Classic Clothes is a retail organization in the Northeast that sells upscale clothing. Each year, store managers in consultation with their supervisors establish financial goals, and then a monthly reporting system captures actual performance.
One of the firm's sales districts, District A, has three stores but has historically been a very poor performer. Consequently, the district supervisor has been searching for ways to improve the performance of her three stores. For May, she set performance goals with the managers of Stores 1 and 2. The managers will receive bonuses if the stores exceed certain performance measures. The manager of Store 3 decided not to participate in the bonus scheme. Because the district supervisor is unsure what type of bonus will encourage better performance, she offered the manager of Store 1 a bonus based on sales in excess of budgeted sales of $670,000; she offered the manager of Store 2 a bonus based on net income in excess of budgeted net income. The company's net income goal for each store is 12 percent of sales. The budgeted sales for Store 2 are $630,000.
Other pertinent data for May follow.
• At Store 1, sales were 40 percent of total District A sales; sales at Store 2 were 35 percent of total District A sales. The cost of goods sold at both stores was 45 percent of sales.
• Variable selling expenses (sales commissions) were 8 percent of sales for all stores and districts.
• Variable administrative expenses were 3 percent of sales for all stores and districts.
• Maintenance cost including janitorial and repair services is a direct cost for each store. The store manager has complete control over this outlay; however, it should not be below 1 percent of sales.
• Advertising is considered a direct cost for each store and is completely under the store manager's control. Store 1 spent two-thirds of District A's total outlay for advertising, which was 10 times more than Store 2 spent on advertising.
• The rental expense at Store 1 is 40 percent of District A's total and at Store 2 is 30 percent of District A's total.
District A expenses are allocated to the stores based on sales.
a. Will Store 1 or Store 2 generate more profit under the new bonus scheme?
b. Will Store 1 or Store 2 generate more revenue under the new bonus scheme?
c. Why would Store 1 have an incentive to spend so much more on advertising than Store 2?
d. Which store manager has the most incentive to spend money on regular maintenance? Explain.
e. Which bonus scheme appears to offer the most incentive to improve the profit performance of the district in the short term? Long term?