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From local to corporate performance

A research on the targeting of local subsidiaries on the their corporate performance.

University of Groningen

Faculty of Management and Organization

Title: From local to corporate performance Author: M.H.J. Letteboer

Studentnumber 1145908 Principals: Drs. M.M. Bergervoet Drs. J.H. van Uitert Company: Biomet Europe B.V.

Dordrecht, the Netherlands Principal: Drs. D.A.A.M. Jaspers Place/Date: Rotterdam, May 2005

The author is responsible for the content of this thesis. The author holds the copyright of this thesis.

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Acknowledgements

Many people have contributed to the final result of this thesis.

First of all I would like to thank Marcel Bergervoet and Hans van Uitert for their support from the University. The changes of focus, which occurred more then once, eventually paid off and increased the relevance of this thesis. The simple question:

‘What is the reason you are walking around over there?’ helped enormously in the phase of the research design.

I also want to thank my colleges of Biomet Europe for their help with the data collection and further support, not only with the interviews, but anytime I had questions someone was willing to help me out. A special thanks goes to Deni Jaspers, his patience and extended explaining about the company, the products and of course SAP BW directly contributed to the quality of the research and the pleasure of working on it.

And of course I want to thank my family: My grandparents for the place to stay during the first month, a perfect solution! My brothers and parents, not only for the support during this thesis, but for their support during my entire study.

Rotterdam, May 2005

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Management summary.

Due to its rapid growth in the last few years Biomet Europe is now represented in 19 countries throughout Europe. Six of the local subsidiaries are selling and manufacturing plants; the other thirteen are selling subs. The transfer pricing system for intercompany transactions between these subsidiaries has led to a difference between the local performance of the subsidiaries, and the corporate performance of Biomet Europe as a whole. In order to reduce this difference, a new calculation for local performance measurement was introduced in the report: ‘Corporate Contribution 2005; New Approach’. According to this new approach local subsidiaries should focus on their corporate gross margin, based on actual manufacturing prices. Until now, the corporate gross margin per subsidiaries can only be calculated by the headquarters on monthly basis. No further detailed information on the corporate gross margin is available for local decision-making.

This lack of detailed information available on local level, is seen as the main problem within this research.

Given this problem the following research objective was formulated:

To provide insight in the information required by central and local management in order to improve targeting local subsidiaries on their corporate performance using the corporate contribution approach.

And in order to achieve this main goal the main question was formulated:

What information regarding the corporate contribution approach has to be available for central and local management in order to improve targeting local subsidiaries on their corporate performance?

Literature study, desk research and tests in the SAP BW database system showing the difference between the local and corporate gross margin, were used as input for interviews held with central and local management of Biomet Europe. From the results it could be concluded that information on the corporate gross margin per product must be fully available on central and local level, as it will contribute to the targeting of local subsidiaries on their corporate performance. However the information on corporate gross margin per product cannot always be decisive.

Besides the information on gross margin, additional information on costs such as selling and marketing cost, inventory cost and transportation cost will be required on product or product group level in order to further improve the targeting on corporate performance. The availability of the information on the corporate gross margin per product will not automatically lead to an optimal use for better decision- making. A discrepancy can be distinguished between central and local management on how and by whom the information must be used, especially regarding the extended product portfolio and the question whether headquarters should intervene in this portfolio when the information on its corporate profitability will be available.

According to central management the extended product portfolio is one of the

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strengths of Biomet Europe, while local management sees it as a disadvantage confusing the focus on the most important products.

In order to improve the targeting of local subsidiaries on corporate performance, the following recommendations were formulated:

The contradiction on the extended product portfolio, which by central management is seen an as a strength and by local management as a weakness, should be sorted out by central management by spreading the strategic vision on the product portfolio throughout the entire organisation. Information on the corporate gross margin per product must make it easier for local subsidiaries to choose between the different products.

With the implementation of targeting local subsidiaries on corporate performance, central management must take a leading role. A local version of the corporate contribution report should be made in order to convince local management of the advantage of the available information, and show them how this information must be used. Standard reports have to be made in order to make the information direct accessible for every user.

Bonus schemes throughout the whole organisation should be adjusted and more weight has to be put on the corporate gross margin achievement. All people that have influence on the corporate gross margin, must be stimulated to focus on corporate performance.

In order to further improve corporate profitability analysis, other cost such as selling and marketing cost, inventory cost and transportation cost should be further allocated per product or product group. Providing insight in cost per product or product group must eventually lead to an increase of the corporate performance of the local subsidiaries.

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Table of content.

Management Summary 4

Table of Content 6

Chapter 1: Introduction 8

1.1 Introduction 8

1.2 Biomet Inc. 8

1.3 Biomet Europe 9

1.3.1 Biomet Europe 9

1.3.2 Biomet Europe Headquarters 9

1.4 Latest developments 10

1.5 Summary 11

Chapter 2: Research Design 12

2.1 Introduction 12

2.2 The Problem 12

2.2.1 Problem introduction 12

2.2.2 Problem stakeholders 13

2.3 Problem statement 14

2.3.1 Research constrictions 14

2.3.2 Conceptual model 14

2.3.3 Sub questions 16

2.3.4 Definitions 16

2.4 Research type 17

2.5 Research methods 18

2.5.1 Research constraints 18

2.5.2 Data resources and collection 19

2.5.3 Theories used 20

2.6 Research model 23

2.7 Summary 24

Chapter 3: Theoretical Framework 25

3.1 Introduction 25

3.2 Organizational context 25

3.2.1 Divisionalized structure 25

3.2.2 Centralization and autonomy 26

3.3 Performance measurement and control 28

3.3.1 Control type 28

3.3.2 Financial performance indicators 29

3.4 Targeting style 30

3.5 Corporate performance and transfer pricing 32

3.6 Information requirement 33

3.6.1 Difficulties in determining information requirement 33 3.7 Relations within the theoretical framework 34

3.8 Conclusions 36

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Chapter 4: Organizational Context 37

