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Eager Pizzas

In February 2009, you started as Group Operational Manager with Eager Pizzas; an organisation that operates a chain of 24-Hour Cooked Pizza Outlets in Australia, Singapore, Hong Kong, Malaysia, India, Fiji, South African, and New Zealand. The organisation divides its operations geographically into strategic business units (SBUs). This geographical segmentation has been selected due to different markets and specific products based on cultural and religious requirements.

SBU's managers in each country have autonomy for decisions related to their SBU's market and products. These decisions include the development and introduction of innovative pizza products or "combo" deals. However, the Australian Head Office makes all decisions about capital investment including larger equipment replacement and store re-fitouts. Each SBU manager is responsible for an average of 50 pizza outlets. Each outlet has a store manager and that manager has a territory with a population of 200,000 potential customers.

This decentralisation of authority is considered necessary by Head Office executives to achieve the organisation's mission:
To provide an ever-changing variety of hot, tasty, value for money pizzas to your door in 30 minutes.

To support this mission, the organisation has the slogan:
"Number One in new products, price and delivery"
During your first visit to the several SBUs in the Asia-Pacific region, you are approached for help by several SBU managers for varying reasons. However, the more common problems experienced by SBU managers are rising costs at the outlets in their territory and there has been an increase in the number of customer complaints. From your own observations and your discussion with each SBU manager, you have established the following information about each outlet within the Hong Kong SBU's control:
1. a store manager is in charge of each outlet.
2. the store manager employs the following staff whose work hours are spread across 3 eight-hour shifts
? four pizza bakers who are employed as permanent staff members
? several counter staff and delivery drivers who are employed as casual staff members.
3. customers order directly to the Customer Service Centre at the SBU's main office by ringing a central telephone number.
4. the outlet that is closest to the customer residence receives the order electronically and is responsible for cooking and delivering the order.
5. raw materials are purchased centrally by the purchasing department at Australian Head Office. Central purchasing is considered necessary to ensure a standard quality and the bulk discount is considered to be greater that the relevant costs incurred by Eager Pizzas. Eager Pizzas use "cost plus mark-up" transfer pricing method and charged a different mark-up percentage rate for each SBU territory. The percentage mark-up is calculated individually based on the purchasing department's costs, freight-outwards costs, as well as an appropriate loading commensurate with the estimated foreign exchange and political risks (business risk) for that SBU territory.
6. At a recent regional conference, the SBU managers during their conversations that some SBU territories were charged a different purchase price, which didn't seem to relate to the distance the SBU territory was from Australia. Before leaving Australia, you were told about this practice of different purchase prices for each SBU territory. At each of your SBU territory inspections, SBU managers with a higher purchase price (unknown to they that it was due to a higher percentage mark-up) complained about the higher price they had to pay because they argue that their performance was not being evaluated on a 'level playing field'. You receive no complaints from any SBU managers who are charged a lower purchase price using the current "cost plus mark-up" transfer pricing method.
7. recent complaints from the customers include wrong toppings, drivers are often late and impolite, and there has been an increase in the number of reported accidents involving delivery drivers.
8. currently, the organisation classes each SBU as a profit centre for responsibility reporting purposes. Head Office evaluate each SBU and each of its outlets for
(a) monthly profitability performance using sales growth, gross profit margin ratio, and net profit before tax (all converted into Australian Dollars), and
(b) monthly short-term solvency performance using current and quick ratios.
Please note: You must write three short separate reports (i.e., a report with a maximum length of 1 page in 10 point font for each of the three requirements). A separate report is required for each requirement because these proposed events or rectifying actions are separate unrelated issues due to the change in circumstances. It is permissible to refer briefly to an earlier report but not repeat the information in detail (e.g., the new situation improves/worsens the XXXX problem I mentioned in my first/second report).

Requirement 1:
You immediately identify problems with the performance evaluation system under the present situation. You write a brief report to the finance director in Australia about these problems and the inappropriateness of the evaluation processes. The report must be a maximum length of 1 page in 10 point font. You should include the following issues in your report.

1.1 Comments on the advantages or disadvantages with the current "cost plus a varying mark-up" transfer pricing method. Your comments must be provided while realising why the current transfer pricing method is used to compensate for different levels of business risks of different SBUs.
.2 Based on your comments in 1.1 about the advantages or disadvantages, provide your comments about the appropriateness the existing financial performance measures used currently to evaluate performance of:
1.2.1 all SBUs from an Australian shareholder's perspective,
1.2.2 a SBU from the local SBU manager's perspective, and
1.2.3 local pizza outlets from the store manager's perspective.

( i.e., sales growth, gross profit margin ratio, and net profit before tax after converting into Australian Dollars as well as current and quick ratios) under the current transfer pricing method ("cost plus a varying mark-up")

Requirement 2:
After thinking through the situation from a company wide perspective, you believe that one way of managing these problems and evaluating performance appropriately would be to design a new performance measure system. You write another report the following evening suggesting to the finance director that a new performance evaluation system should be designed and it should adopt a Balanced Scorecard perspective (that incorporates the international perspective) to support the organisation's business strategy. The report must be a maximum length of 1 page in 10 point font.

