Management Control System Case Study
He and his business partner Frank Edwards had Just bought Airtime Aviation, a floundering enterprise on the verge of bankruptcy, and were excited about putting their business school education to work. The two had scraped together $500,000 so that Air Tex would have at least a little cash to pay some bills. With the amount they had contributed, Airtime had a total of $515,000 in the bank.
“Oh, Mr.. Richards,” Sarah said, “I’m so glad you called. When will you be in? I have a few checks for you to sign. ” “l should be In tomorrow. What are the checks for? ” “I’ve written checks for only our most pressing bills,” she said.
L tried very hard to make sure that only those that are most important be paid. ” “That’s fine,” Ted replied. “What’s the total of the checks you’ve written? “$510,000,” she said. Ted nearly dropped the phone. “Let’s discuss this when I get Into the office. ” He drove down to Airtime the next morning to speak with Sarah Arthur, the compass account- ant.
As it turned out, his first day owning his own company would not turn out exactly as he had planned: I had envisioned that when I bought my company, I would walk in the front door the next morning, and everyone would bow down to me.
There would be a brass band playing, or something. Instead, I walk In through the back door (a) realizing that I have a crisis on my hands, (b) hoping no one is going to see me so I an deal with this crisis, and (c) of course, not really knowing how I’m going to deal with It. What I did was say to Sarah Arthur, “We are not going to pay these bills. ” Well, she was shocked.
“But you have to pay them! ” she said. I looked at this woman, who had been with the company for 20 years, and said, “No, I will decide what bills we are going to pay. She sat back and said, “Okay,” convinced that I was going to make a fool of myself. That was my first day. THE PURCHASE Ted Richards and Frank Edwards met In 1986 when they were students at Harvard Business School.
Although planning on initially working for large companies, they eventually wanted to own their own business. Upon graduation in 1988, Frank took a lob in the corporate finance department of a large electronics company in Los Angels, and Ted went to the Los Angels branch of a well-respected con- sultans firm.
As they were located in the same city, the two met often for lunch. Whenever they met, they talked about going into business together. Instead of starting an entirely new business, Ted and Frank really wanted to find a “fixer-upper” – they wanted to purchase and “turn around” a falling business that showed a lot of attention. “In good business school fashion,” said Frank, “we established some criteria, which were: 1 .
The company couldn’t cost much, since we didn’t have much money. 1 en company Ana to need want we Ana to offer – winch we outhunt at Tanat time were managerial skills. 3. The industry had to be fragmented and non- oligopolies. We didn’t want to be a small fish in a big pond. 4.
We needed to be able to see our way clear to have the company grow at a rate of 20% per year the first five year-period. ” Ted and Frank looked at a number of businesses over the next year and half and in early fall of 1989, located a fixed-base operational at San Miguel Airport in Texas that was losing money and look- inning for a buyer.
After four months of negotiation, on December 29, 1989, Ted, Just 26 years old, and Frank, 28, purchased the stock of the company for $100,000, assumed the lease on the building (and all the assets and liabilities) and were in business. The lease on the facilities had a purchase option at a price considerably less than the market value. By exercising the option and then selling and leas- inning back the building, Ted and Frank were able to ease the $500,000 for working capital.
Ted and Frank discussed the organizational structure at Airtime, and agreed to decentralized its operations by making each operating activity a profit center and grouping them by departments. Each departmental manager would be given author- itty over his operations, including granting of credit, purchasing to a predetermined limit, setting poll- ices, and collecting receivables. He or she would also be held responsible for its results. Frank was concerned, however: I agree with our decision to decentralized this author- itty, but I am concerned whether now is the time to do it.
We’ll have a tough time when we first walk in the door and I don’t know if the departmental managers can be taught some of these management techniques fast enough.
After all, some have never finished high school. Maybe we should begin by making all these decisions ourselves for a month or two. I realize that we don’t know the aviation business yet, but even though neither of us has been a line manager, maybe we can learn the aviation business faster than some of our managers can learn formal management skills.
Either way, we’re putting the company on the line and the two-minute warning whistle has already blown. During the four months they were negotiating the deal, Frank and Ted spent virtually every weekend together. Of this period, Ted commented: 1 Fixed-base operations are companies located on an airport that service the non-airline aviation market.
They generally sell, fuel and maintain aircraft as well as provide flight instruction and charter services. These companies can range from small family operations to multiple-location companies with sales exceeding $500 million.
We spent something on the order often hours a week, of which maybe two or three hours would be trying to understand Sarah Urethra’s accounting system ND accounting statements, and another two or three discussing pro formal financial projections and the rest on what we would do when we acquired the company. Frank basically did the financial projections and I designed the accounting system. Actually, I dreamed it up one afternoon at work. I sat down at my computer and designed the forms myself.
