Pharmaceutical Firm Budgeting and Control Systems

Problem 6-26 "Madden International"
Madden International is a large ($7 billion sales), successful international pharmaceuticals firm operating in 23 countries with 15 autonomous subsidiaries. The corporate office consists of five vice presidents who oversee the operations of the subsidiaries. These five vice presidents report to two executive vice presidents, who in turn report to the president of the firm.
The l5 subsidiaries specialize by pharmaceutical type and in some cases by country. The pace of innovation in this industry is very fast. In addition, each country has its own elaborate regulatory environment that controls new drug introduction, pricing, and distribution. Each market has its own peculiarities concerning hospital drug purchases. It is an understatement to say that Madden International operates in a very complex world that changes daily.
The corporate office requires each subsidiary to maintain an elaborate, detailed budget and control system. The following points summarize the budget and control system in each subsidiary:
• One-, three-, and five-year budgets are prepared each year.
• The vice president overseeing the subsidiary looks for three- and five-year budgets that stretch the subsidiary's capabilities. That is, subsidiaries are pushed to devise programs that increase value.
• These budgets are developed and approved first at the subsidiary level, then by corporate headquarters.
• Every three months the subsidiaries must reconcile actual performance to budget and write detailed reports to the corporate office explaining variances and corrective actions to be taken.
• The corporate vice president assigned to the subsidiary makes quarterly visits for three days of meetings that involve extensive reviews of the budgets and operating results. These meetings involve all the senior managers in the subsidiary.
• Subsidiary senior managers are not compensated or rewarded for meeting budget targets. Rather, they are evaluated on their ability to develop new markets, solve short-run problems, add value to their organization and to Madden International, and manage and motivate their subordinates. These performance evaluation criteria are quite subjective. But the corporate vice presidents have a great deal of in-depth personal contact with each of the senior people in their subsidiaries and are able to arrive at suitable performance evaluations.
• Preparing for these meetings with the corporate vice president and developing the budgets requires the involvement of all the senior managers in the subsidiary. One manager remarked, "I'd hate to see how much more money we could be making if we didn't have to spend so much time in budget and financial review meetings."
It turns out that Madden International is not unique in the amount of senior management time spent on budgeting and financial reviews. A survey of large, publicly traded U.S. firms supports the Madden system. Researchers found that innovative firms in complex environments characterized by high uncertainty and change used much more elaborate formal financial control (budgeting) systems than did firms in more stable, mature industries. Innovative firms seem to employ more financial controls than less-innovative firms.
Required:
a. List the strengths and weaknesses of the budgeting and control system at Madden International.
b. Why might you expect firms like Madden International to rely so heavily on formal financial control systems?