Compagnie du Froid's Business Case

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Memorandum

Campagnie Du Froid is a summer ice-cream business founded in 1985 by the father of Jacques Truman. In 2007, after the passing of his father, Jacques Truman took over the business and emphasized an aggressive growth strategy. By 2009, Campagnie Du Froid was a market leader in the eastern part of France, northeastern coast of Spain, and northern Italy. Each region had its own manager and the main headquarters was located in Paris. Jacques believed decentralizing the decision making as much as possible.

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Each region had its own manufacturing, marketing, distribution and sales organization. The central office took care of accounting, developing of new products, and sharing of learning experiences across the regions. Each year Jacques met with the regional managers to discuss a profit plan for each region. The profit plans laid out regional goals for the upcoming year and were used as a tool to monitor performance. During the summer months, a profit statement every two weeks was generated and sent to Jacques in order to detect any major problems.

The France region is run by Jean Pinoux and had performed exceptionally well in 2009 with profits above budget and sales increasing by 20% from the previous year. Jean had stumbled across a new source of revenue in which he helped deliver packaged food for regional producers using the company’s refrigerated trucks. The incremental cost to provide the service was very low and was seen by Jean as a simple way to increase revenue. Jacques was surprised by Jean’s new initiative, but acknowledged the profit potential in the distribution business.

Pierre Giraux is the manager of the Italian region. The 2009 sales goals were met and Pierre had expanded business into most of the western Italian coast, but suffered from higher wages and lower efficiency than expected, which hindered performance of the region.

Andres Molas is the manager of the Spanish region and his performance had been outstanding up until 2009. There had been many problems that sprung up in 2009 causing the performance of the Spanish region to decline. The first problem was the new machines weren’t working correctly until late August which caused them to run out of capacity several times. The Spanish division had to import product from the French division at a transfer price of full cost plus 5% profit for the manufacturer. On top of that, the Spanish division had to absorb expenses of people traveling to France to fit the Spanish packaging to the French production line. Lastly, there were unseasonably cold temperatures that had driven down tourism and demand. As a result, Andres had to cut prices in order to stimulate demand and keep with competition.

Traditionally, each manager was given the same bonus of 2% of corporate profits, but the results in 2009 challenged the fairness of this evaluation system. The Spanish region performed extremely poor and had driven down company’s profits to the lowest it’s been in ten years. Jacques thought it was unfair for the French and Italian managers to pay for the problems of the Spanish region but wasn’t sure Andres Molas was to blame for the poor results. Jacques Truman needs to make many decisions regarding the evaluation and performance of each region.

In order to properly evaluate the difference between the expected profit versus the actual profit in the Italian region, a causal analysis was conducted on the Italian region. The causal analysis in Exhibit 1 allowed us to better understand the Italian business. First, we evaluated the impact of the change in sales volume. The sales volume variance (Flexible budget in Euros – Static Budget in Euros) produced a sales variance of €119 for Ice Cream sales and €34 for Specialty sales; this represented a profit variance of €58. While the sales volume variance is important, it is also important to understand the amount of sales growth that is attributed to the temperature change versus actual performance of the business. There was €19 worth of growth strictly from the change in temperature between both ice cream sales and specialty sales. The profit side of the causal analysis resulted in a €8 variance attributed to the temperature change and a €50 variance related to performance which resulted in a total volume for profit increase of €58.

The change in prices also had an impact on the Italian region’s expected and actual profit because the €7 total sales variance represented an increase of €7 profit for the actual profit. The €7 variance was calculated by the favorable €20 variance for ice cream sales and an unfavorable variance of €13 for specialty sales (€20-€13=€7). This proves that the Italian region can charge slightly more for their ice cream sales given the increase in demand, while the increase in demand of the specialty product could be more attributed to the decrease in price. Overall, the change in pricing came out to make a positive impact on the Italian region’s profit. The cost of raw materials impacted the actual profit through the price variance and the quantity variance of the direct materials. Using the level 3 analysis, it was determined that the price variance was favorable €46 and the quantity variance was unfavorable €17 which represented a flexible budget variance of favorable €29. This impacts the profit because the Italian region was very efficient with their costs of direct materials, but the Italian region came up short in their manufacturing efficiencies as they experienced an unfavorable quantity variance of €17.

