1. Context 1.1 Brief analysis of the situation
The management of Armco, Inc.: Midwestern Steel Division began implementing a new performance measurement system in January 1991.

Bob Nenni, Director of Finance for the Midwestern Steel Division, explained the rationale for this new system: The old system had managers spending more time explaining why changes in cost were due to accounting system problems than they did fixing the problems.

The new system will provide for management better management focus on the things that are most important for managers to worry about, earlier warning of problems, and improved commitment to achieve objectives.

1.2 Background on Armco, Inc.: Midwestern Steel Division
Armco Inc. is a producer of steel products. Within the Armco Inc. Midwestern Steel Division, the Kansas City Works was the largest entity, accounting for approximately $250 million in sales. However, business at Kansas City Works had declined significantly in the last decade.

The Kansas City Works produced two primary products: grinding media and carbon wire rod. Armco was recognized as the leading supplier of grinding media products in the United States. Carbon wire rods, on the other hand, were made by Armco’s rod mill, which used relatively old technology and was not cost competitive, so rods were not a profitable product. But the rods did generate volume and helped cover some of the fixed costs of the plant.

The Kansas City Works was not a low-cost manufacturer, with its union labour costs higher than some of its nonunion competitors. Also, the Works had an inefficient plant infrastructure, accommodating less than its optimum number of employees and is inefficiently laid out. This cost disadvantage from the plant causes managers to looked for ways to differentiate their products and to develop new higher-value products, and they had some success in doing so.

All salaried employees in the Works were eligible for cash incentive awards based on a performance evaluation made by their immediate superiors and, ultimately, Rob Cushman, the division president. The award ranges from 5-30% of annual salary depending on the individual’s organizational level. The performance evaluations were subjective but were based on, typically, three measures of performance applicable to the position – plant safety, hard production numbers and evaluation of “leadership”.

1.3 Strategy being followed
Armco implements a results control system, where individuals are rewarded for generating good results.

2. Issue Identification
2.1 Challenges facing Armco, Inc.: Midwestern Steel Division

2.1.1 Challenge 1: Ineffectiveness of old system
Before 1991, Armco was measuring cost performance through an ‘Operating Statistics Report’ (“Old system”). Rob and Bob found this to be an ineffective report for managers, with too much data for them. They believed that it causes managers to focus on the details instead of the key objectives.

The old system is also ineffective for management. The performance of the cost center managers and their superiors in the plant were evaluated in terms of cost control and safety. The key cost performance measure was a summary measure called “Cost Above” which included the cost added per ton of steel at each production stage and for the entire plant.

This is ineffective as Cost Above is an evaluation for the entire plant, and not the segment that individuals are in charge of. Thus, the individuals do not have significant influence on the full value of Cost Above. This undermines the effectiveness of using Cost Above as the measure for performance. This is because the individual have limited control on Cost Above, yet it is used as the key indicator to value the individual’s performance.

The cost part of the old performance measurement system was built for accountants, not for management to measure performance.

Furthermore, under the old system, individuals were rewarded based on subjective performance measurements. An individual’s immediate supervisors or the president decides the evaluation and reward.

A lack of objectivity in measuring the results causes the old system to be ineffective. Supervisors can be bias towards certain employees, rewarding them even if when they did not achieve desired results.

When results are tied in with performance bonus, the old system presents a flawed way for managers to lose focus on pressing issues and for management to decide on its incentive distribution.

2.1.2 Challenge 2: Rejection of new system by current employees
The operating managers have become accustomed to the ‘Operating Statistics Report’ (“Old system”) and in general they liked it. Paul Phillips, the Rolling and Finishing Manager, liked the monthly and annual trends and the information comparing actual costs with objectives, stating that the Operating Statistics Report was “the minimum amount of detail necessary”.

When the pilot performance report was released, the initial reactions of the operating managers’ were dissatisfaction. The sample reports did not provide the line-item expense detail to which the mangers had become accustomed. Furthermore, Cost Above information were no longer given. Managers commented that they are receiving “nothing of use”.

Bob Nenni still believes that the company is on the right track with the new system. However, managers continue to have the mindset that the old system was more favorable and many remained uncomfortable with the new system.

2.1.3 Challenge 3: Decision to allow uncontrollable factors affect the evaluations of managers
Rob Cushman had to come to a decision to whether or not he should let uncontrollable factors that affect the plant’s performance and distort the results published on the performance evaluation reports, influence the evaluations of his operating managers.

2.1.4 Challenge 4: Decision to increase the proportion of total compensation that was linked to individual performance evaluations
Rob Cushman was conflicted on the decision of how much of total compensation should be provided in the fixed salary.

2.2 How Armco, Inc.: Midwestern Steel Division cope with these challenges
2.2.1 Challenge 1: Ineffectiveness of old system
The lack of effectiveness in the old system motivated Bob Nenni and other managers to design a new system. The new system defined 10 key performance measures for the Kansas City Works (Appendix 1).

2.2.2 Challenge 2: Rejection of new system by current employees
2.2.3 Challenge 3: Decision to allow uncontrollable factors affect the evaluations of managers

2.2.4 Challenge 4: Decision to increase the proportion of total compensation that was linked to individual performance evaluations

2.3 Efforts made by Armco, Inc.: Midwestern Steel Division to address the challenges

3. Issue Analysis

3.1 Key factors influencing the behavior of people in Armco, Inc.: Midwestern Steel Division
Under the old system, the performances of the cost center managers and their superiors in the plant were evaluated in terms of cost control and safety, with the key performance indicator being ‘Cost Above’.

As a result, managers are likely to place emphasis on this Cost Above value as it is the value being measured to decide each employee’s reward. However, the Cost Above value provides for the performance of the entire plant, which is uncontrollable by an individual. Thus, such performance measure tells us nothing about that were taken by individual managers. It deviates from Armco’s objectives of putting incentives to motivate managers to work towards more profitable methods of production.

In a way, such method of evaluation creates the control issue where there is personal limitation as individuals are not capable of doing what is expected of them, when the value in question is one too grand for an individual to control by himself.

While Armco publishes its objectives, they are projected for the entire company, not for individual cost center managers. Thus, result control is lax as there is no specificity

3.2 How Armco, Inc.: Midwestern Steel Division is prevented from accomplishing its objectives due to these factors

4. Recommendations

4.1 Recommendation
4.2 Intended consequence
4.3 Support for recommendation due to analysis

Appendix 1
10 key performance measures: 1. Heats per week 2. Tons per man hour 3. Disabling injury index 4. Total quality index 5. Spending 6. Maintenance performance 7. Cash flow 8. Product mix 9. Inventory days on hand 10. Sales price minus cost of net metal