Franks projections for the next ten years showed that things were really tight.
Even with the $500,000 from the sale and leaseback of the facilities, Frank projected that we were going to run out of money near the end of the first year. We new this when we were negotiating for the company, and it made us a bit nervous. Well, three days before the closing, Frank came to me, white as a sheet, and confessed that we had made a structural error in the projections. He was computing accounts paddle on ten wrong Dyads, Ana we were going to run out AT money In three months. We had a little discussion as to whether we should blow the whole deal right there, knowing that we could’ t survive.
W e decided to go ahead with the deal. We knew it would be an impossible Job, no matter how we sliced it, but we were prepared to go through with it. AIRTIME AVIATION PRIOR TO PURCHASE Airtime was one of eight fixed-base operations at San Miguel Airport, which served Center County, Texas – one of the most rapidly growing comma- nineties in the nation. Airtime had a loss of $500,000 on sales of $10 million in fiscal year 1989, and this left the company with a negative net worth (see Exhibit 1). The company conducted activities through six informal departments (see Exhibit 2).
Fuel line activity The activity employed twelve unskilled fueling people, with an average tenure with the company of eight months, and three dispatchers who accordion- dated their activities via two-way radio.
It was managed by Will Leonard, a man in his mid-ass, who had been the construction foreman for Bill Dickerson when Bill was a real estate developer. When Dickerson bought Airtime in 1980, he brought Will Leonard with him to manage the “line crew. ” Will was enthusiastic about his Job, extremely loyal to Dickerson, and well-liked by his employees.
Although lacking in any theory of management (he had a high school diploma and some Junior college credits), Will was a good first line manager who was instinctively people-conscious while holding them in line. The fuel activity encompassed five operations: Retail Fueling – A Phillips Petroleum franchise of underground storage of 60,000 gallons of Jet fuel, 20,000 gallons of “VA-Gas,” and five fuel trucks to serve locally based and transient aircraft.
Wholesale Fueling – Service of a fuel farm for Texas Air, a regional airline connecting San Miguel with cities in Texas, Louisiana, Arkansas and Oklahoma.
Airtime bought its own fuel separately. Fuel Hauling – An over-the-road fuel truck and a Texas Public Utilities permit to haul fuel on public roads. The truck, in essence, served Phillips, at a price, by delivering its fuel to Airtime. Rental Cars – An agency of a local automobile rental company, mainly used as a service to train- Steen pilots.
Tie-Downs – Storage of transient and San Miguel- based aircraft in six hangars and 50 open tie-downs. 2 The fuel activity was open 18 hours a day, seven days a week, year-round.
Service and parts The service activity repaired, maintained, and overhauled aircraft. It employed six mechanics and a departmental secretary. The parts activity, a separate accounting entity, employed one person and was managed by the head of service, as sales went almost entirely to the service activity. The manager of these operations was Carl Green, a man in his ass, who had been chief mechanic for Dove Aircraft at Love Field in Dallas prior to moving to Airtime.
Before that, he was the mechanic/copilot for a Dallas oil executive.
Carl had a high school diploma, aircraft and power 2 A tie-down is an area of asphalt or concrete with ropes, where an aircraft is parked by tying it down to prevent it from rolling away or from sustaining wind damage. Plant licenses, and multi-engine and commercial pilot certificates. He knew airplanes, engines and aircraft mechanics. He was, in Tee’s words, “not a self-starter, had a bit of retirement mentality, and avoided conflict except when it came to quality.
You would never worry about anything he rolled out of his shop. Flight training The flight training activity was managed by Roy Douglas, whose pilot license was Selenga Day one AT ten Wright Brothers. Roy Ana neon several world records In platoon’s early days, and was highly respected by the aviation community. He spent a lot of time “hangar flying” with old cronies and, while he didn’t manage the department in any real day-to- day sense, he hired the seven instructor pilots and three dispatchers, eave check rides to students prior to their FAA [Federal Aviation Administration] flight exam, and set safety policies.
He and his chief dispatcher, who now had been with him for over ten years, were intensely loyal to both Airtime Aviation and the flying community.
They had, however, “seen everything and were surprised by nothing,” and they were very resistant to change, be it new aircraft technology, aviation teaching methodology, or accounting systems. The flight training activity, which had lost money each year, had two types of operations: Flight School – Flight training in 18 ingle- engine light aircraft from eight flight instructors coordinated by three dispatchers.
