Enager Industries

Introduction

Enager Industries, Inc. was a relatively young company that consisted of three divisions with distinct services and products. At the urging of CFO Henry Hubbard, Enager’s president, Carl Randall, had decided to begin treating each division as an investment center, so as to be able to relate each division’s profit to the assets the division used to generate it profits.

Analysis

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However, several issues arose regarding this performance evaluation method and other management control choices.

First of all, profitable new project at Consumer Products Division, whose return was 13% calculated from Exhibit 3, could not get approved from upper management because it could not reach the pre-determined universal target return of at least 15 percent, even if all the divisions had completely different line of business. This could potentially discourage product development managers’ incentive to engage in new projects. More importantly, the company could miss out the opportunity on new products in the long-run, although it might not have a large return right away in the short-run.

Secondly, the president of the company, Carl Randall, was both puzzled and disappointed at the discrepancies among the performance evaluation parameters of the company in 1993. Both ROA and gross return dropped from 1992, while return on sales and return on owners’ equity increased. There were also discrepancies across different divisions, as Professional Service easily exceeded the 12% gross return target; while other two divisions, especially the Industrial Product division had a ROA that was only 6. 9%.

These discrepancies could increase the difficulties for the top management to understand the performance, thus hindered manager’s ability to make good decisions. Last but not least, general manager of Industrial Product Division was put much pressure by Randall, the president, because the division “fell behind” compared to the other two in terms of ROA. The divisional general manager argued that they could have achieved a higher ROA if they had older assets as Consumer Products Division did, but Randall could not understand the relevance of the argument.

This is not only a communication problem, but also an evaluation problem caused by the inappropriate treatment of the assets value that is used in calculating ROA. By analyzing the management problems mentioned above, in can be concluded that these problems are the consequences of several management control mistakes, including unreasonable target setting, inefficient method of performance evaluation, and problematic treatment of assets value. Top management of Enager should not set an identical goal for all the divisions since all the divisions engaged in distinct service or production.

The nature of those distinct businesses certainly required different amount of assets to operate, and they would face different levels of competition, and they would surely have different profit margins. Therefore, it was unreasonable only using one single target return to evaluation all the new projects from all three divisions to determine if the projects were profitable. In the case, McNeil’s proposal was rejected because it did not meet the 15% target return. However, the new project did have a favorable residual income and demonstrated the a return of 13%, which can increase the EPS for the company.

If any benchmark were to be set to evaluate the profitability of new projects, it should be carefully engineered according to specific situation that can be applied to specific division, with the comparison to other competitors in the industry or to past performance. For example, Enager can establish a standard costing system based on historical and external information (including financial information, market information, etc) that can allows management to create a standard profit level.

A standard costing system can further allows cost and profit variance analysis, which can be a very powerful tool for management control later on. There were also too many confounding factors in calculating ROA in Enager’s case. Firstly, using net book value of assets in calculating the ROA would surely put those divisions with newer assets in disadvantage. With less depreciation, divisions with newer assets will have lower ROA due to a larger denominator of assets value. The more reasonable way in this case is to use the fair market value, which can better represent the assets’ value in producing profit.

Secondly, it is unreasonable to allocate corporate expenses and assets to certain divisions based on divisional revenue. Since each division had different services and products, revenue could not be the basis of allocating those corporate expenses and assets that did not reflect performance of each division. These confounding factors may be able to explain those discrepancies Randall was confused about. As such, the use of ROA in this case is an ineffective method of performance evaluation.

Recommendation

Based on the previous analysis, the solution to this case is to implement a new method of performance evaluation since ROA is such an ineffective method of performance evaluation. One alternative worth perusing is to use the Balanced Scorecard method to evaluate division performance. Instead of measuring the performance only using financial data, Balanced Scorecard methods requires business units to be assigned goals and then measured form the perspectives of financial, customer, internal business and innovation and learning.

For example, Enager can evaluate the divisions based on the quality of the products, level of innovation, employees’ contribution to the whole company, etc. Balanced Scorecard can be a very critical supplement to financial data because it is part of strategy planning. The Industrial Products group may no longer be under evaluated because of less-than-perfect financial data. Essentially, a Balanced Scorecard method allows the manger to see the big picture on the strategic level.

A Balanced Scorecard method can also promote balances among different strategies in an effort to achieve goal congruence, thus encouraging employees to act in the organization’s best interest. Profitable new projects, like the one that McNeil had proposed, would have a chance of getting approved because it would benefit the company as a whole since it could increase Enager’s EPS. Another advantage of implementing Balanced Score card is that it promotes comparability among different divisions with distinct line of business.

Unlike ROA, Balanced Scorecard taken in to accounts of different perspective of the business into account, since the comprehensive value of the division is reflected in the Balanced Score card design. By implementing Balanced Score card method, the upper management of Enager can obtain a broad-base view of the company in terms of goals and strategy. Although it requires additional work for executives to choose a mix of measurement that accurately reflect the critical factors that will determine the success of the company, it is a better alternative here than ROA as a performance evaluation method.

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