general assignment 2

Boulder Public Schools Edward Caton, a teacher in a midsize elementary school in Boulder, Colorado, hoped someday to rise through the administrative ranks to serve as a principal of his own school, but he felt that to do so, he should understand more about the position to which he aspired. This was especially important to him in terms of the control he might have over the budget, which he knew was central to real power in many organizations. In an effort to learn more about the operations of the Boulder Public Schools, he set up some informational interviews with the principals of an elementary school, a middle school, and a high school. Before making those rounds, he visited the headquarters of the Boulder School Committee to obtain background information for his interviews. BACKGROUND Mr. Caton learned that the Department of Implementation (DI) was central to the school system. It’s manager reported directly to the Superintendent of Schools. The DI was responsible for making school enrollment projections each December for the coming fiscal year (which ran from July to June). These projections were important since annual staffing needs for each school were determined by a rather complex formula that used the DI's projections as the starting point. Moreover, since personnel formed the bulk of the budget, these projections effectively determined a school's budget. Each school had a few weeks to challenge the DI’s projections, and, if a convincing argument could be made, the DI would modify them. Final enrollment projections were established by mid-January of each year. Mr. Caton learned that Boulder, along with many other large cities, had seen declining enrollments in recent years. The decline was caused by a slowing of the birthrate, but also, in Boulder's case, by flight from the city in the face of the desegregation orders which created busing and some violence within the schools. The result was not only a drop in enrollments, but also a change in the composition of the school system population. Specifically, during the past 15 years, the proportion of white students had dropped from 64 percent to only 27 percent. Black students, by contrast, had increased during those same years from 30 to 48 percent, and Hispanics from 4 to 17 percent. Moreover, the proportion of students termed very poor had increased, by one estimate, to two-thirds of the total; 60 percent of the families of Boulder public school students were classified as being at the poverty level of income as defined in federal guidelines. Retrenchment had been necessary in the face of these shrinking enrollments, Staff reductions and the closing of school buildings had become almost commonplace during this era. At present, the BPS operated 77 elementary schools grades K-5, and 1 grades K-8; 22 middle schools grades 6-8, and 1 grades 7-8; and 17 high schools. Nearly 4,000 teachers worked in these schools. THE UPCOMING FISCAL YEAR BUDGET Recently, the city had witnessed the beginnings of a rise in enrollments, and the DI was forecasting an increase to some 58,000 students in the upcoming fiscal year. The budget for the year had been set at $293 million, divided between two funds: Number 017 (General School

HBSP Product Number TCG239. Rev. Oct. 2015

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_____________________________________________________________________________________________ This case was prepared by Dena Rakoff and Professor David W. Young. It is intended as a basis for class discussion and not to illustrate either effective or ineffective handling of an administrative situation. Copyright © 2017 by The Crimson Group, Inc. To order copies or request permission to reproduce this document, contact Harvard Business Publications (http://hbsp.harvard.edu/). Under provisions of United States and international copyright laws, no part of this document may be reproduced, stored, or transmitted in any form or by any means without written permission from The Crimson Group (www.thecrimsongroup.org)

Purposes, or GSP), which comprised $285 million of the total, and Number 027 (Facilities Management/Alterations and Repairs, or A&R), which accounted for the remaining $8 million. The Special Education and Bilingual Education acts of the Colorado State Laws mandated certain levels of spending for their constituents. In the upcoming year, the portion of the Boulder School Committee budget assigned to those acts was 28 percent. Despite some state financial support for these mandates, much of the funding had to be provided by the School Committee, thereby limiting the funds available for regular education programs The State constitution prescribed a formula that determined the amount that the City of Boulder was required to provide to Boulder Public Schools; the school system received this automatically, without being required to make a justification. For the upcoming fiscal year, this “constitutional base” figure was $224.5 million. For additional revenue, the school system had to convince the city of its needs. For the upcoming year, this “supplemental appropriation” from the city was $57.9 million. In addition, the school system expected revenues from miscellaneous sources, mostly federal government entitlement programs, of $10.6 million. These amounts equaled the $293 million budgeted expenditures. CONTROL OF THE BUDGET FORMULATION PROCESS Much of the control of the budget process appeared to Mr. Caton to derive from the Central Office. Under the leadership of a new Superintendent, there had been an emphasis given to centralizing much of the decision making. He advocated a tripartite objective--quality education, equal access, and accountability--and he wanted to reduce what he called operational inefficiencies. In his short tenure with the Boulder schools he had developed the Boulder Education Plan, a document outlining the mission and long-range goals for the system. Indeed, only a few months after assuming office, he had launched a new budget system with new procedures and committees. This new budgeting system was explained in a 100-page document entitled Superintendent's Budget Perspective for the Boulder Public Schools, and was supplemented with two budget manuals, each about 30-50 pages long. The budget document itself was some 75 pages long. In January, in accordance with the new budgeting system, the principals and headmasters of each school had been given budget packets to assist them in preparing their budgets. These packets included forms such as a school profile, requesting formulation of goals and program directions; a program summary on which to detail plans for using allotted staff; and a programmatic reductions form, which allowed the principals and headmasters to make an argument for restoring previously withdrawn funds by documenting the impact of the cut. The principals and headmasters had about 20 days to complete these documents and to submit them to District Superintendents. About a month after that, the District Superintendents had been required to submit the packets to the Central Office. Reviews and hearings had taken place on several community and committee levels, as well as on the central level, prior to arriving at a final budget. Mr. Caton had read that the new Superintendent's longer-term objective for the budget formulation process was a “zero-based” model, where all spending would begin with an empty line and build on a program-by-program basis, in accordance with the rationale for each program. However, that plan had not been in place for the current budget, which had been simply a maintenance budget, keeping stable spending levels from the previous year, combined with a few initiatives and a few cuts. The result was an increase of about 8 percent over the prior year’s budget of $270 million. Mr. Caton noticed that of the $293 million, $190 million consisted of personnel expenditures, including $121 million for teachers and substitutes. He assumed that this money, and much but not all of the administrative support costs, were quite difficult to reduce, given enrollment levels and union contracts for salary levels and teacher-student ratios. Moreover, budget maneuverability appeared to him to be quite restricted by a variety of “givens” within the

TCG239 • Boulder Public Schools 2 of 9_____________________________________________________________________________________________

system: curriculum requirements, accompanied by citywide tests; promotion and graduation requirements; and even length-of-class-period dictates. All of these requirements were handed down by the School Committee. He even had heard of rumors of an initiative being developed by the Colorado Department of Education to require schools to report on matters such as truant days, suspension days, dropouts, and high school seniors' post-graduation plans. He wondered what this would imply for the availability of state funds for individual schools within the system. Mr. Caton also had observed what he thought to be a troublesome dichotomy within the system. On the one hand, he had seen a memorandum from the Deputy Superintendent for Finance and Administration, describing some options that gave principals and headmasters greater budget flexibility (Exhibit 1). But on the other hand, he noted that the new Superintendent was in some ways decreasing the autonomy of schools. He continually heard, for instance, about the slowing of progress toward what the previous Superintendent had called School-Based Management, a program that had made great strides in placing the locus for much decision making in the hands of each school and local community. PERSPECTIVE OF THE PRINCIPALS AND HEADMASTERS Armed with some sense of the school system at large, and toting a set of documents gathered from the Central Office, Mr. Caton next ventured out into the field to interview some school principals. He decided to first visit a high school, followed by an elementary school and a middle school. The High School The high school Mr. Caton visited was relatively new, with an enrollment of some 900 students. He began by attempting to learn more about the matter of budgetary discretion:

Caton: What I'd like to know is where you feel that you have any budgetary discretion. Is the entire procedure out of your hands?

Headmaster: Well, no, not entirely. Look, for instance, at my 620 account. That's the budgetary line that covers Instructional Materials. It's fairly broad, including mainly supplies--books, paper, that sort of thing. The total amount assigned to me in September--or actually in late spring--is determined by my projected student enrollment. A fixed part is removed from my allocation before I ever get the opportunity to assign it; that part covers equipment rental and that sort of thing. Let's say I get about an $85,000 allotment; $8,000-$9,000 of that might be assigned before I see the funds.

Then I have the rest to spend as I see fit. No, let me modify that. I have control over the items purchased with the rest and over the timing of that spending--but within certain guidelines. I must order books that appear on the list of School Committee-approved publications. I must use the vendors identified by them as approved. If there is something I want under $2,000, I can arrange my own vendor. However, I still have to go through the central purchasing format. And, to order books not on the list, I have to get approval from the Department of Curriculum and Instruction, which is quite time-consuming.

In terms of when I spend my funds, there is some pressure to use up the money quickly. You never know when the Central Office might issue a spending freeze, and those monies you were saving for a particular midyear purchase vanish. What's more, sometimes, your money is needed elsewhere--and it's wiped out of your account. So, spend quickly is my motto.

I very much wish I could use the money in a more measured way. Rolling over funds from year to year is a good example of a power that would enable me to save for items greatly needed, or to not spend when the need wasn't strong. But, we cannot keep any surplus till the following year, so I spend now!

If I could choose my vendors, I'm sure I could make more informed choices than the Central people can. I'm sure I could get better prices. But, as I said before, as soon as I make a purchase of over $2,000, I must use the approved sellers, or if no appropriate ones are listed, put the proposed purchase out to bid, which makes for a very lengthy procedure.

TCG239 • Boulder Public Schools 3 of 9_____________________________________________________________________________________________

Caton: I think I heard about money held for payment of substitutes, which reverts to you during the year if you don’t use your full allotment of subs. Is that useful to you?

Headmaster: Sometimes a portion of the unspent balance does come to the school for us to use as we see fit. We've gotten as much as $7,000 in a year that way. I leave the spending decision to the faculty senate. But, again, we bump up against the issue of inability to choose vendors by ourselves. And, you should consider the pressure felt by the faculty in knowing that their absences determine just how much of these funds all of us will have to use. Sometimes there are legitimate reasons to be out--personal sickness, ill children, etc. And, the teachers' union rises in agitation when they worry about too much pressure being put on people not to take advantage of their legitimate benefits. To tell you the truth, I'd rather spend my time solving real problems than focus too much on this “boon.”

Caton: Is there any opportunity to handle your own money more directly when you are awarded grant money?

Headmaster: Yes and no. I recently got an outside grant, funded by the Bank of Boulder and administered by the Central Office. In that case, I had to comply with the usual spending procedures. However, I also had a Carnegie grant of $30,000, and since that was not administered by Central, I could dispense the money as I saw fit.

Caton: I understand that your budget's size is determined by the projected student enrollment. What happens if you take in more students than either you or the Department of Implementation foresaw?

Headmaster: An addendum to the budget is possible. I do feel very strongly, though, that needs and program offerings, rather than numbers, should drive the budget. I'd like to be able to fund a program to train teachers to focus on problem-solving skills here, for instance.

Caton: Is there any way that you, here in your school, can control the numbers reported to Central?

Headmaster: Yes. I try to clean up my DNRs quickly. That stands for “Did Not Report”--in other words, students who were supposed to come to our school but either moved or are attending another school. I don't want them on my rolls any longer than necessary. I send out an attendance officer early to investigate those who do not report, and to drop them early.

Caton: But, doesn't that penalize you when it comes to determining your enrollment?

Headmaster: I run into union trouble if I don't drop them: they make the classes look unrealistically large. My truancy rate looks too large, also. I like clean books.

Caton: What control do you have over changes in budget procedure? How would you go about getting some of these revisions made?

Headmaster: I have a policy of always keeping parent groups informed. It's most important to know how to utilize your constituencies.

The Elementary School Next, Mr. Caton visited an elementary school, built in the 1970s, with an enrollment of 700.

Principal: So, you want to know where I have any discretionary spending power. The 620 account, that's key. Maybe 12% of that is pre-assigned; the rest is mine to do with as I see fit.

Look, here's a copy of the latest expenditure report for this school from Central (Exhibit 2). As you can see, here's my 620 line. It shows me budgeted for about $59,000. Supposedly, according to this, $20,000 has already been spent by me--not by Central on its predetermined purchases. But I know that I've spent more than $20,000. It's very important for you to keep records in-house. That's the only way you can answer them downtown when they say you've overspent, or when they try to assign your funds elsewhere, or when you don't know how much you have left because the expenditure reports don't arrive in a very timely manner.

Caton: Don't you get funds from unfilled vacancies to use within your school?

Principal: They don't come here.

TCG239 • Boulder Public Schools 4 of 9_____________________________________________________________________________________________

Caton: What about unspent substitute money?

Principal: I think that gets reassigned. I don't spend it. But, maybe the reason is that my per diem line gets charged for the long-term substitutes I seem to need each year.

I don't suffer, though. I manage to make things happen. I came to this school when it was a shambles. I've created a very good faculty. Some of the people who contributed very little have left.

Caton: How did you bring that about?

Principal: I simply let my expectations be known; if people wanted to work with me, they stayed; if they didn't, most of them left. Of course there are exceptions.

It took me a few years to get the support of the community. But now I can get parents in to help with the video workshop or with field trips any time I need them. I'm about to launch a program for parents to train them in carrying on at home the teaching that we begin here during the day.

Caton: Do you have any other sources of funds?

Principal: Grants. Grant application-writing, that's something my teachers spend a lot of time on. One of my teachers is presenting a workshop on that during the upcoming Teacher Professional Workshop Day. They really produce.

Grants give us some discretionary money. We sometimes get them for school-wide use, and sometimes individual teachers get them for use with specific classes.

We really must look to external sources. Sales of candy or the like are another place where we turn up money we can use for whatever ends we choose. Parents and children help, last year we raised almost $7,500 through sales. That allows us to buy new blackboards, bulletin boards, to take field trips, and to do some repair of the facilities, which happen to be in fairly poor shape. Fortunately, neither this money, nor our 188 money from the State carry any vendor requirements.

As a matter of fact, look at the 730 account, repairs and maintenance of buildings and grounds. You can see I have an empty line there. The School Committee isn't paying for non-emergencies.

As I say, though, I'm able to get what I need. And, if a teacher needs something, and makes a good case to me for that need, I can provide it. There's always a way.

But, I do have somewhere in my head a list of changes I feel are necessary. One item on that list is the method of determining the budget in the first place. What we need is a program-based budget. We should be able to designate the needs we must meet from the level of the school, and then be given the means and the responsibility to meet them. We shouldn't have to work on what Central says to work on. They claim they understand our programs, but then they do something like what they did this morning--send me a seventh “Behavior Lab” student when six is the limit.

As you know enrollment predictions are very important in determining the budget. Central sends me their estimate every year, and I'm allowed to counter it with my own predictions. In fact, my predictions for the past few years have been right on target. I've worked hard to prove to Central that my predictions are the accurate ones.

Once the budget is set, I can move teachers and use aides to cover if I need to. And, I've been able to distribute enrichment subjects among the student body in a fair way by creating a seven-day roster week; with that, each student gets music or art not once a week in the traditional way, but once every seven-day rotation. Thereby I keep my classes down to a manageable size.

The Middle School Finally, Mr. Caton went to a middle school of about 600 pupils, constructed in the late 1960s. Some people had told him that middle schools were particularly difficult to manage because of their unstable demographics. He also had learned that high schools received more resources than middle schools due, in part, to the fact that high schools operated with departmentalized systems

TCG239 • Boulder Public Schools 5 of 9_____________________________________________________________________________________________

and differentiated staffing. But he also had been informed that, in the past few years, the middle schools had received funding for some additional positions, such as Directors of Instruction, Instructional Support teachers, and Targeted Reading teachers. He was interested therefore to learn more about the perspective of a principal of a middle school.

Principal: You have to understand, Boulder has a system of priorities in its school department. Most important is the high school. They get more personnel, more budget, and more discretionary funding; that's probably because the media features them, and media attention must be respected.

Next come the elementary schools, and finally the middle schools. Historically, our size and importance have been determined by the surges and retractions in the elementary school populations. As you probably know, the junior high schools, which middle schools supplanted, ran from grades 7 through 9. Because of this dependency on elementary school enrollment, we, at times, have been as inclusive as grades 4 through 8; sometimes we're 6 through 8. That variation has made it difficult to focus on an age group, and the abrupt changes have been disruptive to teachers as well.

Middle school years, especially 7th and 8th grades, are important years; those are when the decision to drop out is made. We're beginning to get some funds and programs now to combat middle-school-specific problems like overage students, dropouts, and teenage pregnancy.

Caton: Speaking of money, have you been able to take advantage of the “lag funds,” that is, the unspent money from unfilled vacancies in your school that I understand reverts to you for your own use?

Principal: That's tricky. I have a vacancy right now for an assistant principal. I do get some of the salary money now, about three months' worth to cover August through this month of October, if I take a new person. But if I take a recall, I lose whatever funds are necessary to pay that person retroactively for the difference between his or her previous salary and this one. So, it's likely not to be as much money as you might expect.

But if I do get some money, I can file a Form FA-01, asking for the money to be transferred to my 620 account, and from there I have some discretion as to what it will buy.

You might think that leaving a position vacant could buy you the money you need for programs or whatever. Not really. The union has come in when positions remain unfilled if there are any unassigned teachers within that certificate area. They worry about their members not being utilized--and paid. And, what's more, if you leave a position unfilled for too long, Central might deem your need for the position reduced, and eliminate the funding for it in the coming budget year.

Numbers, in particular enrollments, are all-important. Special Education and Bilingual Education, both of which are programs mandated by the state, but only partially reimbursed by state or federal funds, put a drain on our resources. When it comes to regular education programs, we have trouble making a case for them.

The Department of Implementation each winter projects our enrollment for next year. My projected and actual enrollment figures are never the same. If you think the figures generated for your school are too small when the March budget figures are announced, you can petition to have the projections altered by making a good statistical argument. If your argument is considered valid, your teacher allotment will be raised, but your 620 account will not--it will be calculated on the basis of the original enrollment projections. Teacher allotments are contractual according to class size; instructional materials are not. The result is that if I get enough students to push a special education class over its limit, for example, I'm given an extra teacher, but I do not necessarily get enough extra 620 money to provide the students with books.

Caton: Do you find the 620 account something you can use to increase expenditures where you feel they're needed?

Principal: Yes, to some extent. But some of those expenditures are fixed: paper, Xerox supplies, art supplies, membership in various organizations; all those things are taken from your 620

TCG239 • Boulder Public Schools 6 of 9_____________________________________________________________________________________________

account before the line is open to you. Prediction of costs is a bit difficult here also. Some years, for instance, maintenance of the Xerox is done by Central; some years, you have to absorb the costs yourself. It's important to stay in touch with Central each year to learn the current procedures.