4.1 Introduction 37

4.2 Organizational structure 37

4.2.1 Basis structure 37

4.2.2 Centralization and autonomy 38

4.2.3 Sub conclusion 39

4.3 Performance measurement 39

4.3.1 Financial Performance indicators 39

4.3.2 Control type 41

4.3.3 Sub conclusion 42

4.4 Targeting style 43

4.4.1 Appraisal of the level of centralization and the control type 43

4.4.2 Impact of transfer pricing 44

4.5 Conclusion 45

Chapter 5: Corporate Performance 47

5.1 Introduction 47

5.2 Calculation of local and corporate performance 47 5.2.1 Local performance calculation method 47

5.2.2 Corporate contribution approach 48

5.3 Case study 50

5.3.1 Comparison of subsidiaries 50

5.3.2 Comparison of products 52

5.4 Conclusion 54

Chapter 6: Information requirement 55

6.1 Introduction 55

6.2 Local Management 55

6.2.1 Local management 55

6.2.2 Sub conclusion on local management 57

6.3 Central Management 58

6.3.1 Central management 58

6.3.2 Sub conclusion on central management 60

6.4 Analysis of interview results 61

6.5 Conclusion 61

Chapter 7: Conclusions and recommendations 63

7.1 Introduction 63

7.2 Research question and conclusion 63

7.3 Recommendations 65

7.4 Conclusion on the research 66

7.5 Research reflections 67

Appendices: 71

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Chapter 1: Introduction

1.1 Introduction

In this chapter an introduction will be given on the company Biomet Inc. In paragraph 1.2 a brief history of how the company became as it is now, will be followed by a short overview of the products that are manufactured and marketed.

In paragraph 1.3 will be focused on how Biomet Europe was started and the way the organisation is structured in 2004.

In paragraph 1.4 recent developments will be discussed followed by a summary in paragraph 1.5.

1.2 Biomet Inc.

Biomet, Inc., incorporated in 1977, designs, manufactures and markets products used primarily by musculoskeletal medical specialists in both surgical and non-surgical therapy. The geographic markets of the Company are United States, Europe and Rest of the world.

The Company has manufacturing and/or office facilities in more than 50 locations worldwide. Biomet's principal subsidiaries include Biomet Orthopaedics Inc., Biomet Manufacturing Corp., EBI, L.P., Biomet Europe B.V., Implant Innovations Inc., Walter Lorenz Surgical Inc. and Arthrotek,

The Company's products include reconstructive products, fixation devices, spinal products and other products.

Orthopaedic reconstructive implants are used to replace joints that have deteriorated as a result of disease (principally osteoarthritis) or injury. The Company's primary orthopaedic reconstructive joints are knees, hips and extremities, but it produces other joints as well. The Company also produces the associated instruments required by orthopaedic surgeons to implant the Company's reconstructive devices.

The Company's fixation products include electrical stimulation devices (that do not address the spine), external fixation devices, craniomaxillofacial fixation systems, internal fixation devices and bone substitute materials utilized in fracture fixation applications. Internal fixation devices include products, such as nails, plates, screws, pins and wires designed to temporarily stabilize traumatic bone injuries.

Craniomaxillofacial fixation systems include both neurosurgical titanium and resorabable implants, along with associated surgical instrumentation, principally marketed by Walter Lorenz Surgical, Inc.

Spinal products include electrical stimulation devices for spinal applications, spinal fixation systems, bone substitute materials and allograft services for spinal applications and artificial disc replacement products.

Biomet also manufactures and distributes several other products, including orthopaedic support products (also referred to as soft goods and bracing products), arthroscopy products, operating room supplies, casting materials, general surgical instruments, wound care products and other surgical products.

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1.3.1 Biomet Europe

Biomet Europe initially arose when the Biomet Merck Joint-Venture was founded in 1998. Biomet Merck was established as a joint venture of Biomet Inc. (USA) and Merck KGaA, Darmstadt (Germany) and created one of the market leading orthopaedic companies in Europe. Before 1998 Biomet Inc. already owned some local companies. From 1998 up until now the joint venture acquired many local firms or started firms by it self. Merck KGaA is originally a pharmaceutical company and the joint venture was initialized to share knowledge on both pharmaceutical and orthopaedic issues. In 2004 Biomet Merck Group was the forth player in the European market for Orthopaedic products. This market is expected to keep growing due to demographical changes for the next nearby years. The last years Biomet Europe reported annual sales growth of about 10% leading to a net sales value of USD 383 million in 2004 (fiscal year ending first of may, 2004).

In March 2004, the Biomet Merck Group was renamed upon the acquisition of Merck's 50% interest in the parties’ European joint venture and became "Biomet Europe". The Biomet Europe Group is headquartered in Dordrecht (The Netherlands). Manufacturing takes place in France, Spain, Sweden, Germany, Poland and the U.K. In Europe, Biomet Europe employs approximately 1700 people.

Due to the rapid growth of Biomet Europe from 1998 till now, a large network of subsidiaries arose all across Europe. All of these subsidiaries were already existing local companies, except for Hungary where a totally new firm was started.

Subsidiaries in Europe are now located in 19 different countries. By acquiring existing firms in many different countries, the company is faced with all kinds of different cultures, organisations and systems. All these firms operate quite autonomous although they report monthly to headquarters in the Netherlands and their sales can be checked on detailed basis.

Besides the growth of subsidiaries, there was also a rapid growth in products during the last years. In 2003 and 2004, almost 26.000 different items, divided in about 330 brands, where sold by the local subsidiaries. The local subs are free to source their products wherever they like, at this moment Biomet Europe has approximately 300 different suppliers. Most of the products sold though are sourced by one of Biomet’s own Manufacturers, approximately 82%.

1.3.2 Biomet Europe Headquarters

At the Biomet headquarters in Dordrecht work about 30 people and is lead by a 3- headed board of directors’ with a Chief Executive Officer (CEO), a Chief Financial Officer (CFO) and a general Counsellor. The CEO is the president of the board and the CFO and general Counsellor are both vice-presidents. The CEO is directly in charge of the Business Development department, the general Counsellor in charge of the legal department. Four departments are lead by the CFO, the Internal Audit department, the Supply Chain management department, the ICT department and the department of Finance and Control. Within this last department’s team the business analyst is one of the members. The business analyst is responsible for financial and non-financial analyses of the companies business and markets. This survey is done within the Finance & Control department, in close cooperation with the business analyst.

