Reference no: EM132274837

Case Study: Harwood Medical Instruments PLC

Advanced Management Accounting Case: Harwood Medical Instruments PLC (HMI), based just outside of Birmingham, England, manufactured specialty medical instruments and sold them in market niches that were becoming increasingly competitive and price sensitive because of pressures toreduce health care costs. HMI was organized into nine divisions each run by a general manager. Over the years, HMI had grown both organically and by acquisition. Six of the divisions had been acquired by HMI within the past decade. All of HMI's divisions sold medical products to hospital, laboratories, and/or doctors, so the need for product quality and reliability was high. The divisions varied significantly, however, in terms of the degree to which their success depended on, for example, development of new products, efficiency of production, and/or customer service. Bonuses for division general managers were paid semi-annually. Up to the year 2009, these bonuses were calculated as 1% of division operating profits. HMI's managing director, Andy Guthrie, had concerns though that the operating profit measure was too narrowly focused. He had been reading articles about performance measurement and decided to implement a "more balanced" scorecard. In November 2009, just before introducting a new bonus plan, Mr. Guthrie explained to his chief financial officer that he was willing to pay out higher bonuses than had been paid historically if improved performance warrantd doing so. The new plan provided a base bonus for division general managers of 1% of division operating profits for the half-year period. this base bonus was adjusted as follows: Increased by $5,000 if over 99% of deliveries were on time; by $2,000 if 95-99% of deliveries were on time; or by zero if less than 96% of deliveries were on time. Increased by $5,000 if sales returns were less than or equal to 1% of sales, or decreased by 50% of the excess of sales returns over 1% of sales. Increased by $1,000 for every patent application filed with the UK Intellectual Property Office. Reduced by the excess of scrap and rwork costs over 1% of operating profit Reduced by $5,000 if average customer satisfaction rating were below 90%. If the bonus calculation resulted in a negative amount for a particular period, the manger received no bonus. Negative amounts were not carried forward to the next period. Exhibit 1 shows results for two representative HMI divisions for the year 2010, the first year under the new bonus plan. The surgical Instruments Division (SID), one of HMI's original businesses, sold a variety of surgical instruments, including scissors, scalpels, retractors, and clamps. The markets for these products were mature, so growth was relatively slow. Not much innovation was needed, but controlling costs was critical. The Ultrasound Diagnosti Equipment division (Ultrasound), which was acquired in 2007, sold and serviced ultrasound probes, transducers, and diagnostic imaging systems. The ultrasound market promised excellent growth and profits if the division could keep its sophisticated products on the cutting edge tecnologically and control both product development and production costs effectively. In 2009, the total annual bonuses for the year earned by the managers of SID and Ultrasoundn were approximately $85,000 and $74,000, respectively. Operating results for the Surgical Instruments and Ultrasound Diagnostic Equipment Div, 2010 ($ in 000s) Surgical Instruments Div. Ultrasound Diagnostic Equip. Div 1st half of 2010 2nd half of 2010 1st half of 2010 2nd half of 2010 Sales $42,000 $44,000 $28,600 $29,000 Operating profit $4,620 $4,400 $3,420 $4,060 On-time deliveries 95.4% 97.3% 98.2% 94.6% Sales returns $450 $420 $291 $289 Patent applications filed 0 1 4 8 Scrap and rework costs $51.1 $45.0 $39.7 $28.2 Customer satisfaction (average) 78% 89% 81% 91% The case describes a company whose manager is concerned that the operating profit measure included in the company’s bonus plan was too narrowly focused. He implemented a new bonus plan that reduced the weighting of importance placed on operating profit and that included more measures, including on-time deliveries, sales returns, patent applications, scrap and rework costs, and customer satisfaction.

1. What was the purpose of the change?