After this final interview Mr. Caton looked forward to the evening, when he would sit back in his favorite armchair, notes in hand. From that vantage point, he would attempt to make a coherent whole from the various parts. Assignment

1. Define the key features of the current management control system in the Boulder Public Schools.

2. As the manager (principal or headmaster) of a Boulder public school, what changes would you like to see made in the management control system? (Your proposals should, of course, be limited to those that you think might be acceptable to headquarters.)

3. As the Deputy School Superintendent, what would be your reaction to these proposals?

TCG239 • Boulder Public Schools 7 of 9_____________________________________________________________________________________________

BOULDER PUBLIC SCHOOLS Exhibit 1. Memorandum to Principals and Headmasters

from the Deputy Superintendent, Finance and Administration

Subject: Budget Flexibility One major outgrowth of surveys and interviews done in connection with the Finance and Administration Task Force last spring is that desire for budget flexibility continues to be one of the highest priorities of principals and headmasters. As you know, the School-Based Management Project had already given considerable impetus to this concept, and piloted it in certain schools. The Office of School Site Management has emphasized it as a priority for this school year. This fiscal year promises to be a very tight budget period. While the schools and programs appear to be adequately staffed, lack of appropriate initial funding and unanticipated large-scale costs in transportation and other areas will put a yearlong squeeze on the total school budget. However, since we will more than likely be in tight budget situations for years to come, we should not use that as a reason for totally avoiding the issue of budget flexibility. Therefore with the new Superintendent's approval, we will undertake initial moves on a systemwide basis this year. The budget flexibility options open to all principals and headmasters include:

a. Ability to move positions within individual school budgets throughout the school year as long as there is compliance with state and federal mandates. This can be done by submission of a budget transfer (FA-01) and accompanying explanation to the Budget Office through your community superintendent.

b. Use of lag funds within the 312 account at all levels, and within the lunch monitor account at the elementary school level. This can be done beginning immediately by written request to the Budget Office through the community superintendent.

c. Return to schools of one-third of what is saved in substitute monies once we have factored out the use of district substitutes or building substitutes. This will be done early enough in the spring to enable principals and headmasters to use any funds saved in the late spring.

d. Flexible use of 620 funds to buy equipment, to pay part-time stipends to teachers for special programs for contracted services, for consultants, for tutors, or for hiring temporary help during peak periods. Use of 620 funds in this manner will be by submission of the appropriate FA-01 and explanation to the Budget Office through the community superintendent. (It should be noted that 620 funds cannot be used for creating extra permanent positions, whether full- or part-time.)

e. Pooling of resources between schools. Savings that accrue to an individual school may prove small but pooling resources among several facilities might offer opportunities that otherwise were not possible. For example, two or three small schools might find it possible to purchase jointly audio/visual equipment that none could buy individually. In fact, smaller schools are most likely to obtain maximum benefits from these proposals only if they do cooperate and dovetail their efforts with each other.

It is my belief that this initial movement toward providing flexibility while small at first, will enable school principals and headmasters to purchase some important materials and to try some innovative approaches. It will also allow us as a system to test out ways to provide budget flexibility in a more comprehensive manner in the future. I will be discussing this topic with principals and headmasters as I meet with you by level, and, along with the Budget Director, I will be available for any inquiries or recommendations. Thank you for your continued cooperation.

cc: Superintendent Community Superintendents Budget Director

TCG239 • Boulder Public Schools 8 of 9_____________________________________________________________________________________________

BOULDER PUBLIC SCHOOLS Exhibit 2. School Expenditure Report

EXP CURRENT AVAILABLE OBJ ACCOUNT DESCRIPTION BUDGET RESERVED ENCUMBERED EXPENDED ADJUSTMENTS BUDGET

131 REG EDUCATION TCHR 690,289 58,151 632,137 133 PER DIEM SUBS 32,340 32,340 141 ER 121,752 9,214 112,537 161 BILINGUAL KDG TCHR 22,180 2,272 19,907 171 SPED RESOURCE TCHR 94,146 6,225 87,920 181 SPED SUB/SEP TCHR 245,174 19,721 225,452 191 BILINGUAL TEACHER 202,642 17,893 184,748 312 SCH/DIST ADMINIS 123,714 30,629 93,084 341 PROGRAM SUPPORT 32,777 3,300 29,476 381 ATHLETICF INSTRUC 24,976 2,272 22,703 391 P.T. PROF/STIPEND 588 588 521 CUSTODIAN 157,341 35,919 121,421 576 LUNCH MONITOR 24,486 858 23,627 577 BUS MONITOR 4,236 4,236 578 INSTRUCTIONAL AIDE 8,482 8,482 586 SPED RESOURCE AIDE 9,282 9,282 587 SPEC SUB/SEP AIDE 64,972 2,037 62,934 588 BILINGUAL ED AIDE 30,809 564 30,244 620 INSTRUC. SUPPLIES 58,850 1,432 21,909 20,507 14,999 730 RPRS/MAINTS. BUG 810 INSTRU. EQUIPMENT 1,750 985 753 11 820 NON-INSTR. EQUIPMENT

1,950,786 2,417 22,662 209,562 1,716,128

Granville Symphony Orchestra, Inc. If it weren’t for the special fund drive in conjunction with our 100th Anniversary, this would have been our fifth year in a row with a deficit. Even with the fund drive, the total deficit for the last five years has totaled well over $4 million, which we’ve had to withdraw from capital funds. If we continue this way, our capital funds will soon be exhausted.

The speaker was William Johnson, Chair of the Board of Trustees of the Granville Symphony Orchestra (GSO). He continued:

We’ve got to stop the hemorrhaging. Our plan is to put in place a series of measures that will both help us out on the revenue side and keep our expenses in check. We’ve outlined that plan in our most recent annual report, and I’m sure the board and staff are committed to it, but I’m not completely convinced that it’s attainable.

BACKGROUND

GSO owned two properties. One was Concert Hall in Granville. The orchestra performed there, except in the summer and when it performed in other cities. When Concert Hall was not needed for performances, rehearsals, or recording sessions, it often was rented to other organizations.

The other property was Greenwood, a large complex in the Beaumont Hills, about 130 miles from Granville. The orchestra performed there for nine weeks in the summer. Several hundred stu- dents participated in training programs at Greenwood each summer. (The principal buildings at Greenwood were not winterized and could be used only in the summer.) In the summer of 2012, at- tendance at Greenwood totaled 308,000.

In 2011-12, in addition to Greenwood, the orchestra gave 107 concerts, of which 13 were in foreign countries and 14 in other American cities. The Granville Players Orchestra, formed from symphony orchestra players, gave 63 concerts in Concert Hall and 7 free concerts at an outdoor concert shell in Granville, known as the Terrace. Nearly all orchestra and Players performances were sold out.

Management estimated that Concert Hall was used on 165 evenings a year, of which 130 were for GSO concerts and rehearsals, and 35 were for rentals to outside groups. In the afternoons there were 22 symphony orchestra concerts and approximately 25 rentals to outside groups. The orches- tra used the hall on 125 to 150 afternoons annually for rehearsals, recording, or television sessions.

PROPOSED PLAN

The “GSO/100” fund drive raised about $20 million of capital funds (primarily endowment) over a five-year period. Management recognized, however, that the special stimulus of the 100th Anniversary would not provide the funds needed to balance the budget in the future.

Alternative ways of financing operations were discussed, and the trustees eventually agreed on the plan given in Exhibit 1. In the GSO annual report for 2012 (i.e., for the fiscal year ended August 31, 2012), this plan was described as follows:

As the orchestra embarks on the first decade of its second century, Trustees, Overseers, and Friends must make plans based upon the experience of the past and their best estimate of the economic climate in the years ahead. The single most important assumption in making such a projection is the rate at which “fixed costs” of main- taining the present organization and properties will increase due to inflation. Included in the Analysis of Reve- nue Contribution to Fixed Costs are projections based upon several assumptions:

HBSP Product Number TCG249

THE CRIMSON PRESS CURRICULUM CENTER THE CRIMSON GROUP, INC.

_____________________________________________________________________________________________ This case was prepared by the late Professor Robert N. Anthony, and Professor David W. Young. It is intended as a

basis for class discussion and not to illustrate either effective or ineffective handling of an administrative situation. Copyright © 2012 by The Crimson Group, Inc. To order copies or request permission to reproduce this document,

contact Harvard Business Publications (http://hbsp.harvard.edu/). Under provisions of United States and interna- tional copyright laws, no part of this document may be reproduced, stored, or transmitted in any form or by any means without written permission from The Crimson Group (www.thecrimsongroup.org)

1. That “fixed costs” will increase at a compound annual rate of approximately 7 percent through fiscal 2019-2020.

2. That management will be able to increase the percentage of “fixed costs” financed by concert activities by 1/2 of 1 percent per year.

3. That the Investment Committee and the Resources Committee working together will be able to increase the percentage of “fixed costs” covered by endowment income by 1/2 of 1 percent per year.

4. That the Resources Committee will be able to raise on average about $6,000,000 per year, of which $2,000,000 per year will be available to balance the budget.

5. That the Buildings and Grounds Committee will be able to limit capital expenditures for depreciation, for necessary improvements, and for new facilities to $500,000 per year.

Perhaps the most significant conclusions to draw from the projections [Exhibit 1] are:

1. That, in the absence of some new source of revenue, ticket prices will have to continue to increase so that the marginal contribution from concert activities can increase from $5,709,000 in 2011-2012 to $10,500,000, or 64.5 percent of “fixed costs,” in 2019-2020.

2. That Endowment Income available for unrestricted use must increase from $1,893,000 in 2011-2012 to $4,000,000, or 24.5 percent of “fixed costs,” in 2019-2020

. 3. That the book value of Pooled Investments must be increased from $19,465,000 at August 31, 2012, to

$47,500,000 in 2020 if the yield on endowment funds averages slightly over 8 percent over the period.

During the past five years the orchestra raised a total of $20,000,000 for GSO/100 and $7,000,000 from Annual Fund Drives for a grand total of $27,000,000. Thus, the goal of $6,000,000 per year, or $30,000,000 over the next five years, is challenging, but the task is not much greater than the task already accomplished dur- ing the period of the GSO/100 campaign, and the organization is in place to do the job.

The financial projections in the Analysis of Revenue Contribution to Fixed Costs and the above assump- tions and conclusions will have to be reexamined annually in the light of economic conditions and the financial results of each year's operations, but the nature of the task facing management and volunteer fund raisers will probably not be materially changed by modest differences from the assumptions.

Contribution to Fixed Costs

The concept of “contributions to fixed costs” referred to in the above description was ex- plained in the Annual Report as follows:

Each year the Trustees are faced with certain relatively fixed costs which are scheduled in the Analysis of Revenue Contribution to Fixed Costs report. These are primarily for the annual compensation of orchestra members, the general administration of the orchestra, and the basic costs of maintaining Concert Hall and Greenwood. Management earns a percentage of these “fixed costs” by presenting concert programs, through ra- dio, television, and recordings, and through other projects which involve both direct expenses and related income from ticket sales, fees, and royalties.

Each program or activity, of which there are over 40, is expected to make a “marginal contribution” to “fixed costs.” The “marginal contribution” is the difference between direct income and direct costs of the particu- lar program or activity. The orchestra continued to make progress toward its goal of increasing the percentage of “fixed costs” contributed from operation activities.

The “marginal contribution” from all operations in 2011-2012 covered 62.3 percent of “fixed costs” as com- pared to 59.7 percent last year and 52.4 percent in 2007-2008.

In fiscal 2011-2012, the “fixed costs” amounted to $9,160,000, compared to $8,434,000 in 2010-2011, an increase of 8.6 percent. Operations earned $5,709,000, compared to $5,031,000 last year, a 13.1 percent in- crease. This left an “operating deficit” to be funded from other sources, e.g., endowment income and unrestricted contributions, of $3,451,000 in 2011-2012, compared to $3,403,000 last year.

TCG249 • Granville Symphony Orchestra, Inc. 2 of 5 _____________________________________________________________________________________________

Other Information

The 2012 Annual Report contained the following explanation of endowment income:

Investment Income reached an all-time high of $2,134,000 as compared to $1,838,000 in the prior year. Of this amount, $219,000 was used for restricted purposes, e.g. supporting the winter season programs ($35,000), pro- viding fellowships for the Beaumont Music Center and other BMC activities ($101,000), supporting the Terrace concerts ($47,000), underwriting the Prelude Series ($29,000), and other miscellaneous activities. An additional $22,000 went to non-operational uses, leaving $1,893,000 for unrestricted use in support of operations. This compares to $1,690,000 in 2010-11, a 12 percent increase.

The Annual Report also explained how the budget for 2012 was balanced, as follows:

The percentage of “fixed costs” that had to be provided by unrestricted gifts was reduced from 20.3 percent in 2010-11 to 17.0 percent in 2011-12, amounting to $1,558,000.

The sources of the $1,558,000 required to balance revenues and expenses in 2011-12 were:

1. Annual Fund (net): $989,000, up $250,000 or 34 percent over the previous year.

2. Projects (net): $723,000, up $459,000 or 174 percent over the previous year.

Since funds available from these two sources totaled $1,712,000, it was possible to transfer the excess gifts of $154,000 for other needs.

Exhibit 2 gives the balance sheet, taken from the Annual Report.

Assignment

1. What is the strategy of the GSO? Please be as specific as you can in identifying both the GSO’s environ- mental constraints, and how it differs both from other symphony orchestras, and from a professional sports team, which has many similar constraints and objectives? Why do these differences exist?

2. Reconstruct Exhibit 1 into a more traditional operating statement. What does this tell you about how well the GSO is achieving the strategy you identified in Question 1? What additional financial information would you like to have in making this assessment?

3. How has the GSO managed its financial affairs over the past five years? What criteria did you use in making this assessment?

4. Do the plans for 2013-2020 seem attainable? If so, why? If not, what changes would you propose.

TCG249 • Granville Symphony Orchestra, Inc. 3 of 5 _____________________________________________________________________________________________

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Harbor City Community Center Our deficit is increasing, and we obviously have to reverse that trend if we're going to become solvent. But, for that, we have to know where our costs are, in particular the cost of each of the services we offer.

In March, Liz Conaway, Executive Director of the Harbor City Community Center, expressed concern to Ted Roberts, her new accountant, about the Center’s cost accounting system. The extensive funding Harbor City had received during its early years was decreasing and Ms. Conaway wanted to prepare the Center to be self sufficient, yet she lacked critical cost information.

BACKGROUND Harbor City Community Center had been established 20 years ago by a consortium of community groups. Situated in Torrance, an inner-city residential neighborhood of Los Angeles, California, the Center provided comprehensive services to residents of Torrance and neighboring communities. It continued to maintain strong ties with the community groups responsible for its development and subsequent acceptance in Torrance. Funding of Harbor City was initially provided by the Federal government as part of an attempt to provide broad based community services to inner-city poverty areas in the United States. Two years ago, the city of Torrance supplemented Harbor City's revenue with a small three-year grant. Because Ms. Conaway realized that foundation and government support could not continue indefinitely, she intended to make the Center self-sufficient as soon as possible. Harbor City's income statement is contained in Exhibit 1. The Center was composed of eight client-service departments: Homemaker Service, Family Planning, Counseling, Parents’ Advocacy, Mental Health, Alcohol Rehabilitation, Community Outreach, and Referral and Placement. In addition, the center had a Training and Education Department. The center had 22 paid employees and a volunteer staff of 6-10 students acquiring clinical and managerial experience. Community Outreach, which had been designed by Harbor City’s consumers, was a multidisciplinary department providing a link between the health and social services at the center and the schools services of the community. The department was staffed by a part-time speech pathologist, a part-time learning specialist, and a full-time nutritionist. The Referral and Placement Service was for clients whom the cent›er felt, at the time it received a referral, it could not serve; the staff tried to locate another agency to serve the client. Parents’ Advocacy did not serve clients directly but rather worked on behalf of clients who were having difficulty with housing, schools, and so forth.

EXISTING INFORMATION SYSTEM Harbor City's previous accountant had established a system to determine the cost per client-visit (or related activity such as advocacy). According to this method, shown in Exhibit 2,

HBSP Product Number TCG211

THE CRIMSON PRESS CURRICULUM CENTER THE CRIMSON GROUP, INC.

_____________________________________________________________________________________________ This case was prepared by Professor David W. Young. It is intended as a basis for class discussion and not to illustrate either effective or ineffective handling of an administrative situation.

Copyright © 2017 by The Crimson Group, Inc. To order copies or request permission to reproduce this document, contact Harvard Business Publications (http://hbsp.harvard.edu/). Under provisions of United States and international copyright laws, no part of this document may be reproduced, stored, or transmitted in any form or by any means without written permission from The Crimson Group (www.thecrimsongroup.org)

the cost was a yearly average for all client visits. The accountant would first determine the direct cost of each department. He would then add overhead costs, such as administration, rent, and utilities to the total cost of all the depart(ments to determine the community center's total costs. Finally, he would divide the total by the year's number of visits. Increased by an anticipated inflation figure for the following year, this number became the projected cost per visit for the subsequent year. In reviewing this method with Mr. Roberts, Ms. Conaway explained the problems she perceived. She said that although she realized this was not a precise method of determining cost for clients, the center's cost per visit had to be held at a reasonable level in order to keep its services accessible to as many community residents as possible. Additionally, she anticipated complications in determining the cost per visit for each of Harbor City's departments:

You have to consider that our overhead costs, like administration and rent, have to be included in the cost per visit. That's easy to do when we have a single cost, but I'm not certain how to go about it when determining costs on a departmental basis. Furthermore, it's important to point out that some of our departments provide services to others. Parents' Advocacy, for example. There are three social workers in that department, all earning the same salary. But one works exclusively for Counseling, while another divides her time evenly between Family Planning and Homemaker Service. Only the third spends his entire time in the Advocacy Department seeing clients who don't need other sociÔal services, although he occasionally refers clients to other social workers. In the Alcohol Rehabilitation Department, the situation is more complicated. We have two part-time MSWs, each earning $48,000 a year, and one part-time bachelor degree social worker earning $32,000. The two MSWs yearly see about 1,500 clients who need general social work counseling, but they also spend about 50 percent of their time in other departments. The BA social worker cuts pretty evenly across all departments, except referral and placement of course.

