Chapter 8 Case 8-1

1. Chapter 8 Case 8-1 Lin Wang Bichloan Nguyen Hank Liu Keye Su Jeff Tsai

2. Introduction • Emerson Electric Company • Founded in 1890 as a Manufacturer of Motors and Fans • 1993 Marked Emerson’s 36th Consecutive Year of Improved Earnings Per Share • Manufacturers a Broad Range of Electric, Electromechanical, and Electronic Products for Industry and Consumers • Since 1956, Annual Return to Shareholders Averaged 18% • Is a Major Domestic Electrical Manufacturer • Has Had the Narrowest Focus as a Broadly Diversified Manufacturing Company • Follows a Growth-Through-Acquisition Strategy

3. The Office of the Chief Executive (OCE) • The CEO • The President • Two Vice Chairmen • Seven Business Leaders • Three Corporate Officers • Direct Management of the Company • Meets 10 to 12 Times a Year to Review Division Performance

4. The Divisions • Board of Directors • Division President • Key Managers • Meet Monthly to Review and Monitor Performance

5. Knight’s Strategy (Q1) • Charles F. Knight (1973) • Analyzed Historical Records • Analyzed Data of Competitors • Set Target Growth and Strong Financial Results on a Consistent Basis Reflecting Constant Improvement • Set Target Growth Rate Based on Revenue Growth Above and Beyond Economy-Driven Expectation • Maintained a Very Conservative Balance Sheet rather than using Leverage • Maintained Tight Cost Control and Open Communication Between All Levels of Employees

6. Knight’s Strategy (Q1) [Cont.] • Best-Cost Producer Strategy • Commitment to Total Quality and Customer Satisfaction • Knowledge of the Competition and the Basis on which They Compete • Focused Manufacturing Strategy, Competing on Process as well as Product Design • Effective Employee Communications and Involvement • Formalized Cost-Reduction Programs, in Good Times and Bad • Commitment to Support the Strategy through Capital Expenditures

7. Knight’s Strategy (Q1) [Cont.] • Best-Cost Producer Strategy (Cont.) • Keep Staffs at a Minimum • Competitor’s Products were Disassembled and Studied for Cost Improvement • Regional Labor Rates and Freight Costs were Analyzed • Capital Investments of $1.8 Billion were Made to Improve Process Technology, Increase Productivity, Gain Product Leadership, and Achieve Critical Mass • Increased Quality to Reduce Cost

8. Knight’s Strategy (Q1) [Cont.] • Best-Cost Producer Strategy (Cont.) • Advantages • Reduced Cost • Not Burdened by Heavy Debts and Interest Payments During Economic Downturn • Improved Quality • Reduced Investment Risk • Disadvantages • Does Not Maximize Possible Leverage • Debts are not Used to Expand

9. Knight’s Strategy (Q1) [Cont.] • Planning Process – First Stage • Top Management Sets Sales Growth and Return on Total Capital Targets for the Division • Top Management Wants the Division to Stretch to Reach Its Goal; They Also Reviews the Detail Actions that Division Management Believe Will Lead to Improved Results • The Division Presidents Submit Four Standard Exhibits to Top Management Prior to Its Division Planning Conference • The Division’s Actual Performance for the Past Five Years, Its Expected Results for the Current Year and the Forecasted Growth/Profit/Return for the Next Five Years are Compared

10. Knight’s Strategy (Q1) [Cont.] • Planning Process – Second Stage • Changes in the Division Plant Must Be Submitted for Approval by Top Management • Late in the Fiscal Year, Division Managers Meets with Top Management with Detailed Forecast for the Coming Year and Reviews the Actual Performance of the Current Year • Changes in the Forecast Must Be Submitted for Approval by Top Management • In August, Top Management Performs Detailed Financial Review • In September, Top Management Provides the Corporate and Division Forecast for the Next Year as well as the Strategic Plan for the Next Five Years

11. Knight’s Strategy (Q1) [Cont.] • Reporting • Each Division Submits the President’s Operating Report (POR), which Compare the Actual and Forecasted Results of the Current Quarter along with the Actual Results from the Previous Year • The Division President’s Performance is Measured Using the Fiscal Year’s Forecast and Reviewed Quarterly

12. Knight’s Strategy (Q1) [Cont.] • Compensation • Each Division Evaluate All Department Heads and Higher-Level Managers Against a Set of Specific Performance Criteria • Human Resources are Involved in Strategy Implementation • Each Division Executive Earns a Base Salary and is Eligible for “Extra Salary” based on Division Performance according to Measurable Objectives (Primarily Sales, Profits, and Return on Capital)

13. Knight’s Strategy (Q1) [Cont.] • Communication • Open Communication Highly Encouraged by Top Management • Division President and Planning Managers Meet Regularly with All Employees to Discuss the Goals and Business Strategy • The Company Conducts Opinion Surveys of Every Employee, then Performs Statistic Analysis to Uncover Trends

14. Knight’s Strategy (Q1) [Cont.] • Advantages • Targeted Budget is Highly Achievable • Increased Commitment from Managers to Achieve the Target Budget due to Established Ownership and the Elimination of the Artificial Distinction between Strategic and Operation Decisions • Increased Managers’ Confidence in the Budget • Decreased Organizational Control Cost • Reduced the Occurrence of Managers Engaging in Harmful Earnings Management Practice or Violating Corporate Ethical Standards

