Case Study: Jim Davies

Jim Davies is the manager of one of six large distribution warehouses for Mars & Spars, a multinational clothing and footwear chain store. Jim's warehouse operates as a profit centre whereby purchasing officers based within his warehouse buy in items under appropriately negotiated contracts and ‘sell' them on to the company's UK-based stores, although occasionally the goods can be exported. These are his ‘customers'. Suppliers are both UK and overseas companies.

Goods issued by Jim's warehouse are charged to his ‘customers' at the agreed contract price plus variations for agreed factors such as inflation. Any cost outside the contract price plus agreed variations are borne by the supplier. The charge to Jim's customers is the cost charged to Jim plus 5%. This is thus effectively Jim's performance measure as at the end of the year his warehouse must show a 5% ‘profit' after allowing for all costs. This profit margin determines not only Jim's performance-related pay bonus but also that of every person who works in the warehouse and Jim's distribution network. It also is a factor in determining Jim's promotion chances.

Jim is feeling aggrieved. Every year for the past three years his operating surplus has failed to achieve the necessary 5% target. This has resulted in little or no performance- related pay and he is under pressure from his senior managers to explain why he is fail- ing to perform - particularly as the other five warehouses have all achieved their targets (and more in some cases). Jim conjectures that the way in which the company allocates and apportions overheads to his warehouse causes the failure to achieve targets.

The following summary figures indicate the position for the last three years:

At present the company uses the following definitions of overheads:

· Corporate overheads - costs of board meetings, secretarial staff, board members salaries and expenses, etc.

· Technical support - financial, legal and personnel support, including such functions as business planning, financial advice on budgets, equal opportunities policy advice, etc.

· Buildings - costs for every building owned or occupied by the company.

All these overheads are charged to a trading account for each section - legal, finance, personnel, IT etc. - and then charged to a frontline service such as Jim's warehouse on the basis of a staff time analysis for each division. Staff in the support departments fill in an individual timesheet every three years. They are asked to estimate the amount of time they spend on each activity of the company and then these time sheets are analysed and used as the basis to apportion costs in the appropriate trading account. The last time sheet analysis was completed in 1990.

With buildings, all costs for all buildings are allocated to one central building account. These are then apportioned to all departments and functions on the basis of floor area occupied. For central overhead departments, the final costs are apportioned to all front- line services such as warehouses on the basis of the staff time analysis.

The net result of this process is that all costs of the overhead departments are fully apportioned to frontline departments such as warehouses.

Having read and analysed the above case:

(a) Do you think the issue of overhead allocation is important to companies?

(b) Why do you hold your point of view?

(c) Identify what, if anything, is wrong with the above system.

(d) What alternatives do you think might exist to the above?

(e) Do you agree with Jim that overheads are the cause of all his problems?

(f) How would you go about implementing any alternative?