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Fig. 1: Simplified Organogram Biomet Europe October 2004

1.4 Latest developments

After the acquisition of the other 50% of the Biomet-Merck Joint Venture and the start of Biomet Europe, the company started to focus on more corporate integration.

The Joint-Venture structure obstructed this integration for example at the field of research and development and product manufacturing allocation. Both companies took advantage of the Joint-Venture, the combination of a pharmaceutical and orthopaedic company led to strategic advantages, but the fear of losing important knowledge to the other party, caused that it was not possible to reach an optimal result of the cooperation. According to Laserre (Laserre, 2002), the fear of losing knowledge is one of the reasons Joint Ventures do not work out the way companies expect them to. Also political issues like the distribution of power, partitioning of responsibilities and the way the profit is divided have an important negative influence on the way business is done in a Joint Venture (Laserre, 2002).

During the months after de acquisition, projects were started in order to obtain more standardisation and integration within Biomet Europe. One of those projects was the Cost Price Analysis-project (CoPA-project). This project had the goal to develop a uniform-method to set cost prices for all Biomet’s products. Before, all the subs had there own way to determine their cost prices, this made it hard comparing them.

Another issue for Biomet is to improve the administrative, financial and management information systems. In order to improve these systems, sophisticated tools for automation were implemented. The most important tools are SAP R/3 and SAP Business Warehousing (SAP BW). SAP applications provide the capability to manage financial, asset, and cost accounting, production operations and materials,

CEO

Treasury

Consolidati on SCM-Team ICT-Team

Tax- manager Business Analyse CFO

General Counsullar

Internal Audit

Finance &

Control

Legal Department

ICT

IA-Team

Supply chain man.

Business Developme Engenering

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personnel, plants, and archived documents. SAP is now implemented in twelve countries.

SAP BW is a packaged, comprehensive business intelligence product centred on a data warehouse that is optimized for SAP. Like most data warehouses, BW is a combination of databases and database management tools that are used to support management decision-making. BW supplies the infrastructure typical of data warehouses, analysis and report tools which can be used on both corporate and local level.

Another very important development was called ‘Corporate Contribution 2005, new approach’. This development introduces a new way of looking at the contribution of the local parties within Biomet Europe to the group as a whole. The purpose of this project as stated in the report that was written by the Group Controller: ‘To further improve profitability analysis and to prevent transfer pricing discussions within the group, Biomet wants to implement a corporate contribution allocation system’. In this vision transfer prices discussions are redundant and top management, as well as local management only have to focus on corporate priorities. The transfer price according this vision should only reflect the manufacturing cost of the manufacturer.

In order to make good comparison between products, margins should be corporate based.

1.5 Summary

In this chapter a brief introduction was given on Biomet Europe’s activities, its business and how the organisation looks like. The market for orthopaedic products in which Biomet performs, still can be seen as a growth market due to the demographic tendencies. Biomet Europe has shown a rapid growth during the last few years and the latest developments within the organisation show how the organisation is trying to achieve more integration within the total Biomet Europe group. With the implementation of SAP BW many business information can be made available on both local and corporate level. The project Corporate Contribution 2005 can be seen as the main way of trying to achieve more integration, by focussing on corporate financial goals instead of many different local goals.

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Chapter 2: Research Design

2.1 Introduction

In this chapter the research design will be discussed. First in paragraph 2.2.1 the problem introduction is given. In 2.2.2 the problem stakeholders are determined followed by the problem statement in 2.3, which contains the objective of the research and the main question, the research restrictions, the conceptual model and the sub questions. Paragraph 2.4 will give the type of the research, as it will be carried out. In 2.5 the research methods will be discussed including the research constraints, data resources, the data collection methods per sub question and an introduction on the theoretical framework by given the literature the different subjects. The research model is given in 2.6. The chapter ends with the conclusions in paragraph 2.7.

2.2.1 Problem introduction

At this moment there is a gap between the corporate goals of Biomet Europe and the goals the local subs are pursuing. The main goal of Biomet Europe is to maximize profits of the group as a whole. The goal of the local subs is to maximize their own local profits. According to Sherif (Sherif, 1966) it can be seen as total human behaviour that people prefer their own profit above the overall group profit.

Although the profit of the group is the sum of all the local profits, these goals are not the same. Decisions to maximize local sub’s profit do not automatically maximize the profit for the total group due to the use of transfer prices. Within Biomet Europe local subs have a great autonomy in making decisions at all kinds of fields in their business. Besides that the local sub’s are not directly targeted on corporate goals, also strong cultural factors are influencing the local decisions. Almost every sub was an autonomous company before Biomet acquired them. The companies were not used to giving justification about the way they are running their businesses. Although they say to understand the importance of the performance of the group as a whole, they act in favour of their local interest. Local subs are free to choose where to source their products, as stated before about 82 percent is sourced within Biomet’s own production plants. Local subs are also free in setting their selling prices and therefore have a big influence on the profit they generate. Decisions they make are most of the time based on transfer prices, which only reflect the influence on their local profit. These transfer prices should only be used for tax purposes only, but in practice they are used widely, for example for sourcing decisions.

The corporate contribution is one of the performance indicators in the profit and loss statement, but it is not the main figure where the local subs are targeted on. The local subs do not have information about corporate contribution margins per product and so they cannot directly influence their performance on corporate contribution. This lack of information on the local level is seen as the main constraint why local subs cannot be targeted on corporate goals. This will be seen as the main problem within this thesis.

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2.2.2 Problem stakeholders

According to de Leeuw (de Leeuw, 1990) a problem can be defined as: The situation of subjective dissatisfaction of the problem stakeholder, combined with de desire to do something about it.

