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Merchant, K.A., Van der Stede, W.A. (2003) Management
Control Systems. Third Edition. Financial Times Prentice
Hall. Chapter 7, pp 275-282.
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Kranworth Chair Corporation
Do not remove this notice
In July 2003, Kevin Wentworth, CEO of Kranworth
Chair Corporation (KCC), was considering a major
reorganization - a divisionalization - of his com­
pany's organization structure:
name was a contraction of the founders' names:
Krantz and Wentworth.) KCC was headquartered in
Denver, Colorado, in the foothills of the Rocky
Mountains. KCC produced a broad line of high­
quality and fashionable portable, folding chairs,
Like many entrepreneurs, l have always been focused which were branded as various models of the Fold­
on top-line sales growth, and I have constantly been
impressing on my managers to drive sales. My belief it! brand. In its early years, KCC sold its products
was that if you do that, everything else takes care exclusively to distributors.
Since its inception, KCC had been organized
of itself. Up until recently, I think our approach made
functionally.
In 2003, reporting to the cofounders
sense. We had very little competition, and our mar­
were
vice
presidents
in charge of sales, supply
gins were huge.
Now things are changing. We've got some major chain, and finance and administration, plus staff
competitors who are making headway. I think we managers responsible for advertising and research
needed to take a fresh management approach to find and development (Exhibit 1).
opportunities to do things better. Our new divisional­
Over the years, KCC expanded its product offer­
ized organization structure should help us serve our ings. In 2003, it offered an extensive line of folding
customers better and maybe force us to eliminate chairs. The chairs were produced in various sizes
certain markets or products that are not producing and models, including both adult and child chairs,
results.
But I'm not sure it's working very well. We're see­ single chairs and loveseats, and full- and beach­
ing some finger pointing between the managers of the height chairs. Some chairs had additional features,
newly created divisions and the managers in charge such as cup holders, storage pockets, and trays. The
of corporate departments. There is a lot of politics chairs were produced at several price points, with
involved in defining the roles, responsibilities, ... and varying fabrics, designs (e.g. single vs. double
'rights, of each of the responsibility centers, and it's layer), and frame materials. KCC also offered some
not clear to me yet exactly where to draw the Jines.
related products, such as folding tripod stools, Otto­
mans, cots, and stadium seats. KCC also produced
custom-designed products. It employed screen­
THE COMPANY
printing artists and seamstresses who applied
In.the early 1980s, Weston Krantz, an avid outdoors custom logos, graphics, and lettering to the nylon.
person, developed a new design for a lightweight, KCC products were often seen at corporate trade
pof.table chair that could be stored in a bag and shows and tailgate parties at sporting events. The
carried anywhere. Convinced that his design had company kept track of approximately 1,500 stock
commercial value, in 1987 Weston cofounded keeping units (SKUs)- finished products and vari­
K:t'anworth Chair Corporation (KCC) with his long- ous piece parts that the company sold - although
time friend, Kevin Wentworth, who had an MBA about 85-90% of the sales stemmed from only about
deg,ee and financial expcrtise. (lne corpo,
of
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u,M�!� .. .,.Jv 'jeJe �
V
This case was prep�ed by Professors Kenneth A. Merchant, Wim A. Van der Stede, and research assistant Clara. (Xiaoling) �
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· Copyright© 2004 by Kenneth A. Merchant and Wim A. Van der Stede.
Chapter 7 · Financial Responsibility Centers
Gradually, KCC built sales by investing in more
advertising and by adding other distribution chan­
nels. By 2003, it sold some products directly to
major retail chains (Wal-Mart, K-Mart, Target), as
well as other retailers (e.g. sporting goods stores) of
various sizes. It sold to retailers using the KCC
sales force, outside rep's, and distributors. It also
sold custom products,: directly to corporations and
high school or university bookstores and athletic
departments. The retail channels provided the high­
est sales volumes, but those sales were made at
lower margins.
In the 1990s, KCC moved its core manufac­
turing facilities to Mexico and China to take ad­
vantage of lower labor rates. Only some assembly
("kitting") and customizing facilities were retained
in the Denver location.
In the company's first decade of existence, KCC
had little competition. Its chair designs were pro­
tected by more than 20 patents. Sales grew rapidly,
and average margins were high, in the range of
40-50%, although some margins were sacrificed in
later years in order to generate sales from large
retail chains.