You need to explain to the finance director in your second report that a particular SBU manager (who is charged a higher purchase price because that SBU territory has a higher percentage mark-up) is eager to solve the problem with the current performance evaluation system and offers her territory as a trial, which can be 'rolled out' across the organisation once implemented successfully for that particular SBU's operations.

In your report, you need to provide arguments to support the design and implementation of a new performance evaluation system as well as convince the finance director to consider the following requirements.

2.1 Identify the nature of the organisation's business strategy and the key stakeholders of Eager Pizzas to achieve these goals and why the current performance measurement system does not motivate staff towards these goals.
2.2 List three critical success factors for the organisation's business strategy you identified in Requirement 2.1.
2.3 Develop two relevant performance measures for staff members at each of the following levels: the SBU manager, the Store manager, the pizza bakers, and the delivery drivers. These measures must relate to the critical success factors you identify in Requirement 2.2 and suit the particular level of manager or employee.
2.4 Explain why non-financial performance measures are better suited and more relevant for such operational strategies and operational staff. How can such measures be linked to Eager Pizzas' successful satisfaction of its shareholders' objectives?

Requirement 3:
Upon your return to Australia, you discover that Head Office senior executives are proposing to introduce two new pricing strategies.

The first pricing strategy is to introduce a new transfer pricing policy for all SBUs (including Australia) that will decrease the transfer purchase price paid by SBUs (and subsequently their store outlets) in countries with emerging markets and increase the transfer purchase price paid by SBUs in countries with established markets. A 'market expansion' strategy is driving this new transfer pricing policy so that lower 'cost of goods sold' expenses will allow lower selling prices to be charged in these countries with emerging markets to reach a greater proportion of the population and increase market share.

If this policy is adopted, SBUs (and subsequently their outlets) in four (4) countries will have a higher transfer purchasing price while the SBUs in the other four (4) countries will have lower transfer purchasing prices. This will mean that four of the SBUs will have a lower product cost compared to the other four SBUs that will incur a higher product cost.

The second new pricing strategy is to introduce a higher operating licence fee in two (2) countries that will pay the lower transfer purchasing prices. This increased operating licence fee will be classified as an administration operating expense that will reduce the net profit for SBUs in these two countries.

You write a third report to the finance director. The report must be in 10 point font. In this latest report, you:

3.1 Identify potential impacts of this new proposed transfer pricing policy on the usefulness of the current five (5) financial performance measures before converting into Australian Dollars to evaluate the following comparisons for:
(i) an investment decision comparison among all SBUs from an Australian shareholder's perspective,
(ii) a SBU evaluation comparison from a SBU manager's perspective,
(iii) a local pizza outlet evaluation comparison from the store manager's perspective.
3.2 Identify potential impacts of this new proposed higher operating licence fee on the usefulness of specific current financial performance measures before converting into Australian Dollars to evaluate each
(i) an investment decision comparison among all SBUs from an Australian shareholder's perspective,
(ii) a SBU evaluation comparison from a SBU manager's perspective.

* When discussing each of these measures, you particularly need to refer to the components that create each performance measure, e.g., you need to identify how to calculate the numerator and denominator used to produce the gross profit margin ratio, etc.

Solution Preview

1.1 Comments on the advantages or disadvantages with the current "cost plus a varying mark-up" transfer pricing method. Your comments must be provided while realising why the current transfer pricing method is used to compensate for different levels of business risks of different SBUs.
1.2
There are several advantages of the current cost plus a varying mark up. First, it takes into consideration the cost and freight cost. Second, advantage is that it takes into consideration the currency exchange risk and political risk of the SBU territory. This causes the variation because the exchange risk and political risk varies from country to country. The disadvantages of cost plus varying markup are that such markups are perceived as discriminatory by those SBU managers that have to pay higher markups. Perceptions of unfavorable competition with other SBUs reduce motivation and can create an impression that there is lack of equity in evaluating the SBUs.

1.2 Based on your comments in 1.1 about the advantages or disadvantages provide your comments about the appropriateness the existing financial performance measures used currently to evaluate performance of:
There are three measures being used currently, these include profitability performance using sales growth, gross profit margin ratio and net profit before tax.

1.2.1 All SBUs from an Australian shareholder's perspective,
From the perspective of Australian shareholder's perspective the growth of sales means growth of revenue it is of positive significance. The second is gross profit margin ratio or gross profit divided by net sales. This ratio is of limited use to the Australian shareholder because the gross profit does not directly add to shareholder value. The third is the net profit before tax. This measure has got the most value for Australian investor because it informs him of the potential value addition to his investment.

1.2.2 A SBU from the local SBU manager's perspective, and
From the local SBU manager's perspective, the net profit before taxes is the most important indicator, the reason is that each SBU is being treated as a profit center and the profit is best reflected by net income before taxes.
However, since the SBU is being evaluated on ...

Solution Summary

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