Looking at the problem of the gap between the corporate goals and the behaviour of the local subs, first of all can be said the problem is at this moment only seen by the headquarters. The local subs don’t see the actual situation as undesirable and therefore they will not see it as a problem. Within the headquarters the financial department is involved directly in issues concerning the monitoring of the financial performance of the business, in order to make sure financial goals of the company will be achieved. When these goals are not achieved or not fully achieved, financial data will be analysed in order to find out why these goals are not achieved. The corporate contribution project was initialized be the CFO and together with the group controller he wrote the rapport about the new approach. As head of the financial department the CFO will be seen as the main stakeholder of the problem.

Writing the rapport about the corporate contribution introducing the experienced dissatisfying situation, implicates he has the desire to do something about the problem. The CEO as end responsible is of course also involved in the problem, but his involvement is less direct on this issue.

De Leeuw distinguishes three types of organisational problems: Goal-problems, Perception problems and Reality problems. All three will be discussed here briefly.

Table 1: Different types of problems (De Leeuw, 1990)

Looking at the problem as stated, it cannot be seen as a goal problem. Improving the way local subs behave in order to achieve more corporate targets is not an unrealistic goal. If the goal would be to reach absolute achievement of corporate goals by changing the local behaviour, then it would be unrealistic.

The problem can also not been seen as a perception problem. Analyses of the decisions made by local sub’s show that different results would have been achieved when local managers would have made different choices, according to corporate goals.

According to de Leeuw, when a problem is not a goal or a perspective problem, a problem can by seen as a reality problem. Reality problems are control problems for the problem stakeholder. In this case the situation that local subs cannot be targeted on corporate values due to the lack of information that is available for the local subsidiaries.

Goal-problem Problems arise when the goals of a problem stakeholder are not achievable and unrealistic.

Perception- problem

Problems arise when problem stakeholders have a wrong view of what’s really happening in the organisation.

Reality-problem Problems where the solution cannot be found in the perception or the goals of the problem stakeholder.

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2.3 Problem statement

According to Verschuren (1986), the problem statement of a research must be separated in two parts. The first part is the objective of the research. In the objective of the research, the reason for the research has to be given; it has to give answer to the question why a research has to be carried out.

The objective of the research:

To provide insight in the information required by central and local management in order to improve targeting local subsidiaries on their corporate performance using the corporate contribution approach.

The second part of the problem statement is the main question in the research. The answer to the main question has to provide the information about what is carried out within the research.

The main question in the research:

What information regarding the corporate contribution approach has to be available for central and local management in order to improve targeting local subsidiaries on their corporate performance?

2.3.1 Research restrictions

The research has to be carried out under some specific restrictions, which can be separated in restrictions concerning the content of the research and restrictions concerning the process of the research.

Content restrictions:

- The results from the CoPA-project will not be discussed within the research.

- The relation with Biomet Inc. and the relation with other subsidiaries of Biomet Inc. will not be discussed within the research

Process restrictions:

- The research is carried out for Biomet Europe, Dordrecht the Netherlands.

- Market sensitive information will be excluded from the public version of the rapport.

- The research is carried out during a period of six months, from October 2004 until April 2005.

2.3.2 Conceptual model

The conceptual approach is not an empirical theory but it is a way of looking to organizational problems. Concepts and methods are used for theory and model building in order to approach reality and the relations between aspects concerning the problem (De Leeuw, 1990). In figure 1 the conceptual model that will be used in this research is given.

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The central object in this model is the information requirement. The eventual result of this research is to provide insight in this information requirement for both central and local management in order to make it possible to target local subs on corporate values. In order to influence the local decisions, central management will require specific information to monitor the actions taken by the local subsidiaries. This monitoring of these actions taken will determine the way targets will be set for the local subsidiaries.

Local management will also need specific information to meet the new target set by central management. When new targets are set, in this case the increase of corporate performance instead of local performance, different information will be needed to make the decisions effectively increase the corporate value of the firm.

Figure 2: Conceptual Model

The information requirement of both central and local management is influenced by the organizational context of the firm. According to Pascoe (Pascoe, 1997) for different organizational structures, different information is required to make proper management decisions. The organizational structure also influences the way performances within the organisation are measured. There are many ways of determining the performances of a firm. The performance measurement system has to fit the organizational structure in order to achieve the goals that are set for the firm. Several theories describe the optimal performance measurement systems for Central Targeting

Local Decisions

Increasing Corporate Performance

Information Requirement Performance

Measurement

Targeting Style Organizational

Structure

Organizational Context

Corporate Performance

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the divisionalized firm and also transfer pricing plays a role in determining a firm’s individual performance. Both described organizational context factors influence how the control style of a firm can be characterised. Van Oijen (van Oijen, 1997) distinguishes four different control styles looking at the organizational structure, especially the level of centralisation, and the way divisions are targeted and their performances are measured.

2.3.3 Sub-questions

In order to give answer to the main question, sub-questions are formulated using the conceptual model as presented in the paragraph 2.3.2.

Organizational Context:

1. How can the organizational structure of Biomet Europe be characterised?

2. How can the performance measurement and control system of Biomet Europe be characterised?

3. How can the targeting style of Biomet Europe be characterised?

Corporate Value:

4. What is the corporate performance of a local subsidiary?

5. How do local decisions influence the corporate value of Biomet Europe?

Information Requirement:

6. What information is required on central level in order to target local subs on corporate performance?

7. What information is required on local level in order to make decisions in favour of the corporate performance?

Recommendations:

8. What conditions have to be fulfilled in order to improve the targeting of local subs on their corporate performance?

2.3.4 Definitions

Here an overview is given of the definition of key-items as used within this research.

These definitions will be used in the research, unless stated otherwise Key-item Definition

Contribution Margin A cost accounting concept calculated as total revenue from a product or service, less the manufacturing cost.

Corporate Performance

Performance for the Biomet Europe group as a whole.

Local behaviour Actions and reactions taken as a result of decisions made by local management.

Local Subsidiaries The sales and production organisations in Europe.

