CASE STUDY

Vershire Company

In 1996 Vershire Company was a diversified packaging company with several major divisions, including the Aluminum Cam division - one of the largest manufacturers of aluminum beverage cans in the United States. Exhibit 1 shows the organization chart for the Aluminum Can division. Reporting to the divisional general manager were two line managers, vice presidents in charges of manufacturing and marketing. These vice presidents headed all of the division’s activities in their respective functional areas.

The Aluminum Can division’s growth in sales slightly outpaced sales growth in the industry at large. The division had plants scattered throughout the United States. Each plant served customers in its own geographic region, often producing several different sizes of cans for a range of customers that included both large and small breweries and soft drink bottlers. Most of these customers had between two and four suppliers and spread purchases among them. If the division failed to meet the customer’s cost and quality specifications or its standards for delivery and customer service, the customer would turn to another supplier. All aluminum can producers employed essentially the same technology, and the division’s product quality was equal to that of its competitors.

Industry Background 1

Traditionally, containers were made from one of several materials: aluminum, steel, glass, fiber-foil (paper and metal composite), or plastic. The metal container industry consisted of the hundred-plus firms that produced aluminum and tin-plated steel cans. Aluminum cans were used for packaging beverages (beer and soft drinks), while tin-plated steel cans were used primarily for food packaging, paints, and aerosols. In 1970, steel cans accounted for 88 percent of the metal can production, but by the 1990s aluminumhad come to dominate the industry. In 1996, aluminum cans accounted for over 75 percent of metal can production. The soft drink bottlers who purchased the containers were primarily small independent franchisees of Coca-Cola and Pepsi Cola, which represented their independent bottlers in negotiating terms with the container companies.

Five beverage container manufacturers accounted for 88 per cent of the market. The minimum efficient scale for a container plant was five lines and it cost $20 million in equipment per line. Raw materials typically accounted for 64 percent of the production cost. Other costs included labour (15 percent), marketing and general administration (9 percent), transportation (8 percent), depreciation (2 percent), and research and development (2 percent).

For beverage processors, the cost of the can usually exceeded the cost of the contents, with the container accounting for approximately 40 per cent of the total manufacturing cost. Most beverage processors maintained two or more suppliers; and some processors integrated backward, manufacturing cans themselves. One large beverage company produced one-third of its own container requirements and ranked as one of the top five beverage container producers in the industry.

Prior to the early 1970s, cans were produced by rolling a sheet of steel, soldering and cutting it to size, and attaching both the top and the bottom. In 1972 the industry was revolutionized when aluminum

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This case was adapted by Anil R. Chitkara (T’94) under the supervision of Professors Vijay Govindrajan and Robert N. Anthony. The case is based (with permission) on an earlier case prepared by Professor David Hawkins, Harvard Business School.

1The industry background is based on a similar description in the Crown Cork and Seal Company case, prepared by Prof. Hamermesh, Harvard Business School.

producers perfected a two-piece process in which a flat sheet of metal was pushed into a deep cup and a top was attached. By 1996 the manufacturing process had become even more efficient, producing over 2,000 cans per minute.

In addition to production efficiency, aluminum had other advantages over steel: It was easier to shape; it reduced the problems of flavoring; it permitted more attracted packaging because it was easier to lithograph; and it reduced transportation costs because of its lighter weight. Additionally, aluminum was more attractive recycling material, with a ton of scrap aluminum having almost three times the value of a ton of scrap steel. Four global companies supplied aluminum to can producers: Alcoa, Alcan, Reynolds, and Kaiser. Three of these companies (Alcan, Alcoa, and Reynolds), also manufactured aluminum containers.

EXHIBIT 1 Aluminum Can Division

Plant Manager 1 District 1

Plant Manager 2 District 2

Plant Manager 7 District 15

Budgetary Control System

Divisions of Vershire Company were structured to encompass broad product categories. Divisional general managers were given full control of their businesses with two exceptions: the raising of capital and labor relations, which were both centralized at head office. The budget was used as the primary tool to direct each division’s efforts towards common corporate objectives.

