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Marshall School of Business
University of Southern California
Kranworth Chair Corporation
Teaching Note
Purpose of Case
The Kranworth Chair Corporation (KCC) case describes a company that is making an important
transitionfrom a functional organization structure to one that is divisionalized. This transition
allows the case to be used to motivate discussions of a number of substantive issues, including
Suggested Assignment Questions
1. Identify the most important key recurring decisions that must be made effectively for KCC
to be successful. In KCCs functional organization, who had the authority to make these
decisions? Who has the authority to make these decisions in KCCs new divisionalized
organization?
2. Did KCC's top management go too far in decentralizing the corporation? Did they not go far
enough? Or did they get it just right? Why?
3. Evaluate KCCs new performance measurement and incentive system. Assuming that KCC
will retain its new divisionalized organization structure, what changes would you
recommend, if any? Why?
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4. Assume that the R&D function is to be decentralized (given to the divisions). Would this
necessitate changes to KCCs performance measurement and incentive system? If so, which
and why? If not, why not?
Case Analysis
KCC has to deal with essentially two different markets for their products. Some of their folding
chair models are appealing to the mass market that can be reached through major retail chains.
Patent protection is either weak or about to run out, and competition from Asian countries is
Divisionalization
To introduce the divisionalization issue, ask the students to list the key recurring decisions in the
business, and then to identify who in the organizational hierarchy makes these decisions. (This
addresses Suggested Assignment Question 1.) Table TN-1 presents such a list.
Table TN-1
Key recurring decisions
Level responsible
for making the decision?
Key recurring decisions? Old New
What markets to serve, such as setting product/market
strategy, determining what products to sell, how to price them,
and who to sell to (channels)?
C D
What products to develop? C D (C?)
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
Instructors can then ask whether or not KCC's top management went too far in decentralizing
The advantages of decentralization (creating more autonomous divisions focusing on the two
distinct markets) include:
2. Enhancing the ability for growth by developing the management team.
4. Reducing the distance between the decision maker and local information by giving authority
to the managers who have the most detailed knowledge of their areas.
6. Making managers more cost conscious while being responsive to customer needs and
market developments.
The disadvantages include:
1. Is corporate management willing to give up authority?
2. Are the division managers salesmen who lack the experience to be managers?
3. Is there a potential loss of economies of scale in key functions?
4. Can some tough cost allocation problems be settled, such as for R&D and other corporate
overhead support functions?
6. Is this too complex with unnecessary coordination issues? (Depends on whether or not good
control systems are in placesee below).
This list of advantages and disadvantages can then be used to address whether or not KCCs
new division managers authority should be expanded to include the Supply Chain and R&D
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
198
Performance Measurement
The first issue is to determine what type of responsibility center the divisions are. The divisions
can be evaluated as cost/revenue, profit, or investment centers.
Type of center Managers responsibility
Cost center Delivering certain output (volume and quality as planned) and meeting its
cost budget
Conceptually, a revenue center is equivalent to a cost center, because in both the manager is
responsible for only one side of the business (revenue or costs). A division will be a
cost/revenue, profit, or investment center primarily based on what is controllable by division
managers. For example, if division managers make decisions (on pricing, advertising, etc.) that
The divisional controllable returns measure is defined as divisional operating income over
controllable assets. The numerator of this expression, operating income, is defined as
Divisional sales
COGS
= Gross margin
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
199
occupy, and it is hard to imagine that in the current reorganization the divisions will have any
major authority in making any significant fixed asset investments and financing decisions.
Instructors may also want to ask the students why, then, are R&D and other corporate overheads
(in the numerator) as well as facility costs (in the denominator) allocated to the divisions even
though the division managers seem to have less than perfect control or less than full authority
Incentive Systems
Division managers compensation depends on the extent to which they meet certain
performance targets; in this case, the target set for their divisional controllable return. This
involves a number of decisions. In the case of KCC, a private company, the following are most
important:
1. The proportion of salary versus performance-dependent compensation:
In KCC, division managers (lower-level managers) earn a bonus equal to 30 (1520) % of
2. The proportion of individual versus firm performance linked to compensation:
3. The proportion of formula-based versus subjectively determined compensation:
If performance exceeds target, the bonus could be increased by up to 50 percent at the
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
200
evaluation period when they again become bonusable.12 The effectiveness of this clause will
And, finally, the discretion also protects the organization from paying bonuses for so-called
windfall performance.
4. How to set the performance target:
In KCC, the division managers earn their whole target bonus only when they meet target.
There is no minimum performance threshold (e.g., 80% of the target) at which managers
start earning a portion of their target bonus (e.g., 60% of target bonus). This means that the
In sum, to avoid potential game playing behaviors, corporate management would be wise to
consider at least some smoothing of the all-or-nothing bonus associated with meeting the target,
such as by introducing a minimum performance standard at which some bonus would be earned.
To conclude the discussion pertaining to Suggested Assignment Question 3, we believe that the
evaluation of KCCs performance measurement and incentive system should be quite favorable.
Related, does the current 50/50 allocation to each division of the centralized R&D expenditures
distort the divisional performance evaluations? Often much to the students surprise, it does not!
The allocation amounts for corporate R&D are quite well known at budget time (based on the
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
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Early Experiences
Any change in organizational structure needs time to become fully operational. It is important to
watch for signals suggesting control failures. These can occur in essentially two ways: poor
intradivisional performance (a well-designed performance measurement system should prevent
While KCC benefited from the new divisional structure, there are some signs of what possibly
are divisional failures to cooperate.
2. Loss of economies of scale regarding ad agencies;
3. Potential conflicts about the design of the supply chain function.
One way to address these issues is to intervene centrally (the owners could decide which ad
But there are a number of other ways to adjust the new organizational structure to increase the
incentives to cooperate if needed:
2. Change the performance measures (include non-financial performance measures to reduce
the myopic focus on short-term results).
4. Reduce the difficulty of short-term financial results, and,
5. Reward coordination through subjectively determined compensation awards.
Moreover, KCC chose to promote internally to fill the divisional management positions. Even
though these managers may initially not have all the requisite management skills, they do have
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
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Pedagogy
As with most case classes, instructors must make a decision as to how structured to make the
discussion. However, we recommend following roughly the same structure as presented in this
teaching note to allow sufficient discussion time spent on all the critical elements of a financial
results control system in decentralized organizations, including responsibility centers,
performance measurement, and incentives.
Following this structure will allow instructors to conclude that the Kranworth Chair Corporation
case illustrates:
2. The definition of responsibility centers and the appropriate performance measures for
different types of centers, and,