Targeting Intentional actions taken to influence behaviour of local subsidiaries.

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Transfer Pricing The price that is assumed to have been charged by one part of a company for products and services it provides to another part of the same company, in order to calculate each division's profit and loss separately.

Table 2: Definition of Key-Items

2.4 Research Type

Different types of research can be distinguished in order to give answer to different kinds off problems. According to De Leeuw (1990), research can by characterised in five ways. A brief overview of these research types is given in table 2.

Research Type Description Practical organisational

handling

Taking specific actions in order to solve certain problems.

Problem solving research

Research leading to specifications of the actions that have to be taken to solve certain problems.

Policy- supporting research

Research leading to information about facts and relations that are relevant for decision making. No

recommendations are made.

Policy relevant research Research leading to information about social problems people are concerned about.

Theory forming research Research leading to new theories, no link with a direct problem can be seen.

Table 3: Research types (De Leeuw, 1990)

Looking at this research types, this research can be seen as a policy supporting research. By giving insight in the required information for central and local management, information is generated that is relevant for decision-making. No direct specifications are given for the design of the Management Information System;

only the first step of identifying the problem and the solutions is taken. In figure 2 the model for systems development is given, showing in which phase this research is carried out.

The first activity is the systems analysis. This is the analysis of the problem that the organization will try to solve with the information system. It consists defining the problem and its causes, specifying the possible solution and the information requirements that have to be met by the system. How these information requirements are met, must be specified in the systems design phase. Like a blueprint, it has to give all the specifications that give the system form and structure.

The role off end-users is very important here. After this the new system has to be tested. Several tests can be carried out. For example: Unit testing, system testing and acceptance testing. These tests must determine whether the system produces the desired information under known conditions. If the tests are positive the conversion to the new system can be started. The old system will now be replaced by the new system. Several strategies can be followed for the conversion varying from a direct cutover to a more phased approach. The last activity is the production and

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maintenance. Here system errors will be corrected, processes or procedures will be improved and little changes can be made in the total system.

Figure 3: Model for Information System Development (Laudon and Laudon, 2002 page 316)

2.5 Research methods

In this paragraph will be discussed which methods will be used in order to answer the research question. First the research constraints will be discussed in order to determine under what conditions a research must be carried out.

Second will be discussed how the necessary data will be collected. This will be done by determining a data collection method per sub-question. In 2.4.3 the theoretical framework will be discussed.

2.5.1 Research constraints

According to de Leeuw, (De Leeuw, 1990) a research must be relevant and reliable. A research is relevant when the produced knowledge is in time, understandable for those who have to work with it and there is a direct relation with the management problem. In this research the relevance constraint is tried to be achieved by trying to bring results that are direct related to the problem as stated in the problem description and the relation with the problem stakeholder. In the formulations within the research is kept in mind that it must be possible to read the rapport without explicit foreknowledge about the subject. The time constraint was already discussed in the research restriction, the research is carried out from October 2004 till April 2005, and the final results must be available at least June first.

Reliability contempt’s all the aspects off science that make it possible to that the result can be trusted. This can be parted into correctness; is it true what is stated, precision; the more precise the results are, the more reliable they are, and consistency; inconsistent results are useless.

In order to achieve reliability, the data resources and the data collection are very important. It’s only possible to gather correct and precise information if you use the

Systems Analysis

Programming Testing

Conversion Production

and Maitenance

Systems Design Systems

Analysis

Programming Testing

Conversion Production

and Maitenance

Systems Design Systems

Analysis

Programming Testing

Conversion Production

and Maitenance

Systems Design

Research Domain

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right data source that can give this information, and the way you collect this information matches this data source.

2.5.2 Data resources and collection

De Leeuw (De Leeuw, 1990) distinguishes six types of data-sources, which will be briefly discussed here.

Documents: All different kinds of written information for example books, rapports and magazines, but also archives and other parts of researches

Media: Newspapers, magazines, radio and television contain a lot of information about companies and recent development that could be useful for research

Databases: Lots of information and figures can be gathered from databases composed by government or trade organisations

Reality (The Field): This type can be separated into the physical reality and the social reality. The data collection method is extra important at this type; especially within the social reality it can be hard to distinguish the difference between facts and judgements.

Imitated reality: Laboratory research, not often used in organisational research

Researchers’ experience: A very critical attitude must be held towards this type of data resource.

Several data collection methods can be used in a policy-supporting research. These methods will be discussed here briefly.

Desk research: Analyses of documents, rapports and written policies.

Literature study: Analyses of earlier researches and books on the subject Field research: Question forms, interviews, case studies, experiments, tests, etc.

Below an overview is given of the data source and data collection method per sub question.

Sub question Source Method

1 How can the organizational context of Biomet Europe be characterised?

Documents Field

Literature Deskres 2 How can the performance measurement system of Biomet

Europe be characterised?

Documents Field

Literature Deskres.

3 How can the targeting style of Biomet Europe be characterised?

Documents Field

Literature Deskres.

4 What is the corporate performance of a firm? Documents Field

Literature Deskres.

5 How do local decisions influence the corporate performance of Biomet Europe?

Field Testing

6 What information is required on central level in order to target local subs on corporate performance?

Field Interview

7 What information is required on local level in order to make decisions in favour of the corporate performance?

Field Interview

8 What conditions have to be fulfilled in order to improve the targeting of local subs on their corporate performance?

Field Interview Analysis

Table 4: Data source and collection method per sub question.

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The interviews will be held with both people from the Biomet Headquarter and Biomet Nederland. From the headquarters the CEO and CFO will be approached.

The CFO as problem stakeholder and the person who directly targets local subs on their financial performance, and the CEO as the eventual responsible person for the corporate performance of Biomet Europe as a whole.

From Biomet Nederland the Managing Director as directly responsible for the (financial) performance will be approached. Also the Financial Controller will be interviewed as person who has direct insight on information flows, and influence on decisions made at the local level.

All different kinds of interviews can be distinguished that can be used for scientific research. According to Baarda en de Goede (Baarda en de Goede, 1997), interviews are the best way to analyze people’s attitudes, opinions or knowledge.