Mr. Roberts added a further dimension: I've spent most of my time so far trying to get a handle on allocating these overhead costs to the departments. It's not an easy job, you know. Administration, for example, seems to help everyone about equally, yet I suppose we might say more administrative time is spent in the departments where we pay more salaries. Rent, on the other hand, is pretty easy: it can be done on a square-foot basis. We could classify utilities according to usage if we had meters to measure electricity, phone usage and so forth, but because we don't, we have to do that on a square-foot basis as well. This applies to cleaning, too, I guess. It seems that record keeping can be allocated on the basis of the number of records, and each department generates one record per client visit. Training and Education (T&E) is the most confusing. Some departments don't use it at all, while others use it regularly. I guess the fairest would be to charge for it on an hourly basis. Since there are two people in the department, each working about 2,000 hours a year, the hourly charge would be about $16.00. But this is a bit unfair, since T&E also uses supplies, space and administrative time. So we should include those costs in its hourly rate. Thus, the process is confusing and I haven't really decided how to sort it out. However, I have prepared data on floor space and T&E usage. (Exhibit 3).

As Ms. Conaway looked toward the rest of the year, she decided to calculate a precise cost figure for each department. The center was growing, and she estimated that total client volume would increase by about 10 percent during the year, spread evenly over each department. She anticipated that costs would also increase by about 10 percent. She asked Mr. Roberts to prepare a step-down analysis for last year so that she would know Harbor City's costs for each department. She planned to use this information to assist her in projecting costs for the current year.

Assignment

1. What is the cost per visit for each department? 2. How might this information be used by Ms. Conaway?

TCG211 • Harbor City Community Center 2 of 3_____________________________________________________________________________________________

HARBOR CITY COMMUNITY CENTER Exhibit 1. Income Statement

For the Prior Year (Ended December 31) Revenue from patient fees $1,381,800 Other revenue 20,000 Total revenue $1,401,800 Expenses: Program services $940,000 Record keeping 40,000 Training & Education 100,000 General & Administrative 368,000 1,448,000 Surplus (Deficit) ($46,200)

Exhibit 2. Costs and Patient Visits for the Prior Year, By Department (1) Department No. of Visits Salaries (2) Others (3) Total Homemaker Service 5,000 $80,000 $32,000 $112,000 Family Planning 10,000 20,000 60,000 80,000 Counseling 2,100 120,000 64,000 184,000 Parents' Advocacy 4,000 108,000 24,000 132,000 Mental Health 1,400 60,000 32,000 92,000 Alcohol Rehabilitation 1,500 128,000 32,000 160,000 Community Outreach 2,500 20,000 40,000 60,000 Referral and Placement 6,400 80,000 40,000 120,000 Subtotal 32,900 616,000 324,000 940,000 Administration 152,000 8,000 160,000 Rent 144,000 144,000 Utilities 40,000 40,000 Training and Education 64,000 36,000 100,000 Cleaning 24,000 24,000 Record keeping 28,000 12,000 40,000 Total $860,000 $588,000 $1,448,000 Number of Client Visits 32,900 Average Cost per Visit $44.00 Notes: 1. Client visits rounded to nearest 100; expenses rounded to nearest $1,000. 2. Includes fringe benefits. 3. Materials, supplies, contracted services, depreciation and other non-personnel expenses.

Exhibit 3. Floor Space and Training and Education Usage, by Department (1) Department Floor Space (2) T & E Usage (3) Homemaker Service 1,000 1,000 Family Planning 1,300 200 Counseling 1,800 2,400 Parents' Advocacy 300 100 Mental Health 1,000 --- Alcohol Rehabilitation 500 --- Community Outreach 1,100 100 Referral and Placement 1,000 200 Administration 500 --- Record keeping 300 --- Training and Education 1,200 --- Total 10,000 4,000

Notes: 1. Rounded to nearest 100 2. In square feet 3. In hours per year rounded to the nearest 100

TCG211 • Harbor City Community Center 3 of 3_____________________________________________________________________________________________

Lakeside Hospital A hospital just can’t afford to operate a department at 50 percent capacity. If we average 20 dialysis

patients, it costs us $425 per treatment, and we’re only paid $250. If a department can’t cover its costs, including a fair share of overhead, it isn’t self-sufficient and I don’t think we should carry it.

Peter Lawrence, M.D., Director of Specialty Services at Lakeside Hospital, was addressing James Newell, M.D., Chief Nephrologist of Lakeside’s Renal Division, concerning a change in Medicare’s payment policies for hemodialysis treatments. Recently, Medicare had begun paying independent dialysis clinics for standard dialysis treatments, and the change in policy had caused patient volume in Lakeside’s dialysis unit to decrease to about 50 percent of capacity, producing a corresponding increase in per-treatment costs. By February of the current fiscal year, Dr. Lawrence and Lakeside’s Medical Director were considering closing the hospital’s dialysis unit. Dr. Newell, who had been Chief Nephrologist since he’d helped establish the unit, was opposed to closing it. Although he was impressed by the quality of care that independent centers offered, he was convinced that Lakeside’s unit was necessary for providing back-up and emergency services for the outpatient centers, as well as for treatment for some of the hospital’s seriously ill inpatients. Furthermore, although the unit could not achieve the low costs of the independent centers, he disagreed with Dr. Lawrence’s cost figure of $425 per treatment. He resolved to prepare his own cost analysis for their next meeting. BACKGROUND Approximately twenty years ago, at Dr. Newell’s initiative, Lakeside had opened the dialysis unit, largely in response to the growing number of patients with chronic kidney disease. The hospital’s renal division had long provided acute renal failure care and kidney transplants, but the the most common treatment for end-stage renal disease was hemodialysis. During dialysis, a portion of a patient’s blood circulates through an artificial kidney machine and is cleansed of waste products. Used three times a week for 4 to 5 hours, the kidney machine allows people with chronic kidney disease to lead almost normal lives. The dialysis unit had 14 artificial kidney machines. Because of space limitations, they used only 10 at any one time, reserving the other four for breakdowns and emergencies. Open six days a week with two shifts of patients daily, the unit could provide 120 treatments a week, which meant they could accommodate 40 regular patients. ! From 1973, the year that Medicare began reimbursing for dialysis, all dialysis patients at Lakeside had been covered by Medicare. Until recently, the unit had operated at almost 100 percent capacity, even extending its hours to accept emergency cases and to avoid turning away patients. Patients typically spent their first three months of dialysis in a hospital facility. If there were no complications when this “start-up” period had passed, they were then required to transfer to an independent center. Most independent dialysis centers were centrally owned and operated, and were organized into satellite groups spread throughout urban and suburban areas. The facilities were modern and attractively designed and, because they were separate from hospitals’ institutional environments,

HBSP Product Number TCG115 . Rev. Nov17

THE CRIMSON PRESS CURRICULUM CENTER THE CRIMSON GROUP, INC.

_____________________________________________________________________________________________ This case was prepared by Professor David W. Young. It is intended as a basis for class discussion and not to

illustrate either effective or ineffective handling of an administrative situation. Copyright © 2017 by The Crimson Group, Inc. To order copies or request permission to reproduce this document,

contact Harvard Business Publications (http://hbsp.harvard.edu/). Under provisions of United States and international copyright laws, no part of this document may be reproduced, stored, or transmitted in any form or by any means without written permission from The Crimson Group (www.thecrimsongroup.org)

they offered psychological advantages to patients. Centrally managed with low overhead, they could achieve economies unobtainable by similar hospital units. Supplies and equipment were purchased in bulk, for example, and administrators watched staff scheduling and other costs closely. As a result, their per treatment costs were significantly lower than those in a hospital facility. For example, a treatment in a center operating at 100 percent capacity with 40 patients could cost as little as $160. LAKESIDE DATA Lakeside’s direct and allocated costs for the Renal Dialysis Unit in the previous fiscal year are detailed in Exhibit 1. Dr. Newell also obtained the unit’s cost center report for the same fiscal year (Exhibit 2), which provided a breakdown of the unit’s direct costs. Dr. Newell intended to use the prior year’s costs to calculate the per-treatment cost at various volume levels for the current year. He also wanted to find the point at which the unit’s revenue would meet its costs. He commented:

I plan to use only those costs that can be traced directly to dialysis treatments, and not any overhead costs. If the unit’s revenue meets its direct costs, it is self-sufficient. Peter’s treatment cost of $425 is misleading since it includes substantial overhead, and this year’s overhead will differ from last year’s because of the unit’s decrease in volume. Also, even though this year’s overhead can’t be calculated until the end of the fiscal year, I think I can come up with an estimate. First, though, I plan to calculate the “real” cost of a treatment and, from there, define a “fair share” of overhead.

In reviewing the cost center report, Dr. Newell realized that the nature of the costs varied. There are three types of costs I need to consider in this analysis: those that vary in proportion to volume, those that vary with significant changes in volume, and those that remain the same regardless of the unit’s volume. The first and the last are pretty clear. Medical supplies, purchased laboratory services, and water usage all change according to the number of treatments provided. The other non-personnel expenses will stay essentially the same regardless of the number of treatments. Salary and wages, and employee expense costs are more complicated. Although they didn’t change during the last year, the unit’s number of treatments also remained fairly steady. However, the significant reduction in volume this year might cause a corresponding reduction in salary and employee expenses. Last year, we employed seven hemodialysis technicians, seven nurses, and one administrator (our nephrologists are all on the hospitals’ physicians’ payroll). However, since I had anticipated that volume would fall, I didn’t replace the nurse and two technicians who left in January of this year. So, as of February, our annualized salaries have decreased by $84,000 and our fringe benefits have decreased by $8,400, for a total of about $92,400. Finally, just as a precaution, in case Peter asks, I had my secretary call a hospital equipment supply manufacturer to discuss the resale value of our 14 machines. They told her that machines used for four years or more could not be sold, even for scrap. We purchased all 14 machines five years ago for $210,000.

Assignment 1. On a full-cost basis, how “profitable” was the dialysis unit last year? Please structure your answer in the form

of a contribution income statement. 2. Dr. Lawrence says that it costs $425 per dialysis procedure. How did he calculate that figure? What, if

anything, is wrong with his calculation? 3. Assume that the volume this year will be 3,120 procedures (20 patients, 3 times per week, 52 weeks in a

year). At that level of volume, how “profitable” will the dialysis unit be this year? Be sure you calculate the new direct costs, and that you estimate, as best you can, this year’s allocated (or indirect) costs.

4. What is the unit contribution margin of a dialysis procedure? How might Dr. Newell use this number in thinking about his options? For example, how might he use it to calculate the “breakeven volume” of the dialysis unit?

5. Assuming that Dr. Newell does not want Dr. Lawrence to eliminate the dialysis unit, how should he present his analysis? How do you think Dr. Lawrence will respond to this presentation?

_____________________________________________________________________________________________ Lakeside Hospital • November 2017 2 of 4

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LAKESIDE HOSPITAL Exhibit 2. Cost Center Report—Dialysis Unit

Prior Fiscal Year

Expense Item Oct-Nov Dec-Jan Feb-Mar Apr-May Jun-Jul Aug-Sep Total Supplies and Purchased Services Water usage 3,528$ 3,480$ 3,456$ 3,440$ 3,496$ 3,496$ 20,896$ Medical supplies: 83,904 81,800 81,810 81,612 82,400 82,280 493,806 Purchased lab services 4,232 4,052 4,000 3,988 4,084 4,120 24,476 Total 91,664$ 89,332$ 89,266$ 89,040$ 89,980$ 89,896$ 539,178$

Professional salaries and wages: Nurses 35,000$ 35,000$ 35,000$ 35,000$ 35,000$ 35,000$ 210,000$ Technicians 31,500 31,500 31,500 31,500 31,500 31,500 189,000 Subtotal 66,500$ 66,500$ 66,500$ 66,500$ 66,500$ 66,500$ 399,000$ Fringe benefits 6,650 6,650 6,650 6,650 6,650 6,650 39,900 Total 73,150$ 73,150$ 73,150$ 73,150$ 73,150$ 73,150$ 438,900$

Administrative expenses Salaries and wages 5,500$ 5,500$ 5,500$ 5,500$ 5,500$ 5,500$ 33,000$ Fringe benefits 550 550 550 550 550 550 3,300 Total personnel 6,050$ 6,050$ 6,050$ 6,050$ 6,050$ 6,050$ 36,300$ Administrative supplies 1,570 1,570 1,570 1,570 1,570 1,570 9,420 Major equipment depreciation 4,375 4,375 4,375 4,375 4,375 4,375 26,250 Total 11,995$ 11,995$ 11,995$ 11,995$ 11,995$ 11,995$ 71,970$

Total costs $176,809 $174,477 $174,411 $174,185 $175,125 $175,041 $1,050,048

Number of treatments 980 956 944 940 956 960 5,736

Cost per treatment $180.42 $182.51 $184.76 $185.30 $183.19 $182.33 $183.06

Harlan Foundation Harlan Foundation was created in 1953 under the terms of the will of Martin Harlan, a

wealthy Minneapolis benefactor. His bequest was approximately $3 million and its purpose was broadly stated: income from the funds was to be used for the benefit of the people of Minneapolis and nearby communities.

In the next 50 years, the trustees developed a wide variety of services. These included three infant clinics, a center for the education of special needs children, three family counseling centers, a drug abuse program, a visiting nurses program, and a large rehabilitation facility. These services were provided from nine facilities, located in Minneapolis and surrounding cities. Harlan Foundation was affiliated with several national associations whose members provided similar services.

The foundation operated essentially on a break-even basis. A relatively small fraction of its revenue came from income earned on the principal of the Harlan bequest. Major sources of revenue were fees from clients, contributions, and grants from city, state, and federal governments.

Exhibit 1 is the most recent operating statement. Program expenses included all the expenses associated with individual programs. Administration included the costs of the central office, except for fund-raising expenses. Seventy percent of administration costs were for personnel. The remaining 30 percent included depreciation on administrative equipment, supplies, rent, utilities, postage, and similar items.

During the upcoming year, the foundation had decided to undertake two additional activities. One was a summer camp, whose clients would be children with physical disabilities. The other was a seminar intended for managers in social service organizations. For both of these ventures, it was necessary to establish the fee that should be charged. CAMP HARLAN

The camp, which was called Camp Harlan, was donated to the foundation last year by a person who had owned it for many years and who had decided to retire. The property consisted of 30 acres, with considerable frontage on a lake, and buildings that would house and feed some 60 campers at a time. The plan was to operate the camp for eight weeks in the summer and to enroll campers for either one or two weeks. The policy was to charge each camper a fee sufficient to cover the cost of operating the camp. Many campers would be unable to pay this fee, and financial aid would be provided for them. The financial aid would cover a part, or in some cases all, of the fee and would come from the general funds of the foundation or, it was hoped, from a government grant.

As a basis for arriving at the fee, Henry Coolidge, the foundation’s financial vice president, obtained information on costs from the American Camping Association and from two camps in the vicinity. Although the camp could accommodate at least 60 children, he decided to plan on only 50 at a time in the first year, a total of 400 camper-weeks for the season. With assured financial aid, he believed there would be no difficulty in enrolling this number. His budget prepared on this basis is shown Exhibit 2.

HBSP Product Number TCG213

THE CRIMSON PRESS CURRICULUM CENTER THE CRIMSON GROUP, INC.

_____________________________________________________________________________________________ This case was prepared by Professors Robert N. Anthony and David W. Young. It is intended as a basis for class

discussion and not to illustrate either effective or ineffective handling of an administrative situation. Copyright © 2017 by The Crimson Group, Inc. To order copies or request permission to reproduce this document,

contact Harvard Business Publications (http://hbsp.harvard.edu/). Under provisions of United States and international copyright laws, no part of this document may be reproduced, stored, or transmitted in any form or by any means without written permission from The Crimson Group (www.thecrimsongroup.org)

Mr. Coolidge discussed this budget with Sally Harris, president of the foundation. She agreed that it was appropriate to plan for 400 camper-weeks and also that the budget estimates were reasonable. During this discussion, she raised some questions about several items that were not in the budget.

One such item was the foundation’s central office, which would continue to plan for the camp, provide the necessary publicity, screen applications, make decisions on financial aid, pay bills, and do other bookkeeping and accounting work. There was no good way of estimating how many full-time equivalents this work would require.

Five staff members worked in the central office administration, earning an average annual salary of about $36,000. As a rough guess, about half a person-year might be involved in these activities. However, there were no plans to hire an additional employee. The workload associated with other activities usually tapered off somewhat during the summer, and it was believed that the staff could absorb the extra work.

At the camp itself, approximately four volunteers per week would help the paid staff. They would receive meals and lodging, but no pay. No allowance for the value of their services was included in the budget.

Finally, the budget did not include an amount for depreciation of the camp’s facilities. Lakefront property was valuable. If the camp and its buildings were sold to a developer, perhaps as much as $500,000 could be realized. THE SEMINAR

The foundation planned to hold a one-day seminar in the fall to discuss the effect on social service organizations of some recent changes in income tax legislation and other regulatory developments. (Although these organizations were exempt from income taxes, except on unrelated business income, recent legislation and regulations were expected to have an impact on contributions, investment policy, and personnel policies, among other things.) The purposes of the seminar were partly to generate income and partly to provide a service for smaller welfare organizations.

In early spring, Ms. Harris had approved the plans for the seminar. The following information is extracted from a memorandum prepared by Mr. Coolidge at that time.

I estimate that there will be 30 participants in the seminar. The seminar will be held at a local hotel, and the hotel will charge $200 for the rental of the room and $20 per person for meals and refreshments. Audiovisual equipment will be rented at a cost of $100. There will be two instructors, and each will be paid a fee of $500. Printing and mailing of promotional material will cost $900. Each participant will be given a notebook containing relevant material. Each notebook will cost $10 to prepare, and 60 copies of the notebook will be printed. I will preside, and one Harlan staff member will be present at the seminar. The hotel will charge for our meals and for the meals of the two instructors. Other incidental out-of-pocket expenses are estimated to be $200.

Fees charged for one-day seminars in the area ranged from $50 to $495. The $50 fee excluded meals and was charged by a brokerage firm that probably viewed the seminar as generating customer goodwill. The $495 fee was charged by several national organizations that ran hundreds of seminars annually throughout the United States. A number of one-day seminars were offered in the Minneapolis area at a fee in the range of $150 to $250, including a meal.

