JetSuite, a private jet charter company, prepares the master budget by taking ea

Question

JetSuite, a private jet charter company, prepares the master budget by taking each division manager's estimate of revenues and costs for the coming period and entering the data into the budget without adjustment. At the end of the year, division managers are given a bonus if their actual division profit exceeds the budgeted profit.

What problems do you see with this system?

What are the dangers of using only business unit measures to evaluate the performance of business unit managers?

Recently you overheard a manager at JetSuite saying "If every division manager maximizes divisional income, we will maximize firm income. Therefore, divisional income is the best performance measure."

Explanation / Answer

1. This system poses the risk of managers making lower projections to become over achievers. Typically, managers to gain additional bonus may project lower numbers, which will automatically make them over-achievers. The practicality of these projections will have to be closely monitored to ensure that these projections are realistic and are not a compromise on the overall interest of the business to enhance shareholder wealth. This method also becomes too self-centred, where the managers are working for their own upliftment and not for a common goal as a whole.

2. Lack of co-operation, working in isolation are some of the practical problems that the business may face. The evaluation of performance of business unit managers based on how the unit alone performs makes them work with a closed mind and in isolation. This curbs the ability of the team to learn and experience wider concepts for skill enhancement. The essence of creating a learning organisation which will lead to innovation is non-existent in this environment. In today's world, innovation and creativity are necessary to stay relevant to the market over the long haul and stay ahead of competition.

3. While the statement by the manager does hold some mettle, the sum of whole is always greater than the sum of parts. By providing an open / learning environment will enable better employee engagement, learning opportunities, enhanced productivity, talent retention which are essential for long term sustenance in highly competitive environment. While the basic measure of performance should be maximisation of divisional income, there have to be other key performance indicators (a combination of qualitative and quantitative) which provide overall growth opportunity for the individual (employee) and the firm as a whole.

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