Disadvantages according Baarda en de Goede of interviews are that people are not always aware of their behaviour, social desirability of the answers people give and non-response.

Interviews can be structured or unstructured. Structured interview are most of the time used in case it’s very clear what information is required. The answers to the questions are known before hand, and the interview is used to test which answer the respondent will choose. The interviewer extendedly prepares the questions used during the interview. These questions can be open or closed, depending on the extend of the complexity of the subject and the knowledge of the interviewer. The more knowledge of the interviewer and the less complex subject, the questions can be more closed (Baarda en de Goede, 1997).

In an unstructured interview the interviewer does not have a clear overview of the answers that can be given, the interview is used to explore the respondents’ opinion or attitude. The preparations of the interviewer focus on the subjects that will be discussed during the interview instead of the preparations of precise questions. In an unstructured interview open questions are used due to the higher level of complexity of the subject and the limited knowledge about the answers that will be given (Baarda en de Goede, 1997).

In this research semi-structured open interviews will be held. The purpose of the interviews is to determine the information requirement of both central and local management in relation to the increase of the corporate performance of Biomet Europe. This subject is quite complex and the answers that will be given in the interviews cannot totally be determined beforehand. The interviews will not be totally unstructured, during the interviews analysis will be used that are made on specific cases of Biomets’ operational activities (see chapter five). These analysis together with theoretical subjects focussed on Biomet, will be input for the interviews and will determine the subjects that are going to be discussed.

2.5.3 Theories used

In this sub-paragraph the theory will be discussed that will be used to answer the sub questions, and eventually the main question of the research.

Organizational Context:

As stated when the conceptual model was discussed in paragraph 2.3.2, the main theory used to analyze the organization context is the theory of van Oijen. (Van

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Oijen, 1997). The theory of van Oijen describes the relation between the organizational structure and the performance measurement system by looking at the level of centralization and the control type of the organization. The relation between the centralization and the control type is used to determine the targeting style of an organization. The advantage of van Oijens theory is that it combines theories on relations between organizational structure, performance measurement and targeting style. In literature many authors did research on the relationship between organizational structure and corporate performance like Chandler (1967) and Hill (1988 and 1994). Chandler was the pioneer in the field of the divisionalized structure, as according to his research the functional structure did not meet the requirements of the larger companies in the sixties. Hill (1988) pointed out the difficulties in performance measurement of divisionalized organizations by looking at the accountability of performances to the different divisions within an organization. The internal dependability of divisions makes it hard to make a division fully responsible for a performance. Performances do not simply reflect the efforts made by a division;

Hill describes this as ambiguity of performance (Hill, 1994). Remedies to this ambiguity are the increase of information processing capacity of the headquarters and the use of more subjective performance indicators.

In this research Biomet Europe’s intention to us a corporate contribution approach in order to measure the sub’s performances asks for objective performance indicators.

Although van Oijens theory may be quite abstract, it does not give specific solutions how headquarters should target their subsidiaries, it is very useful to look at the implications of corporate performance indicators in the organizational context.

Corporate Performance:

As mentioned before in the problem introduction the increase of a subsidiaries individual, local performance does not automatically mean the performance of the company as a whole will increase. The transfer pricing system of an organisation determines how internal transactions between subsidiaries have to been taken care of and how the transfer price will be calculated. Transfer pricing systems are used for tax-purposes (for international operating organisations) and for strategic reasons (Eccles, 1983). For this research only the strategic transfer pricing system will be used, the tax reasons for transfer pricing are beyond the scope of this research.

In order to analyze the local contribution of the subsidiaries to the performance of Biomet Europe as a whole, the transfer pricing theory of Eccles will be used (Eccles, 1983). Eccles distinguishes different transfer pricing methods for different strategic purposes. The main difference in transfer pricing systems is whether they are based on market prices or based on cost prices. Looking at the corporate contribution method of determining a subsidiaries performance, the difference between the market and cost price based method is the most important changing factor. Although he is still seen as the most important author on transfer pricing many other authors have criticized the shortcomings of the theory of Eccles. Van der Meer-Kooistra (2001) for example stressed the importance of transaction cost for transfer pricing.

For this research these shortcoming are not directly relevant because they do not influence the way of looking at the current and future transfer pricing systems of Biomet Europe. Looking at the further implications of a transfer pricing system and the shortcomings of the theory of Eccles would go beyond the scope of this research.

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Information Requirement:

In order to asses the information requirement of both central and local management that will be distinguished during the interviews that will be held, the concepts of Davis and Olson will be used. Davis and Olson distinguish different factors that are important when trying to determine people’s information requirement in specific situations. Davis and Olson discuss specific information requirements for management information systems and the difficulties in determining those information requirements of people.

On the one hand the concepts will be used to avoid the pitfalls of gathering information during the interviews, on the other hand they will be used in order to assess the gathered information requirement of both central and local management.

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2.6 Research Model

Figure 4: Research Model

Introduction (Chapter One) Problem Statement (Chapter Two)

Theoretical Framework Sub question 1,2 and 3

(Chapter Three)

Corporate Performance Sub question 4 and 5

(Chapter Five)

Information Requirement Sub question 6 and 7

(Chapter Six)

Introduction

Information Requirement

Corporate Performance Organisational Context

Conclusions & Recommendations (Chapter Seven)

Literature StudyInterviewsTesting

Organisational Context Sub question 1,2 and 3

(Chapter Four)

Field Study

Introduction (Chapter One) Problem Statement (Chapter Two)

Introduction (Chapter One) Problem Statement (Chapter Two)

Theoretical Framework Sub question 1,2 and 3

(Chapter Three) Theoretical Framework

Sub question 1,2 and 3 (Chapter Three)

Corporate Performance Sub question 4 and 5

(Chapter Five) Corporate Performance

Sub question 4 and 5 (Chapter Five)

Information Requirement Sub question 6 and 7

(Chapter Six) Information Requirement

Sub question 6 and 7 (Chapter Six)

Introduction

Information Requirement

Corporate Performance Organisational Context

Conclusions & Recommendations (Chapter Seven)

Literature StudyInterviewsTesting

Organisational Context Sub question 1,2 and 3

(Chapter Four) Organisational Context

Sub question 1,2 and 3 (Chapter Four)

Field Study

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2.7 Summary

In this chapter the research design was discussed. After the problem and the problem stakeholder were described, the goal of the research and the main question were determined in the problem statement. The main goal of the research is determining the information requirement of central and local management system providing information on which basis local management can make better decisions in favour of the corporate performance. In the conceptual model a simplified reproduction of the factors influencing the information requirement is given. Based on these factors sub questions are formulated in order to answer the main question of the research.

