Steel Rona

Subsidiary Railroads of a Major Integrated Steel Producer

Several years ago executive management at a major integrated steel producer directed its operating units to concentrate on return on net assets (RONA) as a key financial performance indicator. As a corporation, all operating units were to achieve at least a 16 percent return on net assets. The RONA formula applied across each profit center or subsidiary is:

Earnings before Interest and Taxes

Return on Net Assets = --------------------------------------------

((Inventory + Accounts Receivable + Plant Property Equipment) - Accounts Payable) + Other Current Liabilities

The subsidiary railroads of the steel producer include six railroads, a trucking company, and an inter-modal carrier. Each operates as a separate business entity (by law), and the parent company measures the financial performance, including net return on assets, of each unit. This case focuses on the railroads only.

The emphasis on net asset return began in the mid 1990s when executive management challenged operating units to develop ways to meet or exceed the established RONA target. Within the railroads, procurement used the inventory for December 1994 as the base year for determining inventory reductions. The initial target for the 1994-1997 period was to reduce inventory investment by 30 percent. By the latter part of 1997, the reduction has been 37 percent. Management has now targeted a 40 percent reduction from 1994 base levels.

The corporate decree to improve RONA forced different functional groups at the railroads to search for ways to increase earnings while simultaneously reducing assets and other current liabilities. The centralized purchasing group representing the subsidiary railroads focuses extensively on the denominator of the RONA equation. As such, this group decided it had to develop creative ways to manage purchased inventory, which is its primary area of responsibility. Locomotives,...