Sales Budget

In May, each divisional general manager submitted a preliminary report to corporate management summarizing the outlook for sales, income and capital requirements for the next budget year, and evaluating the trends anticipated in each category over the subsequent two years. These reports were not detailed and were usually fairly easy to pull together since each division was already required to predict market conditions in the current year and to anticipate capital expenditures five years out as a part of the strategic planning process.

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Division General Manager

Manufacturing Manager

Marketing Manager

Once the divisional general managers had submitted these preliminary reports, the central market research staff at corporate headquarters began to develop a more formal market assessment, examining the forthcoming budget year in detail and the following two years in more general terms. A sales forecast was then prepared for each division; and these forecasts were combined to create a forecast for the entire company.

In developing division forecasts, the research staff considered several topics, including general economic conditions and their impact on customers, and market share for different products by geographic area. Fundamental assumptions were made as to price, new products, changes in particular accounts, new plants, inventory carryovers, forward buying, packaging trends, industry growth trends, weather conditions, and alternative packaging. Each product line, regardless of sixe, was reviewed in the same manner.

These forecasts were prepared at the head office in order to ensure that basic consumptions were uniform and that overall corporate sales forecasts were both reasonable and achievable. The completed forecasts were forwarded to their respective divisions for review, criticism, and fine-tuning.

The divisional general managers then compiled their own sales forecasts from the bottom up, asking each district sales manager to estimate sales for the coming budget year. The district managers could request help from the head office or the divisional staff but in the end assumed full responsibility for the forecasts they submitted.

All district sales forecasts were consolidated at the division level for review by the vice president for marketing, but no changes were made in a district’s forecast unless the district manager agreed. Likewise, once the budget had been approved, any changes had to be approved by all those responsible for that budget.

This process was then repeated at the corporate level. When all the responsible parties were satisfied with the sales budget, the figures became fixed objectives, with each district being held responsible for its own portion. The entire review and approval process had four objectives:

1. To assess each division’s competitive position and formulate courses of action to improve upon it.2. To evaluate actions taken to increase market share or to respond to competitors’ activities.3. To consider undertaking capital expenditures or plant alterations to improve existing products or

introduce new products.4. To develop plans to improve cost efficiency, product quality, delivery methods, and service.

Manufacturing Budget

After final approval at the divisional and corporate levels, the overall sales budget was translated into a sales budget for each plant, broken down according to the plants from which the finished goods would be shipped. At the plant level, the sales budget was then categorized according to price, volume, and use.

Once the sales numbers were estimated, each plant budgeted gross profit, fixed expenses and pretax income. Profit was calculated as the sales budget less budgeted variable costs (including direct material, direct labour, and variable manufacturing overhead-each valued at a standard rate) and the fixed overhead budget. The plant manager was held responsible for this budgeted profit number even if actual sales fell below the projected level.

Cost standards and cost reduction targets were developed by the plant’s industrial engineering department, which also determined budget performance standards for each department, operation, and cost center within the plant-including such items as budgeted cost reductions, allowances for unfavorable variances from standards, and fixed costs such as maintenance labor.

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Before plant budgets were submitted, controller staff from the head office visited each plant. These visits were extremely important because they provided an opportunity for plant managers to explain their situation and allowed controllers to familiarize themselves with the reasoning behind the managers’ numbers so that they could better explain them when they were presented to corporate management. The controllers also used these visits to provide guidance as to whether the budgeted profits were in line with corporate goals, and to reinforce the notion that headquarters was in touch with the plant.

Each visit usually lasted about half a day. Most of the time was devoted to reviewing the budget with the plant manager and any supervisors the managers wished to include in the meetings; but time was also allocated for a plant walk-through so controllers could see for themselves how (and what) the employees were doing.

On or before September 1, plant budgets were submitted to the division head office, where they were consolidated and presented to the divisional general manages, for review. If the budgets were not quite in line with the management’s expectations, plant managers were asked to look for additional savings. When the divisional general manager was satisfied with the budget, the budget was sent to the Chief Executive Officer (CEO), who either approved it or asked for certain modifications. The final consolidated budget was submitted for approval at the Board of Directors meeting in December.

