Question

Officials at Dundas Manufacturing have just completed a post-implementation audit of a distribution center that was built two years ago at a cost of $1.5 million. The marketing group had proposed the warehouse investment, arguing that it would improve sales by increasing product quality and improving customer service. The expected rate of return on this investment was 18%. However, the actual return to date has fallen far below this estimate and is even below the company's cost of capital of 11%.

The post-implementation audit asserts that the managers proposing this investment were ambitious to the point of being reckless in making the estimates underlying the project's proposals and concludes that the investment should never have been made.

In response, the two managers who proposed the project argue that the proposal was a good one on the basis of estimates that seemed sound at the time. However, several unforeseen events, including the entry of a new competitor into the market, caused results to be lower than expected. Moreover, the two managers argue that results would have been even worse for the company if the investment had not been made. How would you deal with this situation?

Answer 1

Answer:

This state of affairs mirrors the serious issue in understanding a situation where events were not as anticipated. The dispute centres on two things. First, it is irrational to expect managers to be accountable for things beyond their control -- what is often called the controllability principle in management accounting. Second, the events that happened in this state were outside the managers' control. Many people trust that the controllability belief is important since it appeals to a common sense of justice, specifically that people should only be held responsible for what they do or control. However, some people have debated that making people answerable for whatever happens stimulates them to search for ways to gain control over their environment. So, while rejecting the controllability principle at first seems punitive and contradictory with a common view of equity, there may be good behavioural reasons for doing this.

However, for the sake of debate here, let us accept that the controllability principle is functional. There are two matters in this case: first, whether or not these managers should sensibly have predicted the influx of the new competitors and second, what would the consequences of the new competitor have been if the organization had not built the new warehouse. These issues are challenging and would have to be fixed by reference to the facts in the particular situation including what other players were doing, public statements by the competitor, and what analysts who were following this market were writing and saying.