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CORPORATION 53 I
tan Rogers. president of Western Chemical Corporation (\VCC). was meeting with
S Samantha Chu, recently appointed director of Investor Relations, and Cynthia Sheldon,
who had recently been appointed vice president and controller. Chu had that morning
received an inquiry from a well-known chemical industry analyst who had some fairly
specific questions about some of the company's investments in E·UfOpC and the Far East.
When she questioned Sheldon, Cynthia suggested rhar they meet widl Rogel's 10 examine
some of the issues Ihal Rogers and Sheldon had been discussing, SO that Chu could answer
the analyst's requests more accurately.
The informaricn Oilthe Iinancinl performance of WCC's foreign operations was pre-
pared by the same acccuumurs who maintained the C0111ptU1Y'S accounts and who prepared
its quarterly and annual reports, A single database for all accounting had been established
some years earlier in the belief that it could serve all accounting needs of both managers and
those external 10 lhe company. A common chart of accounts and accounting policies was
used throughout the company and in all of its subsidiaries,
A variety of new alliances and ownership arrangements bad been used in recent
international ventures to speed entry to new international markers and to minimize invest-
ment and risk. Because of these, Rogers had become convinced that SOmeof tbe reports
the accountants were preparing HboUI SOUleof the ventures could be quite misleading, It
was for tbat reason that be and Sheldon were already discussing alternative ways 10measure
divisional performance, and that Sheldon thought Chu should be brought into their dis-
cusslon before trying to answer the analyst's queries.
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532 CASE 19 WFBT'ERN CI1f.MICAL CORPORATION
its solutions to customer problems and exceptional service to customers. wce bad 4.900
employees nnd operated more than 35 plants in 19 countries, Financial information by
geographic area is shewn In Exhibit 1.
\Vee manufactured in many different countries using a variety of ownership arrange-
ments. Son~ plants were wholly-owned manufacturing sites. and others were operated
as joint ventures with local affiliates. Three of these plants were useful illustrations as
background for discussing the problems (he company raced in mcusuring the performance
of its intcrnauonal ventures. /",\11had been constructed and hnd come on..stream in the
1991 - 1993 period.
A chemical plant on tbe outskirts of Prague in tlle C-L~"ChRepublic was operated as a
join I venture with a local partner. 'Iotal investment in the plant was between $35 and $40
million, incluciing working capital. wee retained a controlling interest in the joint venture
and operated the plant. The company had invested about $5 million in the venture, and Ute
balance of the investment bad come from 'he venture partner and local borrowing.
A similar plant in Piliand was I()()%owned, and the total capital invcsunent of $40 to
$45 million including working capital had been funded by wec. The venture itself had no
external debt.
A third plant in Malaysia was also 100% owned. The plant was built to add capacity
in the Pacitic region, but the plant was considered part of U.e company's production
capacity serving the global market. wce had invested approximately $35 million in this
Malaysian plum.
\\:c are reporting externally a loss or S()46.000 on Ihi~ business, when in truth, relative to (lUI' other
hu..sinesses which are teponod before Imcrcsr charges and before fees. it is contributing (0 our cor-
poratc income. 'Ibis report makes it appear Uta! ",'C arc operating at II loss of just under SI.2 million.
$532.CK)()\')f which is the share of our jclnr venture partner, and (.lHI' share is the S64GtOOO,
ShlJl Rogers 1n this business wee has invested. in uddition to its technical kncwledge and tech-
describcdthe nology. S5 Inillion of it.!> IllOney.ln addition. \\'C do HOtguarantee the debt. y.'hich is
Investment: off balance sbcct so (Q( as wee is concerned .. One other \\'ay INn \yc can look At
these businesses is to iwk al cash ftow~ to \VCC. t'lnd cash return un iovesancnt 10
'vee, When \'':Cdo tllOt, because or l.he $867.000 in fees which nre paid (0 \vee.
CASE 19 \VESTERN CHEMICAL CORPORATION 533
there is some return. Alihough the return i$ smell, it is reasonable III this ~rage of
development of a new business. T11i~business, because of the Ices, has been in »
loss position, bUI because or the fees if has :"hown a positive ca~h rerun) on invest-
menr [0 wee.
Sheldon OUT acrual return consists or the rees paid to \V(:C, or S861.000. and our share of
continued: the reported operating losses, for a net income of $221.000. That is the return Oil
our approxlmntcly $5 million Jnvcstrnem. If the subsidiary were wholly owned with
a total investment of approximately $40 million, \\Ie would be looking at the
SK69,OOOincome before interest and taxes, U) which VIC m~hl decide to apply a
tax, on the invrsuncn( or s.ao million. lbal i, hew we Dlca5rut't the performance of
wholly-owned divisions.
One of the reasons thar this report appears as it docs was that, Q few yean; }lS0, Ihen
current management decided to work from a single data base and 10have one group
prepare both the external financial reports and Ihe management reports for imcmat
use. It wac a tine decision. e".eept for the f&Ct that the external reporters did 001 have
the interest or ability 10 rep'" ~-bal was actunUy going M in the affiliatcs.
