Monza Pharma (Monza) is a developer and manufacturer of medical drugs, based in Beeland but selling its products all over the world. As a listed company, the overall objective of the company is to maximise the return to shareholders and it has used return on capital employed (ROCE) as its performance measure for this objective. There has often been comment at board meetings that it is good to have one, easily-understood measure for consideration.

The company has three divisions:
– the drug development division develops new drug compounds, taking these through the regulatory systems of different countries until they are approved for sale;
– the manufacturing division then makes these compounds;
– the sales division then sells them.

Monza’s share price has underperformed compared to the market and the health sector in the last two years. The chief executive officer (CEO) has identified that its current performance measures are too narrow and is implementing a balanced scorecard (BSC) approach to address this problem. The current performance measures are:

– Return on capital employed
– Average cost to develop a new drug
– Revenue growth

The CEO engaged a well-known consulting firm who recommended the use of a BSC. The consultants began by agreeing with the board of Monza that the objective for the organisation’s medium-term strategy was as follows:

– Create shareholder value by:
Innovating in drug development
Efficiency in drug manufacturing
Success in selling their products

The consulting firm has presented an interim report with the following proposed performance measures:

– Financial:   ROCE
– Customer:   Revenue growth
– Internal business process:   Average cost to develop a new drug
– Learning and growth:   Training days provided for employees each year

The CEO and the lead consultant have had a disagreement about the quality and cost of this work and as a result the consultants have been dismissed. The CEO has commented that the proposed measures lack insight into the business and do not appear to tackle issues at strategic, tactical and operational levels.

The CEO has decided to take this work in-house and has asked you as the performance management expert in the finance department to assist him by writing a report to the board to cover a number of areas. First, following the disagreement with the consultants, the CEO is worried that the consultants may not have been clear about the problems of using the BSC in their rush to persuade Monza to use their services.

Second, he wants you to evaluate the choice of performance measures currently used by Monza and those proposed by the consulting firm.

Third, there has been a debate at board level about how ROCE should be calculated. The marketing director stated that she was not sure what profit figure (of at least four which were available) should be used and why, especially given the large variation in result which this gives. She also wondered what the effect would be of using equity rather than all capital to calculate a return on investment. Some basic data has been provided in Appendix 1 to assist you in quantifying and evaluating these possibilities.

In addition to these concerns, the board is considering introducing a total quality management approach within Monza. Obviously, quality of output is critical in such a heavily regulated industry where the products can be a matter of life and death. There has been discussion about testing this idea within the manufacturing division. The CEO wants to understand, first, the costs associated with quality issues within that division. To aid your analysis, he has supplied some detailed information in Appendix 2. Next, the board requires an outline evaluation of how a total quality management (TQM) approach would fit within the manufacturing division.

Finally, the drug development divisional managers have been lobbying for a new information system which will assist their research chemists in identifying new drug compounds for testing. The new system will need to be capable of performing calculations and simulations which require high computational power and memory but will also need to have access to external data sources so that these scientists can keep up with developments in the field and identify new opportunities. The CEO is worried about the cost of such a new system and wants to know how it would fit within the existing lean management approach within that division.

Required:

(iii) Evaluate the effect of choosing different profit and capital measurements for different measures of return on investment and recommend a suitable approach for Monza. (11 marks)