In 1999, KCC borrowed $30 million because the
founders, particularly Kevin, wanted to take a sig­
nificant amount of cash out of the company. Kevin
had become interested in ranching, and he wanted
to buy a significantly larger ranch. Ranching
had become his passion, and he was spending less
and less time at KCC. (For years Weston had spent
only a small portion of his time at KCC as he trav­
eled and pursued his various avocations.) The debt
service on the loan reduced KCC managers' margin
for error. Cash flow was tight, particularly at the
slow time of the year - October to January.
Starting in the late 1990s, some significant com­
petitors, mostly from Asian countries, entered the
market with comparable chair designs. Despite the
fact that most customers perceived KCC as having
superior designs and higher quality, and customer
satisfaction was high, the higher competition and
the worldwide recession of the early 2000s caused
sales to flatten and profits to drop. The company's
management incentive plan did not pay out in
either 2001 or 2002. In 2003 performance was
slightly improved. KCC's total revenues were pro­
jected to be approximately $70 million, up from
$68 million in 2002, and profits were expected to
be slightly positive.
288
MOTIVATION FOR DIVISIONALIZATION
In 2002, Kevin began to think about changes that
might stem from a change in organization structure.
He thought that the KCC managers needed to focus
more on the quality, and not just the quantity, of
sales. To illustrate the point, he described an ex­
ample in which KCC personne1 had aggressively
sought business from Target, the large retail chain.
In order to develop this retail account, KCC
designed a special chair model for Target and
offered a special price with a lower gross margin.
While Target did sell some Fold-it! chairs, they did
not sell many. Part of the reason for the poor sales
was that many of Target's outlets did not display
the Fold-it! chairs effectively. Instead of displaying
them in the sporting goods department, they
shelved them wherever they had room. Kevin
explained, "I walked into a Target store in a suburb
of Denver and found that our products were sitting
on the bottom shelf horizontally in the back comer
of the Automotive department, where nobody
could ever see them!" Because of the "growth at all
costs" philosophy, KCC incurred significant prod­
uct development and marketing costs and ended up
carrying a large amount of inventory, so overall the
Target account, and some others like it, were very
unprofitable. But to develop more focus on the
quality of sales, KCC had to develop a stronger
customer focus, to understand better customers'
needs and wants, and to improve customer service
levels.
Kevin also thought that divisionalization, if
implemented properly, could help KCC improve its
efficiency and asset utilization. He thought that
with an improved customer focus, it was almost
inevitable that the company could reduce its SKUs,
possibly outsource more functions, and generally
learn to serve customer needs better while tying up
less capital.
DIVISIONALIZATION ALTERNATIVES
W hat kind of divisionalization would be best?
Kev,in thought first about the relatively conserv.at­
ive approach of merely making the sales function
a profit center. This approach would involve charg­
ing Sales for the full costs (or, perhaps, full costs
plus a mark-up) of the products they sold. Sales
would have to pay for tbe costs of customizing
Kranworth Chair Corporation
products and holding inventory. This approach
would make Sales more aware of the cost implica­
tions of their decisions and, hence, more motivated
to generate profitable sales.
But Kevin concluded that KCC should probably
go further to create true product divisions. The
KCC managers had frequent debates about what
products and sales channels were most profitable,
but those debates were not informed with hard data.
A divisionalization would require some disaggrega­
tion of total costs and would facilitate profitability
analyses..,
.If this was done, however, the KCC managers
would have to consider how self-contained the new
operating entities should \ be. Kevin wondered,
"Should [the product divisions] each have their
own supply chain management, sales force, R&D,
and human resources functions, or should those
resources be shared?"
The obvious product split in KCC was between
Retail Products and Custom Products. The Retail
Division would focus on the higher volume, stand­
ard product sales to retail outlets. The Custom
Products Division would focus on the smaller vol­
ume custom sales.
In the approach that Kevin was planning to pre­
sent to his management team, the two product
divisions were to become profit centers. Each entity
would be dedicated to its focused core business,
but their managers would be free to choose how
they did business and what they· incorporated into
their business model. Reporting to each of the divi­
sion managers would be managers responsible f or
sales and marketing, purchasing and inventory con­
trol, and finance and accounting. Supply chain,
R&D, human resources, and advertising would
still be centralized, although these functions
would clearly have to work closely with division
managers.
Kevin hoped that this new structure would allow
the Retail and Custom Products divisions to make
some bold, new decisions. The new ·company focus
would also be on creating value, rather than merely
growing. For the divisions, creating value could
easily mean contracting sales to eliminate
unprofitable or marginally profitable products and
customers. The best customers, for example, were
probably those that bought the most profitable
products, placed inventory requirefl)ents on KCC
that were reasonable and predictable, had a strong
credit standing and payment history, and were re­
latively easy to serve. The divisions might also
decide that they should outsource some functions,
such as warehousing, which might allow KCC to
provide better customer service during the busy
seasons and. to. employ fewer people and assets in
the low seasons.