15. Knight’s Strategy (Q1) [Cont.] • Advantages (Cont.) • Provided Managers with More Effective and Efficient Operating Flexibility • Improved Predictability of Earnings or Operating Results • Enhanced the Usefulness of a Budget as a Planning and Coordinating Tools • Provided Better Decision Making Control • Increased Employee Commitment to Fulfilling the Budgetary Goals

16. Knight’s Strategy (Q1) [Cont.] • Disadvantages • The Management would Limit Expense to Meet the Goals, which Might Hurt the Company’s Expansion in the Long Run or Cause Missed Opportunities • Manual Budgeting Process is Very Time Consuming • Budget based on Historical Data may not be Practical for Forecast Analysis

17. Recommendations to CEO (Q2) • Real-Time Budgeting using Intranet-Capable Software • Online and Real-Time Capability • Shorten the Budgeting Process • Sensitivity Analysis • In-Depth Analysis • Active Involvement • Integrated Strategic Planning, Budgeting, Management Reporting, Sensitivity Analysis, and Financial Consolidations

18. Recommendations to CEO (Q2) [Cont.] • Using Zero-Based Budgeting • From a Zero-Base • In-Depth Reviews and Analysis • Schedule Budgeting Periodically • Using Activity Based Budgeting • Extension of ABC System • Focus on High-Value-Added Activities • Eliminate Low-Value-Added Activities • Cost Reduction • Continuous Improvement • Coordinate and Synchronize Activities

19. Recommendations to CEO (Q2) [Cont.] • Using Kaizen (Continuous Improvement) Budgeting • Demands Continuous Improvements • Based on Improved Practices or Procedures • Choosing the Budgeting Approach • Select a Proper Budgeting Approach for Each Business Segment according to the Characteristics of Each Business Segment

20. Role of Segment Managers (Q3) • Act as a Bridge between Low Level Employee and Upper Management • Provide Valuable Data for Trend Analysis • Performs Performance Reviews • Provide Recommendation and Detailed Budgeting Analysis to Upper Management • Motivate Employee to be Involved in the Budgeting Process and to be Committed to its Implementation • Motivate Employee to Work to Attain the Budgeted Goals • Help Employees Identify the Budget as Their Own

21. Role of Segment Managers (Q3) [Cont.] • Pinpoint Budgeting Problems and Implement Solutions Effectively • Identify Current and Potential Bottlenecks in Operations • Allocate Critical Resources to Ease Any Bottlenecks and Prevent Them from Becoming Obstacles to Attaining Budgetary Goals • Work Out Any Problems the Company Might Face to Minimize the Adverse Effects that the Anticipated Problems Could Have on Operations • Select an Appropriate Budgeting Approach • Use the Budget of the Operating Period to Assess Current Performance and Select Appropriate Budgeting Approach for the Future

22. Role of Segment Managers (Q3) [Cont.] • Cooperate with other Segment Managers • Allow Each Division to Know What It Needs to Do to Satisfy the needs of Other Divisions. • Encourage Open Communication Among Employees • Communicate Expected Actions and Results • Monitor and Control Activities • Provide Guidelines for Operations • Organization’s Success Requires Every Operations be Carried Out As Planned

23. Chapter 8 Reading HOW TO SET UP A BUDGETING and PLANNING SYSTEM Strategic Budgeting: A Case Study and Proposed Framework

24. How to set up a budgeting & Planning System • Penn Fuel Gas (PFG) • public utility company of 550 employees • natural gas, storage and transportation • propane business (not regulated)

25. Motivation for Budgeting System • First annual and long-range operating budget process • PFG’s bankers, board of directors, and management requested additional reports • Similar interests in cash flow projections, future earnings potential • Management wanted capability of slicing and dicing different segments for P&L

26. Flexibility in Budgeting System • Budgeting for natural gas and propane operations • Demand driven by weather • Pennsylvania – 1994 iciest winter, 1995 one of warmest • Rapid growing company • Sensitivity analyses & budget reprojection – quarterly

27. Challenges • Northern and Southern divisions – different reporting system, different accounting software • Chart of accounts – Propane business vs. Utility business • Review expense classification system • Faster accounting system w/o manual processes • Common challenges for new reporting tools

28. Why review chart of accounts? • Accounting system less likely updated as company grows • Budget manager should update classifications immediately to accommodate future budgeting • Difficult to change system once developed

29. Budgetary Games • Manipulation of revenues/expenses to meet budget • Budgets developed with management with agreed-upon, reasonable expectations • Employees/divisions were not penalized if budget not met

30. Reading2 Strategic Budgeting: A case Study and Proposed Framework • Critical Chain technique –Eliyahu Goldratt • Strategic Budgeting Method • Many companies applied it, and reduced project time. - DiamlerChryslter, Lucent, Harris Semiconductor, etc.

31. What is Critical Chain Method

32. Process steps

33. What is the lawnmower method of cost reduction? • cost cutting does not discriminate on the basis of need or capacity • all departments are simply required to reduce costs by a given percentage

34. Slack % of Original Budget

35. What is the strategic budgeting model? • Gathered budget estimates from department heads • Reduced all department budgets by 50% • Grouped all “saving” from department budgets in a Group Budget Buffer. • Told each department head that if he or she needed further funds, the funds would be available but the request would be discussed openly with other department heads.

36. What are the strengths of strategic budgeting? • Ease of Implementation • Increase Communication Between Departments • Lower Overall Spending Levels • Assurance of Output Integrity • Intrinsic Rewards through Goal Achievement