Assignment

1. What weekly fee should be charged for campers?

2. Assuming a fee of $100, what is the break-even point of the seminar?

3. What fee should be charged for the seminar?

_____________________________________________________________________________________________ Harlan Foundation • June 2017 2 of 3

HARLAN FOUNDATION Exhibit 1. Operating Statement

For the Most Recent Year Ended June 30

Revenues Fees from clients $1,024,437 Grants from government agencies 1,899,543 Contributions 790,277 Investment earnings 24,553 Total revenues $3,738,810

Expenses Program Expenses

Rehabilitation $1,449,667 Counseling 157,621 Infant clinics 312,007 Education 426,234 Drug abuse 345,821 Visiting nurses 267,910 Other 23,280 Total program expenses $2,982,540

Support Expenses Administration (1) $480,326 Dues to national association 24,603 Fund raising 182,523 Other 47,862 Total support expenses $735,314 Total expenses 3,717,854

Net Income $20,956

Note 1 Divided 70%/30% between salaries and other administrative expenses. Salaries are for Ms. Harris, Mr. Coolidge, and five staff members. Ms. Harris earns a salary that is 50% higher than Mr. Coolidge.

Exhibit 2. Budget for Camp Harlan

Staff salaries and benefits $90,000 Food 19,000 Operating supplies 4,000 Telephone and utilities 9,000 Insurance 15,100 Rental of equipment 7,000 Contingency and miscellaneous (5%) 7,200 Total $151,300

Milan Sanitation Department I made two pretty significant changes. First, I set up some labor/management committees, each consisting of shop supervisors, trade people, and a shop steward. Second, I created what I called “profit centers” to substitute for work standards in the central repair facility. The results were phenomenal.

The speaker was Emanuele Sponza, Director of The Bureau of Motor Equipment of the Milan Sanitation Department. The Bureau was responsible for maintaining the Sanitation Department's 5,000 vehicles. It had about 1,200 employees and an operating budget of about € 38 million. It op- erated 75 repair garages located throughout the city, and one central repair facility.

BACKGROUND

Two years prior to Mr. Sponza’s assuming the position of Director, the central repair facility used a series of negotiated work standards that covered practically every job, from rebuilding an en- gine to fixing a generator. At that time, according to a report of the Italian Financial Control Board, conditions in the facility, and in the entire Bureau, were chaotic. On an average day, over half the ve- hicles it was responsible for servicing were out of service, resulting in huge amounts of overtime pay for the drivers assigned to the remaining vehicles. Mr. Sponza commented:

I was placed in charge of the Bureau almost immediately after the mayor received the report from the Financial Control Board. I spent a few weeks discussing the problems with everyone from supervisors to mechanics. No one seemed happy. The mechanics thought that the work standards were demeaning, and the supervisors com- plained that the effort needed to enforce them was oppressive. Clearly, some sort of radical change was needed.

Mr. Sponza decided to begin with the central repair facility, where the problems seemed to be the most serious. Rather than attempting to solve the problems himself, however, he created eight labor/management committees, one for each of the facility’s eight departments (usually called shops): transmission, axle and related, upholstery, radiator, exhaust system, brakes, electrical sys- tem, and engines. He commented:

I gave the committees a mandate to solve problems, improve the quality of work life, and increase productiv- ity. I instructed them to meet monthly with the manager of the facility to recommend improvements. Early on, it became apparent that committee members were concerned that if they suggested ways to improve pro- ductivity, and if their suggestions were implemented, management would subsequently adjust the work stan- dards upward. So there was a lot of distrust. We seemed to be at an impasse. That was when the profit center idea occurred to me. Of course the idea took some selling, but in the end the committees accepted it.

The profit center plan had the following elements. First, management would no longer focus on work standards as applied to specific jobs and individuals, and individual records of time spent on jobs would no longer be required. Instead, management would focus only in whether each shop as a whole was producing at an acceptable level. The “value” of output would be measured by what it would have cost to purchase the same items or services from outside vendors, and the total value of output for a period would be compared with the total cost of operating the shop.

HBSP Product Number TCG 217

THE CRIMSON PRESS CURRICULUM CENTER THE CRIMSON GROUP, INC.

_____________________________________________________________________________________________ This case was prepared by Professor David W. Young based on a case prepared by the late Professor Robert N. An-

thony. It is intended as a basis for class discussion and not to illustrate either effective or ineffective handling of an administrative situation.

Copyright © 2012 by The Crimson Group, Inc. To order copies or request permission to reproduce this document, contact Harvard Business Publications (http://hbsp.harvard.edu/). Under provisions of United States and interna- tional copyright laws, no part of this document may be reproduced, stored, or transmitted in any form or by any means without written permission from The Crimson Group (www.thecrimsongroup.org)

The output values were determined by checking outside price lists or by obtaining price quotes for specific jobs. If the electric shop repaired an alternator, for example, the shop would receive a credit equal to what it would cost to buy a rebuilt alternator from a private supplier. The costs included la- bor costs (salary, fringe benefits, sick pay, vacations, and jury duty), material costs, depreciation of machinery, and other overhead costs. The difference between output values and cost was called “profit,” and the eight shops were therefore called profit centers. Mr. Sponza reflected on the im- pact.

This system provides a mechanism to measure productivity without threatening the individual workers. Labor has responded enthusiastically to this concept. In addition, employees in individual shops can now see how well they’re doing compared to the private sector. Each shop has a large chart in a visible location, and a spirit of competitiveness has developed, further spurring their desire to increase efficiency. The combination of the “profit motive” and the elimination of threats has worked like magic.

RESULTS

Within two years, the Bureau was supplying 100 percent of the primary vehicles needed every day. Mr. Sponza commented:

I estimate that we have avoided over €16 million of costs, such as overtime, during the time this new sys- tem has been in place. Some people might considered this to be a somewhat soft number. Fine, but take a look at this table [Exhibit 1]. The productivity improvements speak for themselves.

As Exhibit 1 shows, all profit centers except the Engine Shop reported an annualized profit. The situation in the Engine shop illustrated the difficulty of measuring output. Initially, the shop's credit for rebuilt engines was the same as the cost to buy new engines because reliable data on the price of rebuilt engines were not available. As Exhibit 1 indicates, productivity was less than 1.0, meaning that the city could have purchased new engines for less than it spent rebuilding them.

As a result of decisions made by the shop's labor/management committee, the Engine shop doubled its productivity and appeared to be producing at a substantial “profit.” However, once a data base containing the outside price of rebuilt engines had been developed, and once all the shop's past reports were converted to the rebuilt values, the shop was again operating at a “loss.” This led the labor/management committee to take further steps to increase productivity, including the discon- tinuation of unprofitable products and the transfer of personnel from support functions to line functions. Within a few months, the Engine shop’s productivity factor had risen to 1.19.

The relatively low productivity in the Brake Shop had a different cause. Employees were still required to list the actual time it took to do each job, and they feared that if they consistently beat readily available industrywide standards, sooner or later management would either require more work from them or would track each person’s daily performance. Thus, they omitted certain jobs from their daily work sheet, thereby leaving their productivity factor at just above 1.0. According to Mr. Sponza, this problem was solved in a way consistent with his overall philosophy.

After the reasons for the artificially low productivity figure became apparent, I convened some meetings be- tween the labor/management committee and the entire shop's work force. One result was to agree that em- ployees would no longer need to list the actual time it took to do a job. A few months later, the report for the shop showed that productivity had risen to 1.30.

More generally, I have found that getting labor involved in the running of an operation is not only excit- ing and rewarding, but also extremely worthwhile in terms of improving productivity and service quality. Our experience belies the common notions that the government worker cannot be productive or that the out- put of a government operation cannot be measured.

There is no simple formula for succeeding in the change from a traditional approach to the labor/management approach, and there should be no doubt that management's commitment to the process is a critical factor. But given a true desire to see it succeed, and a willingness to spend the necessary amount of time and effort, it can work. The simple proof is what has been achieved by our bureau.

_____________________________________________________________________________________________ Milan Sanitation Department • June 2012 2 of 3

Assignment

1. What are the strengths and weaknesses of the system that Mr. Sponza developed for the central repair facil- ity?

2. Records on performance by individuals or on costs for individual jobs were discontinued. Do you agree with this policy?

3. What recommendations, if any, would you make to Mr. Sponza concerning the system he has developed? How might you improve on it?

MILAN SANITATION DEPARTMENT Exhibit 1. Profit Center Status Report

Number of Weeks of Operation from Annualized (€ 000)

Inception to Productivity Profit Center to Present Time Input Output Profit Factor*

Transmission 37 € 350 € 716 € 366 2.05 Axle and related 40 1,280 2,146 866 1.68 Upholstery 35 126 183 57 1.45 Radiator 36 263 438 175 1.67 Exhaust system 23 643 1,562 919 2.43 Brakes 30 494 534 40 1.08 Electrical system 37 603 717 114 1.19 Engines 43 1,272 822 (451) .65

Total € 5,031 € 7,117 € 2,086 1.41

* Output ÷ Input

_____________________________________________________________________________________________ Milan Sanitation Department • June 2012 3 of 3

Dovetown Parking Authority In late May, a meeting was held in the office of the mayor of Dovetown to discuss a proposed

municipal parking lot. The participants included the mayor, the traffic commissioner, the head of Dovetown’s Parking Authority, a city planner on the mayor’s staff, and the city’s director of fi- nance. The purpose of the meeting was to consider a report by Richard Stockton, a staff analyst in the Parking Authority, concerning the estimated costs and revenues for the proposed facility. After some introductory remarks by the mayor, Mr. Stockton began his presentation:

As you know, the mayor proposed two months ago that we construct a multilevel parking garage on the Elm Street site. At that time, he asked the Parking Authority to assemble all pertinent information for consideration at our meeting today. I would like to summarize our findings briefly for you. First, the Elm Street site is owned by the city. All that stands on it now is the old Embassy Cinema. We estimate that it would cost approximately $500,000 to demolish that building and clear the site, including paying for the re- moval of asbestos and any other hazardous waste that we encounter. Based on our conversations with local contractors, we estimate that a multilevel parking garage, with space for 800 cars, could be built on the site at a cost of about $5 million. Its useful life would be about 15 years before we needed to undertake signifi- cant renovations.

The city could finance construction of the garage through the sale of bonds. Our credit rating is good, and we could float an issue of 15-year tax-exempt bonds at 5 percent interest. Redemption would commence after three years, with one twelfth of the original number of bonds being recalled in each succeeding year.

A parking management firm has already contacted us with a proposal to operate the garage for the city. They estimate that the operating costs, exclusive of their fee, would be about $600,000 per year. Of this amount, $375,000 would be personnel costs; the remainder would include utilities, mechanical maintenance, repairs, cleaning, insurance, and so forth. In addition, they would charge a management fee of $120,000 per year. Any gross revenues over $2,000,000 per year would be shared 90 percent by the city and 10 percent by the management firm. If total annual revenues are less than $2,000,000, the city would still have to pay the full management fee, however.

The city would derive an additional $200,000 a year or so by renting the ground floor of the structure as retail space.

We conducted a survey at a private parking garage only three blocks from the Elm Street site to help estimate revenues from the prospective garage. The garage, which is open every day from 7:00 a.m. until midnight, charges $3.00 for the first hour, $2.00 for the second hour, and $1.00 for each subsequent hour, with a maximum rate of $8.00. Their capacity is 400 spaces. Our survey indicated that during business hours, 75 percent of their spaces were occupied by “all-day parkers''--cars whose drivers and passengers work downtown.

In addition, roughly 400 cars use the private garage each weekday with an average stay of three hours. We did not take a survey on Saturday or Sunday, but the proprietor indicated that the garage is usually about 75 percent utilized by short-term parkers on Saturdays until 5:00 p.m., when the department stores close; the average stay is about four hours. There's a lull until about 7:00 p.m., when the moviegoers start com- ing in; he says the garage is almost always full from 8:00 p.m., until closing time at midnight. Sundays are usually very quiet until the evening, when he estimates that his garage is about 60 percent utilized from 6:00 p.m. until midnight.

In addition, we studied a report issued by the City College Economics Department last year, which es- timated that we now have approximately 50,000 cars entering the central business district (CBD) every day from Monday through Saturday. Based on correlations with other cities of comparable size, the economists calculated that we need 30,000 parking spaces in the CBD. This agrees quite well with a block-by-block

HBSP Product Number TCG247

THE CRIMSON PRESS CURRICULUM CENTER THE CRIMSON GROUP, INC.

_____________________________________________________________________________________________ This case was prepared by Professor David W. Young, based on a case prepared by the late Graeme Taylor and the

late Professor Richard F. Vancil It is intended as a basis for class discussion and not to illustrate either effective or ineffective handling of an administrative situation.

Copyright © 2012 by The Crimson Group, Inc. To order copies or request permission to reproduce this document, contact Harvard Business Publications (http://hbsp.harvard.edu/). Under provisions of United States and interna- tional copyright laws, no part of this document may be reproduced, stored, or transmitted in any form or by any means without written permission from The Crimson Group (www.thecrimsongroup.org)

estimate made by the traffic commissioner's office last year, which indicated a total parking need in the CBD of 29,000 spaces. Right now we have 22,000 spaces in the CBD. Of these, 5 percent are curb spaces (half of which are metered, with a two-hour maximum limit for $1.00), and all the rest are in privately owned garages and open lots.

Another study indicated that 60 percent of all auto passengers entering the CBD on a weekday were on their way to work. Another 20 percent were shoppers, and 20 percent were business executives making calls. The average number of people per car was 1.75. Unfortunately, we have not yet had time to use these data to work up estimates of the revenues to be expected from the proposed garage.

The Elm Street site is strategically located in the heart of the CBD, near the major department stores and office buildings. It is five blocks from one of the access ramps to the new cross-town expressway, which we expect will be open to traffic next year, and only three blocks from the Music Center, which the mayor dedicated last week.

As we all know, the parking situation in that section of town has steadily worsened over the last few years, with no immediate prospect of improvement. The demand for parking is clearly there, and the Parking Authority therefore recommends that we build the garage.

The mayor thanked Mr. Stockton for his report and asked for comments. The following dis- cussion took place:

Finance Director: I'm all in favor of relieving parking congestion in the CBD, but I think we have to consider alternative uses of the Elm Street site. For example, the city could sell that site to a private developer for at least $2 mil- lion. The site could support an office building from which the city would derive property taxes of around $300,000 per year at present rates. The office building would almost certainly incorporate an underground parking garage for the use of the tenants, and therefore we would not only improve our tax base and increase revenues but also increase the availability of parking at no cost to the city. Besides, an office building on that site would improve the appearance of downtown; a multilevel garage built above ground, on the other hand, would not.

Planning Director: I'm not sure I agree. Within a certain range we can increase the value of downtown land by judicious provi- sion of parking. Adequate, efficient parking facilities will encourage more intensive use of downtown traffic generators such as shops, offices, and places of entertainment, thus enhancing land values. A garage con- tained within an office building might provide more spaces, but I suspect these would be occupied almost exclusively by workers in the building and thus would not increase the total available supply.

I think long-term parking downtown should be discouraged by the city. We should attempt to encour- age short-term parking--particularly among shoppers--in an effort to counteract the growth of business in the suburbs and the consequent stagnation of retail outlets downtown. The rate structure in effect at the privately operated garage quoted by Mr. Stockton clearly favors the long-term parker. If the city constructs a garage on the Elm Street site, we should devise a rate structure that favors the short-term parker. People who work downtown should be encouraged to use our mass transit system.

Finance Director: I'm glad you mentioned mass transit because this raises another issue. As you know, our subways are not now used to capacity and are running at a substantial annual deficit borne by the city. We have just spent millions of dollars on the new subway station under the Music Center. Why build a city garage only three blocks away that will still further increase the subway system's deficit? Each person who drives downtown instead of taking the subway represents a loss of $2.00 (the average round trip fare) to the subway system. I have read a report stating that approximately two thirds of all persons entering the CBD by car would still have made the trip by subway if they had not been able to use their cars.

Mayor: On the other hand, I think shoppers prefer to drive rather than take the subway, particularly if they intend to make substantial purchases. No one likes to take the subway burdened down by packages and shopping bags. You know, the Downtown Merchants Association has informed me that they estimate that each new parking space in the CBD generates on average an additional $10,000 in annual retail sales. That represents substantial extra profit to retailers; I think retailing after-tax profits average about 3 percent of gross sales. Besides, the city treasury benefits directly from our 3 percent sales tax.

TCG247 • Dovetown Parking Authority 2 of 3 _____________________________________________________________________________________________

Traffic Commissioner: But what about some of the other costs of increasing parking downtown and therefore, presumably, the number of cars entering the CBD? I'm thinking of such costs as the increased wear and tear on city streets, the addi- tional congestion produced with consequent delays and frustration for the drivers, the impeding of the move- ment of city vehicles, noise, air pollution, and so on. How do we weigh these costs in coming to a decision?

Parking Administrator: I don't think we can make a decision at this meeting. I suggest that Dick [Stockton] continue with his work to date, and include answers to the questions that have come up today.

Assignment

1. Using the information presented at this discussion, should the city of Dovetown construct the proposed garage?

2. What rates should be charged?

3. What additional information, if any, should be obtained before making a final decision?

TCG247 • Dovetown Parking Authority 3 of 3 _____________________________________________________________________________________________

Moray Junior High School This budget cut is a serious problem for us. I don't know quite how to reduce our costs because there really wasn't much flexibility in the budget to begin with. However, we're all in the same situation; we expect to have only $2.2 million to spend on Moray and we have to find some way to live with that.

Ms. Hilda Cook, Principal of Moray Junior High School, had just returned from the March meeting of the Moray Public School System’s School Committee, where she had agreed to cut her school’s budget by almost 12 percent. Although Ms. Cook did not consider her projected costs to be excessive, neither did several of the other principals, who also had agreed to attempt to reduce their budgets.

BACKGROUND Moray Junior High School was one of three junior high schools in the town of San Pedro, Ari-

zona. It was in excellent physical condition, and had an enrollment of approximately 700 students a year. The quality of education was considered extremely high, and a student-teacher ratio of no more than 15:1 had always been maintained. Among the school's special programs were a highly regarded Drug and Alcohol Awareness Program, and an Understanding Handicaps Program, in which trained parents and handicapped speakers provided a course of instruction to both students and teachers to acquaint them with the various handicapping conditions, such as epilepsy, blindness, physical handicaps, retardation, and deafness.

Moray was best known, however, for its Spanish Language Program, which used native speak- ers of Spanish to teach courses that began in the 7th grade and continued through the 9th grade. A special language laboratory with 30 student “stations” and three instructor stations was equipped with the latest in audio technology, including an “interrupt” feature that allowed an instructor to listen in on a student practicing with a cassette tape and intervene electronically, when necessary, to correct the student's pronunciation or grammar. Students successfully completing the Program were considered to be extremely proficient in the Spanish language, and a special field trip to a “sister” junior high school in Anguila, Mexico was organized each year for the 9th graders. The students lived with local families for an entire week while actively participating in the Anguila school system's activities.