Now, let's look: at the report for our s·ub:,idinry in Poland (Exhlhit 3). This plunt Is
100',:"r.Il)\vtled,so \V~ do uot report uny intel'CSIor fees. The local capital investment
was funded by the company lind totaled about $110Or $45 million including working
capital, T11~re is 110external debt or minority interest and no "ce~.The other chnrgt:l')
include dle amortization of inCCI'CSllhal\10'3.$ c~iuili~ during the construction of
Ihe plant. The CO$.[of sales includes some profit Ircm materials lh3l are putChascd
from other plants, but the prices paid are reasonable if you compare them with
competitors" prices. 111i~i~ another interesting problem that w't struggle with, since
we are probably reporting $2 or $3 mitlion in profus elsewhere because of uiese
plant purchases. But consider ItO\\'this would look it" vIe were deducting interest 011
$30 million of debt. and re~\ of 8% of revenues as \\'C do in the case of the Prague
alfiliaae. We would then be soo..ing • 1<>«ftom abc bus. noAA of abom S3 million,
The accountants do not consider this, 300 their report Ill3ke.t it appear lhat tht
business \va~ doi ng just fine.
Samantha Chu Your explauation implies !hut there tHUSlbe some other menaurcs of performance
spoke up: that tell you uow these plantl: are performing, Wnat are those?
Sheldon: We use buds~tsand the original business plans, We look at me performance against
thOSI;:.expectations.
Rogers: Also. although we do n(.11ntonfrcr cash flows to the degree that we ought Ill, we
have in our head the cash contribution c(unpared to the mllOluH~ that \VC have
invested. In the Czech Republic we call look ahcud and see 1hat in the Iuture we
will have :\ 35% to 45% en!i.hon cash return. Poland is draining cash out of U~at a
renl3rkabfe rate. and we ha\~ not yet figured out a way 10 ~op it. Tbere are still
a lot of unresolved business problems, Compared to the. origill:ll business plnn we
have not been able to generate the revenues that were forecasted and the costs have
been higher, \Ve do not present cash flow reports 10our managers, so these anoly~e~
(In have to be done in Our neads. The information we would need ro brine llli~
about
formally is ull available, but we just have not 3..~Jtcdanyone to dn it. ...
\Vhat we have arc Ih~ dew pl:mts buill al al)(')U(the same lime..each having \'CI')'
complex und dift'erent financilll reporting issues that lead }'()u to have compteh:l),
difrerelll vic\\"Sof th<.~busine~1:.Cynthia. sho\v SlIlllantha the reporl on the plant in
~1aJaysin and what happens When \ve ililJOOUC,Call cconc)Jnic vall.le added (EVA)
tlppr(l<l;ch. " , •
Sheldon: TIle third planl \\'as buill to suppJy a high mil'(;in J)3.I1of our business. That part of
our business b truly a global bu.)int:SS in that we can actually ~hip our product from
any of sC\'em1lllants to anywhere il~ the world, \\'hen the deci.!\iOI~to build a plunl in
M(IJny~ia \l/:l~Juade \....c wcn~ running out or cllpacity. We. nltlde (I s!nllegic deCi:lioll
534 CASY. Iq WESTE.RN CI1EMICAL CORPORATION
that we wanted 10 be 1~ltd in ~1alaysi3. bUI uli~ was to be part 0( our l)roduClion
1
facilili", U) serve the glob... IDlIrl<cl.we do not usually build a ""I",r:". plant to
supply only the high n>ar¥in products, The volumes sold 11",1 shipped tend to be
small, and adding the techuustructure cf'tcchnical service afKllabor.lIorics to u p)unl
makes the economics somewnar unfavorable unless there are several utht:r uniL, in
the same plant (')rOducing higher volume products to help CarTYthe cosu 01 these
necess eiry add-ens.
Looking at the column labeled "Region of Manufacture," you can sec the sulcs ;lfllL
profitability of U,. manufacturing r"cilily in Malaysia (Exhibit 4). II s"lIs S 12
million W(II'lh of product. and you (;UHsee that with the costs lx~illg whol they OJ'C.
I
The capital charge thrl' we show i~
(he plant Is losing i\ IOlof JHUIICY. au nuemp: to
get a ITICaSUrc of Ih<.i economlc value added by lite plant, As was the caso with
Poland, Ihis report does not include ~IJ\Yinterest on the. total iJlvu:.IIIICUL of almost
$35 million, or any fees.
The E\'A approech uses a 12% capital charge based on the USl>t:I$:elnploycd includ-
ing working eapital including accounts payable and fixed capital. Depreciation i-:
included in cosr or sates. I think the way v..e use BVJ\ is very simple, eXllcl1y the
"'ay it is employed by other fQlb. bet. some get much more sophi"ticaled about
allocations, capitalized ..,..,,,rch
and developm<nt. and tho like. We do not do that.
