HCC Industries

COMM414 Case 2: HCC

Chloe Chan 10089132

COMM414 Case #2: HCC Industries For: Professor Kurt Schobel Due: Tuesday, October 20, 2015

Due: October 20, 2015

COMM414 Case 2: HCC

Chloe Chan 10089132

Due: October 20, 2015

Chloe Chan (10089132) Executive Summary This following report highlights the main issues that HCC is currently facing and how they prevent the public company from meeting its targets under the new budgeting and incentive philosophy. The key problems include: missing targets, lack of motivation, and lack of transparency. The report then outlines the possible alternatives that HCC can take to combat these issues. Final recommendations are to be implemented immediately in order to maximize effectiveness. The recommendations are: (1) communicate financial data to division personnel and (2) re-assess bottom-up budgeting method. Upon successful implementation, the company will be able to re-align its operational strategy to meet HCC’s long-term vision while achieving its immediate targets. Situational Analysis Company Structure There were four divisions within HCC: Hermetic Seal, Glasseal, Sealtron, and Hermetite. All the divisions manufactured connectors, with the exception of Hermetite, which specialized in micro-electronic package production. They all operated independently as each served different customers, had different part number systems, product standards, and accounting and information systems. Management believed that decentralization would be effective in providing managers with greater autonomy to manage their respective divisions. Budgeting Philosophy Prior to 1987, HCC demanded that its division mangers must meet stretch performance targets. Managers were unable to attain these unrealistic, overly optimistic objectives. Thus, not only was motivation understandably dampened, employees did not receive bonuses. The updated philosophy involved managers establishing “minimum performance standards” (MPS) and missing budget would cost them their jobs. MPS budgets were to be set so that the felt probability of achievement was 100%. Corporate management felt that division managers had weak budgeting skills, thus division managers’ budget proposals must go through a comprehensive and lengthy approval process – which contribute to inefficiency. Despite management’s meticulous efforts, some of the divisions missed their MPS by large margins. Evaluation of Divisions’ Performances In order to assess the performance of each division within HCC, management adopted seven key performance criteria. Among these metrics, the company placed the most emphasis on profit before tax (PBT). Division and corporate management would agree on performance standards during the company’s formal planning process, a critical activity

COMM414 Case 2: HCC

Chloe Chan 10089132

Due: October 20, 2015

that would conclude just before the new fiscal year. Firstly, division managers projected sales forecasts. They then collaborated with operating managers to prepare expenses, capital expenditures, and cash flow. Next, corporate management would review and revise the targets. Lastly, the budgets were presented to the board of directors for final approval. The approved budget would become a fixed evaluation standard for each of the four divisions. Bonus Plans & Incentives The budget targets had direct impact on employees who qualified for the bonus plan. Should division managers meet their targets, they would receive a bonus of 30% of their base salary. The bonuses paid were based half on PBT and half on subjective rating performance. The subjective evaluation was based on corporate “management’s judgment of the degree of accomplishment of the targets in all seven performance areas.” Not only did division managers raise concern about the accuracy of the subjective portion of the assessment and the delayed payments, their subordinates were dissatisfied with having no information on what their bonus potential was or the bases on which the bonus awards were made. Performance Monitoring The COO, Al Berger, was responsible for monitoring division performance by reviewing performance report meticulously and contacting division managers frequently. Each division was required to write a commentary explaining its results. Berger placed higher emphasis on meeting quarterly budget than monthly budget. Issue Identification There are 3 key issues that HCC must address immediately. Issue #1: Missing Targets Experience told Andy Goldfarb, the CEO of HCC, that stretch performance targets derived from “the great incentive plan of 1982” were described as a “pie in the sky”. The divisions were unable to reach the overly optimistic targets. Thus, his intent of operating with the new minimum performance standard (MPS) was to enable division managers to submit budgets that they deemed as realistic and could be achieved with 100% probability. However, in addition to MPS, he required managers to set targets that reflected performance level considered above-normal capacity. According to Berger, these goals represent 50% probability of achievement; the likelihood of meeting the new targets was even lower than that of the former stretch performance targets (between 75% to 80%). Issue #2: Lack of Motivation

