Chapter 10 – Strategy and the Master Budget
Chapter 10
Strategy and the Master Budget
Teaching Notes for Cases
10-1: 1Emerson Electric Company
Background
Emerson is an $8 billion company.
Its successful strategy is efficient, quality, and low cost production. R&D does not get a great deal
of attention from top management.
Planning Process
Top management sets sales growth and return on total capital targets for the divisions.
Each fiscal year, from November to July, the CEO and several corporate officers meet with the
management of each division at a one or two day division planning conference:
Prior to its division planning conference, the division president submits four standard exhibits
to top management:
1.Value measurement chart
2.Sales gap chart
3.Sales gap line chart
4.5-back-by-5-forward P&L
The division president and appropriate division staff then meet with top management to present a
detailed forecast for the coming year based on the result from the division planning conference and
conduct a financial review of the current year’s actual performance versus forecast:
Contingency plans for several lower levels of activity also developed to protect profitability
at lower sales levels.
However, changes to the division’s forecast are not likely unless significant changes occurred
in the environment or in the underlying assumptions. Changes in the forecast must be
approved by top management.
In August, the information generated for and during the division planning conferences and fiscal
reviews is consolidated and reviewed at corporate headquarters by top management.
In September, top management presents the corporate and division forecasts for the next year and
the strategic plan for the next five years to a conference attended by top management and top
officers of each division.
Reporting
Each month each division president submits to Office of the Chief Executive the President’s
Operating Reporting (POR).
Corporate top management meets quarterly with each division president and the division’s chief
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Chapter 10 – Strategy and the Master Budget
financial officer to review the most recent POR and monitor overall division performance.
Compensation–Base salary and “extra” salary:
An extra salary amount is established at the beginning of the year.
The executive of a division earns the extra salary if the division hits targeted performance.
The targeted performance consists of primarily measurable objectives such as sales,
profits, and return on capital.
The multiplier ranges from 0.35 to 2.0.
Other factors considered include inventory turnover, international sales, new product
introductions, and an accounts receivable factor.
Stock options and a five-year performance share plan also available to top executives.
Question 1: Evaluate Chief Executive Officer Knight’s strategy for the Emerson Electric Company.
In view of the strategy, evaluate the planning and control system described in the case. What are its
strong and weak points?
Planning at Emerson is top-down with CEO Knight actively involved from the start of the
process.
The first four exhibits capture the essence of the planning system.
The value measurement chart contains comparisons in five-year increments for
The strength of the Emerson process is that it gets commitment from the division presidents.
Certainly, they participate in the planning process to a great degree. There is no reliance on
planning staff. Division presidents are given full responsibility and accompanying authority.
The linkage between the plan and the detailed forecast (the one-year operating budget) is
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Chapter 10 – Strategy and the Master Budget
interest and taxes. Monthly reporting during a quarter can lead to a change in the forecast data for
that quarter. The CEO and senior managers review performance.
Advantages include heavy involvement of division presidents in the planning process and the cost-
reduction programs:
There seems to be a lot of discussion and interaction between division managers and top
management.
While there are a lot of numbers in the planning documents they don’t seem to be a great burden as
Disadvantages include:
The possibility of overly optimistic top-down directives on sales and return on investment targets.
The tight linkage of numbers between the plan and the one-year budget may lead to budget rigidity.
Question 2: What role should the eight business segment managers have in Emerson’s planning and
control system?
When questioned on the role of the new business segment managers, a top Emerson official remarked that
it was a good observation. Evidently the planning system does not explicitly involve the business segment
managers. What might their role be? Emerson consists of forty divisions organized into eight business
segments. This is an average of five divisions per business segment. The case says the reasons for this
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Case 10-2: Letsgo Travel Trailers
The Letsgo Travel Trailers case is designed to prompt student discussion of the interactions between
various functional areas of the company, for example, the impact of the sales projection and desired
inventory levels on production. The case also allows the instructor to discuss both short-term and long-
term strategy. In the short term, Letsgo’s major problems occur because of an uneven sales and production
schedule, which may lead to product-quality problems. The use of alternative approaches to production
planning and cash management is also introduced in the case.
