Armco Inc.

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Case 25-2: Armco Inc.: Midwestern Steel Division* Note: This case is unchanged from the Twelfth Edition. Approach The Armco case was designed to illustrate a performance measurement system with measures cascading from strategic priorities down to the lowest organization levels. The system is not tightly linked with incentive compensation, although that is being discussed. Still, the focus on measured results promises to change managerial behaviors significantly. The case is particularly interesting because it describes a major change from an old measurement system which was primarily designed for standard financial reporting purposes and was not perceived, at least by top management, to be effective for management control purposes. The new performance measurement system eliminated most of the allocations of indirect costs and helped managers understand the critical success factors in their areas. In this case, then, students can understand two performance measurement systems and the companys reasons for changing from one to the other. They can evaluate the new system and decide whether the division managers have made optimal choices in designing their new system, and they can make a judgment as to whether the system should be used to increase the proportion of total compensation linked to performance. Most of the students will conclude the new system is a substantive change for the better. But then they will get a dose of reality as they see the problems Armco is having getting managers to adapt to the new system. Suggested Assignment Questions 1. What was wrong with the Midwestern Steel Divisions old system? (As part of your analysis, study Exhibit 3 carefully and figure out what the columns tell you, individually and in total.) 2. If the old system was so bad, why did the operating managers seem to like it? This teaching note was prepared by Professor Kenneth A. Merchant. Copyright 1998 Kenneth A. Merchant. * 25-7 Chapter 25 - Reporting and Evaluation 3. 4. Evaluate the new system and the way in which it was being implemented. What changes would you recommend, if any? Why? 5. What should Rob Cushman do about the two items described in the Remaining Issues section of the case? Case Analysis and Pedagogy 4. What factors most determine the success or failure of the Midwestern Steel Division? In particular, how important is cost control? Carbon wire rod is a commodity product, so cost control is critical for this line of business. There is some product differentiation in grinding media. Customers can measure how long the steel balls last, and they value long-lasting balls. Armco believes it has a superior manufacturing technology that causes its balls to last longer. Further manufacturing technology innovations would provide additional profits to the division. Cost control is also important for grinding media, as Armco is the high cost producer in this market. Plant throughput (productivity) is one key to cost control. Armco can sell all the product it makes. (The plant has been operating at capacity for three years straight.) Among the cost control challenges in the plant are the fact that the plant has old equipment, generally poor preventative maintenance practices (40% of the 700 hourly workers in the plant were maintenance workers), and less than optimum worker productivity. The people left in the plan are the most senior. They would not be hurt that much by a shutdown. They have pensions. Cost control is not that important to them. It would cost the company about $200 million to shut down the plant (environmental clean-up, pensions, etc.). Students might ask why Armco does not put more people or more equipment in the melt shop so it wouldnt be a bottleneck. The answer is that they would have to add a furnace, making an investment of approximately $100 million. This would add capacity which is not needed in the industry. 5. How were managers controlling performance with the old system? What were the strengths and...
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