As principal of Moray for over ten years, Ms. Cook had witnessed numerous changes in the school. For over 40 years, Moray had been the only junior high school in San Pedro; however, in the late 1970s, when migration from the northern U.S. had led to a large influx of new residents, additional demands had been placed on the school system. As a result, Moray had been expanded and two new junior high schools had been built.

With such a dramatic increase in services, the School Committee had become increasingly con- cerned with budgeting, cost control, and accountability. Accordingly, in the past few years, Ms. Cook had become more actively involved in the financial management of Moray. Beginning with the current fiscal year, she, along with other principals in the San Pedro system, had assumed re- sponsibility for constructing her school's annual budget. Moray's proposed budget for the upcom- ing fiscal year is contained in Exhibit 1.

Budget Data San Pedro's budget process began in January. At that time, the Central Office made enrollment

projections, and, using these figures, all school principals held conferences with their teachers and program heads to determine their school's requirements for staffing, supplies, and other cost items.

HBSP Product Number TCG 219

THE CRIMSON PRESS CURRICULUM CENTER THE CRIMSON GROUP, INC.

_____________________________________________________________________________________________ This case was prepared by Professor David W. Young. It is intended as a basis for class discussion and not to illus-

trate either effective or ineffective handling of an administrative situation. Copyright © 2012 by The Crimson Group, Inc. To order copies or request permission to reproduce this document,

contact Harvard Business Publications (http://hbsp.harvard.edu/). Under provisions of United States and interna- tional copyright laws, no part of this document may be reproduced, stored, or transmitted in any form or by any means without written permission from The Crimson Group (www.thecrimsongroup.org)

For the current fiscal year, all budget needs for Moray were calculated on the basis of a pro- jected enrollment of 690 students, although not all programs served all 690 students. In particular, as Exhibit 1 shows, Regular Instruction was scheduled to serve 615 students, Special Education 75 students, and the Spanish Language Program 180 students. (As Exhibit 1 indicates, some students were enrolled in more than one program.) The student-teacher ratio in Regular Instruction was scheduled to be 15:1, while in the Special Education Program it was only 6:1.

Shortly before the budget was completed, Ms. Cook and other principals met with the Director of Finance and Administration to discuss the Central Office costs. These “indirect” costs were al- located to individual schools based on measures such as salary expenses and student enrollments. The specific allocation bases for the upcoming budget year are shown in Exhibit 2.

In reviewing her budget, Ms. Cook realized that the nature of the costs varied. She quickly as- certained that the budget contained no superfluous costs that simply could be cut; indeed, the in- structional and administrative supply costs reflected only higher supply prices, and the teacher and administrative salaries were based on a very small increase in the wage rate. It appeared that if Ms. Cook wanted to reduce the budget, she would have to analyze the behavior of each cost, and adjust those that were flexible. If necessary, she also was prepared to alter Moray's operations to comply with the School Committee's budget ceiling.

To prepare a modified budget for the School Committee, Ms. Cook decided to meet with some of Moray's teachers and program heads, who she thought could provide information concerning some of the budgeted expenses. Her first meeting was with Mr. Steven Hartman, the teacher with the greatest seniority in the school, and the designated representative of the teachers' union, to dis- cuss the teachers' salary expense. Ms. Cook hoped to make substantial cuts in the teacher salary expense item by increasing the average class size from 15 to 20 students. Mr. Hartman's response was not particularly encouraging:

We can't possibly cut teachers' salaries in the way you envision because the teachers are already over- worked. We have to cover lunch and recess periods, and most of us substitute regularly during our break periods for teachers who are out sick. So we need a minimum of 1 teacher for every 15 students. Unless we cut down on students, we can't possibly reduce the number of teachers.

Next, Ms. Cook met with Dr. Mariana Olivera, the lead teacher for the Special Education Pro- gram, and Ms. Lillian Higgins, the librarian. Ms. Higgins, the most senior of the two, discussed the use of books and other instructional supplies, and her ideas for reducing costs:

The instructional supplies and library item does appear to be a large amount, but there is really nothing in- cluded in it that's excessive. I think we're already quite frugal in our supply use, and we can't just stop or- dering pencils, paper, books, or anything else we need for instructional purposes.

I do see one problem with the budget, however; we're budgeting for a full 690 students when, in fact, due to absences, we probably have only about 650 students in school at any one time. If we adjust the budget to reflect our actual attendance, we can cut costs by at least 5 percent.

Dr. Olivera also had an idea for cutting costs. She suggested that the school reduce or elimi- nate the Spanish Language Program, thereby reducing the budget by almost $189,000. In consider- ing Dr. Olivera's suggestion, Ms. Cook called the audio equipment manufacturer to discuss the re- sale value of some of the school's equipment. The company informed her that machines used for four years or more could not be sold, even for scrap. All of the equipment in Moray's language laboratory had been purchased at least five years ago.

Ms. Cook also reviewed the salaries for the Spanish Language Program and found that $35,000 was for a lead teacher, with the remaining $50,000 designated for two regular teachers, at $25,000 each. No substitutes were budgeted since, in the case of a teacher absence, the aide could cover. She also noted that the program's size was limited by the number of teachers. That is, since a strict 10:1 student-teacher ratio was maintained, and the students attended the lab daily, the maxi- mum number of students the program could accept was 180 (30 per class period with six class pe- riods in a day). This did not mean that the lab equipment was fully utilized, however, since the na- ture of the instructional process was such that some days the students would not use the lab at all.

As she reflected on the nature of the task before her, Ms. Cook realized that she had to consider the interactive effects of several factors. First, there was the question of the nature of the direct costs in her budget. Although Mr. Hartman had given her a good indication of how teachers' costs might

_____________________________________________________________________________________________ Moray Junior High School • June 2012 2 of 5

change with changes in enrollment, the behavior of the other costs was less clear. Administrative salaries and supplies, she reasoned, would remain about the same regardless of the number of stu- dents. This would probably be true for operations and maintenance expenses as well. Instructional supplies and library expenses, on the other hand, would probably change in direct proportion to the number of students.

A second consideration of Ms. Cook's was the level of indirect costs. When she called the Cen- tral Office to learn more about the allocation process, she was told that the distribution of indirect costs among programs within Moray used a different set of allocation bases from those used to al- locate the costs to the school; these are shown in Exhibit 2. She also realized that at least some of the indirect costs allocated to Moray from the Central Office would change as both student enroll- ment and the level of Moray's direct costs changed. Nevertheless, she felt quite certain that the School Committee would hold her responsible for whatever amount was allocated. But then, if she was responsible for these costs, she wondered about the extent to which she could control or reduce them.

Finally, Ms. Cook mused about Dr. Olivera's suggestion. Reducing or eliminating services did not seem appropriate, yet it might be the only way to meet the targeted budget reduction. If she were to cut the Spanish Language Program in half, she thought she might be able to reduce some of the Program's costs, but she was not at all sure. She also noted that, approximately two-thirds of the depreciation in her budget was for language laboratory equipment.

As she began to prepare her budgetary modifications, Ms. Cook realized that Dr. Olivera's sug- gestion posed some very difficult issues. She decided to revise her budget first by making the ap- propriate changes in costs associated with an average attendance of 650 students. Only if this failed to produce the requisite reduction, would she consider cutting back the Spanish Language Program. However, in order to demonstrate to the School Committee the true impact of its request, she also decided to calculate what her average attendance in the Regular Instruction Program would have to be in order to meet the Committee's requested cut without curtailing the Spanish Language Pro- gram. Since several teachers were expected to retire at the end of the current fiscal year, she realized that if attendance levels were cut on a permanent basis, she might be able to get by without hiring replacements.

Since Ms. Cook would soon be required to make employment offers for any new or replace- ment teachers, she realized that preparing revised budgetary projections and gaining School Com- mittee approval for them was of the utmost priority.

Assignment

1. What is the average teacher salary for the Regular Instruction and Special Education Programs?

2. Analyze the costs in the category “Direct Costs-Instruction,” and classify each line item as either fixed, variable, semi-variable, or step-function. If variable, semi-variable, or step-function, indicate specifically how the cost behaves. How, if at all, is this analysis useful to Ms. Cook?

3. What are the budgetary options open to Ms. Cook? What are the cost savings associated with each?

4. What should Ms. Cook do?

_____________________________________________________________________________________________ Moray Junior High School • June 2012 3 of 5

MORAY JUNIOR HIGH SCHOOL Exhibit 1. Budgeted Statistics and Expenses

Regular Special Spanish Instruction Education Language Other Program Program Program Programs Total [1]

Statistics Number of registered students 615 75 180 450 690 Number of days in academic year 170 Number of potential students days 117,300 Expected number of student days 110,497 Attendance rate 94.20%

Direct Costs -- Instruction Regular teacher salaries $1,119,300 $376,875 $85,000 $15,000 $1,596,175 Substitute teacher salaries $37,200 $12,500 $0 $0 $49,700 Aide salaries $20,300 $9,100 $6,500 $3,000 $38,900 Instructional supplies and library $84,870 $37,275 $8,280 $1,100 $131,525 Travel and lodging $0 $0 $3,000 $0 $3,000 Depreciation $12,300 $8,000 $40,000 $0 $60,300 Total $1,273,970 $443,750 $142,780 $19,100 $1,879,600

Direct Costs -- Administration [2] Administrative salaries (Regular teacher salaries) $87,655 $29,514 $6,657 $1,175 $125,000 Administrative supplies (Regular teacher salaries) $10,869 $3,660 $825 $146 $15,500 Operations and maintenance (Square feet) $175,500 $40,500 $27,000 $27,000 $270,000 Other (Regular teacher salaries) $5,259 $1,771 $399 $70 $7,500 Total $279,283 $75,444 $34,881 $28,391 $418,000

Total Direct Costs $1,553,253 $519,194 $177,661 $47,491 $2,297,600

Indirect Costs -- Allocated from Central Office School Committee $2,419 $815 $184 $32 $3,450 Administration $30,362 $10,223 $2,306 $407 $43,298 Health/Life insurance $94,514 $31,824 $7,177 $1,267 $134,782 Operations and maintenance $4,739 $1,094 $729 $729 $7,290 Rent and depreciation $2,243 $518 $345 $345 $3,450 Contract services $1,048 $128 $307 $767 $2,250 Travel $581 $196 $44 $8 $828 Total $135,905 $44,796 $11,092 $3,555 $195,348

Total Direct and Indirect Costs $1,689,159 $563,990 $188,753 $51,046 $2,492,948

Average Cost per registered student $3,613

Notes: 1. Registered students do not crossfoot, since students are enrolled in more than one program. 2. Basis for allocation to programs shown in parentheses ()

Moray Junior High School Exhibit 2. Allocation Bases

Indirect Cost Basis for Allocation to Moray

School Committee $5.00 per registered student Administration $62.75 per registered student Health/Life Insurance $.08 per teacher salary dollar (regular teachers, substitute

teachers, and aides) Operations and Maintenance $.027 per Operations and Maintenance Dollar in the school Rent and Depreciation $5.00 per registered student Contract Services $.018 per administrative salary dollar Travel $1.20 per registered student

Indirect Cost. Basis for Allocation to Programs within Moray

School Committee Proportion of regular teacher salaries Administration Proportion of regular teacher salaries Health/Life Insurance Proportion of regular teacher salaries Operations and Maintenance Proportion of floor space: 65% to Regular Instruction;

15% to Special Education; 10% to Spanish Language Program; 10% to Other Programs

Rent and Depreciation Same as Operations and Maintenance Contract Services Proportion of registered students Travel Proportion of regular teacher salaries

Examples of Calculations for Allocation to Programs within Moray

School Committee Regular Instruction salaries = $1,119,300; Total salaries = $1,596,175. Proportion = .7012. Therefore Regular Instruction share = .7012 x $3,450 = $2,419.

Administration Regular Instruction share = .7012 x $43,298 = $30,362 Health/Life Insurance Regular Instruction share = .7012 x $134,782 = $94,514 Operations and Maintenance Regular Instruction share = .65 x $7,290 = $4,739 Rent and Depreciation Regular Instruction share = .65 x $3,450 = $2,243 Contract Services Regular Instruction share = [615/(615+75+180+450)] x

$2,250 = $1,048 Travel Regular Instruction share = .7012 x $828 = $581

_____________________________________________________________________________________________ Moray Junior High School • June 2012 5 of 5

Hillside Hospital This has been one of the ugliest things I've ever done—all the personal abuse, just for following the damn rules the university sent down. It is the closest I've come to quitting my job.

In September, Dr. Richard Wells, Chief of Medicine at Hillside Hospital in Chicago, Illinois, announced that all full-time doctors in the Department of Medicine were required to join the Medi- cal Practice Plan or leave the hospital premises. In his eight years as chief, Dr. Wells had initiated numerous changes in the department, but never one as controversial as the Practice Plan.

Dr. Wells had established the Practice Plan or “trust” two years earlier to serve two purposes. First, it was intended to regulate each physician's professional income to comply with the Kent Medical School Salary Regulation, and second, it would augment the department's income with funds not otherwise attainable. Additionally, Dr. Wells was convinced that, as an academic depart- ment of Kent Medical School, the Department of Medicine needed guidelines to ensure a standard of excellence:

I think this has to be done in any academic institution. Doctors here are supposed to provide ongoing patient care, carry on research, and teach. Now if you're at all good as a physician, your private practice will skyrocket, and your research and teaching will lose out. It's fun and lucrative to practice medicine, but in a teaching hospi- tal you have other responsibilities, too.

BACKGROUND The Department of Medicine was a clinical department of the 85 year-old Hillside Hospital in

Chicago. Hillside had been a teaching affiliate of Kent Medical School since 1925. In its many years as a teaching hospital, Hillside had demonstrated a firm commitment to teaching and research as well as patient care. Insisting that the three were interdependent, and together enhanced the qual- ity of medical care, Hillside's medical staff had distinguished itself among hospital teaching staffs. Hillside had become the most popular hospital among Kent medical students and attracted gradu- ates of the top medical schools for its 175 intern and resident slots.

As part of the teaching hospital, Hillside's clinical departments were subject to the medical school’s guidelines. Kent's guidelines, which primarily stressed the school’s commitment to scho- lastic achievement, had had little effect on the school's clinical departments. Dr. Wells explained:

For years, we'd had what you'd call a “Gentleman's Agreement” with the medical school. They gave the depart- ment a modest budget and paid doctors something for their teaching and research. Other than that, doctors could work for the hospital and carry on a private practice making about as much money as they wanted. There was some innocuous stipulation in our agreement allowing doctors to make as much money as “didn't interfere with their scholarly activities.”

A few years later, Kent Medical School began feeling the financial constraints besetting most academic institutions. Unable to continue supporting its clinical departments, it altered the agree- ment, asking that patient fees support hospital clinical departments. The school issued a Salary Statement Regulation, from which the following is excerpted.

Total Compensation paid to full-time members of the Faculty of Medicine may not exceed the level set for each individual in the Appointments and Compensation Requirements for the Faculty of Medicine at Kent Uni- versity. The member's total income is equal to the sum of his/her Academic Salary plus Additional Compensa- tion plus Other Personal Professional Income and may not exceed twice the member's Academic Salary.

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_____________________________________________________________________________________________ This case was prepared by Professor David W. Young. It is intended as a basis for class discussion and not to illus-

trate either effective or ineffective handling of an administrative situation. Copyright © 2012 by The Crimson Group, Inc. To order copies or request permission to reproduce this document,

contact Harvard Business Publications (http://hbsp.harvard.edu/). Under provisions of United States and interna- tional copyright laws, no part of this document may be reproduced, stored, or transmitted in any form or by any means without written permission from The Crimson Group (www.thecrimsongroup.org)

Each Clinical Department head shall be responsible for maintaining the records and reporting the income of all full-time members of the Department. . . . Fees earned that are in excess of an individual's compensation level must be reported and disposed of as directed by the institution responsible for setting the level of compen- sation in consultation with the Dean of the Medical School.

Inasmuch as the System has been adopted by the faculty and approved by the Kent Corporation, it is under- stood that no Faculty member may continue in the full-time system unless he/she is in full conformity with the system and the procedures designed to implement it.

According to Dr. Wells, this was a difficult confirmation for the chiefs to give:

The new guidelines caused quite a commotion, as you can imagine. Doctors were critical of the policy because they now had to report their salaries--something they'd never had to do before.

When I asked people in my department for income disclosures, some of them tried everything to get around the rules. They were giving me their salaries after taxes and expenses--and it was unreal what they were calling “expenses.” They were, of course, making just what they had been before. And it was becoming clear to me that I couldn't enforce the regulation.

Meanwhile, the Department of Medicine's income, which was derived from the hospital and grants, was not meeting its needs. Some physicians joined Dr. Wells in his concern about the de- partment’s financial problems. Dr. Eleanor Robinson, Associate Director of the Department of Medicine, explained:

We were finding the department had needs, mostly of an academic nature, that we didn't have the money to sup- port. Occasionally, we'd want to send residents to meetings or postgraduate educational programs but couldn't afford to. Or someone would need financial assistance for a small research project that wasn't covered by long- term NIH grants, and the money just wasn't there.

THE MEDICAL TRUST

Responding to these administrative and financial problems, Dr. Wells decided to establish a faculty practice plan. He intended to structure it as a department fund that would pool physicians' professional fees and pay them salaries according to Kent's regulation. Any surplus of fees would be retained by the department for its use.

The Practice Plan was organized as an educational and charitable trust fund with nonprofit, tax- exempt status. Although the hospital and medical school became the trust's beneficiaries, the trust maintained total responsibility for its policies and budget. Dr. Wells commented:

I watched the Department of Anesthesia at Memorial Hospital form a practice plan through their hospital about eight years ago. Everything goes into the hospital, and it gives the group a yearly budget. The chief is now having difficulty getting a run-down from the hospital on the department's finances when he knows the depart- ment is making money. If he wants another anesthetist, he has to justify it to the hospital. I don't want to crawl to the hospital for what I need if I've got the space. So I chose not to do that.

Dr. Robinson, who aided in administering the trust, added:

We generally agreed that patient income for the department's use should be administered outside of the hospital budget, mainly because we didn't want our money used to subsidize other departments. We hadn't had problems with the hospital but it was a preventive measure.

The Medical Trust offered members a salary in accordance with the medical school guidelines plus benefits and a conditional overage expense account. As an incentive, salaries were graded down from the guideline ceiling with increases based on yearly evaluation meetings between Dr. Wells and the doctor concerned. Dr. Wells explained:

A physician’s salary is a function of his or her overall contribution to the department plus academic rank. What the medical school gave us is a maximum for each position. At the evaluation conferences, I decide, with the doctor, where he or she falls on that scale. In reality, we're all pretty close to our maximums but it's an incen- tive to get the work done.