Letsgo manufactures travel trailers used primarily by young families and retirees interested in a light,
low-cost trailer that can easily be pulled by a mid-sized family car. The travel trailer industry is expected
to experience high growth rates (in the case, at least through 2020) due primarily to the aging “baby-
boomer” population. Yet the environment is changing, and many factors will affect Letsgo Travel
Trailer’s projected sales growth rate. Changes in the aluminum industry and increasing demand for light-
weight construction materials will affect Letsgo’s ability to access a critical raw material. Demographic
trends and changes in the demand for and production of aluminum will have a profound effect on the
future success or failure of Letsgo.
Budgeting, approached as a team effort, can be a powerful coordinating tool. Effective cooperation
among functional areas (i.e., sales, production, purchasing, and finance) would allow Letsgo to negotiate
lucrative prime vendor contracts and implement JIT. Unfortunately, Letsgo currently approaches
budgeting as a mathematical exercise to be performed by accounting, based on narrowly viewed sales
projections. Furthermore, Newman, the company president, does the sales projections with little or no
mention of outside resources or input from Letsgo’s functional managers and line employees.
In the longer term, Letsgo will inevitably face increased outside competition as the desirability of
marketing to the growing population of baby-boomer retirees increases. The case allows discussion of
sales projections and the need to identify both the underlying demographic factors that may affect future
sales and the more finite market forces, such as barriers to entry and lower-cost manufacturing threats.
Suggested approaches to the case questions follow. The instructor need not take the suggested
approach explicitly for all questions, however, since the case allows numerous opportunities for the
instructor to guide the class discussion into more or less depth on many of the case questions. Please refer
to the case addendum in which we provide a recent article from The Wall Street Journal. This article can
be used to update some of the information contained in the case.
Suggested Approaches to Case Questions
Question 1: Discuss the validity and reasonableness of Letsgo’s sales projections
The source of Letsgo’s sales projections is not revealed in the case. The projections may be too
optimistic. Actual sales increased 8.1% from 1992 to 1993, 7.5% from 1993 to 1994, 11.4% from 1994 to
1995, 10.2% from 1995 to 1996, and 18.8% from 1996 to 1997. The projected increase of 20% from 1997
to 1998 and for each of the years between 1998 and 2002 does not appear to be substantiated by prior
experience. Examination of underlying demographic data (e.g., projected number of retirees, health
factors, income levels, etc.) would add support to the projected numbers. Competitive analysis is also
called for (who are Letsgo’s current competitors, what are the barriers to entry in this line of business,
etc.).
Letsgo’s sales are heavily seasonal, with more than 40% of the sales taking place in just three months
(February, March, and April). It may appear odd to students that people are buying travel trailers in
February and March, until students become aware that the company sells its trailers to retail outlets, such
as L.L. Bean, which begins preparing for the summer season early in the spring.
Does Letsgo plan to concentrate exclusively on the retiree market? The company president appears to
consider the future to be retirees. It is unclear, however, that the company has adequately utilized market
research. Do market data support Newman’s beliefs? Further, the company’s strategy needs to be
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clarified. Budgeting provides the communications tool to implement strategy. The production budget and
materials purchases budget must reflect the product. If the company is giving up the young family market
and concentrating on retirees, how should the product be modified (if at all)? The lack of involvement in
the budgeting process by the functional areas may hinder the company in tailoring the product to the
market.
Question 2: Prepare production, purchasing, and cash budgets for Letsgo for the fist six months of
1998. Discuss the advantages and disadvantages of the budgets you prepared. Who in the company
does the budget help and whom, potentially, does it hurt? Does the budget help or hurt the sales
department? What about production and finance? How are the various functional areas affected,
and why?
Note to Instructor: An Excel spreadsheet solution file is embedded below. You can open the spreadsheet
object that follows by doing the following:
1. Right click anywhere in the worksheet area.
2. Select “worksheet object” and then select “Open.” To return to the Word document, select
“File” and then “Close and return to…” while you are in the spreadsheet mode. The screen
should then return you to the Word document
3. You can also use this method to copy a portion or all of the embedded spreadsheet into an Excel
spreadsheet for your own use.
Production Budget: The production schedule appears to be dictated by sales and marketing. The
storage and financing of large inventories. Students may suggest just-in-time (JIT) as a solution. JIT
requires goods to be delivered defect-free and on-time, however, and the productions schedule as detailed
in the Excel file solution suggests significant potential problems both with quality and timeliness of
production.
Students should be promoted to view the production schedule from the production manager’s
perspective. Production varies from a low of 1,000 trailers in June to a high of 4,600 trailers in March. To
meet production highs, manufacturing will almost certainly be forced to hire part-time workers or work
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Chapter 10 – Strategy and the Master Budget
extensive overtime, both of which heighten the potential for quality problems and production delays.