COMM414 Case 2: HCC

Chloe Chan 10089132

Due: October 20, 2015

While it is true that the HCC competed in two distinct markets (connector and microelectronic packages) and PBT goals were expected to differ across divisions, there was huge discrepancy in budget setting philosophy between division managers and corporate staff. Management questioned the division mangers’ abilities to set budgets because most of them had engineering background but with no business training. Management also failed to communicate clearly to division managers about their expectations, resulting in proposed budgets that were either too conservative or too aggressive. Between the CFO, COO, and division management, there was inconsistency in felt probability of budget achievement (e.g. With respect to Sealtron’s target set in March 1987: division manager had 60%; CFO had 90%; COO had 100%). Issue #3: Lack of Transparency HCC lacked transparency between organizational levels, which fostered distrust and frustration among employees. Particularly, employees that were eligible for the bonus plan did not understand their bonus potential or the bases on which the bonus awards were made. This was a result of division-level managers keeping financial results private, as they feared that their subordinates would leak information to competitors. Chris Bateman, the CFO, indicated that management would involve general managers in longterm planning (over two years) discussions only occasionally. Without any communication of HCC’s long-term strategies, it is unsurprising that management viewed Hermetite’s general manager, Alan Wong, as “naïve” when they were merely unaware that they must meet certain expectations from upper management. Issue Analysis Issue #1: Missing Targets The old stretch target system required division managers to assess their actual performance against their targets. This was an advantage as it presented employees the opportunity to redeem themselves if goals were not met. Managers were satisfied with the fact that their COO was lenient with explanations on missing monthly targets. In addition, they only needed to achieve 60% of the budget in order to enjoy bonus payments. For the most part, the stretch budgeting concept was well received amongst division management. Conversely, because the stretch budget targets were widely known across the organization to be too optimistic, division managers fostered a culture of being “OK to miss budget”. It was clear that they did not have the motivation to truly meet stretch targets because they would still be rewarded as long as they met 60% of the budget at a minimum. Furthermore some divisions were able to achieve targets while others did not. This caused the corporate staff a great deal of stress and frustration. While Hermetic Seal and Glasseal divisions were able to achieve their own stretch targets, HCC as a whole had not been able to meet any high-level organizational objectives.

COMM414 Case 2: HCC

Chloe Chan 10089132

Due: October 20, 2015

Under the new budgeting philosophy, Andy Goldfarb wanted general managers to propose budgets for their respective divisions. This bottom-up budgeting approach, aligned with HCC’s decentralized system, provided division managers with the opportunity to participate in making key decisions, thus improving employee morale. The other advantage with the approach is its accuracy. Managers were actively involved in day-to-day operations and it was reasonable to assume that their estimates were more precise and realistic compared to what corporate management could predict. In reality however, there were major flaws with this method at HCC. Budgets must go through a lengthy review process facilitated by upper management until they were finally presented to the board of directors. Carl Kalish (Glasseal Manager) and Lou Palamara (Sealtron Manager) both faced pressures from corporate staff to increase their PBT targets in their proposed budgets. As a result, not only did they perceive management to be “dictatorial”, the two managers also feared that their jobs were in jeopardy (since they would get fired for failing to meet MPS). Evidently, HCC operated with a top-down target setting approach, which counteracted all the benefits associated with bottom-up. Issue #2: Lack of Motivation Each division manager had a different goal-setting philosophy. Subsequently, their performance rewards (bonus payments) would vary. Mike Pelta (Hermetic Seal) vs. Management Mike Pelta, the general manager of Hermetic Seal, had the most conservative approach in goal setting. Even though he was required to report to corporate management, he had an advantage during the budget negotiating process with Al Berger, the COO. This is due to the fact that Pelta was a major HCC stockholder the co-founder of the company. His special, longstanding relationship with the company alluded to his influence and power over most employees, including those at corporate level. Berger, who was a recent hire in 1987, was unable to persuade him. Pelta explained, “[t]hey can’t make me do something I can’t do.” Clearly, no one had control over his goal setting approach. Furthermore, HCC acknowledged that he was (1) poor at managing his subordinates and (2) nearing his retirement age. Therefore, his ability to reach conservative budget goals for 33 years consecutively was not due to luck or his superior work performance; rather it was management’s inability to address what they considered as a “serious problem”. Carl Kalish (Glasseal) vs. Management Since his market projections in the past four years “had been highly accurate”, Carl Kalish – Glasseal’s general manager, felt very confident in submitting his 1988 budget proposal of $7.4 million in bookings and $7.2 million in shipments. Though management had pressured him into increasing his targets, Kalish’s confidence level of achievement remained the same at 90%. This revealed that he, like Mike Pelta, had been setting conservative goals in the old stretch target system. The unaffected felt probability proved that he knew that his goals were easy to meet; he did not have a strong motivation to establish more challenging goals because he did not receive pressure from management HCC was operating under the former stretch budgeting concept.