In addition we have ru(.~n(ly started to look oot just at "region of nW1ufactu.n:"
but also al un:gi()u or $3Ie~"primarily to get an unde~(anding of whether or nol a
marker is auractlve. 'fhc second column labeled "Region of Sale" i~all product
being, sold in Southeast A$lu even ir it is be-ing manefactured ourslde, so it includes
the cost of manufacturing product. shipping it. and delivering it to eU;10mc!$ in the
region, On uim hnsi~ the earnings before interest and (axes arc about S4 million. rf
\VC wanted 1(') get down to economic value added. we would need l() deduct taxes
and a capital charge Find the economic value added woukl still he negotlvc but nol
so much so rhm WI.) could not develop some reasonable suareglcs to fix it curupared
to the region C)f manufacture measure which is preuy damning.
Stan Rogers There is an incr¢rnentnl layer of complexity here in thai this plant is Shu'! ins to pro·
inicrjcctcd: duce for the rest of the wcrkt because we arc running out of e:)f)neity nnd nrc
using this plan I us urc !\willii, plant. Thosc shipmcuts will show up ill the Region of
Manufacture numbers, but they will net show up in the Region of Sale 1I111JIherj:,..'''Ie
have not yet sorted 1his 0\11.but Ill)' suspicion is that you CNOH'"h)()k :n it thi~ way
and gel an intriguing 'Vicw-a solid view-of the bu.,ine.(\s. \Ve probably beve 10
look 81 the wbote ~y~lt.m and analyze the incremental revenues and ~.\) of the
wbole bu.,ine~$.
TIle!reason why I see thl' a) unodJef'"ilel'3tion of lbc same or ,:ornple.ll.ity01 the S3Jl1C
_problem. is that in Pnt¥IIC und Poland we bad the diO'crenl corporate s.nICIU~ lbitl
led (0 dirrerc:nl accounting. treatments of interesl and fees, \vhieh g3\'e 0.:1\:olllple:lely
warped views on \\'Ilot was going on in the business. This presunl!\ the same cbal
leuge but adds the dime1IS1!)1I::> or region of manufacture and region ()t"~aJenccounting
and the need Cor 1<'11111 ~)'!\tell\ analysis,
Samantha Chu
broke the
~ih:lIl,;.(:,of lhe Have you found \\ sV)lIlil)11 10the Iwohlenl yet?
pause v/ruch
foUo\vcd:
RQgcr~ 'Ve understand it. 'Ve have Dot iu:;'i{uliollalized a Inanagcment rcp(wlillS ~ystcn1 thai
..ed:
al)~\','e \vould lead someone whcl if; inteJligenl but docs nol undel:~landtile background to
underslilnd wluu i~l'e:1l1ygoing on. \Vc do not have 3 n\anagcnu~nl rcpOJ'ljll~ "yfo.leUl
ill place thal "ho\v:;the rcJalivc JX~rf()flllanCe of tlte threc phtnts in » clear Inanner.
On this basis the :sy~tetnlloes not Ylork.
==~b=_==~_~~=-
__-= =- __ ~~==~J
CASE 19 WESTERN CHEMICAL CORPORATION 535
Stan Rogers summed up his feelings 01) the division performance measurement prob-
Iems, echoing some of the conclusions of Sheldon:
You know, I would say the SHIne (hing, There is not a planning department here lhtd
thinks about EV'J\ and all (hat kind 1)1' sluff. ~'c probably could usc better numbers,
but driving ihc business off any single number probably would not work,
Questions
1. What is causing the problems in measuring division performance at Western Chemical Corpora-
lion?
2. Are there alternative methods for IlIe~JS\lringdivision performance that would avoid the problems
that \'Vee management is having with the methods that (hey have been using?
3. Bvaluatc the approach to using economic value added (EVA) that \VCC management is discussing
and using experimentally, \Vllal ure the strengths and weaknesses of this approach?
4. How should {he performance of divisions or wee he measured?
5. \',,'1IaLshould S;uYI()nlhaCOli teU the analyst if he asks specifically about (he investments in the
Czech Republic, Poland, and Mataysia?
536 CASF. 19 W~STERN CHEMICAL CORPOR,\TION
Id.nliG"J,1c AS-<Cf<
SI74.7
~
-
S262.9 $260.3
Exhibit] Continued
Amounts for North America sales in the rabulation above include exports to the fol-
lowing areas:
The decrease ill operating earnings in 1994 was mainly attriburable to the pretax provi-
sion of $68 million for consolidation expenses. Of Ihat amount, approximately $34 million
was inc1udcd in European operations.
Revenues $11,510
Cost of sales (9,5'11)
Selling, technical expenses. and administrative expenses (&91)
Other income/Other charges (209)
Income before interest and taxes $ 869
Inrore..SI (1,120)
Fees (867)
Foreign exchange (oO)
Revenues 532.536
Cost of sales (28,458)
Selling. technicnt expenses, and administrative expenses (2,52'1)
Other income/Other charges _Oill
InCQ[Jle before interest and luxc~ S 1.428
Interest
fees
Foreign exchange
Income
Mioori(y tmeresr
Taxes
Net income $ 1.462