Once the budget had been approved, it was difficult to change. Any problems that arose between sales and production at a given plant were expected to be solved by people in the field. If a customer called with a rush order that would disrupt production, for example, production could recommend various courses of action but it was the sales manager’s responsibility to get the product to the customer. If the sales manager determined that it was essential to ship the product right away that would be done. The customer was always the primary concern.

Performance Measurement and Evaluation

On the second business day after the close of each month, every plant faxed certain critical operating variances which were combined into a “variance analysis sheet.” A compilation of all variance sheets was distributed the following morning to interested management. Plant managers were not supposed to wait until these monthly statements were prepared to identify unfavorable variances; rather they were expected to be aware of them (and to take corrective action) on a daily basis.

Four business days after the close of every month, each plant submitted a report showing budgeted and actual results. Once these reports were received, corporate management reviewed the variances for those items where figures exceeded budgetary amounts, thus requiring plant managers to explain only the areas in which budgeted targets had not been met. The focus was on net sales, including price and mix changes, gross margin, and standard manufacturing costs.

The budgeted and actual information submitted is summarized in Exhibit 2. Supplemental information was provided by supporting documents (see Exhibit 3). Both reports were consolidated for each division and for the entire company, and distributed the next day.

The fixed costs were examined to see if the plants had carried out their various programs, if the programs had met budgeted costs, and if the results were in line with expectations.

EXHIBIT NO.2 Performance Evaluation Report for a Plant for the Month of November.

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MonthItems Actual $ Variance $ Year – to Date Variance $

Total Sales Variances due to Sales price Sales mix Sales volumeTotal Variable Cost of Sales Variances due to Material Labour Variable overhead Total Fixed Manufacturing Cost Variances in fixed costNet ProfitCapital EmployedReturn on Capital Employed

Management Incentives

The sales department had sole responsibility for the price, sales, mix, and delivery schedules. The plant manager had responsibility for plant operations and plant profits.

Plant managers were motivated to meet their profit goals in a number of ways. First, only capable managers were promoted, with profit performance being a main factor in determining capability. Second, plant managers’ compensation packages were tied to achieving profit budgets. Third, each month a chart was compiled showing manufacturing efficiency2 by plant and division. These comparative efficiency charts were highly publicized by most plant managers despite the inherent unfairness in comparing plants that produced different products requiring different setup times, etc. Some plants ran internal competitions between production lines and departments to reduce certain cost items, rewarding department heads and foremen for their accomplishments.

EXHIBIT NO.3 Supplemental Reports

Individual Plant Level ReportsReport Content

Analysis of sales by customer groups Detailed analysis of sales volume, sales dollars, profit dollars, and profit margin by end user customers (e.g., beer companies, soft drink companies).

Analysis of sales More detailed backup analysis to Exhibit 2 regarding

Variances due to sales price, sales mix, and sales volume Analysis of costs More detailed backup analysis to Exhibit 2 regarding

Variances due to variable costs and fixed costs of

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manufacturing.

Division Level ReportsReport ContentComparative analysis of profit

performance

Comparison of sales and profits across plants

Comparative analysis of manufacturing

Efficiency.

Comparison of efficiencies in variable and fixed costs across plants.

Questions:

1. Outline the strengths and weaknesses of Vershire Company’s planning and control system.2. Trace the profit budgeting process at Vershire, starting in May and ending with the Board of

Directors’ meeting in December. Be prepared to describe the activities that took place at each step of the process and present the rationale for each.

3. Should the plant managers be held responsible for profits? Why? Why not?4. How do you assess the performance evaluation system contained in Exhibits 2 and 3?5. On balance, would you re-design the management control structure at Vershire Company? If so,

how and why?

2Manufacturing efficiency = Total actual variable manufacturing costs *100 Total standard variable manufacturing costs.

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