Assignment
Hightech Industries specializes in manufacturing medical equipment, a field that has become increasingly competitive. Last year, Pedro Rodriguez, president of Hightech, decided to revise the bonus plan (based entirely on operating income at the time) to encourage division managers to focus on areas that were important to customers and that added value without increasing cost. In addition to introducing a profitability incentive, the revised plan includes incentives for reduced rework costs, reduced sales returns, and on-time deliveries. The company's new plan calculates and awards bonuses semi-annually on the following basis: a base bonus is calculated at 2% of operating income; this amount is then adjusted by the following factors related to rework, deliveries, and sales returns:
1) Rework
a) The bonus is reduced by excess of rework costs above 2% of operating income
b) No adjustment is made if rework costs are less than or equal to 2% of operating income.
2) Deliveries
a) The bonus is increased by $4,000 if more than 98% of deliveries are on time and by $1,500 if 96-98% of deliveries are on time.
b) No adjustment is made if on-time deliveries are below 96%.
3) Sales Returns
a) The bonus is increased by $2,500 if sales returns are less than or equal to 1.5% of sales.
b) The bonus is decreased by 50% if sales returns are over 1.5% of sales.
Note: If the calculation of the bonus results in a negative amount for a period, the manager simply receives no bonus, and the negative amount does not carry forward to the next period.
Results for Hightech's West and East divisions for 2021, the first year under the new bonus plan, follow. In 2020, under the old bonus plan, the West Division manager earned a bonus of $20,295 and the East division manager a bonus of $15,830 based on 2% of revenues. The old bonus plan did not adjust for rework, on-time deliveries, or sales returns.
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West Division
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East Division
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Jan-Jun 2021
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Jul-Dec 2021
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Jan-Jun 2021
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Jul-Dec 2021
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Revenues
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$3,150,000
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$3,300,000
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$2,137,500
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$2,175,000
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Operating income
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$346,500
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$330,000
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$256,500
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$304,500
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On-time delivery
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95.4%
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97.3%
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98.2%
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94.6%
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Rework costs
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$8,625
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$8,250
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$4,500
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$6,000
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Sales returns
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$63,000
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$52,500
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$33,560
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$31,875
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Task
A. Why is revenue alone not an ideal measure of performance? What specifically about the revised performance measures compels the managers of the East and West divisions to pursue the company's goals?
B. Calculate the semi-annual bonuses earned by each manager for each six-month period and in total for the 2021 year.
C. The managers were not advised of the new plan until after their first bonus in June 2021. What effect did the change in the bonus plan have on each manager's actual behaviour in the second half of 2021? What changes, if any, would you make to the new bonus plan?