COMM414 Case 2: HCC

Chloe Chan 10089132

Due: October 20, 2015

Lou Palamara (Sealtron) vs. Management Tension was created when Sealtron’s division manager, Lou Palamara, tried to justify his $900,000 PBT target to the CEO, who demanded a PBT goal of $1 million. Not only was the back-and-forth process cumbersome, Palamara felt discouraged that the unrealistic target would cost him his job. Next, Sealtron missed its targets during the 1987 fiscal year and employees within the division did not receive bonuses. This raised huge concern since other divisions were rewarded as long as they met 60% of the budget goal. Palamara believed that, without proper compensation, attracting and retaining talent would become problematic. Here, his priority was not to meet PBT target, rather it was to hire talent because his motivation stemmed from improving HCC’s long-term profitability. Issue #3: Lack of Transparency It is logical to limit financial information access to only to those who are involved in the budget setting process – namely corporate management and division managers. Sharing too much information with division personnel might overwhelm them, as financial statements are difficult to comprehend. At the same time, HCC is a publically traded company, thus its financial information is required to be accessible by people inside and outside the organization. Management failed to communicate its (1) long term strategy to division managers and (2) intent of increasing PBT goals for Glasseal and Sealtron. The absence of clear, consistent communication contributed to managers’ inability to meet management’s expectations. For instance, Lou Palamara assumed that it was his job to make a company long-term investment by hiring talent. However the CFO believed that the organization “could not afford any fat”. Another example is where Alan Wong aimed for optimistic targets; he assumed that HCC wanted his division to become a profitable operation. But the COO thought he was naïve. This caused tension and awkwardness between division managers and corporate staff. Another concern was that the evaluation criteria were too subjective, according to division managers. On the other hand, a subjective performance evaluation was more efficient for upper management to process. Recommendations Firstly, it is recommended that division personnel are provided with very high-level updates on quarterly performances. Have division managers perform the following steps four times a year: 1. Extract key information from financial statements, then summarize data 2. Present data in a friendly, easy-to-understand format in front of division personnel (those who qualify for bonus plans) 3. Outline how their bonuses are impacted by that particular quarter’s performance

COMM414 Case 2: HCC

Chloe Chan 10089132

Due: October 20, 2015

Should personnel request to view the company’s income statement for cross-referencing, make it a requirement for them to sign appropriate nondisclosure agreements and performance contracts. This will ensure all parties are legally protected. It is imperative that these forms are signed before management distributes the income statement to the individuals who made the request. By doing so, HCC will improve its transparency across levels and instill trust in its corporate culture. Secondly, HCC should stay true to bottom-up budgeting method and allow division managers to set their target goals. Since budget of 1988 have already been approved, no adjustments can be made. However, Andy Goldfarb should immediately distribute company-wide letters indicating the following: - Division managers have absolute control over 1989 quarter’s budget; they will set their own target goals in all seven performance areas (PBT, Bookings, Shipments, Returns, Rework Aging, Efficiency, Delinquencies) - Corporate management may ONLY act as a guidance during the budget planning process that will take place from 1988 December to 1989 mid-March. They can provide advice, upon division managers’ requests; but their opinions will not impact general managers’ final decisions in any way - Consequently, the budget negotiation process will be removed as division managers will be fully responsible for setting their own targets - To discourage division managers from setting excessively easy targets, the average PBT results from 1988 Q1 to Q4 will serve as the new MPS for 1989 - The division that shows the highest growth (1989 MPS vs. 1989 Target) by the end of 1989 fiscal year is subjected to receiving 40% bonus of base salary within the first quarter of 1990 - Those who do not meet the target will not be penalized - This budgeting and incentive concept is effective from 1988 December to 1990 November (one year) Rather than penalizing managers for not meeting targets, Andy should reward the manager who can lead the highest growth. For example, if Sealtron division’s actual PBT is $195,000 in 1988, it will become Lou’s MPS in 1989. He must establish a goal that is both challenging and realistic. If his year-over-year PBT is greater than that of another HCC division, then he will receive the 40% bonus. Furthermore, establishing competition between the four divisions will significantly increase their motivation to perform beyond normal capacity. Assuming that division managers are sensible and responsible enough to not pad their budgets, this new system will incentivize mangers to work hard towards ambitious goals and eliminate their fear associated with losing their jobs. Lastly, in the worst scenario that the system does not work as well as intended, management can adjust its policies after its beta-testing year. Conclusion In sum, HCC will be able to achieve its corporate targets and experience sustainable growth if these recommendations of (1) communicating financial data to division

COMM414 Case 2: HCC

Chloe Chan 10089132

Due: October 20, 2015

personnel and (2) re-assessing bottom-up budgeting method are implemented immediately. Not only are divisions more likely to meet their own targets, corporate and division managers will receive their bonus payments on time and foster trust and transparency within HCC’s organizational culture.