On July 28, 2003, Kevin presented his division­
alization ideas to his management team. Figure 1
shows an excerpt from the presentation he gave: ·
FtGURE 1 Excerpt from presentation given by Kevin
Wentworth
The new product divisions will be lean, mean fighting
machines with a direct purpose and the vision to carry
that purpose out. With our [corporate managers'] help,
they will look at how they do business now and what
they can do better. They will have the opportunity
to dream. If we were to start a new product-line
business, think of the questions that would have
to be answered:
1. How should we staff?
2. How should we source?
3. How should we warehouse?
4. How should we sell?
5. How should we ship?
6. How should we finance?
These are just some of the many questions that a new
company has to address.
We have a certain advantage since we already
have a baseline. But we also carry along a
disadvantage. We have become entrenched in our
ways and are the costliest product in the market.
If we forced ourselves to completely reevaluate the
business, could we significantly reduce costs, provide
better customer service, and yield higher operating
profits? That answer must be ''yes" In order to stay in
business in the future. Think of the fabulous business
opportunity in .front of us!
Some of the KCC managers were enthusiastic
about the proposed change. Others thought that the
ideas were radical. A few managers were bewil­
dered, as they had never worked in an organization
with a divisional structure and had trouble visualiz­
ing how it would work. In the ensuing discussion,
many questions arose, such as relating to the
289
specifics as to who would be responsible for what
and how performance would be measured and
rewarded. It was decided that the idea needed more
specifics.
A follow-up meeting was held two weeks
later. By then most of the managers realized that
top management had already made this decision;
the company was going to be divisionalized.
They then became highly interested in shaping the
details oe'. the change. The focus of the second
meeting was on defining division management
responsibilities.
After considerable discussion, there was general
agreement regarding the following general division
of responsibilities:
Responsibilities of top management and corporate
staff:
I. Overall vision and strategy for the company.
2. Financing and other high•level financial matters.
3. Engineering, design, and R&D.
4. Facilities.
5. Legal and intellectual property.
6. Supply chain and quality.
7. Corporate identity (e.g. public relations, some
general advertising).
8. Human resources.
9. Information technology.
10. Acquisitions and joint ventures.
Responsibilities of division management:
I. Overall vision and strategy for their respective
markets.
2. Development and implementation of divisional
annual budgets.
3. Staffing.
4. Operations, including purchasing of parts and
materials specific to respective markets, receiving,
warehousing, shipping, and inventory management.
5. Controllership and accounting.
6. Product-specific advertising and collateral material.
7. Information technology support.
With this general understanding of the distribu­
tion of responsibilities in the company in place, the
next task was the development of ideas regarding
performance measurement and incentives. This
task was assigned to Robert Chang, VP - Finance
and Administration.
290
PERFORMANCE MEASUREMENT ANO
INCENTIVES
Robert developed a measure that he called control­
lable returns, which was defined as operating
income (before tax) divided by controllable assets.
To get to operating income, all the division direct
expenses were subtracted from division revenues,
as were as many of the corporate expenses that
could be reasonably allocated to the divisions.
The assets deemed controllable by the divisions
included their receivables, inventories, and an
assigned cost of facilities they used.
Robert proposed an incentive plan that provided
22 managers, down to the director level (one level
below division manager), with a cash award based
on achievement of annual targets set for control­
lable return at the divisional and corporate levels.
For corporate managers, the bonuses would be
based solely on corporate performance. For man­
agers assigned to a division, the bonuses would be
based 75% on division performance and 25% on
corporate performance.
Robert proposed that the expected payouts be set
initially at relatively modest levels. If the annual
performance targets were achieved, Kevin and
Weston would be paid an award of 40% of salary,
division managers would be paid 30%, and man­
agers lower in the hierarchy would be paid
15-20%. No payouts would be made if actual per­
formance was below plan. 1 If actual performance
exceeded plan, the payouts could be increased by
up to 50%, at the discretion of top management and
the company's board of directors.
Robert explained that he proposed the relativelY:.
modest awards because the costs of this plan wour .
probably be in excess of $500,000, a signific '
additional expense for the company. Maintain"
competitive total compensation levels was not.
issue because KCC managers were currently .­
accustomed to earning a bonus, since the old s ·
growth-based incentive plan had not paid out ..
thing in either 2001 or 2002. Plus Robert tho ·
the company needed to get some experience ·
setting division-level performance target�
measuring and evaluating performance in �1
If the division (corporate) plan was met, but the corpo
sion) plan was not, division management would still r
divisional (corporate) portion of the bonus.