Further, the need to scale down production in May and June will most certainly lead to layoffs, which
may increase labor cost and have an impact on future quality as the firm becomes known for poor labor
practices.
The case notes that the company does not keep track of work-in-process (WIP) inventories. This
appears to be a potentially serious flaw in managerial control. Lack of control over WIP violates
management’s fiduciary responsibility to protect and control shareholder assets. Accounting for inventory
is not, however, the only way to control WIP. Letsgo may be tracking production directly by monitoring
throughput time or output rate.
Is a six-month budget adequate for planning and control? Most companies plan at least 12 months
ahead, a fact that can prompt a discussion regarding “continuous budgeting.” The availability of sales
forecasts five years in the future may also prompt discussion of three- to five-year planning budgets and
the role of budgets in achieving longer-term strategic targets.
Materials Purchases Budget: The uneven production schedule is reflected in the uneven sheet
aluminum purchasing schedule. Preparation of the material purchases budget allows students to begin
recognizing the broader need for cross-functional coordination. Purchasing as well as production and
could help the company obtain sheet aluminum at an annual amount closer to $6 per square yard, the
company’s prior problems in repaying loans may reflect a general cash problem. JIT requires users to
adhere to strict payment schedules to maintain favorable relations with prime suppliers.
Cash Budgets: Letsgo will be unable to repay the anticipated $800,000 loan in 90 days (January 1—
March 31). Further, the company will need to borrow an additional $1,411,000 to finance operations
through May 31st.
selling price of the trailer in April just prior to the slowest selling time of the year (June, July, and August)
Letsgo may drive sales down even further. Students may be led in a discussion of how sales prices are set
(competition, market strategy) and the potential impact on production and profitability. Closer
The budgeted expenses for equipment rental, equipment purchases, depreciation, and selling/
administrative costs raise questions. Why, for example, do equipment rentals vary only in the month of
April? Students expect either of two scenarios. Either the equipment rental should vary with production (a
very reasonable but difficult production scenario from a practical aspect), or the amount should remain
flat over the entire six-month period. In fact, what is happening is the replacement of rented with owned
equipment. Newman plans to replace all rented equipment with owned equipment over the next three
years. This replacement of rented with owned equipment is also responsible for the increase in
depreciation expense in April. The company’s policy is to initiate depreciation expense on new equipment
following the quarter in which the equipment was purchased. Students should recognize depreciation as a
non-cash expense.
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The replacement of rented with owned equipment, which apparently is being financed either through
operations or with short-term financing, can initiate a discussion of the role of different financing
vehicles. Long-term debt or issuance of capital would, in most instances, be a preferable financing
vehicle.
The existence of a minimum cash balance can prompt student discussions of the need for an optimal
amount of cash-in-the-bank at any time. The role of the Board of Directors in setting a minimum cash
balance to be maintained, while not necessarily typical, may prompt discussion of the Board’s role and
the responsibilities assumed by its members.
Question 3: Andy Baxter, newly hired by Letsgo from a competitor, suggests preparing the
production budget assuming stable production. Prepare a second and third set of production,
material purchases, and cash budgets with production held constant at 3,000 trailers per month for
the second set of budgets and 3,500 trailers per month for the third set of budgets, using the
following approach for the production budget (the purchasing and cash budget formats remain as
presented above in question (2).
Discuss the advantages and disadvantages of the second and third sets of production, material
purchases, and cash budgets you’ve prepared. Who in the company do these budgets help and
whom, potentially, do they hurt? Do these budgets help or hurt the sales department? What about
production and finance? How are the various functional areas affected, and why?
Production Budget: (NOTE: the solution generated for Question 3 differs from the published
solution by the author of the case, in two respects: (1) treatment of cash outflows for wages (labor)
expense, and (2) treatment of cash outflows for materials purchases (both aluminum and non-aluminum
materials. To generate a solution for Question 3 we made some assumptions, which are clearly identified
A level production schedule will allow the production department to maintain better quality by hiring
and training a corps of workers. Use of part-time workers and overtime will be minimized. The 3,000
units per month most closely mirrors the six months’ sales projection (18,000 produced, 17,500 projected
to be sold); unfortunately, the monthly deduction in sales results in stockouts in March, April, and May–
the prime selling season. Stockouts may also be viewed as part of the strategy, a way to control product
substantial advantages to be gained through JIT, prime vendor, and cash control.