Flight ratings were offered from private pilot through air trans- port ratings. Pilot Shop – Sales of flight supplies, such as logbooks, navigational charts, and personal and training flight supplies. Sales were made from three display counters by the flight school dispatchers. Avionics Avionics was a single-person activity conducted by Leon Praxis.
Leon was a college- trained electronics technician whose responsibilities included repair- inning radios and electronic navigational equipment. He started at eight every morning and left reemploy at five, so that he could spend time working on other interests at home.
Aircraft sales Airtime had been a Piper Aircraft dealer until two months before its sale. The owner, Bill Dickerson, was unable to finance the number of aircraft Piper required to be carried in inventory, so he lost the franchise, fired his two salespeople, and closed down the department. Accounting The Accounting Department was central to the company in two ways.
First, it was located in a glass-enclosed office in the center of the building, where it could be seen by everyone and everyone could be seen from it (see Exhibit 3).
The second part of its centrality was the role that its manager, Sarah Arthur, played in Airtime. Sarah had worked for Bill Dickerson for more than 20 years. In his absence, which was frequent, Sarah managed the company. While her title was accountant, she had no accounting training of any kind, and her idea of running the company was to be the central repository of all information. She received and opened all the mail – not Just mail for her depart- meet – and she would distribute it to the depart- meet heads as she saw fit.
What she distributed, in Tee’s words, “was typically nothing – bills would come and she would keep them. Checks would come and she would keep them. And, at the end of the day, she would collect cash from all the depart- meets and keep it. ” Sarah managed all the receive- abeles and payable. All accounting information was Sarah’s, and nothing left her office. The department managers knew nothing about the profitability of their opera- actions.
All they knew was that airplanes would fly and that Sarah Arthur would come around at the end of each day and collect their money.
Then, occasionally, she would berate the department managers for their high receivables. Of course, they had no idea how big their receivables were, or who they presented. They would Just “be beaten over the head. ” As Ted described it: The management system that was in place when we bought the company was one woman won magically Kept everything In near nana . Inner was a Eliminate Ana almost incomprehensible formal system.
There were basic financial statements and a set of reports that were produced for and according to Piper Aircraft’s specifications each month, but they helped Piper, not the management.
We may have negotiated with Bill Dickerson, but we were going to take over the management of the company from Sarah Arthur. ASSUMING MANAGEMENT RESPONSIBILITIES The roles of Ted and Frank Frank and Ted took over the business not only as full and equal partners, but as best friends who understood each other very well. Frank assumed the chairmanship, and turned his attention to specific and critical projects, the first being the reestablishment of aircraft sales – potentially a major profit area. Ted took the title of president and chief operating officer, and began to manage the rest of the business.
As Ted said later: I knew Frank wouldn’t be right at my side at every decision, but I made sure that four times a day I could walk into his office and say, Frank, I don’t really know what I’m doing,” and he would give me a pat on the back and put my head in order.
Frank, in turn, depended on Ted for operational inputs and intellectual support. They both worked 12-hour days, five days a week, with Ted, not mar- ride, putting in 10-12 hours each day on weekends as well. Frank, who had a family, tried to put in three or four hours a day on the weekends.
Management and control Beyond the immediate cash crisis, Ted viewed his three most important tasks as: 1 . Revamping the management of Airtime.
2. Installing a control system that would both support the management and provide information needed in order to make decisions. 3. Wresting De facto control of the company from Sarah Arthur promptly. Frank and Ted believed that it was very import- ant to provide an environment where the depart- mental managers could make correct decisions on their own, since they had decided they could not make all the decisions themselves.
They had neither the time nor the technical knowledge.
As Ted put it: One of the things I was very concerned about was how to manage by providing an environment that encouraged the managers to make decisions the way I would want them made. That was very, very import- ant to me. I wanted to provide a framework that didn’t limit their actions but certainly provided very fast feedback as to how they were doing and made it personally worthwhile for them to do the right things. I spent a lot of time thinking about how to do that, and it occurred to me that there were really two ways to do that.
I recognize that there has to be the black hat and the white hat in any of these situations, and so I decided to make the control system represent reality and my personal role would then be that of an memo- action leader as opposed to a task leader. I would let the control system be the task leader, and then I could exert more avuncular personal leadership.
I also realized that I didn’t have the time to train everyone in the management approach we wanted to use at Airtime. Nor did I have the guts to fire everyone and bring in new talent, and that wouldn’t have been a good idea anyway.
I also realized that unless I changed the basic attitudes in the company, we would never survive. In order to do that, we needed to do a lot of education, and that would be my personal role. But, if I was going to do that successfully, I couldn’t at the same time be berating them about the achievable, so it was necessary to take the unity-gritty daily tasks of banging people over ten nana Ana put teem somewhere else. I Llano’s really Tell Tanat Frank snouts 00 that, and so to provide this environment for decentralized decision making was very, very important.