An overall favorable flexible budget variance of €29 represents a positive impact on the profit for direct materials. The cost of labor impacted the actual profit through the rate variance and the efficiency variance of the direct labor. Using the level 3 analysis, it was calculated that there was an unfavorable rate variance of €2 and an unfavorable efficiency variance of €11. This impacts the profit because the Italian region paid more for their labor than expected, which turned into an unfavorable variance of €2; this variance is related to the changes in the prices of labor. Also, the Italian region was not as efficient with their labor forces which showed in the unfavorable efficiency variance of €11; this is related to the labor efficiency of the workforce.

Overall, the impact of the direct labor was negative to the profit as the Italian region was both inefficient and paid more per labor hour than estimated. The fixed costs impacted the actual profit by having an unfavorable variance of €20. This shows that the Italian region was slightly less cost conscious with some of their fixed costs and this negatively impacted the profit. After considering all of the different components of the profit of the Italian region through a causal analysis, the Italian region experienced a favorable variance of €58 on their overall profit.

The manager of the Italian region should be evaluated relative to multiple criteria to gain a holistic view of his region’s performance. In order to compare the three regions together, causal analyses were performed for each region, see Exhibits 1-3. The first crucial measure should be sales growth, and this goes for all regions, not just the Italian region. Sales growth year-over-year is crucial to any business because businesses become more expensive to run as time goes on due to inflation. It is best to look at sales quantities relative to changes in price because if you were to just look at changes in quantity sold, the manager could steeply decrease the price just to make his or her performance look stronger. The next crucial measure should be price and quantity variance. Price variance shows how strong of a negotiator a manager is with suppliers, which can result in huge cost savings. Quantity variance shows how efficient workers are in producing products. A favorable quantity variance evidences workers are not creating much scrap, and therefore are saving money.

Another key indicator of manager performance is labor efficiency variance because it shows how productive workers are when producing product. A strong labor efficiency variance shows that the manager is staying on top of workers and demanding consistently strong performance from them. We do not believe that much weight should be put on labor rate variance because the manager often has little control due to unionization and government regulations within the area of operation. The above measurements of effectiveness of the Italian region and more specifically, the Italian manager can be found in Exhibit 1 which breaks down the relevant variances in determining the appropriate evaluation of the Italian manager. The more specific-scope variances mentioned are shown in Exhibit 6. All of the above tie into the bigger picture variances, which are the flexible-budget variance and the sales-volumes variance, which are shown in Exhibit 5 for Italy in 2009. These then roll into the static-budget, which determines if a manager met the profit plan for the region, which is shown in Exhibit 4 for Italy in 2009. This gives a rather vague view, and can sometimes distort how a manager truly performed unless the variances that roll into it are investigated further.

Both the manager of the French region and Spanish region should be judged on similar criteria as the Italian region manager besides a few small nuances that France and Spain have in their operations. All of the measurements mentioned above in analyzing the Italian region manager’s performance should be used for France and Spain, as these measurements provide the same value no matter the region. A causal analysis for both France and Spain were conducted and can be found in Exhibits 2 and 3, respectively. For France, the more specific scope variances, flexible-budget and sales-volume variances, and the static-budget variance are shown in Exhibits 9, 8 and 7, respectively. For Spain, the more specific scope variances, flexible-budget and sales-volume variances, and the static-budget variance are shown in Exhibits 12, 11 and 10, respectively. France’s revenue from distribution should be taken out of all variance analyses it is considered in because the other regions do not have this service in place, and it would distort the view of relative performance.

Also, France’s revenue should not include the 5% markup for transferring product to Spain because this is an intercompany sale and is not based on France’s customer demand but instead is based on Spain’s. We believe it is therefore necessary to remove the 5% markup from the purchase price for Spain because this will cause a heavily unfavorable price variance for direct materials. We feel that it is best to instead take this as a qualitative judgment in the manager’s performance in the sense that sales are outpacing inventory. It can also be noted that competitors have generally shown to steeply decrease market prices when demand weakens, but we feel this is best to account for qualitatively instead of through what seems to be an arbitrary measure of change in sales relative to temperature.