After this the research constraints and the research methods were discussed in order to determine the way the research will be carried and which theories will be used.

Finally in the research model the structure of the research is given. The structure of the thesis is directly corresponding with this research structure.

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Chapter 3 Theoretical Framework

3.1 Introduction

In this chapter theories and literature concerning this research will be discussed. A brief overview will be given of the history of performance measurement of divizionalized firms and the roles of central management and the most important theories. The relationship between these factors will be discussed using the theory of van Oijen. After this, theory on information requirement for Management Information Systems will be discussed.

3.2.1 Divisionalized Structure.

The divisionalized structure arose in reaction on the functional form, which was the only organisational form for large companies for many years. In 1962, Chandler was the first to write about the shortcomings of the functional structure. According to Chandler top management was too much involved in operational activities and had no time and information to be a good entrepreneur and were not able to make proper strategic decisions (Chandler, 1962). Decisions were made as the result of negotiations between functional managers only interested in their particular part of the business and not interested in the performance of the company as a whole (Chandler, 1962). The shortcomings of de functional structure especially became clear when companies expanded geographically or diversified their product portfolio. The

‘bounded rationality’ of people implicated that top management has a limited span of control and a companies have to be aware of this when they expand (Williamson, 1975). In order to adjust to the right span of control, additional hierarchical levels have to be created.

Different forms of the divisionalized structure can be distinguished. According to Dessler (Dessler, 1986), divisions can be formed by product group, client group, distribution channel or geographical area. In practice this partitioning is used in a hybrid form, functional departments are later on departmentized according to the factors mentioned above. A very common example is a sales department (functional) that is later divided in several sales districts (divisional).

One thing in which the divisionalized structure differs from other organizational structures is that within the same structure, different structures can exist (Mintzberg, 1983). In theory any other organizational form can be seen within each division. In contrast to many expectations, divisionalized firm can be quite centralized. The division’s manager still can keep most of the power by preventing further decentralization down the line or by horizontal decentralisation to staff members.

The most famous example is that of General Motors’ restructuring in the 1920’s. GM is known as one of the first divisionalized companies worldwide but also as one of the most centralized companies. A company can be divisionalized with only one extra level in the hierarchy, the level between top and middle management, creating the autonomy of the divisions.

Research findings concerning the benefits of the divisional structure over the functional structure suggest two conclusions: The divisionalized structure facilitates

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coordination (Walker en Lorsch, 1968) and, as mentioned before, the divisionalized structure fits best to companies with a diversification strategy (Chandler, 1962).

Figure 5: Divisionalized structure (Free to Mintzberg, 1983 and van Oijen, 1997 page 13.) 3.2.2 Centralization and Autonomy

According to Mintzberg (1983): The divisionalized firm relies on the market basis for grouping units at the top of the middle line. Divisions are created according to markets served and are then given control over the operating functions required to serve these market.

The key part of the divisionalized structure is the middle line (the division managers). Responsibility for operational activities have to be delegated to this middle line in order to give top management the possibility to focus on strategic and entrepreneurial issues. Not all responsibility and power will be delegated to middle management, this would involve that the function of top management will be redundant (Mintzberg, 1983). Harmonisation has to be found in the deviation of responsibility and power between middle and top management. The problem within this harmonisation is how top management can maintain control while middle management keeps enough autonomy to manage the operational business.

According to Malone (Malone, 1997) the rise of IT offers solutions for these kinds of problems as information system can help to sort out top down/bottom up questions.

The solution to this problem has to be found in the performance measurement system as the main coordination mechanism (Mintzberg, 1983). For the divisionalized firm the performance measurement system has to focus on standardization of outputs. Most of the time divisions almost have full autonomy to make their decisions and this implicates that performance evaluation is done after the facts occurred. Most of the times in quantitative terms like profit, sales or return

Top-management

Staf

Headquarters

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of investment. In paragraph 3.3 the methods and theories on performance measurement systems will be further discussed.

Another coordination mechanism according to Mintzberg is the standardization of managerial skills. Due to the autonomy in decision making of middle management, the competence of this middle management is the most important factor determining the performance of the organization as a whole. The interest of top management will be to ensure the division managers to pursue the broader goals of the organisation instead of goals of their own divisions. This kind of coordination most of the time takes place in the form of meetings or conferences organized by headquarters and is the only direct form in which top management will influence operational decision making. To have a closer look on the labour and power division between top and middle management, here the most common functions of both will be discussed according to the division Mintzberg distinguishes.

The responsibilities of the middle management are quite simple. According to Mintzberg: Divisions are given the power to run their own businesses. They control the operations and determine the strategy for the markets that fall under their responsibility.

For top management Mintzberg distinguishes six functions (powers), which will be briefly discussed in table 5.

Function Description

Overall strategy Determining the product-market combination for each division (the strategic portfolio).

Allocation of financial resources

Managing the shared resources of the divisions.

Authoriztion for larger capital projects influences the autonomy of the divisions.

Appointment middle management

Appointing and replacing middle management. Most direct influence on operating decisions, competence of middle management is crucial.

Design of the perfor- mance control system

Determining how performances are measured, reported and evaluated.

Monitoring

divisional behaviour on personal basis

Kind of direct supervision by visiting divisions’ plant to

“keep in touch”. Information can be exchanged between top and middle management.

Providing certain support services common to divisions.