Ted began to implement a management control structure, incorporating the following policies: 4. Profit centers would be established for each major activity. These profit centers would be combined where appropriate into departments. 5. Revenues and expenses would be identified by profit center and communicated to the profit center manager.
. Departmental managers would be responsible for their profit centers, and would receive a bonus of 10% of their profit center profits after administrated- eve allocation. 7.
The profit center managers would have pricing authority for their products or services, both inter- anally and externally. The fuel department manager could, and did, charge the Flight School retail price for the fuel they used, whereas he charged the Service Department his cost for its oil.
5. The profit center managers could buy products externally rather than internally, if it was in their best interests to do so. The Flight School manager could, and did, have his aircraft repaired outside Arête’s shop when it was unable to fulfill his service needs. . The profit center managers could buy needed cap- ITIL equipment and operating supplies on their own authority within established purchase order limits. Ted recalled one of the first times this decentralized authority was tested: When we bought the company, it had an old, rotten, obsolete copier.
It was under the control of Sarah Arthur, and everyone who wanted a copy of anything had to go to Sarah, the Witch of the North, and plead – which was really an awful thing to do.
I remember one day, Will Leonard, the manager of the Fuel Department, said, “Can’t I get a copier? ” I said, “Will, you can do anything you want within the limitations of the POP. ” So, he bought the smallest copier he could find, and he let everyone in the company make copies, charging them 10 cents a copy. At the end of the month, he would present bills to every department for the copies they used. He made money on his copier because everyone else was scared to death to walk into the Accounting Department and face the Witch of the North.
Here was a classic entrepreneurial example, and it became almost a cause c©l©beer. People were saying, “How did he get a copier? What right does he have to charge me for the copier? ” I would say, “If you want a copier, go get one. ” But with one here at 10 cents a copy, they realized they couldn’t really afford one them- selves, so they grumbled and went about their business. 7. The profit center managers had the authority to hire, fire, and administer the salary schedule in their departments quite independent of the rest of the company.
CASH MANAGEMENT Cash and accounts payable When Ted arrived at Airtime on the first day of his ownership, he gathered up the heck Sarah had written and pulled up the accounts payable file on the computer, called in his departmental managers one by one and said, “Who are your most important suppliers? ” He looked at the individual accounts to see how old the balances were and called up each of the suppliers, saying, “I’m the new owner of Airtime Aviation, and I would like to come down and talk to you about our credit arrangements.
” He later said: Over the next six months, I got on good terms with the suppliers.
I talked to them, took them out to lunch, and let them take me out to lunch. We paid them a little bit here and a little bit there, and we stayed out of serious trouble. A direct result of Tee’s assumption of the accounts payable decision was that era Arthur Degas to view near stay at Lealer as Delve Eliminate to ten Tour months agreed upon. As it became clear that Ted was not going to let her make the manage- meet decisions anymore, she limited her work for the company strictly to the four- month transition period agreed upon in the purchase agreement.
As Ted put it: She effectively said, “I will work from 1 1 a.
M. To 2:00 p. M. Every day. I will answer your questions and that is all.
That was fine with me. I hired a new accounting clerk to be Sarah’s assistant. She worked from 8 in the morning until 7 at night. I hired her; she worked for me. And when Sarah Arthur quietly packed up and left, the departure was easy. Cash and accounts receivable With the accounts payable crisis on the road to a solution, Ted turned his attention to cash inflow.
In his words: My biggest worry was how we were going to control cash, or rather, how I was going to provide a system that would motivate the departments to manage cash. The solution I came up with was to take the receive- abeles and give hem back to the departments. That was very controversial. Everybody in the whole company fought me on that. Frank didn’t like it – I was totally alone.
First of all, the managers didn’t understand it. They had never seen receivables, they didn’t know what they were. They felt as though they were playing with dynamite. “Here they are, but what do I do with them? Frank, on the other hand, was concerned that things would get totally out of control because our most important asset – our incoming cash flow – had suddenly been handed out to amateurs. Sarah Arthur may not have been perfect, but she had a lot of experience. In the Fuel Department, I handed the receivables to the dispatcher, a 20-year-old surfer who had dropped out of college after two years.
In the Flight School, I also gave them to the dispatcher, a 55-year-old, loyal employee. These were the only two departments with significant accounts receivable.
In Service and Avionics, I gave them to the managers, but these were not significant. One Saturday morning, I sat down at the computer and printed up all of the balances, and physically pre- scented them to these two women – the De facto depart- meet heads. Then I sat down and showed them how to input the correct information using the current weeks transactions.
