Formosa Plastics Group Case 25-3 Acctg 835 Advanced Managerial Accounting Group 1 Front Row Productions Kassidy

Frederick, Lu Liang, Jake Norby, Neil Bergman April 24, 2013

General Overview: Formosa Plastics Group (FPG) was a large corporation headquartered in Taiwan. It was founded in 1954 and had grown into the largest private company in Taiwan. It produced and sold a broad range of products including, chemicals, electronics, textile products, a hospital, nursing school, and technical college. The corporation had a unique management control system for a large corporation. All employees were evaluated subjectively. FPG was organized into three main corporations, which also had multiple divisions. These divisions were reasonably autonomous, but many administrative functions were centralized. FPG is also unique in the fact it had a presidents office, comprised of 340 people, whose function was to help division management. The central staff personnel set up procedures, trained management, monitored performance, and facilitated the spreading of effective practices from one division to another. Most of FPGs chemical divisions sold commodity products, so their strategy was to be a low cost producer in their market segments. It was important for them to produce at full capacity because most of the production costs were fixed. Taiwanese labor cost and standard cost of living were on the rise; therefore FPG managers were constantly looking for ways to automate production processes to improve productivity. We were hired to consult with the top management on FPGs control system.

Questions and Responses: 1. Describe the Formosa Plastics Group (FPG). Formosa Plastics Group is a conglomerate chemical company that is based out of Taiwan. The company is the largest privately held company in Taiwan and produces a variety of plastic products as well as running a hospital, medical school, and a technical college. With over 47,000 employees the company had turned a profit for an amazing thirty consecutive years. The company is run by a pair of brothers who hold the President and the Chairman positions within the corporate structure and still hold a good majority of the stock. The majority of the divisions within the chemical side of the company sold commodity products which forced them to be highly sensitized to their cost structures. During the past few years FPG has sought to become more automated in its processes and develop new products that could be sold at higher margins. The company used a bottom-up process to set budgetary goals for managers that began in September and ended in December. These budgetary plans were based upon a continuous improvement idea in which costs were expected to be lowered using new technology available to managers. Due to the commodity nature of the businesses, selling price and raw material price were deemed to be uncontrollable therefore only allowing managers to be judged on sales volume, quality of product sold, consumption levels, and efficiency. 2. What are the major types of financial responsibility centers at FPG? The individual companies and divisions that make up FPG are all judged upon ROI. Profit for this ROI measure was judged before taxes but were allocated a portion of all corporate expenses. The investment part of the ROI calculation focused only on the investments that could be directly traced to that unique company/division. Plants and product groups were considered as profit centers while production processes and groups

of machines were treated as cost centers. Along these lines non-production units were expense centers. Every component of any manufacturing process was assigned a standard cost using the companys extremely extensive historical records. These standard cost metrics were constantly being revised and reviewed based upon relevant subjective news such as new corporate investment in plant and equipment. 3. What are the major problems facing FPG management in the early 1990s? In the early 1990s the case specifically lists three problems as being critical to FPGs success: a shortage of quality labor, the rising costs of this labor, and a radicalization of the environmental movement. Labor costs are currently about 20% of the companys overall cost structure. As the living standard has risen in the past few years in Taiwan, the cost of labor has increased along with it. Many divisions within the department are highly dependent upon the costs of the raw materials that make up their finished products; however, the divisions are not able to raise their prices when the raw material costs increase. Furthermore, the polyolefin division is being squeezed on several fronts. The division cant effectively import needed ethylene to produce its product polyethylene due to cost limitations. It also cant purchase enough ethylene domestically from its only supplier CPC due to environmental and supply and demand concerns. As the department is still forced to compete globally based on price the limiting factors of a producing a commodity product are severely limiting the success of the department. 4. Describe and evaluate the major elements of FPGs control system. One element of the control system is that the companies and divisions of FPG are measured on their return-on-investment basis. The return is measured as the before tax profit including allocations of corporate expense, while the investment is only the divisional investment. FPG also has a detailed cost accounting and reporting system to set standard costs when planning their budget. If conditions warrant, FPG revises the cost standards in order to motivate continuous improvement. In order to combat problems that arise, FPG has an extensive set of financial, income, and irregularities reports that management uses. The president of FPG also closely monitors performance by holding monthly meetings with his 30 senior managers and division managers. At these meeting every division is discussed, and managers are allowed to hear ideas from other groups. The president was also aided by a presidents office which included 340 people who would evaluate managers and help new processes to be spread between different divisions. Bonuses were also used in the control system as everyone received a year-end bonus based on how the corporation performed. The amount of the bonus was in line with Chinese culture where bonuses are typically 3 to 5 months of the base salary. Everyone below the level of section chief received a bonus that averaged between 20 and 26 percent of their salary. The employees above section chief were evaluated annually and provided the basis for their bonus. 5. Describe FPGs annual planning process. Is it more a top-down or bottom-up process?

