Divisional Performance Evaluation
Transcript of Divisional Performance Evaluation
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Managerial Economic s and Organizational Architecture, 5e
Managerial Economics andOrganizational Architecture, 5e
Chapter 17: DivisionalPerformance Evaluation
McGraw-Hil l /IrwinCopy right 2009 by The McGraw-Hil l Comp anies, Inc. All Righ ts Reserved.
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Managerial Economic s and Organizational Architecture, 5e
Measuring Divisional Performance
Rewards are based on performanceevaluations
Must be consistent with decision rightsgranted to the unit manager
Units can be characterized into five
groups
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Cost Centers
Manufacturing
Assigned decision rights to produce astipulated level of output
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Cost Centers
Economic efficiency (minimize costs forgiven output)
Technical efficiency (maximize output forgiven budget)
Note: minimizing average cost does notyield profit-maximizing sales level
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Expense Centers Personnel, accounting
Managers are given fixed budget andasked to maximize service/output
Output is more subjectively measured thanin a cost center
Budgets may be benchmarked with those
of other firms Lack of charge back leads to overuse
Risk of empire building
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Managerial Economic s and Organizational Architecture, 5e
Revenue Centers
Sales, distribution
Managers compensated for selling a set ofproducts
Objective to maximize revenue for a givenprice or quantity and budget
May not be consistent with value
maximization Revenue maximized when MR=0
But MC may be greater than 0
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Managerial Economic s and Organizational Architecture, 5e
Profit Centers
Combined cost and revenue centers
Managers are given a fixed capital budgetand allocated decision rights for input mix,product mix and selling prices
Evaluated on difference between actualand budgeted accounting profits
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Profit Centers
Firms must be wary of individual unitsmaximizing profits at the expense ofmaximizing value of the whole firm.
Complications Selection of transfer price
Overhead allocation
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Managerial Economic s and Organizational Architecture, 5e
Investment Centers
Profit centers with decision rights overcapital expenditures
Evaluated on basis of return on capital
Return on assets
For the investment centerthe ratio of accountingnet income to the total assets invested in the
center Economic value added
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Managerial Economic s and Organizational Architecture, 5e
Transfer Pricing
Price paid for intra-organizational transfersof goods and services
Choice determines both distribution ofprofits among units and overall profits
If transfer prices are mis-measured,managers in various divisions will makeinappropriate decisions
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Managerial Economic s and Organizational Architecture, 5e
Transfer Pricing
The optimal transfer price for a product orservice is its opportunity cost
Often difficult to measure
Measurement Costless information
Opportunity cost is the marginal cost
Asymmetric information Managers may have incentives to hide true costs
and may charge monopoly price instead of priceequal to MC
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Managerial Economic s and Organizational Architecture, 5e
Profit-Maximizing Product Price
110
60
Price(indollars)
$
Firm profit = $500
MR
MC = $10
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DQ
Quantity
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Decentralized Firm
transfer price
110
60
10
Costs(indollars)
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Quantity
DMRMC
Q
$
Profits = $250
Manufacturing division
$
110
85
60
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Quantity
DMRQ
MC
Profits = $125
Distribution division
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Managerial Economic s and Organizational Architecture, 5e
Internal Accounting
The accounting system
Decision management requires estimates offuture benefits and costs
Backward-looking accounting systemssupport decision control
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Internal Accounting
Tradeoffs between decision managementand control
Accounting measures are not under the
control of those being monitored
Managers with decision making rights areoften dissatisfied with financial measures for
making operating decisions
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