Kranworth Chair Corporation
way before ratcheting the performance-dependent
rewards upward while, probably reducing the pro­
portion of total compensation paid as fixed base
salaries.
These suggestions were discussed in a staff
meeting held on October 13, 2003.2 The major
point of dissension was regarding the proposed
assignment of some of the corporate expenses to
the divisions.' Some of the personnel who were
slated for assignment to a division complained that
they could not control the terms of deals that
corporate staff negotiated for them, such as for
insur�ce. Kevin headed off this discussion by
explaining that these cost assignments would be
built into the performapce targets, so they would
not affect the actual vs. targeted return comparison.
Further, division managers would have near com­
plete freedom of sourcing. If they did not like the
services provided to them by corporate staffs, they
were free to purchase those services from outside
the company.
A follow-up meeting was scheduled for October
27, 2003. That meeting was intended to be used
primarily to design the new organization - who
would be assigned to what division and in what
role (see Exhibit 2). It was hoped that the new divi­
sionalized structure would be completely in place
by January 1, 2004, and the first incentives based
on controllable return would be paid based on
2004-performance.
HOPES AND CONCERNS FOR THE FUTURE
Kevin was convinced that the new divisionalized
organization structure would give KCC its best
chance for future success:
Most of us are now convinced that this is a good idea.
Although it creates a more complex organization, it
will make most of our managers feel more empowered.
It will also force us to be more focused on returns,
rather than revenues and cost control.
Privately, however, Kevin expressed concern that
this major turning point in the company's history
was quite risky.
2
Sales personnel were still included in a sales-based commission
plan. At this meeting the idea came up that the sales commissions
should be weighted based on product profitability, but detailed
discussion of this idea was deferred.
I'm delegating considerable decision-making power
to the division managers. If they make mistakes, our
business can go down the tubes. The managers will
make out all right; they can go find another job. But
the fortunes of my family and those of the other major
owners would be devastated.
He had a specific concern about one manager,
Joe Yarmouth, the current VP�sales who would be
appointed as general manager of the Retail Division.
Joe is in his early 50s, and he has a lot of experience.
But most of the experience is in sales, rather than mar­
keting and other functions, and all of his experience
before KCC was in big companies - Clorox,
Hershey's. Culturally he does not have the small com­
pany mindset. He has no experience in understanding
costs, cash flows, and returns. I think he should have
been able to set up more deals that don't require any
working capital investment, but he just doesn't think
that way.
So Kevin, and indeed most of the KCC man­
agers, looked to the future with both eager anticipa­
tion and trepidation.
EARLY EXPERIENCES
KCC's early experiences with the divisionalized
structure created more concern. The first major
initiative of Ed Sanchez, the manager of the new
Custom Division, was to propose the procurement
of a more sophisticated fabric cutting machine.
This machine would allow the fabric to be cut more
efficiently and lower both material and labor costs
slightly. A discounted cash flow analysis suggested
that this machine was a worthwhile investment.
But, Kevin explained:
In my opinion, this investment does not address the
real issue in the Custom Division. Our real issue is
turnaround time. We have plenty of margin in custom
work, but we need to reduce our turnaround time to
serve our customers better. I think Ed is turning the
wrong dials.
Kevin also knew that in Retail, the newly
installed division manager Joe Yarmouth, who had
good contacts in the advertising world through his
prior jobs, was talking with a new advertising
agency about the possibility of a new campaign _to
advertise retail products more aggressively. Kevin
wondered whether this was in the best interest of
the company. He commented:
291
commitments to take delivery of full containers of
finished products right at the port of entry (from
either Asia or Mexico). This would eliminate fur­
ther kitting in the Denver plant and reduce invent­
ory significantly. Kevin thought this could be a
Joe, in tum, had already been grumbling to Robert good idea, but he was not sure who should take
about late deliveries and missed sales, as well as responsibility for working out the details. He was
product returns due to quality problems, which also worried about the politics involved in redraw­
were caused, in his opinion, by vendor problems ing the lines of responsibility so early into the new
that were under the purview of Carrie Jennings, the divisionalization.
