how would you assess the financialperformance of the division managers in Mexico,Denmark, and Japan?

Which manager should be awarded the highestbonus, and which should be awarded the lowestbonus?

Current PES: Each Subsidiary is responsible for budgeted US Dollar profit.

Year 2004 Mexico Denmark Japan

Budgeted Profits( US $ )

14,910,000 8,282,640 20,420,825

Actual profits( US $ )

14,937,721 9,691,788 17,839,177

Difference 27,721 14,09,148 (2,581,648)

Highest Bonus Lowest Bonus

Question 2Using the approach outlined in Appendix A, calculate thenominal and real changes of exchange rates for Mexico,Denmark and Japan during 2004?

In light of your calculations what revisions if any would youmake in the 2004 dollar budgets at the time of tracking them?

How would you assess the financial performance of the threecountry managers of Falcon?

Which manager should be awarded the highest bonus? Why?

Evaluate appropriateness of the three country managersresponses to the changes in exchange rates?

Nominal and Real exchange rate

Exchange rate(LC per US $ )

Mexico Denmark Japan

2003 10.72 6.88 119.8

2004 10.985 6.47 111.8

Real Exchange rate

Mexico: 10.72*1.05/1.023 11.00

Denmark : 6.88*1.043/1.023 7.014

Japan : 119.8*1.0225/1.023 119.74

Presently Budgets have been evaluated by 2003 exchange ratesand performance of 2004 by the rates prevailing in 2004.

A common metric should be used for subsidiary evaluation, Hence2004 budgets should be recalculated by using 2004 exchangerates.

If ROI method used to evaluate the performance of managers.

Mexico’s ROI:14937721/149100000*100=10% Denmark's ROI:9691788/20706600*100=47% Japan’s ROI:17839177/510520625*100=3%

Hence Denmark should be awarded highest bonus and Japan theleast

Question 3: If ROI, rather than profit margin wereused as the performance measure would theperformance ranking of three subsidiary bedifferent?

Describe the advantages and limitations of using ROIas a performance indicator?

Would you consider ROI as a superior measure?

Advantages & Limitations of ROI

Comprehensive measure: Anything that affects financial statements is reflected in this ratio

Simple, easy to calculate and understand

Can be used to compare performance of different units

Increase in ROI may reduce overall profits

Ignores cost of raising capital

Question 4 : Evaluate the appropriateness ofFalcon’s use of the beginning of the yearexchange rate for budget setting, andaverage-of-the-year rate for budgettracking.

Describe the approaches for preparingcountry managers to better respond toinflation and exchange rate changes

Falcon believes that the operating part of foreign exchangerisks should be born by subsidiaryHowever subsidiary managers should not be held responsiblefor the same and common metric should be used forcomparisonTools such as hedging of currency should be used so as tosafeguard forex risksBeginning of the year exchange rate does not represent thecorrect conversion factor. Rather the applicable forward ratesprevailing in the market for next year should be consideredFurther, falcon should implement appropriate treasuryfunction for hedging their exposure and that treasury should beresponsible for the profit / loss due to exchange ratefluctuations.Subsidiaries should not be held responsible for exchange ratefluctuations unless they are being given authority to hedgetheir exposure.

Question 5 : Assume that for each of the past fiveyears, the Japanese subsidiary has reported lowerthan budgeted profit margins and ROI in dollarterms. If adjustments are made for the realexchange rate changes however its performance ineach of those five years turns out to be better thanthe revised budget.

Would you recommend closing Japanese subsidiary?Why or why not?

Real exchange rate has significant effect on competitivepositions.

A decline in nations real exchange rate makes its exports morecompetitive and vice versa.

Eg:1$=10 yen earlier1$=8 yen now

Hence Local currency profits would reduce

Now if real exchange rate is 1 $=9 yen the performance of companywould improve

We do not suggest for closing of Japanese firm on below reasons - Japanese firm has achieved better cost target and saved on

production costs in JPY.- These costs are not exposed to US currency as production in local

market only- However, due to conversion factor only the production cost in US

currency looks higher.- Further, Japanese firm has achieved higher sales in USD currency

( sales is in USD only) as compared to target.- However, due to conversion factors the sales and profitability is

impacted and looks trim- Japanese firm has outperformed in both the responsible area i.e.

in sales and cost of production. However, only because ofexchange rate policy adopted in PES, shows Japanese as poorperformer.

- Hence, we do not recommend for closing of Japan Sub. ratherrecommend for change in PES.

Question 6 :Describe the strengths and weaknesses incurrent PES for foreign Subsidiaries. What changes in PESwould you recommend :

Existing System : Strength :- All subsidiaries are at par for evaluation purpose and all are measured

by profitability in USD which is ultimate aim of the business strategy- Easy to understand by manager and they are clear of their goals.- Systems are followed strictly and no benefits / exception being

considered on case to case basis.Weakness :

- Exchange rate differences are contributing to the performance of themanager which is not within their control.

- Managers should be evaluated for the performance within theircontrol.

- Denmark subsidiary is responsible only for revenue within Denmarkand has only one right to procure the product is from US Falcon.Hence, they are not responsible for the cost still charged for thesame.

Existing System : Weakness contd.. - Japan is responsible for low cost manufacturing as well

generating revenue in US market. Japan is producing in localcurrency but selling in US Currency. Hence, there is mismatchin exchange rate fluctuation between revenue and costs.

- Mexico has revenue and cost both in domestic currency. Stillthey are evaluated on converted exchange rate in USD.Further, the budgeted exchange rate and average exchangerate is different on which the performance of the subsidiary isimpacted.

Suggested Performance Evaluation System :

- All three subsidiaries operate in different territory and withdifferent goals. Hence common yardstick should not be used forPES.

We suggest following PES for each subsidiary :1. Mexico :

- Responsible for cost of production and revenue generation.- Both revenue and costs are in local currency

Hence, Mexico should be evaluated on ROI basis in localcurrency.The target should be provided considering the exchange rateeffect in USD and to take care of interest of shareholders of US

2. Denmark: (suggested PES)- Goods are supplied by US only and no other purchase option- Responsible for revenue generation in Denmark for US products

and revenue in local currency- Hence, Denmark should not be responsible for Costs as it is not

within their control.

Denmark should be treated as Revenue Center in local currency. Corresponding manufacturing plant in US should be considered

as Cost Center fro production of goods. The profitability / revenue target should be decided based on

the exchange rate between two countries The transfer of goods from US to Denmark should be hedged in

advance to avoid the exchange rate differences.

2. Japan: (suggested PES)- Goods are produced in Japan as low cost production facility - Responsible for selling goods in US with exclusive rights - Hence, Japan should be considered as an Investment Center- Further, Japan has foreign currency exposure in Revenue and

local currency only in production costs.

Japan should be given full authority to produce and sell goods and also do the hedging of their sales

The budget should not be prepared based on closing exchange rate of the previous year. But should be prepared based on one year forward exchange rate prevailing in the market.

Japan sub. Should be given authority to hedge their revenue at that forward rates.

After above, delegation of authority japan should be evaluated on ROI basis in US currency.

Thank you