Las Ferreterias de Mexico, S.A. de C.V.

We had been operating our company like a family, but maybe were too big to operate
that way. I think some of our people have gotten lazy, and our performance has suffered.
That is why I asked for the design of a new incentive compensation plan. We need to be
more competitive to survive. I want our people to focus on what they can do to improve
company performance, and if were successful, I am quite willing to share a good
proportion of the procceds of our success.
!ernando "onzalez
#hairman and #$%
&as !erreterias de 'e(ico, ).*. de #.+.
THE COMPANY
&as !erreterias de 'e(ico, ).*. de #.+. ,!erreterias- was the second largest retailer of
lumber, building material, and home improvement products and materials and
homeimprovemen product ans equipment in 'e(ico. !erreterias operated ./ stores in
'e(i(o #ity and troughout most of the nortern regions of 'e(ico. $ach of !erreterias
stores offered between 01,111 to /1,111 stock keeping units ,)23s- in a retail sales area,
an outside lumberyard area, and in a garden center. The total store areas ranged from
01,111 to 45,111 square feet.
!erreterias was founded in 061/ in a suburb of 'e(ico #ity by !ernando
"onzalezs grandfather. %ver the years, the company added more locations. It was listed
on the 'e(ican )tock $(change in 06.4. In /11/.
$7I8IT 0
&*) !!$T$9I*) :$ '$7I#%, ).*. :.+.
Income )tatement as of 0/;40;/11/ ,<s 111-

=et sales /,/0>,5?1
#osts of sales 0,5./,>@1
"ross 'argin >44,.@1
)elling, "eneral and *dministrative
$(penses 4@@,5.1
:epreciation $(pense >5,@?1
Interest $(penses 0?,4/1
Total $(penses ?5@,>?1
$arnings before Ta(es 0@>,/41
Incesome Ta( <rovision 5., /?1
=et $arning after Ta(es 00@,661
!erreterias had saies of /./01 million pesos and profits of almost 0/1 million pesos ,see
summary financial statements in $(hibits 0 and /-.
)tarting in the late 06.1s, !ernando "onzalez launched a maAor company needed
to emulate the methods of the large *merican homebuilding retailers, such as Bome
:epot and &owes, in order to survive. Thus, improving market share and improving
operation efficiencies becme !erreteriasC strategic priorities.
The store managers enAoyed considerable autonomy. They were responsible for
hiring, firing, and supervising their storeCs personnel. While the store hnd the same
architectural designs and some basic stock keeping requirements, the individual store
managers were allowed to adapt their merchandise offerings, their inventory levels, and
their advertising and promotional activities to their local markets, which were quite
diverse. The store managers were given considcrable latitude to reduce princes to move
e(cess inventory or to meet competition. They were responsible for making credit
granting decisions, although for large accounts they were e(pected to ask finance
personnel at headquarters to perform a credit check. *nd some aggressive store managers
tried to generate new business by calling on prospective customers themselves.
The ./ store were organized into nine geographical regions. The regional
managers, each of whom was a former store manager, provided oversight and advice.
*t the of the case, one 'e(ican peso worth appro(imately 3))1.01.
Their role was seen as an important part of the management structure because most of the
store managers had little formal education. %nly a few were college educated, and few of
those had formal business education. $ach region also contained a regional sales office
with specialisis who worked with larger customers, though, were made through the store
nearest to the Aob.
The corporate staff of !erreterias provided a range of centralized function,
including purchasing, human resources, marketing, real estate, and investor relations.
Inventory was shipped to the store from one of three regional warehouses.
*ll !erreterias employees were paid a base salary or hourly wage plus a bonus
based on a share of the companys overall profits. These bonuses were small, usually in
the range of / D 5 percent of base salary, depending on organization level. In addition,
!ernando "onzalez typically provided some discretionary bonus awards to employees
whose performance in a given year was e(emplary. "enerally, though, these types of
bonuses were not considered to be effective at motivating behavior, as was indicated in
the comment by 'r. "onzalez presented at the beginning of the case.