It’s important to realize though, that salaries don't reflect the patient fees generated by the doctor. If a physi- cian has a steady practice and generates an average income in patient fees but is an invaluable teacher or re-

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searcher, he or she might be promoted academically and hence be paid more than another physician whose best skills are in seeing patients.

Dr. Wells acknowledged that this could also be a disadvantage:

There's a practical problem with tying salaries to academic rank. It isn't always possible for people to do all three things equally well. If they don't do the academics, their salaries suffer. For example, we have some super cardiologists —absolutely super—but they don't have time to write academic papers. Their salaries are stuck at their academic rank, whatever happens.

But this is an academic hospital and if doctors are interested in making money, they shouldn't be here. They can move up the street and make as much money as they want.

The trust's benefits were health, life, and malpractice,, long-term disability insurance, and a tax- deferred annuity program. These were benefits that had previously been purchased with members' after-tax dollars. Thus, the trust sought both to maximize members' income potentials within the Kent ceiling and to offer tax advantages.

If doctors generated more income than their salaries reflected, they received an overage account for professional expenses. That is, 50 percent of a doctor's surplus income would be credited to him or her to cover expenses such as subscriptions, books, and conference travel. According to the by-laws of the trust, however, overage money could not be converted into salary. The remaining surplus income was to be used for department expenses.

The department would collect supplemental income from “chief-service patients.” Prior to the trust, those patients who did not have private physicians were the responsibility of the chief resident and received free professional services. Because chief-service patients were admitted to the hospital without private physicians, the medical services they received did not qualify for reimbursement.

When the department established the trust, they employed the senior chief resident as the Group's “junior-staff physician” and admitted all junior-staff patients as patients of the profes- sional practice plan. The trust could then bill junior-staff patients through its provider status. As a result, the trust collected fees that were not available when each doctor maintained an independent practice.

GOVERNANCE AND MEMBERSHIP

The trust was governed by a board of trustees. The five-member board was responsible for trust policies and approving loans and budgets. The board members were Dr. Wells, who held a perma- nent position, two trustees appointed by him, and two trustees elected by the department. In addi- tion, Dr. Wells would hold periodic meetings for all trust members.

By winter, there were four members of the trust: the junior-staff physician, Dr. Wells, and two other young physicians. Critical of the trust's organization and planning methods, four or five doc- tors opposed joining. Dr. Melvin Jefferson, a cardiologist at Hillside for 10 years, was the most vo- cal about his position:

I was not going to join the trust until I knew exactly what was being proposed. A number of important issues were left extremely vague. The reasons for establishing the trust were even vague, in my mind at least, and our meetings did little to clarify the specifics. Some of the important issues, especially reconciling salaries, faculty rank, and academic and financial contributions to the department, were unresolved. I don't think these things had been thoroughly thought out, yet we were being asked to join. So a few other doctors and I refused to join until we knew more about the details.

In the spring of the following year, Dr. Wells asked all physicians to join the trust. A few doc- tors who had verbally committed themselves to the trust, but had postponed joining, became mem- bers. But because attitudes in the department continued to differ, Dr. Wells decided membership had to be mandatory for all full-time academic physicians. He explained:

Membership had to be a prerequisite for remaining in the department because I knew what was going to hap- pen. I had a few nice guys, resigned to the idea of the trust, carrying the department. And there were these other fellows, you know, friends of everyone; they'd been here a long time and didn't want to join. Some of them were earning significant compensation. Others, their friends, were towing the line.

I knew that some people wouldn't go along with it, and maybe for good reasons. You have to be realistic about the specialty you're talking about; if cardiologists and gastroenterologists can make big bucks, how can

TCG133 • Hillside Hospital 3 of 7 _____________________________________________________________________________________________

you keep them down on the farm? In another one of our divisions, everyone is leaving. They're moving down the street to private offices. They're good specialists and it's too bad we're losing them, but if they're interested in making money, that's where they should be.

At the announcement of mandatory participation, every physician was forced to make a deci- sion. Dr. Ben Lewis, head of the gastroenterology division, explained his decision to join the trust:

We were told by Dr. Wells that the department was not in compliance with the medical school's guidelines. He told us that we had to change our system to comply and that if we didn't, we'd have to leave.

I said fine. I trusted Dr. Wells totally, I admired him greatly, and I liked my work. I was willing to change, even though I knew the financial and emotional costs. I knew the financial cost because I subtracted the guide- line figure from my salary and that was my loss. The emotional cost, loss of independence, is harder to evalu- ate and still troubles me.

It makes you wonder why people stay here. Why do they? I guess it's because they like Wells. I think that's the main reason everyone stays. He's created a good faculty and a relatively favorable environment.

Other physicians, however, were still opposed to the trust. Dr. Jefferson, the most reluctant to join, explained that his reticence stemmed from his impression of the trust's operational structure:

In thinking about the trust earlier, I'd had exalted goals in mind. I thought we could use it to make a more uni- fied and cohesive Department of Medicine. We could spread the patient care experience to the younger physi- cians and improve the department academically by removing some of the economic motivations. Somehow the trust got sidetracked into an instrument whose sole purpose was to collect chief-service fees for the department, which resulted in a lot of divisiveness.

For example, look at the method of remuneration as initially spelled out: a salary based on academic rank and an admittedly extremely modest fringe benefit package. That left the question of overages and benefits es- sentially unresolved. We were being asked to sign a document involving a significant financial decision that could theoretically involve making considerably less money than before, without having the specifics spelled out. We were just told that “no one would be hurt.”

I also thought it was absurd to erect a gigantic administrative superstructure. If the purpose was simply to conform to the medical school guideline and earn a little extra money for the department, we didn't need this whole organization with a billing office and everything else. I think we should have started small and built up; the fact is, we just don't have any big earners who can support a trust of this size.

From Dr. Well's perspective, the trust had by then become:

…a tremendous can of worms. I had physicians philosophizing about everything, you should have heard them. All upset because of their “loss of control.” It wasn't loss of control at all, it was loss of money. The absurd part of it was that a lot of those people weren't losing money. Believe me, doctors can be a difficult bunch to work with.

Unfortunately, there's no uniformity in the way clinical departments interpreted the guidelines so doctors could point to other departments and claim that they weren't complying the way we were. They were right, par- ticularly in this school, because the dean is afraid to interfere too much in the autonomy of the hospitals.

BILLING SYSTEM

At the outset of the trust, Dr. Wells intended to have all members' billing managed by a central billing office. He had hired a business manager to administer billings, collections, and reports for members. He planned that each doctor would submit a daily “activity sheet” to the business office, detailing services rendered, patient names, and fees.

However, because many present and future trust members opposed the centralized billing plan, Dr. Wells postponed implementing it. Instead, upon joining the trust, each doctor had the choice of centralized billing through the business office or their previous system wherein secretaries billed for doctors' private practices. Given the choice, half the physicians chose central billing and half chose to remain with the old system. Ann Miller, the business manager, explained:

Doctors really hold a spectrum of opinions on billing; some don't care at all about their bills while others want to see and discuss every one. I think some doctors don't like the business aspect of medicine—they prefer not having to handle it. The others don't like not having control of it. They feel removed from their practice if they don't see the bills go out.

TCG133 • Hillside Hospital 4 of 7 _____________________________________________________________________________________________

The doctors who continued to bill privately were to submit duplicate bills and their monthly col- lections to the business office. But most doctors never sent their duplicate bills, leaving the office with incomplete billing information. Ms. Miller was forced to establish a bill-receipt record system, posting bills and receipts simultaneously and setting them equal to each other.

It was a crazy system and we knew it, but what could we do? Physicians set their own fees, and we had no idea what they were. At the end of the month they would send us money with a record of patients' names and amounts paid. So we'd record that amount as billed and paid.

But it was no way to run a business office. For example, one day a doctor brought in $15,000 in checks, just like that. We hadn't expected it at all. We never had any idea of our accounts receivable or collection rates.

Ms. Miller added that centralized billing had developed its own complications: Our main problem was that the information we received varied immensely from doctor to doctor. We didn't pro- vide them with a formal activity sheet, so the doctors used their own systems of recording. As you can imag- ine, we were receiving dissimilar information from all of them.

From what they gave us, my three assistants would compile standard data sheets, which was unbelievably time-consuming. On top of that, we were billing for five doctors, collecting and recording for 11 doctors, and attempting individual monthly reports for 11. It was taking us three weeks to do just the monthly reports.

It was also becoming obvious to Dr. Wells that the trust billing had to be uniform and managed by a central system:

Finally, I'd had it. The only efficient way to collect money for so many people was through one system. It had to be cheaper and more accurate plus it would keep everyone honest. I figured that if collections changed at all, they should increase because one office was handling all the data.

Many physicians, however, disagreed with Dr. Wells on this issue, including Dr. Lewis: I felt all along that it was crucial that we do our billing independently. Very simply, no one is more interested in his collections than the person who worked for them: I can do it better because I care.

Secondly, there are complications in people's billings, which can only be settled by the doctor. A patient is on welfare and can't pay. After one bill, I'd know enough to drop it. A professional courtesy charge—I'm never sure what the billing office charged or if they understand my intention.

Sometimes people come in and say, “doctor, I've been in here three times and I haven't received a bill yet. Why?” I have to say, “I don't know,” which makes me feel foolish. When my secretary did billing, I'd just step out, ask her and get the answer. Now with the business office all the way over in Talbot, geographically re- mote from the department, it is very difficult to know what the current situation is.

In January, the trust hired a company to manage its billings. The company was to receive billing and payment information from the business office and would process it by batches into claims and collections. They would apply claims and collections to physicians' balances and maintain a contin- ual record of the trust's financial status. The company agreed to produce monthly printouts, by pro- vider, so that doctors would have accurate records of their accounts. Nevertheless, the company never produced the information. Ms. Miller explained:

We had a terrible time with that company. The first problem was they never produced any reports according to doctor. We kept asking and they kept agreeing, but they never gave us anything useful.

By the time we realized we weren't going to get that out of them, we had a more serious problem: they had dropped $15,000 in payments from the records. They just hadn't applied it to any accounts, so although we had the money, we didn't know which accounts, i.e., doctors, it belonged to. That meant that the rates we had manually calculated were also meaningless. We got rid of the company then, but I'm afraid it was too late.

Some doctors, affected by these errors, were already furious. With minimal billing information and startling fluctuations in collection rates, doctors blamed the centralized billing system. In an at- tempt to trace the problems, Dr. Robinson studied the collection data. After analyzing patient mix, payer class, and service mix, she reached no conclusion:

I felt that centralized billing should, if anything, improve collections, but that wasn't our experience. Of course, with our other computer problems the issue became more complicated because our information was in- complete.

TCG133 • Hillside Hospital 5 of 7 _____________________________________________________________________________________________

Nevertheless, I think we have to separate questions of administrative efficiency from problems with the sys- tem itself. This is difficult to do, but we can't treat them all as one big problem with the billing system. Of course, we also have to consider that when physicians send their bills to a collection office, they feel like they're losing control. That's the motive for doing the billing ourselves.

Dr. Wells considered the billing problem to be one of administrative oversights:

Obviously, there were problems with that company but I don't see why this would be inherent to centralized billing systems. I've discussed the problem with other groups and our experience is atypical. It happened though, and we can't explain it.

There's also the issue of overhead; doctors are seeing it now like never before. They can see costs that the hospital and department formerly paid, like secretaries, coming directly out of the trust, and they're not pleased.

Other physicians, including Dr. Lewis who had become an elected member of the board of trustees, maintained their opposition to the system. He commented:

I've been against centralized billing from the start, and I think time has borne me out. For one year, I've worked with no idea of what my collections have been. As a result, I don't know my overage, or if I even have one. If I submit receipts, I don't know if they'll be covered.

I got some information for a few months last year and according to that, my collections had fallen by 33 percent. Yet, Dr. Wells calls this a more efficient system . . .

This method must be costing us more. My secretary still prepares the background information on bills and sends that to the billing office to finish. She might as well do the whole thing. It's unnecessary and inefficient to involve that whole office.

Dr. Jefferson thought that, for himself, the system was less efficient than his previous one:

Last year I tried to get some information about my collections and was appalled at how little they'd collected and how little they knew. They couldn't even give me records on patient payments. I did find out though that overhead was about 19 percent of my salary. We all agreed that this was excessive.

Dr. Lewis added that, in his opinion, the controversy over billing methods and other administra- tive matters was indicative of the trust's overall administrative policies:

What happened with billing is typical of the way the trust is run. I like and respect Dr. Wells, but our finances are in shambles because he isn't interested in them and doesn't have the necessary skills. For example, look at what happened with the billing company that he and Ms. Miller engaged.

What it comes down to is that the trust is really Dr. Wells. It reflects his personality, plus he controls the majority of votes. Of the five board members, three are Dr. Wells and his two appointments, giving him 3/5 of any vote—it would be impossible to beat him. Not that there has been a showdown but the fact is, he's play- ing with a loaded deck. It's okay as long as you like and trust him, but it makes for an uncertain future.

EVALUATION By late winter, all 14 full-time physicians at Hillside had joined the trust. Five doctors had left

the department in the previous two years for reasons both related and unrelated to the trust. Some joined the staffs at other hospitals, others left to establish independent private practices. Dr. Wells gradually filled their positions with physicians who joined the trust upon joining the department.

Although reactions in the department still differed on some aspects of the trust, there were also points of general agreement among members. One such area concerned the trust's effect on the de- partment's economic condition. Dr. Robinson commented on it:

One of the most important results of the trust has been the increased revenue generated for the department. It re- mains to be seen whether any of this is from the changes in the billing system, but collecting chief-service pa- tient fees has certainly helped us financially.

Before the trust, the department was stretching to take care of the usual expenses. In the past few years we've not only covered our usual costs but we've been able to pay for postgraduate education and extend interest-free loans to residents. We even lent travel money to a resident so that his family could go to England with him when he was studying there.

The problems in the trust were really administrative and business problems. People here are devoted to aca- demic pursuits so they're not concerned about who is generating the most income—that's not the point of

TCG133 • Hillside Hospital 6 of 7 _____________________________________________________________________________________________

medicine. I think these problems are getting smoothed out and the trust will run much better in the future. I also think it will improve as more people join the department.

Dr. Jefferson agreed with Dr. Robinson that the trust had helped the department, but he re- mained critical of the trust's operations:

It's still difficult to get a handle on precisely what's going on. The process of forming the trust was not salu- tary on communication problems within the department, and these problems remain.

In a way, the trust has had no real effect on me. I do exactly what I did before and am not significantly better or worse off because of it. The available funds have allowed the department to survive, which was important, but when the trust was formed, Dr. Wells was never as frank as he should have been about the economic prob- lems of the department. He said “we'd make a little extra money” but we never knew that there was a signifi- cant economic problem. If we had, we might have all discussed it and come up with an agreeable solution. The emphasis was always on the medical school guidelines.

I think Dr. Wells is a much better chief of medicine than a businessman. There are many business issues and it was preposterous to go about them in an un-businesslike way. I think Wells had the attitude that it isn't nice to talk about money. So because he can't talk about it we have a major communication problem. We still need frankness about this because we're getting new people into the trust and they have to know the details.

Dr. Lewis gave his opinion of the trust's shortcomings:

It's a nice feature of the department to have supplemental funds. I've set up a library in my office for medical students and residents in gastroenterology. I've also used money for honoraria and visual aids, and residents have been reimbursed for expenses from various meetings.

As for the other side, I would say that reduced personal income and loss of independence are disadvantages of the trust. And there have been mistakes. The whole concept of centralized billing was a big mistake. I've voted against it every time it's come up, but it exists. Of course, the mistake was exacerbated by the choice of a bill- ing company.

I believe the real problem in organizing the trust was asking people to change. People were asked to go from a liberal, laissez-faire system to a structured one, and resisted. That's not unusual and could have been pre- dicted.

Commenting on the trust four years after he'd organized it, Dr. Wells noted that some questions remained unanswered:

It's a difficult situation because there still is no uniformity in the medical school. I did what I thought had to be done to keep a Department of Medicine functioning academically, but some departments haven't done anything. An,d realistically, I know academic rank doesn't always reflect someone's contribution. But what could I do?

Then there's always been the budget problem. We never really know where we stand with any of our four budgets. We have budgets for the hospital, the medical school, the grants, and the trust; research funds for this department alone are $10 million. That's big business, and we're not trained for that.

Assignment

1. Classify the activities of Dr. Wells into the categories of strategic planning, management control, and operational control. How, if at all, does this assist you in understanding the problems faced by the trust?

2. How would you characterize the management control structure of the trust? Was it well designed? If not, how would you have changed it?

3. What is your assessment of the management control process of the trust?  How, if at all, would you have changed it?

4. What might Dr. Wells have done differently to achieve a smoother process of change in the department?

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Carleton Fire Department As everyone knows, our performance is very tricky to measure. In part it’s affected by the size of the area we have to cover, and in part by how well we train our fire fighters. It’s also affected, of course, by the our citizenry and how careful they are in their use of fire. Nevertheless, we need to find some metrics that the city council can use to judge how good a job we’re doing. Otherwise, we’re going to have a hard time justifying our budget.

The speaker was Julian Talbot, Chief of the Carleton Fire Department. Chief Talbot had just been given the preliminary findings of an 18-month evaluation of fire protection in a national study of 1,400 fire departments. He knew he would soon be asked to compare Carleton’s performance to similar fire departments in cities of comparable size nationwide. He wanted to be ready.

BACKGROUND

The Carleton Fire Department—whose resources included 4 engine companies, 1 aerial ladder, 68 paid personnel, and a volunteer force that functioned in an auxiliary capacity—protected both the City of Carleton and part of Alamo County. The city itself comprised some seven square miles, a population of approximately 60,000, and property with a total market value of approximately $800 million.

Alamo County had no paid fire department. Its protection was maintained through a network of 6 volunteer companies that included 250 people. For many years, the county also had had an agree- ment with the city that Carleton’s fire department would respond automatically to fire alarms origi- nating within a specified 30-square-mile area of the county, which included most of the urban area surrounding the city. This area had a population about 20,000 and property valued at some $200 million.

