1. Evaluate the decision to use “minimum performance standard” (MPS) targets instead of “stretch” targets HCC has changed from ‘stretch’ performance targets to ‘minimum performance standards’. This was because the stretch targets didn’t work very well. The ‘stretch’ targets are doing a good job in companies that have a great understanding of their markets and that can influence the market. HCC however is too small to do marketing and market research, so it hasn’t enough information about their market. Because of that HCC wasn’t achieving any growth.
The stretch targets didn’t perform well because only a couple of divisions reached their targets and so the company couldn’t grow, as it wanted to. An implication is that the people at corporate haven’t earned any bonuses and that is not increasing their motivation. A problem with the stretch targets is that they were quite optimistic, what implies that they were really tough to get. The result of this was that there came a culture where it was OK to miss your target. This was further encouraged because when people only reached 60% of their budget, they still got 80% of their bonus.
This meant that employees didn’t have to worry about meeting budget. Another problem was that they were too subjective and complex to communicate to the middle managers. As also the communication of the details of the plan were hindered at 2 divisions because managers didn’t want to unveil financial information out of fear that it would be leaked to the competition. This implies that none of the personnel knew their bonus potential and didn’t know on what specific base the bonus was based on. Lastly, managers weren’t happy about the delay in payments that occurred when they reached their bonus. This is why HCC has changed its philosophy.
HCC now asked to set ‘minimum performance standards’ to the managers. This minimum performance standard budgeting model (MPS) ought to bet set on a level that provides certainty of achievement. A positive aspect of this type of target setting, which provides certainty of achievement, is higher manager achievement compared to the stretch target system. Higher manager achievement is related to a feeling of self-esteem or proudness, what can result in better performances in the next period/year. Another positive aspect is an increased manager commitment to the achievement of targets. This involves an increased care for budget plan preparations.
Finally, if managers don’t reach the MPS, they might get fired. This rule is developed to give them incentives or motivation to reach the minimum performance. In addition to the MPS, a bonus system providing an incentive to reach target levels beyond the MPS enlarges motivation. Yet, MPS seemed not to be the appropriate target system in the case of HCC Industries. Due to a lack of information concerning sales forecasts and as quoted in the case ‘‘this concept of MPS may be ok for a normal business, but we’re not normal. Nobody knows what is the standard for Hermetite’’ (HCC Industries case study, L.
Ferreira, K. Merchant). This has led on the one hand to the implementation of too optimistic MPS throughout all divisions with a probability of achievement varying from around 90 % in some divisions to only 60-65% in one division. This regarding the fact that MPS should provide a certainty of achievement. On the other hand, this inappropriate MPS setting causes some severe stress for managers, knowing that they might get fired after not achieving these MPS. A manager says: ‘‘now I am still only 90% sure, but the difference is that my job depends on it’’ (HCC Industries case study, L. Ferreira, K. Merchant).
This might influence manager performances in a negative way. Increased stress prevents people is some situations from thinking clearly and causes them to make the wrong decision. As explained above, there is no real improvement in systems. This could be attributed to the fact that not enough information is known in the company about the divisions. Hermetic seal, Glasseal and Sealtron are 3 (out of 4) divisions where the market is fragmented and so they don’t have much information about market share, business possibilities etc.
This makes it very difficult to make any presumptions about targets and actually implies that they just set the targets at good luck. The other division, Hermetite, is in a very turbulent market. They have no idea what can be expected so it is very difficult to set minimum performance targets as well. As a conclusion, it is evident that a lack of appropriate and accurate information concerning the market is the main problem in the HCC Industries Case study. A first evident solution is investing in market research. This, though, would mean high expenses regarding the dearth of readily available marketing information.
Whether the company’s financial situation would have been enough to support this research or not, is not stated in the case but smaller improvements could seem also plausible. Some improvements:
- An improvement that could be made it that the managers could be even more involved. Involvement can encourage the managers to work even harder. Firstly, it improves the commitment to the target. Secondly, another benefit is that information is better shared because the local managers have a better view of the market and possibilities. Lastly, involvement can help managers think about the targets and how to best achieve them.
- Making an enhanced schedule for the objective portion of the award, under the stretch budgeting concept. In the case, and as explained earlier, the achievement of 60% of the PBT led to a bonus of 80%. Making more portions and providing a better bonus distribution plan can moderate the negative effects of targets that are set on a good luck basis.