FPG has a bottom-up planning process that starts in September and end in December. The process is started by division managers who submit sales and production plans to upper management. Part of these plans must be to show continuous improvement within a division. The plans are usually revised a few times as upper management knows that the division managers are conservative in their plans. However, the corporate managers also try to make sure the division target has a success rate of 80 to 90 percent. 6. Describe FPGs performance evaluation process. A key part of FPGs performance evaluation is that it is subjective rather than objective. This is done so that uncontrollable factors can also be taken into consideration such as environmental changes and wars like the Gulf War. Changes that management made through the year are also considered in evaluation along with the employees amount of time at the company and their future ability with the company. This is taken into consideration when evaluating along with the normal aspects of controllable factors. 7. Is the Polyolefin division a profit center? We would not consider the Polyolefin division a profit center. By definition a profit center is a division of a company that is treated like its own business and therefore, the managers of such division are held accountable for their divisions profits. While Polyolefin is treated like its own business with revenues and expenses measured, Mr. Hsia Chi-Hsiung is not held accountable for the profits of Polyolefin division. This is mainly because ethylene, the only raw material in polyethylene production is the major cost item for the division, accounting for 60-65 percent of the total production cost. There was only one local ethylene supplier, which was a government corporation and importing was difficult and expensive. This caused significant fluctuations of ethylene prices and the price of polyethylene did not fluctuate with these ethylene prices. 8. So what is Mr. Hsaio held accountable for? Mr. Hsaios performance rating was estimated to be based on 40% of production efficiency, 30 % quality, and 30% of the following factors: unit consumption of important elements of cost, cost of maintenance, and leadership. FPG normally holds their managers accountable for profit, but due to the fact that the cost of raw material is uncontrollable in the Polyolefin division, it is excluded from Mr. Hsaios performance measure. 9. Is FPGs choice to allow high subjectivity in performance evaluations a good one? While in the United States subjective performance evaluations are rare, we believe it works for FPG. The company has grown and thrived for years. One of the managers said, We are as close to perfect today as we can be. If we have good ideas, we implement them. We are continually refining our system. It seems that management really believes in the system and is motivated to continuously improve with the system. As the saying goes, If it aint broke, dont fix it. 10. Are any of FPG managers control choices affected by national or cultural factors? If so, which choices were affected and which factors affected them?

