Quality Metal Service Center - Final

Quality Metal Service Center Group 2 Araojo, Oscar Jan Asis, Alvin Magboo, Mike Raniel Manzano, Krystele Ann Peralta, Diana Marie Rodriguez, Jerelleen

EXECUTIVE SUMMARY Quality Metal Service Center has shown its resilience in the industry through its century old existence banking on industry knowledge and high quality products. The company is doing well and would like to maximize its potentials by looking into its control system. Analysis has shown that potentially profitable projects may not be pushed through due to some inefficiencies in their performance evaluation and incentives system. The company is currently using ROA as the sole criterion of evaluation. However, ROA will be lower on companies with newer assets that those with older ones. This will lead managers to reject proposals of new projects with large capital outlay. The Economic Value Added is a more appropriate measure in this situation. In light of the application of the EVA, the issue with the Columbus District manager will be resolved, and the proposed project should be accepted. INDUSTRY ANALYSIS The Metal Distribution Industry is highly competitive and fragmented industry which composed of fewer companies because of the high costs of establishing and maintaining this kind of business. It is on its mature stage that improved efficiency on production is the priority in order to beat the competitors in the industry. End users still have different needs which are unmet by the market players. Processing capabilities should then be improved by the service centers through obtaining processing equipment necessary to meet the demand of the customers. Nevertheless, the percentage of industrial steel products shipped through services centers had increased dramatically due to key trends in the metal industry: 1. Steel Mill’s Retrenchment Service Centers is grabbing the opportunity when major domestic metals producers had cut back on service to customers and reduced the product lines. They profited from this by offering wide product lines and increasing customer service. 2. Just-in-Time Inventory Management Metal users are trying to minimize the cost of ownership and maintenance of inventory. Service centers, recognizing this trend, partnered with the metal users in order to deliver on time to their customers the inventories which are needed to the current production. This resulted to smaller order quantities and more frequent deliveries. 3. Productivity Improvement and Quality Enhancement Product profitability and reputation are major concerns of metal users. This is achieved through partnering with service centers who are able to meet their specific quality, availability and service requirements. For these users, stronger ties between suppliers and customers resulted to better quality of the products produced. COMPANY POSITION With regard to the aforementioned trends in the Metal Distribution Industry, Quality Metal is in a good position compared to its competitors. Its corporate strategy is aligned with the current industry observations. Moreover, with their updated marked database, they have adequate information they need to identify the needs of their customers.

Internal Factors Quality Metal targets markets more effectively through its corporate strategy of focusing its sales efforts on particular markets which provide higher margins. In addition, QM’s corporate strategy also allows the company to have a better understanding of customers’ needs in different geographic region due to its updated database, which is considered to be the most accurate in the country. This allows them to gain knowledge of their customers and use this knowledge to develop techniques to increase market shares. The company has excellent products and services to cater to the customer’s growing need for quality. It has good relationships with its customers up to the point of assisting them in procuring just-in-time inventory. However, Since Quality Metal just focuses on some specialty users, it will lose other customers and reduce the profits. Also, QM’s current incentive scheme may lead to rejection of profitable projects due to decreases in expected bonuses of District managers. External Factors The prevalence of the just- in- time inventory management allows service centers more opportunities to expand its market since consumers will require small purchases of inventories in less lead time. Having few competitors in this growing industry is also an advantage for QM. On the other hand, even if there are only few competitors, competition is still stiff since customers allow only a small range of suppliers which give them the highest quality products. Competitive Strategy Since the company is competing in a broad target and has the ability of lowering its cost due to economies of scale and can produce high technology metals, it should use a combination of cost leadership and differentiation strategy to be able to earn more than its competitors. Customers who bank on quality need to know that QM offers the best, therefore, the strategy should be packaged as a differentiation strategy. Moreover, differentiation creates brand loyalty to keep customers away from rivals. In order to implement such strategy, the company should differentiate itself through its high quality products and good customer relations. This includes having shorter lead times in order to fulfill customer orders. CURRENT ISSUES AND ANALYSIS In examination of one district, a problem was raised regarding a new investment in equipment that would further process products in that district needed by the customer which could have been processed in a different district. However, further processing in another district would cause a longer lead time. Since the company’s competitive strategy is to provide good customer relationships, having this equipment which would shorten the lead time would be to their advantage.

The following sections discusses the issues arising from the decision-making process of the district manager. Capital Investment Proposal The capital investment proposal of the sales manager has pros and cons: Pros: ●

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Con: ●

The area within the Columbus District has a reasonable demand for processed inventory. Currently, the company is unable to meet this demand. According to Elizabeth Barret, sales manager of the district, the new processing equipment will be able to produce processed inventories which will satisfy the needs of the customers. The district will be entering a new market with lots of opportunities because of this asset acquisition for the district producing processed inventories. Favorable earnings and positive sales growth for the district will be achieved if there would be proper implementation and marketing of the product produced. A capital investment with a low Payback Period of 4.5years, an Internal Rate Return of 21.8% and a Net Present Value of $286,000 is attractive to a company because of these tangible benefits.

This proposal is disadvantageous to Ken Richards due to the unfavorable effect on its incentive bonus because of the lower payout rate to be multiplied by his base salary which will result to lower bonus.

Performance Evaluation and Incentives District managers are evaluated based on the Return on Assets (ROA) criterion. The larger the actual ROA exceeded the 90% of the ROA target, the larger the bonus the district manager will receive. The amount of the manager’s base salary also contributes to the size of the bonus. The region’s performance, in addition to the district’s performance, also affects the bonus of the district manager. It can be inferred from this scheme that bonuses are awarded on the basis of incentive profits in which bonus increases in proportion to incentive profits. No bonus is awarded if incentive profits are less than zero. The maximum bonus amount is 75% of manager’s base salary. ANALYSIS OF ALTERNATIVES There are three ways to evaluate the performance of an investment center - ROA, which is currently being used by the company, Return on Equity, and Economic Value Added. The advantage of ROA is that targets can be adjusted to focus managers’ attentions on key success factors and also because every manager can be measured by the same metric. However, certain circumstances causes managers to make decisions that are bad for their organization such as QM’s situation where the ROI target is not consistent with the entity’s capital cost, in which case the investment

center manager will under-invest [sometimes over-invest] in assets. Moreover, the depreciation rate used in calculating ROI is not the true economic rate of depreciation, in which case managers may make bad decisions about both the maintenance and the acquisition of assets. ROE is somewhat similar to ROA, except that liabilities are subtracted from the assets. This incorporates an evaluation of how managers used leverage on their capital investments. EVA, on the other hand, is a bit more complicated than ROE and ROA. However, it takes into consideration all the costs including the cost of equity capital which is ignored in normal accounting. This accounts for the true value of an investment decision to a firm. RECOMMENDATIONS ●

Approval of the Capital Investment Proposal

Ken Richards should send the proposal by the Sales Manager to home office for its approval since this will be beneficial to the company as a whole particularly the increase in market share and favorable earnings. As you can see from the analysis section, pros of acquiring the asset outweigh the cons. Thus, recommending the investment proposal to the corporate headquarters is the proper thing to do. ●

Performance Evaluation and Incentives Investments with relatively new assets will show a lower ROA than investment with older assets. As such, QM should evaluate the performance of the investment centers based on the Economic Value Added.