With production level at 3,500 trailers per month, purchasing can attract prime vendors due to the
level demand in aluminum (105,000 square yards per month). However, as reflected in the cash budget,
Letsgo will need to borrow additional funds as compared to the situation illustrated in Question 2. A
number of explicit assumptions were made regarding materials and labor costs and payments in order to
or controlled productions and sales (i.e., limiting the number of trailers available).
The preparation of three separate yet connected sets of production, purchasing, and cash budgets
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acquaints the student with the power of budgeting as a planning tool.
Question 4: What should Letsgo use to measure performance for each of the managers in the case?
What bonus system would you suggest that incorporates these measures and also encourages the
managers to work as a team?
Letsgo suffers from a customer-driven sales pattern. Examination of Exhibit 1 in the case reveals
significant swings in sales from month to month. In 1997, for example, sales dropped from a high of
3,981 in March to a low of 793 in July, with the greatest drop (1,485 trailers) occurring between April and
May. This type of demand schedule creates significant problems for production, leading to quality
problems and difficulties in securing prime vendors.
As individual departments attempt to deal with a predominantly seasonal sales pattern, their actions
inadvertently have an impact on other areas of the company. Unfortunately, the current individualized
bonus system only tends to aggravate the problem. For example, as Letsgo’s vice-president of marketing
struggles to raise sales (consistent with his bonus scheme), production problems will increase. The easiest
Recommendations
Letsgo should develop performance measurements with strong quality considerations. While the current
bonus scheme appears to cater to customers, by prompting sales to meet all customer demand, the actual
impact on customers is negative due to quality problems.
Letsgo can best serve customer needs, particularly those of seniors, who value quality, by
implementing performance measures that reward quality. Furthermore, the performance of all managers
should be evaluated in a team atmosphere. For example, an effective bonus scheme would reward the
vice-president of sales and marketing for gains in quality created by a shift to the flat production schedule
suggestion in Question 3. In similar fashion, the production manager should be rewarded, in part, for the
cost savings of JIT, prime vendor contract that can, practically, be obtained only when the production
schedule is consistent.
Case 10-2: Addendum
The instructor might find the following Wall Street Journal article a useful update to the case as originally
written.
Roadside Distraction: The Trouble with RVs
As Sales Soar, Retirees Face Leaks, Breakdowns, Recalls; the Limits of the Lemon Laws
By JENNIFER SARANOW; May 31, 2006; Page D1
Mary Lou and Herb Humphries sold their home in Massachusetts last July to travel the country full time
in a new, nearly $500,000 motor home. But so far, they haven’t gone much farther than the dealership lot.
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Since they bought the luxury Beaver Patriot Thunder, made by Monaco Coach Corp., they have faced
problem after problem, including burned-out fuses, mold, misaligned doors, and a broken alternator that
caused a breakdown on the highway last fall. Since buying the motor home last August, the Humphries,
who live in the coach, have split most of their time between the dealership and the manufacturer’s service
facility, both in Florida.
“We‘ve lost nine months out of our retirement life because of this motor home,” says Ms. Humphries, who
says the coach has required about 400 repairs (many of those repeats), covered under warranty. “Our
dream has literally turned into a nightmare.”
Sales of recreational vehicles have jumped in recent years, boosted by the large number of baby boomers
reaching retirement age and wanting to take to the road. (Late last month, the movie “RV,” starring Robin
Williams, opened No. 1 at the box office.) According to the Recreation Vehicle Industry Association,
384,400 RVs were shipped to dealers last year, up about 4% from a year earlier and a 27-year high. Motor
homes, which can sell for as much as $400,000 or more, make up about a fifth of the RV market and
towable trailers, which generally cost anywhere from $5,000 to $100,000, about 80%.
But as summer travel season starts, complaints about recreational vehicles are mounting. Some of the
downsides: So-called lemon laws, which guarantee consumers replacement motor vehicles or refunds
after a certain number of problems or days in the shop, vary by state and often don’t apply to RVs.
Consequently, RV owners, stuck awaiting repairs, often have little legal recourse. Gas prices also remain
high.
The RV Consumer Group, a nonprofit group that rates recreational vehicles for safety and handling, says
it gets about 100 complaints a month related to structural deficiencies with RVs, up from about 50
complaints a month a decade ago. The Council of Better Business Bureaus Inc. received 844 complaints
about RV dealers in 2005, repair issues being among the most common, up from the 488 complaints it
received in 2000.