* =$W I=#$=TI+$ <&*=
In Euly /11/, 'r. "onzalez hired a consulting firm to design a new performancebased
compensation plan. Be asked his chief financial officer and head of human resources to
assist the firm with its work.
'r. "onzalezCs original intent was to include all company salesmen, buyers, and
managers in the new incentive plan. *fter a series of interviews, however, the consulting
firm reported that it would not be easy to measure the performances of either salesmen of
buyers. While most customers were assigned to one particular salesperson, it was difficult
to assess whether a sale came from the assignes salespersonCs offorts. 'any customers
had dealt with !erreterias for years, and they placed their orders regardless of whether or
not they received a call from a !erreterias salesperson. )ome of the large contractors had
also established personal relationships with one or more corporate or regional staff, and
oftentimes they called their friends for advice, rather than relying on the salesperson
formally assigned to them. 'easuring the performances of the buyers was similarly
problematic. The primary aspect of buyer performance that could be measured the prices
paid for items purchasedwas affected by many factors over which the buyer had little
control. These included the order size and market conditions. 8ecause of these
measurement problems, the consultants concluded that the measures that could be tracked
would not provide meaningful bases on which to assign bonus awards. They
recommended that they work first on designing an incentive plan for managers, which
included the individual store managers ,./-, regional managers ,6-. *nd corporate staff
managers ,5-. ,=either !ernando "onzalez nor his chief operating officer was to be
included in this planF the compensation committee of the companyCs board of directors
determmed their bonuses-.
The consultantCs suggestion for the management incentive plan included the
following featuresF
0. 8onus pool. * total bonus pool would be created according to the following
formulaF ? million pesos plus . percent of the corporate income before bonuses
and ta(es in e(cess of 0/1 million pesos. The total bonus pool would be divided
into three classes as followsF
)tore managers @1G
9egional managers 05G
#orporate staff managers 05G
/. 9%I measure of performance. The bonus pools would be assigned to managers
based on their entityCs return on investment ,9%I-. :efined as bonuseligible
revenues minus e(penses divided by total store investments. The following
gundelines were provided to facilitate the calculation of the 9%I for bonus
purposes.
The revenues eligible for bonuses include all shipments from the store
e(cept those stemming from sales orders written by regional or head
quarters personnel.
The e(penses include all direct store costs and all regional and
headquarters costs. The costs of significant regional and headquarters
activities traccable directly to a given store HH. #ost of preparing a
customer credit report, cost of a building upgrade would be charged
directly to that store. *ll other costs would be allocated to the stores.
*ctivitybased allocations would be used where possible, such as in using
the stores relative proportions of receipts into inventory to allocate
purchasing e(penses. *ll other e(penses would be allocated based on a
proportion of bonuseligible store revenues.
4. *llocation HHHH..
!or store managers who had been in that position for less than the full year
and managers who transferred between stores during a year, bonus units would be
assigned by the relevant regional manager,s- by applying the basic bonus unit
award philosophy as closely as possible.
The regional managersC bonus pool would be divided among the regional
managers based on a proportion of the bonus units earned by the stores in their
region divided by the total bonus units earned by all stores.
The allocation of the corporate staff bonus pool would be decided by
!ernando "onzalez based on the corporationCs annual 9%I performance.
?. !orm of the awards. 8onuses were to be paid in cash as soon as the financial
statements were prepared and audited and the amounts could be calculated.
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*s 'r. "onzalez looked over the consulting firmCs design, he had some concerns. !irst, it
was obvious to him that the new plan would increase the companyCs compensation
e(pense. Bow much would that e(pense increase, and would the benefits of the plan be
worth that e(penditureI )econd, he knew that he would have to be the one to announce
the implementation of the plan. Be had to anticipate what his managersC reactions would
be. What were they mostly likely to complain aboutI Is this plan fair to all of the
managersI *nd, finally, he still lamented the fact that personnel in the regional sales and
corporate purchasing organizations were not included in this plan. If their individual
performances could not be measured obAectively, was there some other way he could
motivate them and reward them for performing their roles, which were critical to the
companyCs successI
Juestions
0. $valuate the proposed performance measurement and incentive plan
/. Bow, if at all, would you modify the proposed planI