P
rofessor Kenneth A. Merchant wrote this teaching no
t
e as an aid to instructors using the Hoffman Discount Drugs, Inc. case.
Marshall School of Business
University of Southern California
Hoffman Discount Drugs, Inc.
Teaching Note
Purpose of Case
The Hoffman Discount Drugs case was written to illustrate a different method of dealing with
uncontrollability problems. This company makes adjustments for uncontrollables only if they
are larger than a pre-set threshold level through a type of ad hoc variance analysis performed by
Suggested Assignment Questions
Evaluate the HDDI Store Management Bonus Plan. What, if anything would you change?
Explain.
Case Analysis and Pedagogy
As this is a fairly easy case, I use it as the first case in which students are asked to consider
controllability issues explicitly. Then I start class with a lecturette on risk aversion, the costs and
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Performance Standards
The only thing that is somewhat unique about the performance standards is that they are set in a
topdown manner. Do corporate and regional managers know enough to be able to set good,
fair, monthly standards for sales, net income, and inventory performance for each of the 400
stores? They claim they do. They are aided by a database containing detailed histories of each of
Performance Measures and Links Between Measures and Bonus Payments
Managers earn bonuses based on performance measures: net income and sales, with the
importance weighting between these two measures 75% and 25%, respectively.
1. Are these the right measures? They are both very short-term oriented (but store managers
2. Why should store managers have to cover allocations of corporate expenses? (It doesnt
3. Why any focus on sales? Isnt the goal to produce profits (or really shareholder value)?
4. What is the advantage of basing bonuses on net income and sales, rather than a set of MBO-
type targets (e.g., growth, inventory control, cost control, store cleanliness)? (This raises the
5. The bonus formula considers both positive and negative variances from net income
6. There are upper and lower bonus constraints. If annual sales are less than 90% of budget, no
Rewards
The bonuses are paid in cash. As described in Chapter 9, cash rewards are not durable (people
quickly forget they got them), but they are a common, and valued, form of reward.
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The bonus objectives vary by level. Store general managers objectives ranged from 15 to 20%
of base salary; assistant managers bonuses ranged from 3 to 5%. These bonus potentials are not
high, but these are not high-level managers in the corporate structure.
Adjustments for Uncontrollables
Corporate managers established for themselves the right to make whatever adjustments to the
measured results they wanted to adjust for uncontrollable effects. They claimed, however, to
make adjustments for only three types of uncontrollables: natural disasters, robberies, and
rioting and looting. But are all of these events really uncontrollable? Many fires are caused by
poor building maintenance or careless personnel. (For example, what if the fire was caused by
an employees careless discarding of a cigarette?) Some robberies are caused by lax security
measures. Shouldnt the corporate managers investigate the causality (controllability) of each
event (or would it be too costly to do so)?
Do store managers have the right to decide whether to buy insurance to protect against the costs
of some of these events? Probably not, but if this were the case, should corporate provide any
adjustments if the insurable events occur and the manager decided to self-insure?
Corporate managers will make no adjustments for changing economic conditions, bad
performance standards, or other forms of bad luck (e.g., personnel turnover). If adjustments are
Corporate managers also limit their adjustments to material effects which, for a larger store,
means a profit effect of greater than $10,000 per incident. This policy means the store managers
have to manage all the little things well, but they are protected from the deleterious effects of
large uncontrollable events. The line defining materiality is admittedly arbitrary, however.
Is there room for gameplaying by the managers? Might they be inclined to throw some extra
merchandise into the fire in order to make the loss greater than $10,000?
The example described at the beginning of the case shows the negative behavioral effects of the
policy. But are Jane Firstenbergs complaints credible? A loss of $10,000 is probably around
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Other
The system is conceptually fairly simple. The explanation of the plan (Exhibits 1 and 2), which
are disguised, real company documents, seem quite complex, however. Do the store managers
really understand how the plan works? Couldnt it be simplified without great loss of
effectiveness (e.g., by removing the sales measure from consideration)?