Harwood Medical Instruments PLC (HMI) manufactures specialty medical instruments. The incentive compensation scheme was based solely on operating profit and did not take into account any other key performance indicators. HMI instituted a new bonus plan that takes into an account a more balanced scorecard approach and is based on operating profit and other key performance indicators. The problem in this case is whether the new bonus system is successful and whether it is the most appropriate incentive program for the company. Case Data
Harwood Medical Instruments PLC is based outside Birmingham, England and manufactures specialty medical instruments. The company is organized into nine separate divisions each run by general manager. The company is culturally diverse and the product lines are separate as six of the divisions were acquired by HMI within the past decade. The company sells its products to hospitals, laboratories and/or doctors and the need for product quality and reliability is high. The success of each division relies on various factors such as new product development, efficiency of production and/or customer service and differs for each division. In November 2006 Andy Guthrie, the HMI’s managing director expressed willingness to pay higher bonuses if the improved performance warranted doing so. The company introduced a modified bonus plan in 2007. Under the previous bonus plan the annual bonuses for division managers were paid semi-annually and were calculated as two percent of the division’s operating profits. The new bonus plan is calculated semi-annually and is based on one percent of the division’s operating profits and it is further adjusted based on several key performance indicators such as on time deliveries, sales returns, patent applications filed, scrap and rework costs and customer satisfaction ratios. If the final bonus results in negative amount the manager receives no bonus. Under the previous and the current plan negative amounts are not carried forward. Data of the operating results and the key performance indicators after the new bonus system was implemented in 2007 for the Surgical Instruments Division and the Ultrasound Division is shown in Exhibit 1. Exhibit 1 – Operating results for the Surgical Instruments and Ultrasound Diagnostic Equipment divisions, 2007 ($ in 000s)
Surgical Instruments DivisionUltrasound Diagnositcs Equipment Division
1st half of 20072nd half of 20071st half of 20072nd half of 2007 Sales$42,000$44,000$28,600$29,000
Patent applications filed0148
Scrap and rework costs$51.1$45.0$39.7$38.2
The annual bonus paid to the general managers of the Surgical Instruments Division and the Ultrasound Division in 2006 under the old bonus plan was $85,000 and $74,000 respectively. A comparison of the bonus amount that would be paid in 2007 under the several alternatives is shown in Exhibit 4 and Exhibit 5.
The company can utilize bonus system based solely on operating profit. The amount of the annual bonus would be 2% of the operating profit paid semiannually. The company can utilize the newly instituted bonus system based on operating profit and adjusted depending on performance of several key performance indicators as shown in Exhibit 2. The company can utilize a bonus system based on operating profit and adjusted depending on the performance of several key indicators as shown in Exhibit 3.
Exhibit 2 – Division Managers Bonus for half-year period under Alternative 2 Base Bonus1% of operating profits
On Time DeliveriesIncreased by $5,000 if over 99% of deliveries are on time. Increased by $2,000 if 95% to 99% of deliveries are on time. No increase if on time deliveries are less than 95%
Sales ReturnsIncreased by $5,000 if sales returns are...