Providing coordinated services that must be offered to a range of divisions or must be provided at the common strategic top.

Table 5: Functions of top management of a divisionalized firm (free to: Mintzberg, 1983)

These functions are most of the time very strictly divided. Operational information flows have to be limited in order to prevent headquarters meddling in operational decision-making. This meddling would be a severe violation of the autonomy of the division.

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3.3. Performance Measurement and Control

As mentioned in paragraph 3.2, according to Mintzberg the performance measurement system is the most important coordination mechanism for the divisionalized form. Performance Measurement of multi-divisionalized companies has been an area of interest for many managers and authors ever since the divisionalized form rose. In this paragraph an overview will be given of the most widely accepted performance measurement concepts and theories. In paragraph 3.3.1 different control types will be discussed using the theory of Goold and Campbell.

After this in paragraph 3.3.2 a brief overview will be given of financial ratios used to determine a divisions performance. In 3.3.3 the influence of transfer pricing on performance measurement will be discussed.

3.3.1 Control Types

In addition to the functions of central management mentioned in paragraph 3.2.2 here different control types will be discussed that central management can apply when targeting local divisions and local management. The control types in fact describe how the functions of central management are carried out in practice, for example on what functions is mostly emphasized, not every function will be equally paid attention to.

A very general distinction in control types is the difference between tight control and loose control (Merchant & van Stede, 2003). Although the functions of Mintzberg seem quite clear and strict, there are many ways in which they can be carried out. For example resource allocation, within one organization a telephone call will do in order to receive an additional amount of cash for different purposes. In other organizations full analysis has to be given for what reason the cash is needed and how it will be spent. In the first organization the control type can be characterised as loose, and in the second organization as tight.

Other examples can be seen with the performance measurement system. Especially the frequency of reporting is very important. It makes quite a difference whether divisions have to report on monthly, quarterly or yearly basis. Also the quantity and level of detail determine how tight or loose the performance measurement function is applied.

The other distinction in control types is the well-known typology of Goold and Campbell. According to Goold and Campbell (1994) the control types, or management styles as they call it, can be characterised using two dimensions:

Planning influence and Control influence. Planning influence refers to the approach that central management takes to the formulation of plans, strategies, and budgets in the businesses. It varies from low influence (highly decentralized), to high influence (more centralized). The control influence refers to the approach central management uses to control the process. This dimension can vary from emphasize on the short- term financial targets to emphasize on the long-term strategic and competitive position.

As shown in figure 6, the two dimension lead to three different control types;

Strategic planning with a high planning influence and a flexible control influence, Financial Control with low planning influence and tight financial control influence, and Strategic Control that is a combination of both.

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Fig. 6, Management Styles, (Goold, Campbell and Alexander, 1994 page 412)

3.3.2 Financial Performance Indicators

Many different ways can be distinguished in measuring the performance of a firm or division. External performance measurement like (semi) annual reports, have to be made under strict legal conditions. All kinds of standards are made in order to reach uniformity in the way companies present their financial results. These figures from the external reports most of the times give a good insight how a company is doing, but they don’t offer a handle to target companies, divisions and their managers. For this purpose all different kinds of performance indicators were developed during the last decades especially for comparing performances of different divisions within a company. These indicators differ from very simple sales based figures till more complex indicators like Return On Investment, Economic Value Added and Residual Income. Some of these figures that are relevant for this research will be discussed here.

The first line on any income statement is an entry called total revenue or total sales.

This figure is the amount of money a business brought in during the time period covered by the income statement. It has nothing to do with profit. The revenue figure is important because a business must bring in money to turn a profit. If a company has less revenue, all else being equal, it’s going to make less money.

Many companies break revenue or sales up into categories to clarify how much was generated by each division. Clearly defined and separate revenues sources can make analyzing an income statement much easier. It allows more accurate predictions on future growth.

Gross Margin is the first step in analyzing how well the company is doing. It helps to evaluate the mark-up over cost of goods sold. If you are in a highly competitive business your mark-up or gross margin will be lower than that of another business that has more control over pricing.

Planning Influence

Control

Flexible Tight Strategic Tight Financial High

Low

Strategic Planning

Strategic Control

Financial Control

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The profit margin tells you how much profit a company makes for every $1 it generates in revenue. Profit margins vary by industry, but all else being equal, the higher a company’s profit margin compared to its competitors, the better. Several financial books, sites, and resources tell an investor to take the after-tax net profit divided by sales (Merchant & Van Stede, 2004). While this is standard and generally accepted, some analysts prefer to add minority interest back into the equation, to give an idea of how much money the company made before paying out to minority

“owners”. Either way is acceptable, although you must be consistent in your calculations. All companies must be compared on the same basis. Operating expense ratios simply measures any expense you choose as a percentage of Net Sales. There are a variety of expenses, but the biggest ones are usually wages, rent, and materials.

It is not necessary to focus in on the expense of paper clips used to net sale. It is more important to select those expenses that represent the largest percentages of your budget. Contribution Margin & Break Even are closely related as they are both focusing on Fixed Costs. Fixed Costs that do not change with the level of production or sales volume such as rent and insurance. By subtracting all the direct variable costs of production from the sales dollar you are left with an amount that will be applied to fixed costs and profits, the contribution margin. Break even occurs when all costs of production, both fixed and variable, have been recovered through sales.

3.4 Targeting style

In this paragraph the relation between the organizational structure (§ 3.2) and the performance measurement & control system (§ 3.3) will be discussed using concepts of van Oijen (1997).

To determine the targeting style of an organization van Oijen distinguishes two dimensions; Centralization and Control. Using these two dimensions, four different targeting styles can be found. Two of these styles are undesirable because there is no fit between the level of centralization and the control type. The other two targeting styles do have a fit and are useful for multi divisional organisations, see figure 8.

Figure 8: The four targeting styles of headquarters (van Oijen, 1998: page 16) Centralization

Control type

Strategic Financial

High

Low

Cooperative Style

Under targeted

Competitiv e Over targeted

(‘Snake’)

Referenties

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