Nationwide law firm Krohn & Moss, which specializes in lemon laws, has received nearly 1,500 inquiries
about problem RVs since it started an online free case review database two years ago, and it has started a
special division devoted to RV lemon cases. The magazine of Escapees Inc., an RV-owner club based in
Livingston, Texas, included its first article on the topic of lemon RVs in its May/June issue.
RVs often have more problems than other vehicles because they are made in much smaller quantities than
cars and without the same sophisticated manufacturing methods. Unlike cars, motor homes are made by
multiple manufacturers. Auto makers typically build the engine and transmission. RV manufacturers then
assemble living quarters, often by hand, increasing the chance for human error. More RVs on the road
also means a greater chance of problems.
According to the National Highway Traffic Safety Administration, there were more than 100 recalls
involving RVs last year, up from 83 in 2000, for defects varying from faulty microwave ovens to
improperly installed furnace exhaust vents. A 2005 survey commissioned by the RV industry found that
64% of motor–home owners brought their RVs in for services beyond a routine visit, most often citing
problems with the interior, appliances or electrical components. A quarter of owners were dissatisfied
with how problems were corrected.
In response, legislators in Michigan, Pennsylvania and Montana have introduced bills that create RV
lemon laws or expand existing lemon laws to include RVs. According to the law firm Kimmel &
Silverman, lemon laws in 17 states and Washington, D.C, don’t cover RVs at all and those in 20 states
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cover only their motor-vehicle components. Motor homes are covered in the lemon laws of 13 states —
but often only those under a certain weight.
Manufacturers argue that buyers today unfairly expect RVs to meet the same quality standards as cars
when they should be comparing the coaches to homes. RVs tend to have more problems than cars
“because of the nature of it,” says Richard Coon, president of the Reston, Va.-based Recreation Vehicle
Industry Association, which represents the RV makers and component suppliers. “Put your whole house
on a truck bed and drive it down the street and things start happening,” he says.
While the RV industry has lobbied against including RVs in lemon laws, manufacturers and dealers say
they are working to improve quality and service.
In regard to the Humphries’s problems, a spokesman for Monaco Coach says the company doesn’t
comment on specific cases. But Monaco has instituted an inspection system for each vehicle that comes
off the assembly line. Coachmen Industries Inc. has opened a center in California to service vehicles on
the West Coast so that customers there don’t have to rely on dealers for warranty repair work. Companies
such as Winnebago Industries Inc. and Thor Industries Inc. are focusing on “lean manufacturing”
processes that cut down on how often parts are handled during production, reducing the chance of
damaging them. Thor Industries says many of its brands have put in place electronic warranty processes
to speed up the repair-approval process.
In states where RVs aren’t well covered by lemon laws, consumers who end up with problem motor
homes often have few choices other than to sell the RVs at a loss or postpone trips and make repairs. The
good news is owners often aren’t responsible for paying for repairs during the first few years of
ownership. RVs are generally covered under one- or two-year base warranties and additional ones for
various parts.
Earlier this year, the Recreation Vehicle Dealer Association started a new pilot certification program for
dealer service managers to make them more effective at getting the units serviced correctly the first time.
The association, which has had certification for technicians since the early ’90s in a joint program with the
Recreation Vehicle Industry Association, has also released a guide for parts personnel to help them
increase their expertise.
In Florida, where the lemon law covers only the motor-vehicle components of motor homes, RV makers
are funding a new mediation program operated by an independent third party, in which RV owners and
manufacturers try to reach a settlement before going through the lemon-law arbitration process. During
mediation, owners can bring up issues that go beyond the lemon law, such as problems with leaks in the
living quarters. As of last July, they also can bring them up in arbitration if manufacturers agree (so far,
none have). The Recreation Vehicle Industry Association says it would like the Florida program to be a
model for other states.
Groups such as the Family Motor Coach Association and publications such as Trailer Life Magazine have
intermediary and ombudsman programs that will help RV owners solve problems they may be having
with dealers or manufacturers.
Attorneys say they can defend RV owners using other laws, such as a federal law that provides protection
to buyers of consumer products under warranty, but say they turn away many RV owners because such
cases are harder to win, expensive and can take years. RVs also don’t have many of the protections homes
do, such as state laws requiring owners to disclose problems and pre-purchase inspections.
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