The county contributed to the annual budget of Carleton’s fire department in proportion to the services it received. Last fiscal year, this amounted to about 18 percent of the department’s budget. The county also maintained one engine company located at Carleton’s main fire station, which nor- mally was used to respond to county fires. Chief Talbot commented:

Because of this arrangement, we serve two distinct regions: the city itself and a portion of the county. I need to evaluate and compare the kind of fire protection we provide to each area. It’s going to be tricky to keep the pieces separate.

FIRE DEPARTMENT CLASSIFICATIONS

The national evaluation classified all fire departments studied into four categories: fully volun- teer, mostly (50 to 90 percent) volunteer, fully paid, and mostly (50 to 90 percent) paid. The depart- ments then were further divided by size of population and type of community protected (center, ring, or fringe). A center city was an urban area with a population greater than 25,000, having a con- siderable fire hazard and a paid fire department. A ring city was a suburban community with a population of less than 100,000 and with a fire department that included some volunteer personnel. A fringe city was a rural, low-density community on the edge of an urban or suburban area.

Carleton had been classified as a center city with a population between 25,000 and 100,000, and a fully-paid fire department. Chief Talbot commented on the classification:

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_____________________________________________________________________________________________ This case was prepared by by Professor David W. Young, based on the case Charlottesville Fire Department, by

S.A. Young and C.J. Tompkins, Michigan Technology University. It is intended as a basis for class discussion and not to illustrate either effective or ineffective handling of an administrative situation.

Copyright © 2013 by David W. Young, C.J. Tompkins and The Crimson Group, Inc. To order copies or request permission to reproduce this document, contact Harvard Business Publications (http://hbsp.harvard.edu/). Under provisions of United States and international copyright laws, no part of this document may be reproduced, stored, or transmitted in any form or by any means without written permission from The Crimson Group (www.thecrimsongroup.org)

Clearly, the classification issue is tricky and may influence how we are judged. Ideally, we would be considered a center city with a mostly, rather than fully, paid force, but no such classification exists. Nevertheless, “fully- paid” is pretty close to the situation since over 90 percent of all fire alarms are handled with paid personnel.

The 30 square miles of Alamo County that were protected by the city had been classified as a ring city, with a population between 5,000 and 25,000 and a mostly-volunteer force. The county’s force was considered mostly volunteer because, while the city did respond to fire alarms in the area, its function was considered to be ancillary to the county volunteer companies that also responded to alarms. The city normally responded to alarms with one engine company and three fire fighters, but it usually was outnumbered by volunteer equipment and personnel.

MEASUREMENTS

The evaluation had considered both effectiveness and productivity. Effectiveness had been measured in terms of loss of life, personal injury, and property loss. Seven specific items were used: (1) number of fires per 1,000 population protected, (2) dollars of property loss per capita, (3) dollars of property loss per $1,000 of market value of property, (4) dollars of property loss per fire, (5) number of civilian injuries and deaths per 100,000 of population protected, and (7) number of firefighter injuries and deaths per 100 fires.

Productivity had been measured in terms of the relationship between results obtained and re- sources used. Rather than relying strictly on levels of effort (expenditures) to measure fire depart- ment costs, the study used total cost, which was defined as the sum of expenditures and dollar property losses. The specific indicators used were (1) expenditures per capita, (2) expenditures per $1,000 of market value of property, (3) total cost per capita, (4) total cost per $1,000 of market value of property, and (5) total cost per fire.

The evaluation had used data gathered over a three year period, which were averaged and, where appropriate, corrected for inflation. After obtaining all measurement figures for each fire depart- ment, and computing the averages, the analysts classified the departments into quartiles. Because a low score was considered better than a high one, departments in the lower quartile were considered to be high performing, and those in the upper quartile low performing.

CARLETON’S PERFORMANCE

As shown in Exhibit 1, the number of fires per 1,000 protected in Carleton averaged 10.68 for the three-year period, meaning that the city was between the lower quartile (7.24) and the median (12.78). The county figure of 2.98 compared favorably with the lower quartile of 6.63. Chief Talbot commented on these results:

The city’s shortfall here can pretty easily be attributed to the fact that we don’t have a well-developed fire-pre- vention program. Last year, for example, there was only one fire-prevention officer, which meant that the pro- gram was conducted on what you might call a “hit and miss” basis. I feel pretty strongly that more time spent on public education and prevention programs would bring our score down to the lower quartile.

The low figure for the county is due to its low population density, which, of course, makes the fire hazard much lower than for a high-density area, such as the city. I would expect the county’s figure to increase as its population grows and its structures get older.

Property Loss

Property loss per capita and per 1,000 of market value of property for the city were both above the median figures. In contrast, the property loss per fire for the city was slightly below the median. In Chief Talbot’s view:

We have a relatively low number of firefighters per engine company. Clearly, the number of firefighters im- mediately present at a fire can help to increase the number and type of suppression activities that are initiated. The longer certain activities are delayed, the greater the chance of increased property loss.

On the other hand, the fact that we have relatively little industry compared to other cities of our size, helped us to keep the property loss per fire below the median. More industry would increase the risk of indus- trial fires, where property loss is normally greater than in dwelling fires (which is mainly what we have in Carleton).

TCG255 • Carleton Fire Department 2 of 5 _____________________________________________________________________________________________

In the county, property loss per capita and per $1,000 of market value of property were well above the low-performing quartile. Chief Talbot explained:

These figures are somewhat misleading. The property loss totals used in the study were averaged for the three- year period, but in two of those years there were large industrial fires in the county, both of which had high losses. Without those two fires, property loss would have been substantially less for both years. When adjust- ments are made to eliminate these two fires, the property loss indicators fall, although they’re still in the “low performing” range.

Also, when using property loss figures in terms of per capita and per fire, it’s important to keep in mind the low population density in the county, and also the low number of fires that occurred in the county [59 a year versus 598 for the city]. And, finally, another factor contributing to higher property losses in the county was the long response time we experienced, meaning that the fire was already somewhat advanced by the time the engine company arrived.

Civilian Injuries and Deaths Civilian injuries and deaths per 100 fires were very high for Carleton as compared to other cit-

ies its size. They also were relatively high for the county. In Chief Talbot’s view:

One reason may be the way injuries and deaths are reported in Carleton versus other cities, a factor that the evaluation did not allow for. In Carleton, we report any civilian injury at the scene of a fire, however slight. Other cities may have reported in the same way, or they may have reported only those injuries of a more seri- ous nature. The cities that use the latter policy obviously will show better results.

In addition, grouping together injuries and deaths may be misleading. Carleton averaged one death due to fire per year. In one of the years studied, we had 19 injuries and one death, and some of those injuries were pretty minor. Does that total of 20 carry the same weight as 19 deaths and one injury?

In terms of the county, there again may be a problem with the reporting procedure. And, of course, the longer response times for county alarms could be a factor. In fact, I would guess that 25 percent of injuries could be related to the longer response time.

Firefighter Injuries and Deaths Firefighter injuries and deaths per 100 fires for the city were extremely low—well below the

25th percentile figure—whereas the county figure was relatively high. Chief Talbot commented:

Our good performance in the city was due, in no small measure, to the mandatory protective clothing and re- quired training for our firefighters. In the county, on the other hand, there are a lot of volunteers, and they nor- mally wear less protective clothing. They also have much less training.

Expenditures and Productivity Fire department expenditures per capita and per $1,000 of market value of property were low

for both the city and the county. For the city, the relatively low total cost per capita resulted from a combination of extremely low expenditures per capita with higher than average property losses. The total cost per $1,000 of market value of property showed a similar pattern, as did the total cost per fire. In the county, the results were influenced by the two high-cost fires discussed above. A mem- ber of Carleton’s city council commented on these results:

These results demonstrate pretty dramatically that low expenditures are not necessarily good. You need to keep in mind that our property loss figures were relatively high, which could indicate that we were “penny wise and pound foolish.” Of course, we can’t tell whether this is due to underfunding the department or a poor use of the resources that it had available.

You also need to keep in mind that Carleton’s fire department is classified as “fully paid,” but that’s not strictly true; there is an auxiliary force available. If we hadn’t had the auxiliary force, we no doubt would have needed to hire more personnel and therefore would have incurred additional costs.

Finally, the so-called “total cost” concept, while perhaps more informative than expenditures, also can be misleading. By combining property losses and expenditures, it purports to be a measure of both effectiveness and efficiency, but it’s indifferent to the tradeoffs between property loss and fire department expenditures. For example, the same total cost could be achieved both by a department with low expenditures but high property losses and by one with high expenditures but low property losses. And, of course, it also is indifferent to the emotional cost a citizen experiences with the loss of a home.

TCG255 • Carleton Fire Department 3 of 5 _____________________________________________________________________________________________

Chief Talbot responded to these comments:

A service-oriented agency such as a fire department cannot be indifferent to these tradeoffs. The department’s goal of minimizing property loss due to a fire must be part of any productivity measure. I’m not certain, then, that two departments that have equal total costs are equally productive. One may spend more money but have a good suppression record, while the other may spend a minimal amount but have a history of high property loss. Somehow the measure, if it’s to be useful, should be weighted in a manner that reflects a department’s goals and objectives.

Assignment: 1. Assume the information in Exhibit 1 is the only information available. What is your assessment of the

performance of the Carleton Fire Department?

2. What additional information, if any, would you like to have (if it could be obtained at a reasonable cost) to better inform your assessment?

3. What do you think of the qualifications that Chief Talbot has introduced into the discussion? How would you respond to the comments by the city council member?

TCG255 • Carleton Fire Department 4 of 5 _____________________________________________________________________________________________

CARLETON FIRE DEPARTMENT Exhibit 1. Performance Measures

High Performing Low Performing Measure Score (Lower 25%) Median (Upper 25%) Prevention:

Number of fires per 1000 of population Carleton 10.68 7.24 12.78 19.23 Alamo County 2.98 6.63 9.43 15.95

Suppression: Dollar property loss per capita

Carleton 10.90 5.39 10.40 14.96 Alamo County 27.47 5.10 7.69 11.98

Dollar property loss per $1,000 of market value Carleton 1.25 0.31 0.54 2.10 Alamo County 2.69 0.34 0.50 0.75

Dollar property loss per fire Carleton 1,021.00 394.00 1,112.00 2,211.00 Alamo County 9,219.00 439.00 938.00 1,647.00

Civilian injuries and deaths per 100,000 population Carleton 35.71 13.84 19.09 28.48 Alamo County 5.05 0.00 7.93 21.73

Civilian injuries and deaths per 100 fires Carleton 3.34 0.86 1.66 2.23 Alamo County 1.70 0.00 0.85 1.79

Firefighter injuries and deaths per 100 fires Carleton 0.84 1.07 2.51 4.14 Alamo County 1.70 0.00 0.58 2.65

Levels of effort: Expenditures per capita

Carleton 8.61 20.92 24.77 31.75 Alamo County 5.28 8.08 15.02 21.02

Expenditures per $1,000 market value of property Carleton 0.62 0.86 1.84 3.22 Alamo County 0.52 0.51 0.98 1.44

Productivity measures: Total cost per capita

Carleton 19.51 23.12 33.10 44.17 Alamo County 32.76 18.36 28.75 30.77

Total cost per $1,000 market value of property Carleton 1.42 1.01 1.66 5.99 Alamo County 3.20 0.96 1.38 2.05

Total cost per fire Carleton 1,827.00 2,373.00 3,041.00 4,134.00 Alamo County 10,993.00 1,467.00 2,635.00 3,638.00

TCG255 • Carleton Fire Department 5 of 5 _____________________________________________________________________________________________

Omega Research Institute I’m puzzled. A few weeks ago, I got a progress report from Joe Oster, telling me that earlier friction between our team and Ormico had lessened considerably, that high-quality research was under way, and that the prospects for a long-term relationship with Ormico appeared fairly good. Then today I get this letter from John Westphal [vice president of Ormico, Inc.] saying that he wants to terminate the Ormico contract effective immediately.

Larry Simms, Head of the Physical Sciences Division of Omega Research Institute, was speaking with Joyce Gardner, Head of the Electronics Division. He continued:

As you know, we had some difficulties with this project and had to replace Wayne [Sweeney] to avoid losing the contract. But I distinctly remember how pleased John was just a few months ago when we produced a second patentable process. I called in all the participants, got some special reports, and tried to piece together what happened here. Now I need to make some recommendations to senior management that can help to avoid a situation like this again.

BACKGROUND Omega Research Institute was a multidisciplinary research and development organization conducting research in the physical and natural sciences. It employed approximately 1,000 professionals, and was organized by branches of science. The main units were called divisions and the subunits were called laboratories. A partial organization chart is shown in Exhibit 1. Most of the institute’s work was done on the basis of contracts with clients, and each contract was a project. Responsibility for the project was vested in a project leader, and, through him or her, up the organizational structure. Occasionally, some members of a division’s project team were drawn from laboratories other than the one where the project leader worked. In fact, it was the ability to put together a team from several of a single division’s laboratories, and with a variety of technical talents, that was one of Omega’s principal strengths. Since team members worked under the direction of the project leader during the period they were assigned to a project, an individual might be working on more than one project concurrently. The project leader could also draw on the resources of central service organizations, such as model shops, computer services, editorial, and drafting. The project was billed for the services of these units at transfer prices that were intended to cover their full costs. THE ORMICO PROJECT

In October 2015, John Westphal, a vice president at Ormico, had telephoned David MacInnes of Omega to outline a research project to examine the effect of microwaves on various ores and minerals. Mr. MacInnes was Associate Head of the Physical Sciences Division and had known Mr. Westphal for several years. During the conversation, Mr. Westphal asserted that Omega ought to be particularly intrigued by the research aspects of the project, and Mr. MacInnes readily agreed. He was also pleased because the Physical Sciences Division was under pressure to generate more revenue, and this potentially long-term project from Ormico would make good use of the available work force. Indeed, senior management of Omega had recently circulated

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_____________________________________________________________________________________________ This case was prepared by Professor David W. Young based on a case prepared by the late Professor Robert N.

Anthony. It is intended as a basis for class discussion and not to illustrate either effective or ineffective handling of an administrative situation.

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several memos indicating that emphasis should be put on commercial rather than governmental work. As Mr. MacInnes remembered it: I was a little concerned that the project didn’t fall neatly into one laboratory or even one division, but in fact required assistance from the Electromagnetic Sciences Lab [of the Electronics Division] to complement work in two of our labs [the Chemistry Laboratory and the Materials Laboratory]. To try to reach some clarity, I organized a joint client-Omega meeting to determine what Ormico wanted and to plan the proposal. Besides myself, all the relevant Omega actors attended the meeting: Larry Simms, Joe Oster, Wayne Sweeney, Joyce Gardner, and a few researchers chosen by Joe and Wayne. I wanted to have Bob Baumgartner attend, but he was out of town and couldn’t. John also didn’t come, but instead sent his assistant, Ron Humphrey, who told us that he would be the Ormico liaison officer for the project. At the meeting, Ron Humphrey described the project as a study of the use of microwaves for the conversion of basic ores and minerals to more valuable commercial products. He said that the study was to consist of two parts: Part A was to be an experimental program to examine the effect of microwaves on 50 ores and minerals, and to select those processes appearing to have the most promise. Part B was to be a basic study to obtain an understanding of how and why microwaves interact with certain minerals. He also emphasized to the group that an early start was essential if Ormico was to remain ahead of its competition.

Dr. Simms reflected on his view of the meeting and its aftermath: We agreed that the project would be a joint effort of three laboratories: Materials, Chemistry, and Electromagnetic, and that I would have overall project responsibility. We were very pleased when Mr. Humphrey proposed that the contract be open-ended, with a level of effort of around $20,000-$25,000 a month. We had no trouble reaching agreement on the content of the proposal. After the meeting, David proposed that Wayne act as project leader. Wayne had had experience as a project leader on several projects, and had impressed David at the pre-proposal meeting. Although he seemed a little young [37 years old], he was a Ph.D. chemist, and seemed well suited to head the interdisciplinary team. I regretted that Bob [Baumgartner] couldn’t participate in that decision. In fact, because he was out of town, he was neither aware of the Ormico project nor of his laboratory’s involvement in it until he returned.

The following day, Dr. Sweeney was told of his designation as project leader. During the next few days, he conferred with Dr. Oster (the head of the other Physical Sciences laboratory involved in the project). Then, toward the end of October, as he recalled: Mr. Humphrey began to exert pressure on me to finalize the proposal, stating that the substance had been agreed upon at the pre-proposal meeting. I drafted a 5-page letter as a substitute for a formal proposal, describing the nature of the project and outlining the procedures and equipment necessary. At Mr. Humphrey’s request, I included a paragraph that authorized him and members of his staff to visit Omega frequently and observe progress of the research program. The proposal’s cover sheet contained approval signatures from the laboratories and divisions involved. I signed for my own area and for Bob, who was still away. I also telephoned Dr. Gardner to relay Mr. Humphrey’s sense of urgency, and she authorized me to sign for her. David signed for the Physical Sciences Division as a whole. At this stage, I relied mainly on the advice of colleagues within my own division. Since I didn’t know personally anyone in the Electronics Division, I didn’t call on them at this point. Also, since I understood informally that Dr. Cohan was quite busy and often out of town, I didn’t try to discuss the project with him. However, after the proposal had been signed and mailed, I sent Dr. Cohan a copy. The proposal listed the engineering equipment the client wanted us to purchase for the project, and described how it was to be used.

According to Dr. Cohan: When I got the proposal from Wayne, I worried that the performance characteristics of the power supply [necessary for quantitative measurement] specified in the proposal were inadequate for the task. I asked Wayne about it and he said that the client had made up his mind as to the microwave equipment he wanted and how it was to be used. He told me that Mr. Humphrey had said he was paying for that equipment and intended to move it to Ormico’s laboratories after the completion of the contract with us.

All these events transpired rather quickly. By the time Dr. Baumgartner returned, the proposal for the Ormico project had been signed and accepted. He commented:

TCG253 • Omega Research Institute 2 of 10 _____________________________________________________________________________________________

When I found out about this, I went to see Larry immediately. I told him that I had dealt with Humphrey on a project in another research institute and had serious misgivings about working with him. Larry assuaged some of my fears by observing that if anyone could work with Humphrey it would be Wayne, who, he argued, was flexible, professionally competent, could move with the tide, and could get along with clients of all types.

Conduct of the Project

Thus the project began. Dr. Sweeney described his view of the process: Periodically, when decisions arose, I got opinions from division management. However, I was somewhat unclear about my role. David had appointed me project leader, but I normally work for Bob. Also, although Joe’s laboratory was heavily involved in the project, he was very busy with other projects. Adding to my uncertainty, I often received phone calls from Dr. Cohan, whom I didn’t know well. He told me he expected to be heavily involved in the project.

