Alice and Jon Harrison operate two full-service dry cleaning outlets in the St.

Question

Alice and Jon Harrison operate two full-service dry cleaning outlets in the St. Louis metropolitan area. One of the outlets generates over $800,000 revenue per year and has more than a million dollar investment in state-of-the-art equipment. The other outlet is older, generates $20,000 revenue per month, and has 20-25 year-old equipment currently worth $85,000. Both outlets are profitable with growing market bases. Managers at each location are currently paid a base salary, and receive a year-end bonus which is five percent of total profits produced by both outlets combined. Alice has just finished a workshop on strategic business unit evaluation, and wants to change the evaluation and reward structure, hoping to motivate the two managers to produce greater revenue and profit. Required: What type of evaluation mechanisms should she propose for the two managers?

Explanation / Answer

The primary purpose of this problem is to force the student to confront a situation in which no single measure, whether ROI, RI, or EVA, will produce comparable measurement of separate business units.)

There is significant difference between the two investment centers in revenue and asset size. In addition, the assets of the two outlets are very different in age and book value.

Return on investment (ROI) has the advantage over residual income (RI) of being reported as a percentage, which allows for comparison of units of different size.

A more difficult problem is the dramatic difference in the age of the two outlets' asset bases.

Use of gross or net book value for both units would distort comparative results; current market value would be a more appropriate asset base. Because this is a smaller firm, the use of economic value added (EVA) as the performance metric may not be cost-justified.

Since the two units are so different, consideration should be given to using separate evaluation techniques for each outlet.

The disadvantage of separate outlet evaluation techniques is that the firm's overall performance evaluation measure cannot be consistent with at least one of the two outlets.

there is the entire issue of limitations of short-run financial performance indicators, and the need for a balanced view of "performance" by expanding the analysis to include relevant non-financial performance indicators.

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