Example service and repair work are quick oil change, auto repair, the body shop work and auto parts supply. Recently, the company adapted a new control system as a strategy to improve its sales and increase its profit. There were five departments within North Country Auto: the new car department, the used car department, the service department, the parts department and the body shop. Originally, these five departments operated as part of one business. And the performance of each department was not individually evaluated. Under the new control system, all five departments operated as an individual profit center.
The owner assumed that, by doing this, all managers of the five departments would be encouraged to increase their departments’ profit so as to have better evaluation and better income. However, under this new control system, there were still problems needed to be dealt with, because the business conducted by these departments affected each other. In this case, if one department tried to maximize its profit, it may affect the profit of other departments. For example, when the new car department manager tried to sell a new car, he would offer a very high trade-in price for the customer’s used car so as to attract the customer.
If this high trade-in cost was allocated to other departments, it would be unavoidable that the cost of those departments would increase and their profit would decrease. Therefore, the questions raised from this case would be: should all departments be treated as an individual profit center; and how the transfer price should be set between the departments; as well as how to correctly allocate the cost among different departments. In my opinion, I think the parts department and the body shop should not be considered as the profit centers, since most demands for these two departments were from service department.
If these two departments tried to maximize their profit, it would be very difficult for the service department to maintain high profit. In my opinion, the parts department and the body shop should be considered as cost centers. In addition, the transfer price among all departments should be the market price instead of another price determined internally. And any losses on inter-departmental business like trade-ins should be proportionally allocated to three profit centers: the new car department, the used car department and the service department.
In addition, under the current control system, the year-end bonus of each department manager was based on his/her department’s performance. The profit to be evaluated was the department’s gross profit instead of its net profit. This evaluation method may encourage all managers to focus on selling activities only. They may ignore other important responsibilities such as cost control or reduction, as well as inventory control. Therefore, I think the evaluation for each department’s performance should be based on the net profit. This would encourage the managers to be responsible for overall cost control and profit-making.