Difficulties and delays began to plague the project. The microwave equipment specified by the client was not delivered by the manufacturer on schedule, and there were problems in filtering the power supply of the radio frequency source. Over the objection of Omega Electromagnetic Sciences engineers, but at the insistence of the client, one of the chemical engineers tried to improve the power supply filter. Eventually the equipment had to be sent back to the manufacturer for modification. This required several months. In spring 2016, Mr. Humphrey, who had made his presence felt from the outset, began to apply strong pressure. As Dr. Sweeney recalled: “Listen,” he told me, “top management of Ormico is starting to get on my back and we need results. Besides, I’m up for review in four months and I can’t afford to let this project affect my promotion.” He was constantly at Omega during the next few months. He was often in the labs conferring individually with members of our teams, and he also visited my office frequently. As a result, a number of related problems began to surface. I had agreed to do both theoretical and experimental work for the project, but Mr. Humphrey’s constant pushing for experimental results began to tilt the emphasis. Theoretical studies began to lapse, and experimental work became the main focus of the project. From time to time I argued that the theoretical work should precede or at least accompany the experimental program, but Humphrey’s insistence on concrete results led me to temporarily de-emphasize the theoretical work. There were lots of symptoms of this shifting emphasis. For example, one day a senior researcher from Dr. Oster’s laboratory came to me to complain that people were being “stolen” from his team. “How can we do a balanced project if the theoretical studies are not given enough work force?” he asked. I explained the client’s position and asked him to bear with this temporary realignment of the project’s resources.

As the six-month milestone approached, Mr. Humphrey expressed increasing dissatisfaction with the project’s progress. Seeking concrete results to report to Ormico management, he told Dr. Sweeney to change the direction of the research a number of times. On several occasions various members of the project team had vigorous discussions with Mr. Humphrey about the risks of changing directions without laying a careful foundation. Dr. Sweeney himself spent a good deal of time talking with Mr. Humphrey on this subject, but Mr. Humphrey seemed to discount its importance. Mr. Humphrey began to avoid Dr. Sweeney and to spend most of his time with the other team members. Eventually the experimental program, initially dedicated to a careful screening of some 50 materials, deteriorated to a somewhat frantic and erratic pursuit of what appeared to be “promising leads.” Drs. Simms and Gardner played little or no role in this shift of emphasis. On June 21, 2016, Mr. Humphrey visited Dr. Sweeney in his office and severely criticized him for proposing a process (hydrochloric acid pickling) that was economically infeasible. In defense, Dr. Sweeney asked an Omega economist to check his figures. The economist reported back that his numbers were sound and that, in fact, a source at U.S. Steel indicated that hydrochloric acid pickling was “generally more commercially feasible than the traditional

TCG253 • Omega Research Institute 3 of 10 _____________________________________________________________________________________________

process and was increasingly being adopted.” Through this and subsequent encounters, the relationship between Mr. Humphrey and Dr. Sweeney became increasingly strained. As Dr. Sweeney recalled:

Mr. Humphrey continued to express concern about the Ormico project’s payoff. In an effort to save time, he discouraged the Omega team from repeating experiments, a practice that was designed to ensure accuracy. Data received from initial experiments were frequently taken as sufficiently accurate, and, after hasty analysis, were adopted for the purposes of the moment. Not surprisingly, Mr. Humphrey periodically discovered errors in these data, and he informed Omega of them. His visits to Omega became more frequent as the summer progressed. Some days he would visit all three laboratories, talking to the researchers involved and asking them about encouraging leads. I occasionally cautioned him against too much optimism, but I also continued to oblige him by restructuring the Ormico project to allow for more “production line” scheduling of experiments and for less systematic research. In August, we discovered that vertile could be obtained from iron ore. This was a significant discovery, and Ormico applied for a patent. If the reaction could be proven commercially, its potential would be measured in millions of dollars. A little later, our team discovered that the operation could, in fact, be handled commercially in a rotary kiln. Ormico was notified and began a pilot plant that would use the rotary kiln process. However, Ormico’s engineering department, after reviewing the plans for the pilot plant, rejected them, arguing that the rotary process was infeasible and that a fluid bed process was needed instead. Mr. Humphrey then asked us to conduct an experiment to test the fluid bed process. I warned him that agglomeration [a sticking together of the material] would probably take place. It did. He was very upset, reported to Mr. Westphal that he had not received “timely” warning of the probability of agglomeration taking place, and indicated that he had been misled as to the feasibility of the rotary kiln process.1

Work continued, and two other “disclosures of invention” were turned over to Ormico by September 30. Personnel Changes

On September 30, 2016, Mr. Humphrey came to Dr. Sweeney’s office to request that Sidney Young be removed from the project. Mr. Humphrey reported that he had been watching Mr. Young in the Electromagnetic Laboratory, which he visited often, and had observed that he spent relatively little time on project-related work. Dr. Sweeney, who did not know Mr. Young well, agreed to look into it. But Mr. Humphrey insisted that Mr. Young be removed immediately and threatened to terminate the contract if he were allowed to remain. Because Mr. Young was on vacation, Dr. Sweeney was unable to talk to him before taking action. He did talk to Mr. Young as soon as he returned, however, and the researcher admitted that, due to the pressure of other work, he had not devoted as much time or effort to the Ormico work as perhaps he should have. Three weeks later, Mr. Humphrey called a meeting with Drs. MacInnes and Simms. It was their first meeting since the pre-proposal meeting. The following conversation took place:

Humphrey: I’m here because we have to replace Sweeney. He’s become increasingly difficult to work with and is obstructing the progress of the project.

Simms: But Sweeney is an awfully good man . . .

MacInnes: Look, he’s come up with some good results thus far. What about the process of extracting vertile from iron ore he came up with. And . . .

Humphrey: I’m sorry, but we have to have a new project leader. I don’t mean to be abrupt, but it’s either replace Sweeney or forget the contract.

Dr. MacInnes reluctantly appointed Dr. Oster as project leader and informed Dr. Sweeney of

TCG253 • Omega Research Institute 4 of 10 _____________________________________________________________________________________________

1 Ten months later Ormico was using the rotary kiln process in its laboratory to produce vertile from iron ore.

the decision. Dr. Sweeney went to see Dr. MacInnes a few days later, and Dr. MacInnes told him that although management did not agree with the client, Dr. Sweeney had been replaced to save the contract. Later Dr. Simms told Dr. Sweeney the same thing. Neither Dr. Simms nor Dr. MacInnes made an effort to contact Ormico’s senior management on the matter. Following his appointment, Dr. Oster made many efforts to get the team together, but morale remained low. Mr. Humphrey continued to make periodic visits to Omega but found that the Omega researchers were not talking as freely with him as they had in the past. Mr. Humphrey became skeptical about the project’s value. Weeks slipped by. No further breakthroughs emerged. Simms’ Problem

Throughout the project, Dr. Simms received weekly Project Status Reports, one of which is shown in Exhibit 2. He had a few informal conversations about the project, principally with Drs. Sweeney and Oster, but did not read the reports submitted to Ormico. If the project had been put on Omega’s “problem list,” which comprised the projects that seemed to be experiencing difficulty (about 10 percent of the projects), Dr. Simms would have received a weekly written report on its status, but the Ormico project was not on that list. He reflected on the dilemma:

Westphal’s letter terminating the contract makes it seem that he, too, didn’t have full knowledge of what was going on. For example, he mentions the “glowing reports” that he received in the early stages of work. However, these reports, which came to him only from Humphrey, were later significantly modified, and Humphrey apparently implied that Omega had been “leading him on.” Westphal’s letter also mentions a “complete lack of economic evaluation of alternative processes in the experimentation,” but he seems unaware of the fact that, at Humphrey’s insistence, all economic analyses were supposed to be done by Ormico. He seems most dissatisfied that we have not complied with all the provisions of the proposal, particularly those that required full screening of all materials and the completion of the theoretical work. Yet, the suspension of theoretical work also was at Humphrey’s insistence. All of this makes me wonder why the Omega team didn’t document Humphrey’s changes to the proposal. Why didn’t either John or I learn more about the project’s problems before this? In an effort to get to the bottom of all of this, I requested a technical evaluation of the project [Exhibit 3] from Robin Scott [the Process Economics Director]. I also asked David for his evaluation of the project [Exhibit 4]. As I review these reports, I can’t help but think that we need to change the way we do business around here. I’m just not sure what the changes should be.

Assignment

1. Prepare a list of the problems associated with the Ormico project, classifying them into categories that you consider meaningful for managerial action.

2. What changes should Dr. Simms recommend be made to avoid similar problems in the future?

TCG253 • Omega Research Institute 5 of 10 _____________________________________________________________________________________________

OMEGA RESEARCH INSTITUTE Exhibit 1. Partial Organization Chart

President and CEO

Chief Operating Officer

Head Physical Sciences Division

Larry Simms

Head Electronics Division

Joyce Gardner

Associate Head David MacInnes

Director Electromagnetic

Sciences Laboratory Gordon Cohan

Director Chemistry Laboratory Robert Baumgartner

Associate Director, & Manager of Chemical

Development and Engineering

Wayne Sweeney

Director Materials Laboratory

Joseph Oster

TCG253 • Omega Research Institute 6 of 10 _____________________________________________________________________________________________

OMEGA RESEARCH INSTITUTE Exhibit 2. Weekly Project Status Report

PROJECT/ACCOUNT Org Acct Sub s/o Week ending Type Rev Type Price Client Int/Dom Page STATUS REPORT 325 3273 000 000 12/22/2016 PROJ INDUS SCA YD DOM 1 Division Department Supervisor Leader Project Title MICROWAVES IN PHYSICAL SCI MATERIALS LAB J. OSTER J. OSTER CONVERSION OF BASIC ORES AND MINERALS Client Ready Date Stop Date Term Date Burden % Overhead % Fee % ORMICO 11/5/2015 - - 11/6/2017 28.00 105.00 15.00 Transactions Recorded 12-15-2016 - 12-22-2016 COST OBJECT DOLLARS LABOR HOURS LABOR HOURS CATEGORIES CODES PTD13WK TO DATE ESTIMATE TO DATE BALANCE ORG OBJ NAME WEEK TO DATE Supervisor 11,12 1,120 72 322 13 Oster 6.0 150 Senior 13 384 35,972 2696 322 13 Dash 8.0 25 Professional 14 300 33,574 3356 322 14 Cook 15.0 30 Technical 15 1,058 10,598 2074 325 15 Howard 15.0 82 Clerical Support 16,17,18 602 168 325 15 Speltz 15.0 68 Other 10, 19 144 144 24 325 15 Gyuire 15.0 17 Labor 1,886 82,010 3288 325 15 Dillon 40.0 64 Burden 496 22,962 325 15 Nagy 31.0 31 Overhead 2,454 110,220 LAST BILLING 652 15 Kain 8.0 20 Overhead Premium 21 320 3,080 DATE 11/30/2011 Other Premium 22-29 484 952 AMOUNT 22,700 HOURS DOLLARS Total Personnel 5,040 219,224 ACCOUNT STATUS TO DATE LABOR STRAIGHT TIME 117 1,886 Travel 56-59 1,552 BILLED 309,166 PAYROLL BURDEN 496 Subcontract 36 PAID 309,166 OVERHEAD RECOVERY 2,454 Material 41,42 7,452 OVERTIME PREMIUM LABOR 320 Equipment 43 OTHER PREMIUM LABOR 484 Computer 37,45 TOTAL PERSONNEL COSTS 5,640 S Commun 62,63,70,71 4 1,014 Consultant 74,75 TIME BALANCE % 39.4 MATERIALS AND SERVICES Report Cost 44,47 COST BALANCE % 43.5 PO NO. REF NO. OBJ RESP. 84 Other M&S 108 198 TIME BALANCE WKS. 41 61289 54065 48 KIRK 20 Total M&S 112 10,196 17234 87413 48 COOR 4 Commitments 53,694 ESTIMATED BALANCE 44610 71 NAGY 112 S Total Less Fee 5,752 283,114 500,870 217,756 Fee (15%) 316 48,752 75,130 26,378 FEE 316 Total 6,062 331,866 576,000 244,134 TRANSACTION TOTAL 6,068 T

OMEGA RESEARCH INSTITUTE Exhibit 3. Technical Evaluation

by Robin Scott, Director, Process Economics

Principal Conclusions

1. The original approach to the investigation as presented in the proposal is technically sound. The accomplishments could have been greater had this approach been followed throughout the course of the project, but the altered character of the investigation did not prevent the accomplishment of fruitful research.

2. The technical conduct of this project on Omega’s part was good despite the handicaps under which the work was carried out. Fundamental and theoretical considerations were employed in suggesting the course of research and in interpreting the data. There is no evidence to indicate that the experimental work itself was badly executed.

3. Significant accomplishments of this project were as follows: a. Extraction of vertile from iron ore by several alternative processes.

Conception of these processes was based on fundamental considerations and demonstrated considerable imagination. As far as the work was carried out at Omega, one or more of these processes offers promise of commercial feasibility.

b. Nitrogen fixation. This development resulted from a laboratory observation. The work was not carried far enough to ascertain whether or not the process offers any commercial significance. It was, however, shown that the yield of nitrogen oxides was substantially greater than has previously been achieved by either thermal or plasma processes.

c. Reduction of nickel oxide and probably also garnerite to nickel. These findings were never carried beyond very preliminary stages and the ultimate commercial significance cannot be assessed at this time.

d. Discovery that microwave plasmas can be generated at atmospheric pressure. Again the commercial significance of this finding cannot be appraised at present. However, it opens the possibility that many processes can be conducted economically that would be too costly at the reduced pressures previously thought to be necessary.

4. The proposal specifically stated that the selection of processes for scale-up and economic studies would be the responsibility of the client. I interpret this to mean that Omega was not excluded from making recommendations based on economic considerations. Throughout the course of the investigation, Omega did take economic factors into account in its recommendations.

5. The Omega reports were not well prepared even considering the circumstances under which they were written. For example, actual and effective decisions of significance were not documented by Omega and only to a limited extent by the client. There was no attempt on Omega’s part to convey the nature or consequences of such decisions to the client’s management.

6. It is possible that maximum advantage was not taken of the technical capabilities of personnel in the Electromagnetic Sciences Laboratory. Furthermore, they appeared to have been incompletely informed as to the overall approach to the investigation.

TCG253 • Omega Research Institute 8 of 10 _____________________________________________________________________________________________

7. There was excessive involvement of the client in the details of experimental work. Moreover, there were frequent changes of direction dictated by the client. Undoubtedly these conditions hampered progress and adequate consideration of major objectives and accomplishments.

8. In the later stages of the project, the client rejected a number of processes and equipment types proposed by Omega for investigation of their commercial feasibility. From the information available to me, I believe that these judgments were based on arbitrary opinions as to technical feasibility and superficial extrapolations from other experience as to economic feasibility that are probably not valid.

9. The client claims that he does not criticize Omega for failing “to produce a process.” He says that he never expected one. Instead, he wanted a good screening of ores and reactions as called for in the proposal, and that he had hoped for results from the theoretical studies. This he feels he did not get. He therefore feels that he did not do what the proposal called for.

10. The statement that a process was not expected seems entirely contrary to the course of the project. There was universal agreement among Omega personnel involved that almost immediately after the project was initiated it was converted into a crash program to find a commercial process. In fact, the whole tenor of the project suggests a degree of urgency incompatible with a systematic research program. It is quite true that the theoretical studies were never carried out. According to the project leader this part of the proposal was never formally abandoned, it was merely postponed. Unfortunately, this situation was never documented by Omega, nor were other significant decisions.

Additional Comments 1. It appears that the first indication that the client expected economic studies or

evaluations of commercial feasibility occurred during the summer of 2016. At this time the project leader was severely criticized by the client’s representatives for having proposed a process (hydrochloric acid pickling) that was economically infeasible. The basis for this criticism was that hydrochloric acid pickling of steel had not proved to be economically feasible. It is totally unreasonable to expect that Omega would have access to information of this kind, and such a reaction would certainly have the effect of discouraging any further contributions of an economic or commercial nature by Omega rather than encouraging them. Actually it is patently ridiculous to directly translate economic experience of the steel industry with steel pickling to leaching a sulfided titanium ore. Nevertheless, I directed an inquiry to a responsible person in U.S. Steel as to the status of hydrochloric acid pickling. His response (based on the consensus of their experts) was diametrically opposite to the client’s information. While there are situations that are more favorable to sulfuric acid pickling, hydrochloric acid pickling is generally more economical and is becoming increasingly adopted.

2. The reports written by Omega were requested by the client, but on an urgent and “not fancy” basis. If such were the case, it is understandable that the project leader would be reluctant to expend enough time and money on the report to make it representative of Omega’s normal reports. However, the nature of the reports seems to indicate that they are directed toward the same individuals with whom Omega was in frequent contact, or persons with a strong interest in the purely scientific aspects. The actual accomplishments of the project were not brought out in a manner that would have been readily understandable to the client’s management.

TCG253 • Omega Research Institute 9 of 10 _____________________________________________________________________________________________

OMEGA RESEARCH INSTITUTE Exhibit 4. Memorandum to Larry Simms from David MacInnes

To: Larry Simms From: David MacInnes Re: The Ormico Project--Conclusions Date: January 8, 2017

My findings are as follows:

1. The decision to undertake this project was made without sufficient consideration of the fact that this was a “high risk” project.

2. The proposal was technically sound and within the capabilities of the groups assigned to work on it.

3. There was virtually no coordination between the Physical Sciences and Electronics Divisions in the preparation of the proposal.

4. The technical conduct of this project, with few exceptions, was, considering the handicaps under which the work was carried out, good and at times outstanding. The exceptions were primarily due to lack of attention to detail.

5. The Omega reports were not well prepared, even considering the circumstances under which they were written.

6. The client, acting under pressure from his own management, involved himself excessively in the details of experimental work and dictated frequent changes of direction and emphasis. The proposal opened the door to this kind of interference.

7. There was no documentation by Omega of the decisions made by the client which altered the character, direction, and emphasis of the work.

8. There was no serious attempt on the part of Omega to convey the nature or consequence of the above actions to the client.

9. Fewer than half of the major complaints made by the client concerning Omega’s performance are valid.

10. The project team acquiesced too readily in the client’s interference, and management acquiesced too easily to the client’s demands.

11. Management exercised insufficient supervision and gave inadequate support to the project leader in his relations with the client.

12. There were no “overruns” either in time or funds.! ! ! ! ! ! ! ! !

TCG253 • Omega Research Institute 10 of 10 _____________________________________________________________________________________________