Marshall School of Business
University of Southern California
Las Ferreterías De México, S.A. de C.V.
Teaching Note
Purpose of Case
This case was written to illustrate some of the basic problems with the return on investment
(ROI) measure of performance. The problems arise in both the numerator (profit) and
denominator (investment) of the ROI measures. The case provides sufficient detail to allow
students to discuss both how to measure the basic elements of profits and investments and the
Suggested Assignment Questions
2. How, if at all, would you modify the proposed plan?
Case Analysis
Background
It is useful to start the discussion by clarifying some key facts. Ferreterías is a publicly held
company. Its managers aspire to have the company be a Mexican equivalent of Home Depot or
Lowes.
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Ferreterías is not a small business. It operates 82 stores, organized into 9 geographical regions.
Table TN-1
Key Recurring Decisions
Key Recurring Decisions Person(s) Responsible
for Making the Decision
Order right items in the right quantities S
Staffing with right numbers of good people S
Pricing S
Granting credit S (with corporate check on large decisions)
Selling S, R (large contractors only)
Store location and design C
Advertising S
Control expenses S
Key:
S = store
Old Incentive Plan
Before this new proposal, performance-dependent incentives were not an important part of the
Ferreterías management system. Bonuses were small (25%) of base salary, and they were
New Incentive Plan
A consulting firm designed the new incentive plan. A number of issues might be discussed. One
is the decision to exclude all employees except the store, regional, and corporate managers.
Clearly the lower-level employees create value for the company, but the consulting firm decided
to exclude them with the reasoning that Ferreterías could not measure effectively the
performances of these individuals. If prompted, some students will undoubtedly be able to
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
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A third issue is the function linking the measures with the bonus awards. There is a lower-level
cutoff of 5%; no manager of a store earning an ROI of less than 5% earns any bonus. There is
also an upper cutoff at 11%. In 2002, then, 6 store managers earned no bonuses, and 15
managers earned the maximum. Students should be asked to consider the behavioral
A fourth issue is controllability. The performance standards are the same for all the stores, but
their performance prospects are almost assuredly not equal. Some stores have better locations,
and some probably have more efficient layouts. Ideally, performance standards should vary by
Finally, the logic of basing bonuses on a proportion of corporate profits can be questioned. The
bonus pool feature does limit the companys exposure. This is a wealth-sharing feature of the
The Calculation of Profit
The accounting treatment of revenues seems unfair in part. Stores are not given credit for sales
orders written by personnel at regional or corporate levels, yet the store has to provide the good
for that sale. Thus the stores incur the stocking and handling costs. Customer service on these
sales may also suffer because the stores are not dealing with their own customers.
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
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The Calculation of Investment
The calculation of investment similarly raises a number of measurement issues. Including
month-end cash balances as investment will encourage managers to get rid of their cash at the
end of the month. End-of-period gameplaying like this is commonly referred to as window
dressing. What purpose is served by holding managers accountable for cash balances and what
behavioral effects are produced should be of concern.
Implementation Issues
While little information is given about the process by which the plan has been developed,
students can infer that the managers who will be greatly affected by the plan seem to have had
little or no input into the design. At the end of the case, Mr. Gonzalez is lamenting that he will
have to be the one to announce the implementation of the plan. This lack of participation can be
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
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Pedagogy
This teaching note has been written in roughly the order in which we suggest discussing the
issues. At the start of class, it is desirable to clarify both what is important for Ferreterías and
who in the organization is responsible for the various key decisions.
Before evaluating the new plan, it is useful to clarify the key elements of the plan. We like to
have the students describe the plan along many of the common plan dimensions, including the