Question

Case Study Harwood Medical Instruments PLC 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 to reduce health care costs. HMI was organized into nine decisions 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 hospitals, 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 a “more balanced” scorecard. In November 2009, just before introducing 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 warranted 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 is less than 95% of deliveries were on time. • Increased by £5,000 if sales returns were less than or equal to1% 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 rework costs over 1% of operating profit. • Reduced by £5,000 if average customer satisfaction ratings were below 90%. If the bonus calculation resulted in a negative amount for a particular period, the manager 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, scapels, 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 Diagnostic 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 technologically and control both product development and product costs effectively. In 2009, the total annual bonuses for the year earned by the managers of SID and Ultrasound were approximately £85,000 and £74,000, respectively. Exhibit 1 Harwood Medical Instruments PLC Operating results for the surgical Instruments and Ultrasound Diagnostic Equipment Divisions, 2010 (£ in 000s) Surgical Instruments Division Ultrasound Diagnostic Equipment Division 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% Assignment Questions 1. What was the purpose of the change? 2. Calculate the bonus earned by each manager for each 6-month period and for the year 2010. 3. Evaluate the new plan. Is there any evidence that it produced the desired effects? What changes to the new plan would you suggest, if any? 4. Analyze the recommendation for a “more balanced” scorecard in performance measurement. What system would you recommend and what are its potential benefits and challenges in measuring performance?

Answer 1

Given that the following information about

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 to reduce health care costs. HMI was organized into nine divisions each run by a general manager.

1) This concept is based on Balanced Scorecards (BSC) approach.

BSC was created by Robert Kaplan and David Norton as a means of moving the organizations away from concentrating solely on financial data. The objective is to focus on financial information and on creating the abilities and intangible assets required for long-term growth. This is done by translating a company's strategy into specific measures within each category. Companies generally use BSC as a management tool to:

• Clarify and communicate strategy
• Align individual and unit goals to strategy
• Link strategy to the budgeting process
• Get feedback for continuous strategy improvement

Some of the factors for measuring indicators of a Balanced Scorecard are Customer acquisition, satisfaction and retention, Timeliness, Productivity, Quality, Team performance, Competence etc.

2) BONUS EARNED BY EACH MANAGER FOR EACH 6-MONTHS PERIOD AND FTYE 2010

	Surgical Instruments Division	Ultrasound Diagnostic Equipment Division
	FTYE 2010	FTYE 2010

particulars	For the Second Half	For the First Half	For the Second Half	For the First Half
Operating Profit	$3420	$4060	$4620	$4400
Base Bonus	$34.20	$40.60	$46.20	$44.00
On-Time Deliveries	97.3%	98.2%	95.4%	94.6%
Adjusted	$2000	$2000	-	-
Sales Returns	$291	$289	$450	$420
% of Sales	1.02	1.00	1.07	0.95
Adjusted	($2.50)	$5000	($15)	$5000
Patent Acquisition	4	8	0	1
Adjusted	$4000	$8000	-	$1000
Scrap & Rework Cost	$45.00	$39.70	$51.10	$28.20
1% of Operating Profit	$34.20	$40.60	$46.20	$44.00
Adjusted	($10.80)	-	($4.90)	-
Customer Satisfaction	89%	81%	78%	91%
Adjusted	($5000)	($5000)	($5000)	-
Half-yearly Total	$1020.90	$10040.60	($4973.70)	$6044
Grand Total (Yearly)	$11061.50		$6044

3) A strategy focused organization has these following aspects of changing a plan:

- All of the measures used in the BSC (financial & non-financial) should be derived from the firm's vision and strategy

- Processes become participative rather than directive

- Change is not limited to cost cutting and downsizing but includes repositioning the firm (new or mores specialized competitive markets, a customer based focus, a performance mind-set etc.)

- The organization must adopt new cultural values and priorities.