It should be the regional manager’s job to address the decrease in the demand instead of have it be excused due to temperature change. In evaluating performance, it can be noted that the conditions did not allow for demand as strong as in other regions, but should not allow for a manager’s performance to be comparable to a region with widely stronger sales. Please note the standards used for Compagnie du Froid are listed in Exhibit 13.

Based on our analysis of each of the regions’ performance for the year of 2009 and other important information, we believe that Italy’s regional manager did the best job. First and foremost, the region exceeded profit expectations are set forth in the profit plan, as shown in Exhibit 6. Italy also earned favorable variances relative to both the flexible-budget variance and the sales-volume variance. The more specific-scope variances were strong as well with the only major weakness being in the quantity variance for ice-cream, but the strength of the other variances outweighs this one significant weakness that can easily be improved through training or overall experience.

The direct labor efficiency variance is the only relatively weak variance, however Mr. Trumen noted that new machines were causing labor efficiency issues. It was mentioned that this was included in the profit plan already, however it can be expected that this variance will fluctuate until the equipment begins running normally. Revenue growth also exceeded expectations, which as mentioned earlier, is key to growing any business and maintaining positive cash flows.

There are three main problems that Jacques Truman appears to be facing. The first problem involves whether or not to change how much each manager receives as a bonus. Each manager’s bonus is currently calculated at a fixed 2% of corporate profits but after the poor performance of the Spanish division during 2009 has Jacques considering new ways to evaluate each manger’s bonus. Jacques is considering whether to link each manager’s bonus to a performance measure such as a profit plan, revenue growth, or some overall economic measure of results. A second problem is how to calculate transfer pricing from one division to another. The Spanish division was charged full cost plus a 5% profit margin from the French division. Andres Molas believed this was way too much for a transfer price and in turn made his division look bad. Jacques needs to decide for current and future purposes on how to handle transfer pricing in case of a similar event happening again.

The third problem involves whether or not to allow Jean Pinoux of the French division to continue providing the distributing services to regional food producers. Jean claims the distributing services add extra revenue with very little incremental cost. Jacques needs to decide whether Jean’s claims of the distributing services are true. After careful analysis of all three problems, we’ve developed some recommendations for Jacques Truman to consider. Our first recommendation involves implementing a new way to calculate the performance bonuses managers receive at the end of each year. We don’t believe that every manager should simply receive 2% of corporate profits. Each manager’s performances can be measured by a variety growth metrics and budget variances while also taking qualitative factors into consideration. The growth metrics that should be considered are things like sales growth year-to-year and sales quantities relative to changes in price. Variances that should be considered are: price variance, quantity variance, and labor efficiency variance.

Qualitative factors such as unseasonal temperature changes and intercompany transfer of product should also be taken into consideration. For reasons discussed earlier, we believe considering these metrics will give the most accurate view of each manager’s performance. Using these benchmarks will allow Campagnie Du Froid to calculate a more appropriate performance bonus for each manager. The second recommendation involves how transfer prices should be calculated between divisions. Assuming there are no capacity constraints at the French division because of the two new machines it just bought, transfer pricing should be set at the variable cost per litre of €2.76. When the French division has excess capacity, there is no opportunity cost to be lost and it should be indifferent for them to make these extra units for the Spanish division. Fixed costs don’t need to be added to the transfer price because they will be incurred regardless and the 5% profit margin is unnecessary because all profits eventually go to corporate.

This will cut transfer costs for the Spanish division by €0.77per litre and €459,000 total. This type of transfer pricing will be beneficial to the buying division in the future and allow it to spend less when it runs into these types problems. The third recommendation involves the new distribution arrangements that Jean Pinoux wants to engage in the French division. In 2009, revenues from distribution were €79,000. The incremental costs for delivery expenses were €47,000 and €3,000 for depreciation of the trucks. The revenues from distribution outweigh the incremental costs by €29,000; therefore we recommend the French division continues with the new distribution arrangements. We believe these recommendations will help Campagnie Du Froid become a more efficient and profitable company.