FPG managers control choices are affected by national or cultural factors. In our opinions, there were about seven control choices affected by national or cultural factors. First, even though FPG has become one of the largest petrochemical corporations around the world, it is substantially owned and dominated by one family, the family of Mr. Yung-ching Wang. Mr. Wangs enormous influences was not only reflected by his significant proportion of FPGs stock, but also reflected by the ever worries and doubts in the Taiwan commercial world when he declared his retirement. Furthermore, Mr. Wang had monitored performance closely and learnt the lots of details of FPG businesses through monthly review meetings with 30 senior managers. This was an illustration of the influences of Asian business history. Compared with European and American businesses, Asian was a latecomer to the modern business world. More Asian corporations insist on a traditional management approach which characterized with management in person and high level of personal influence. Second, division managers were mostly middle ages. As it mentioned in the case, division managers in FPG ranged in age from 40-60 years and were invariably career FPG employees. Such personnel framework is popular in Asian corporation. In the traditional Asian culture, age meant experiences and authority to some extent. Therefore, corporation top management liked to promote senior managers from middle-aged ones who had longer employment histories. Third, many administrative functions were centralized to take advantage of economies of scale. When FPG was still a small corporation, it started to adopt such a unique corporation organization in which a large presidents office comprised of 15 teams of specialists whose function was to help division management. In our opinion, this practice indicates traditional Asian political philosophy in some extent. Asian countries had been dominated by imperial bureaucracy that emphasized high centralization for more than two thousand years, and this fact also affected their management philosophies for businesses. Consequently, it was not unusual for FPG to adopt such a centralized management style. Fourth, FPGs system focuses more on its detailed monthly performance reviews and appeared very short-term oriented, without long-term incentive program. Compared with long-term growth, FPG valued stable short-term performance more. High emphasis on detailing is also a symbol of FPGs corporation culture. Mr. Wang, as the founder of FPG, had summarized that detailing accounted for 95% of the success of FPG. FPG encourages its employees to pay attentions to details and solve problems from details. One principle of FPG is to develop through the pursuit for the detail rationalization. Fifth, annual evaluation system and year-end bonuses also reflect the influence from traditional Chinese culture. FPG prefers having its bonus payments being relatively constant over time. FPG puts a total amount in the budgets at a fixed number and that amount is not varied by the actual profit for the year. In addition, all employees at section chief level and above are evaluated annually. The Chinese traditional philosophy emphasizes stability more than variability. This philosophy explains why FPGs bonus and evaluation systems are different from its Western counterparts who prefer making bonus payments more variable and employee evaluation based on short-term performance. Sixth, FPG uses more subjectivity in performance evaluations. When making performance evaluations, FPGs top management does not only consider the persons specific role and division, but also consider his or her ability and potential for future,

years in the company, teamwork, cooperation, and the situation faced. The heavy use of subjectivity in performance evaluations is more common in Asian companies than in Western companies. In most Western companies, objective evaluation system including maximized controllable factors and minimized uncontrollable factors are more popular, for that such objective system provides more assurance on fairness and justness. Seventh, FPG emphasizes accuracy and tends to be more conservative compared with its Western counterparts. Under FPGs financial control system, standard costs were set for every aspect of manufacturing, and the cost standards were highly refined and accurate. Additionally, cost standards were revised promptly when conditions warranted. Furthermore, corporate managers wanted the division targets to have a 80-90 percent probability of achievement, and they have a tendency to be very conservative about figures. This is also an indication of traditional Chinese culture, which is more conservative and steady than Western philosophies. 11. What happens when the chairman and president retire? Mr. Wang was both the chairman and president of FPG. Since FPG had been operated quite well under his management in person, when the news of his retirement came out, the Taiwan public showed close concerns to issues such as who would be his successor and the future of FPG, and the Taiwan businessmen also showed their worries and doubts. Although he announced that he retired and would not participate in the operations of FPG in 2002, he was still the chairman and the spiritual leader of FPG. Moreover, FPGs stock prices in Taiwan market also suffered certain fluctuations when he died in May, 2008. 12. Does anything else threaten FPGs system? There are several factors that may threaten FPGs system. First of all, since Mr. Wang had excessive influence on the FPG system, it was uncertain that if the FPGs system could perform well continually without the participation of Mr. Wang. The worries and doubts from Taiwan public and the fluctuations of FPGs stock price both illustrated this threat. Secondly, with the rapid development of multinational corporations and globalization, the tendency of using younger managers to replace older managers is prevalent in Asian companies in recent years. FPG faces the choices of retaining the traditional management personnel framework or introducing excellent younger managers into FPGs system. Once younger managers enter into the FPG system, it is uncertain that if they would follow the current FPG system. They may make changes to the current system with their new management philosophies and management style. Finally, the increasing cost of labor and advanced Taiwanese standard of living also threaten the implementation of the FPG system. With the increase in cost of labor, it becomes more difficult to motivate employees. Moreover, the younger generation is generally not as hard-working as the older generation; this fact might affect the efficiency of the FPG system as well.