So, we started to collect data on the accounts receivable. To motivate the department heads to manage their accounts receivable, Ted gave them the credit- granting authority and the responsibility for cool- election.
He also established the following monthly charges against their departmental profits: Receivables 60 days old or less 1% of the balance Receivables 60-90 days old 3% of the balance Receivables 90-120 days old 3% of the balance Receivables over 120 days old 6% of the balance charged the balance to the profit center Cash and the banks When Frank and Ted acquired Airtime, they also acquired short-term bank notes payable of $300,000 from the Center National Bank. The notes had been outstanding for several years, and Ted was concerned, since if the bank called the notes, it would put the company into bankruptcy.
As Ted recalled: One of the people I called Just before we bought the company was Hal Latter, the manager of the branch we did business with.
I took him out to dinner, and over dinner, I told him about the company and how it was doing, as well as some of my plans for the future. I said, “But we have this problem of the $300,000 1 owe you. I would love to convert that to a 24- Mont note to get It out AT ten snort-term category, so as to Increase our working capital to make us more attractive to our suppliers.
That way, we can get bet- term terms from them. ” He looked at me and, without thinking it over, said, “Fine, I’ll do it. ” He had made a gut decision based upon some good vibes, and I was shocked, since I was prepared to negotiate with him.
I thought to myself, “The basis upon which business is done, at least with this man, is total candor and honesty. ” So, I started this program of giving the bank our internal financial reports every month, along with a over letter summarizing what I was doing. Hall’s reaction was great.
He thought it was the best thing he’d ever seen. No customer had ever done that to him before. The result was that whenever I went to him – we paid off the loan ahead of time – and said, “Hal, it looks as if I’m going to need $500,000 for 60 days,” he would say, miss, Eve been following it.
Eve been watching your receive- abeles growing because of your extra business. I know a growing business needs money from time to time. It’s no problem – I’ll put the money in your account this afternoon. ” THE ACCOUNTING
SYSTEM By the end of the second month, Airtime was pro- dicing a profit and loss statement on the activities of each department. Each department kept account of its own sales, receivables, inventories, expenses and, through the POP system, expenses initiated by the department.
In order to provide a predictable, and simple method of cost allocation which still would be understood and “managed” by the department heads, Ted established an Administration Profit Center which paid taxes, borrowed money, paid interest, utilities, bills, and other general admissions- iterative expenses. The
Administrative Department in turn levied a series of monthly charges to each department as follows: I Social Security taxes, health insurance, and other fringe benefits were charged to departments as a predetermined percent of wages. Thus, when a manager took on a new employee, he or she knew that it would cost the department, say, 125% of the wage. I Accounts receivable – a monthly charge based on the amount and age of the receivables. I Operating assets – including the Parts Department inventory and the Service Department’ s shop equipment – were charged to the departments using them on a predetermined percent of the asset’s cost.
I Rent, fire and occupancy insurance, building main- tenancy and depreciation, and other occupancy costs were charged as predetermined rental per square foot of floor or ramp space occupied. I A predetermined percentage of sales which repress- ended the cost of Tee’s office and the Accounting Department was also charged. As all the charges were predetermined, calculus- elated and announced twice a year, the managers would control their expenses by managing their receivable balances, conserving on equipment purr- chases, and varying the square footage they coco- pied.
There were ever any unanticipated expenses, and the charging rates were set for breakable. As Ted put it: There was an interesting example of the effects of this system.
Airtime had a total of 5. 2 acres of land, of which approximately 3 were for tie-downs that accommodated approximately 60 aircraft. The fuel Department always wanted more space because it meant that they could accommodate more transient aircraft. The Flight School always wanted more space to make it easier to manage their comings and goings.
The Shop always wanted more space as a service and convenience to customers leaving or dropping off aircraft to be serviced. Before the departments were changer Tort ten area teeny occupied tenure was no way to Intelligently resolve tens conflict.
Bill Dickerson, the former owner, or Sarah would have to make what was essentially an arbitrary decision. With our system, however, there was a definite price to be paid for demanding more space. And with the manager’s bonus system, 10% of that price came right out of the manager’s pocket. The result was that we had very few of these ids- cushions that did not reach a natural compromise.
And when, over time, each department truly needed more space and was more and more willing to ay the rent, we raised the rent until demand equaled supply.
It was great to see a free market in action: As an aid towards educating departmental man- eager in the management of their operations and for keeping them aware of their activities, response- abilities and results, Frank and Ted instituted a Daily Department Report, which required the departments to submit internally consistent operate- inning and accounting information.