Harvard Business School

CHEMICAL BANKAllocation of profits

Chemical BankSixth Largest U.S. commercial bank in 1983With 20,000 employees Having $ 46.9 billion in assetsOffered a broad range of financial services

throughout the world.

Major Profit centres

Chemical Bank

Personal and Banking

Services group

World banking Group

Treasury Group

Areas involved in Due bills controversyPersonal and

Banking Services

group

Metropolitan Division

Trust and Investment

Division

Treasury Group

Government Trading segment

Finance Division

Treasury DivisionLooked after the funding needs of

Chemical bank.Bonus Pool: (10-15)% of net earnings

before tax- direct & allocated costs

Treasury

Foreign Exchange

Government Trading

Municipal Trading

Money Market Trading

Metropolitan Division

Goal: To become “One-stop” Financial center for its customer

Products Offered: 1. Money Market Accounts 2. Discount Brokerage services

Components of Metropolitan division

Metropolitan

Retail branch network

VISA

Chemical consumer Finance corporation

Master Card

Metropolitan Division (Contd.)Evaluation Criteria: Senior Manager: Profit

center basis Branch Manager: Goal

SystemGoal System1. Budget: Expected performance level. 2. Base Accounting level: minimum

performance level3. Goal: Target level to achieve

Trust and Investment DivisionServices offered:• Money management services to individual

and institutional investors• International banking services• Set up Due bills accounts and provide data

processing services

Finance DivisionMajor responsibilities• Strategy Planning• Corporate Finance• Accounting and control• Management Accounting & Taxes Management Accounting & Taxes which

managed product & customer profitability was headed by Ken Lavine. Ken was responsible for resolving all transfer pricing issues and had ultimate decision – making authority in this area.

Due BillsAn acknowledgement that the bank had sold securities to the

customer, that his account has been charged and that if requested, the securities will be delivered when they become

available

Profit was earned in the following ways:1. Net Interest income: When the treasury

invested due bill funds to warn a higher rate than it had to pay the customer

Spread=Rate earned on investment- Rate paid to the customer

2. Trading Profits: Profit earned by trading T-bills in the secondary market and earning a trading profit

3. Fees: Customer was charged at $ 25 fee

Background of controversy over Due bills

Metro division loosing $26.50Reason: i) T&I was charging Metro for cost of processing

Due Billsii) Metro was receiving no credit for Due billsiii) Treasury was credited with all Due Bill

revenue.

Metro’s suggestion:Treasury should charge additional fee of $25

along with the transaction fee for Due Bills

Treasury’s View:Opposed to the additional fee of $25 because of

the following reasons• Increase in fee would not attract the untapped

source of customers• Possibility of customers switching to other

banks and this will lead to the transfer of entire relationship

Treasury refused to give the credit to Metro.. !!!

Arguments: They felt that traders were the ones generating

revenue Metro just reacting to customer’s needs and not

pushing it Treasury doing a favor by providing its customers

with this service

Market condition in 1982Profit declined in late 1980’sReasons:1. A drop in interest rates2. Advent of bank offered money market accounts

Implications:3. Treasury’s funding spread decreased4. Trading profits from Due Bills decreased5. Attractiveness of T-Bills decreased6. Decrease in volume of Due bills sold

Steps taken by Metro division to retrieve the market shareIncentive of 10 basis points to the branch

managers on all new deposits brought to the bank

Conditions:• The proceeds of the new new accounts

should NOT be from an existing Chemical checking or saving A/C.

• Proceeds diverted from Due Bills, even those purchased by Chemical, were allowed under this scheme.

Review by Finance divisionObservation:• Due Bills were more profitable than Super

Saver (new money market accounts)• Allocation of profits made the profits less

profitable for MetroProblem:• Metro had little incentive to sell the Due

bills • Who should perform the admin duties

associated with maintenance?

Current Allocation of profits

Possible Alternatives by Finance Division

Fee sharing on all sales – all or part of $25 Fee sharing on new sales – all or part of $25 Include Due bills in Metro goal systemOthers?

Treasury’s recommendation They will share $25 fee with metro on all sales

that exceeded the 1981 average Due bill balance plus 10%.

The rationale was that Metro should be rewarded only for bringing Due Bill volume above past levels.

Metro’s recommendationSharing the fees which would be reduced to $30 and the cost of processing

ConclusionsBy increasing $5 they might lose some new

customers Extra $5 increase in revenue could improve

their bottom line as wellAnyways there is no point in gaining profit at

the expense of the loss to a particular unit