Another issue that had arisen involved the R&D
corporate head of Supply Chain and Quality. In
the new organization structure, Supply Chain was function. Corporate R&D was responsible for new
responsible for obtaining and maintaining an ade­ product designs and refinements. Even though most
quate vendor group, primarily in Asia and Mexico, ideas for new products or product improvements
to secure both high-quality subassemblies and on­ came from the division managers and their sales
time delivery, while reducing dependency on any people in the field, division management did not
given vendor. The divisions .had responsibility only have much control over which R&D initiatives
for placing the day-to-day purchasing orders (POs) received priority. Joe Yarmouth commented:
with these vendors. Joe complained:
There is too much filtering by corporate R&D of the
I'm worried about losing economies of scale from
dealing with different ad agencies and about what this
"go-it-alone" advertising will do to our corporate
identity. And in any case, lack of advertising was not the
problem we faced at Target; it was product placement!
If I keep having delivery and quality issues due to
problems with our ·overseas vendors, over which I
have no control, I'm sure going to miss my perform­
ance target for the year. I am the one - not Carrie who feels the pain of lower sales and higher costs due
to product returns, because it directly affects the
numerator of my controllable returns measure, and
thus, my bonus that is totally based on it. I have
already lobbied corporate to let me have control over
vendor negotiations. If they won't do that, they should
at least adjust my targets so that my evaluations aren't
affected by others' failures. But so far they don't
seem to want to listen to me.
ideas that we feed them. We can't get anything done
without Ken Simmons' [R&D manager] blessing, and
Ken rnally takes his orders from Weston (Krantz]. We
ought to have more influence. We know our markets
better than anyone else in the company, and we are
paying for the function. We [the divisions] each fund
50% of the corporate R&D budget. I'm about to take
a $150,000 hit for corporate R&D in my 2004 P&L,
and what do I get for that? And why do we [the divi­
sions] each have to share the burden equally? I'm also
annoyed that Custom is getting a lot more R&D sup�
port than I do. Certainly Retail is much larger than
Custom, but we're not getting much support from
R&D. All they' re doing for us are a few tweaks on our
standard products.
Robert estimated that the divisions had about
85% control over their own P&L results. He be­
Ed Sanchez [Custom], in tum, was complaining
lieved that was significant enough:
that R&D was much too "reactive" to new producj
Joe's arguments have some merit, but no manager features already introduced by competitors, despi 'i
ever controls everything. Our managers need to work the fact that he and his sales people has propose
with others in the organization, within the constraints many ideas for more radical changes.
in which they are placed, to react to a lot of changing
Under this pressure from the division m.
conditions, and to deliver the needed results. If Joe agers, Kevin was considering whether KCC sho,
can't do this, then we'll find someone else who can.
allow the divisions to do their own R&D. He
Robert did not think that corporate managers doing so would solve the problems the divis·
should make any changes either to the assigned managers were complaining about, but he w
sure which new problems it might create. Kevin
responsibilities or the bonus plan.
Joe had also proposed some other ideas for a not like the whining. But he also did not watj
leaner Retail business that could potentially affect undercut the local initiative that the new org
the design of the Supply Chain function. He wanted tion promised to bring to KCC. And in anY,
to enter into arrangements with large retailers that there were pressing issues to attend to on his
would provide favorable pricing in return for ranch.
292
EXHIBIT 1 Kranworth Chair Corporation: 2003 organization structure
Chairman, Weston Krantz
President/CEO, Kevin Wentworth
Advertising, Yv
R&D, Ken Simmons
VP Finance & Adr:ninistration
Robert Chang
.,' '.."""""""'"""",,...;"f"i'""'"'"'°""""'"""'d
Finance
Information
Systems
HR
VP Sales
Joseph Yarmouth
VP Supply Chain
Carrie Jennings
Foreign
Production
(China,
Mexico)
Domestic
Assembly &
Customization
Niche
Accounts
Retail
International
Logistics
EXHIBIT 2 Kranworth Chair Corporation: 2004 organization structure
Chairman, Weston Krantz
President/CEO, Kevin Wentworth
Engineering, Design,
and R&D
(Ken Simmons)
Finance & Administration
------+------' HR, Information Systems,
and Legal
(Robert Chang)
Supply Chain and
Quality Control
( Carrie Jennings)
Corporate Advertising
and PR
( Yvonne Hahn)
Custom Division
Ed Sanchez
Retail Division
Joseph Yarmouth
Marketing
Accounting &
·Administration
Graphic
Accounting &
Administration
Operations
Sales
Operations
Sales
- Buying (POs)/Receiving
- Inventory Management
- "Kitting"/Scheduling
- International/Domestic
- Order Management
- Inventory Management
- Shipping
- Buying (POs)/Receiving
- Cut & Sew Operations
- International/Domestic
- Dealer Sales
- Order Management
- Inventory Management
- Shipping