Harvard Business School 9-480-054

January 1, 1980

Technotronics, Inc.
Ilene Carter, manager of the Audio Products Section of Technotronics, had spent the last
several days wrestling over her problem with the Magnetic Materials Section. After five years of
research and $1.2 million of developmental expenditures her section had discovered a new magnetic
material (called X-27) which had the potential to replace almost all other magnetic materials now
used by Technotronics. Patents covering the manufacturing process had already been granted by the
U.S. Government. Carter was "on top of the world" when, one day in August 1979, she was paid a
visit by Sam Grant, manager of the Magnetic Materials Section at Technotronics. Things had gone
steadily downhill since that meeting. . . .

The Company

Technotronics, Inc. was a nationwide organization engaged in the design, manufacture, sale
and servicing of a wide variety of electrical and allied products. Incorporated in 1909 to manufacture
a specialized line of electric motors, it had, over the last 70 years, grown substantially in sales volume
and diversified its product line through the acquisition of, or merger with, a number of small
electrical companies. Aside from losses in 1930 and 1931, Technotronics' operations had always been
quite profitable, and it was recognized as a leader in the electrical industry. Technotronics had 1978
sales of $2.1 billion and employed over 40,000 people.

In the last decade Technotronics witnessed particularly rapid expansion of its operations and
product lines. By 1979 Technotronics maintained sales outlets in all major cities in the country and
had design, manufacturing, and/or assembly operations in 46 states.

Organization

Prior to 1974 Technotronics was organized along functional lines with responsibilities for
production, marketing, finance and control vested in separate divisions which cut across product
lines. As Technotronics grew, management witnessed a number of significant organizational
problems. Operating decisions were not being made in a timely manner and were often made by
headquarters personnel inadequately versed in the local problems. As a result, headquarters-field
relations steadily worsened. After considerable study, the management of Technotronics, decided to
shift to a decentralized product-centered organization in 1974 (Exhibit 1) where "authority,
accountability and responsibility" would be placed as close as possible to the actual level of
operations.

From 1974 to 1979, Technotronics implemented the decentralization policy in all of its
operating divisions and component departments. Divisions and departments were run as profit

This case was prepared as a basis for class discussion rather than to illustrate either effective or ineffective handling of an
administrative situation.
Copyright © 1980 by the President and Fellows of Harvard College. Distributed by HBS Case Services, Harvard
Business School, Boston, Mass. 02163. All rights reserved to the contributors. Printed in the USA.

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 480-054 Technotronics, Inc.

centers and divisional and departmental vice presidents had broad authority within their
organizational charters.

In 1979, Technotronics was grappling with the process of decentralizing profit

responsibilities down to the level of section managers. Gerald Bannon, president of Technotronics,
issued the following policy statement in that regard in February 1979: "It is planned to make the
section manager as much like the president of his own small business as possible, within the
framework of company policy. He should be constantly thinking about what is best for his own
section and then frame this question within the broader question of what is best for Technotronics."
Each section manager was accountable to his department vice president for his section's profit and
return on investment. Section charters broadly defined the product lines for which it was responsible,
and, within the limits of this charter, a section manager had the responsibility for determining and
implementing policies and practices related to such areas as: development of new products,
discontinuation or expansion of particular product lines, production facilities and processes for its
products, and the costing, pricing and sales of its products. General accounting and personnel
policies were standardized throughout the company, but each section was responsible for the
interpretation and execution of these policies.

Responsibility for a particular product line, as defined in a specific section's charter, meant
that only this section could sell this product to customers outside the company or license other
manufacturers to produce it. However, other sections using that product as a component part of their
own products had the authority either to purchase the component from the section responsible for
producing it, or to produce it themselves; each section was expected to decide in favor of the
procedure which would most benefit the company as a whole. Under the decentralization policy,
sections selling products within the company could expect to make a "reasonable profit" on these
sales. It was Technotronics' general policy not to purchase component parts from outside the
company unless the company did not produce the parts itself, or could not produce them to meet
necessary standards of quality or within the necessary limits of cost and time.

The section charters were drawn up with the intention of precluding competition among the
sections on the sale of general product lines to customers outside the company. They were not
designed, however, to diminish competition among the sections in such areas as product
development, production, and sales of any of their products within the company. The department
vice presidents realized that this kind of competition among the sections could be at once both a
valuable asset and a severe liability of a decentralization policy. They anticipated that there would be
numerous problems to be resolved among the sections, but they agreed that if the sections could be
encouraged to resolve these problems for themselves, the long-range benefits of decentralization
would be best realized. They concluded that clarification of many aspects of how the decentralization
policy should work at the section level should come as a result of the sections' efforts to wrestle with
their own problems. The department vice presidents in 1979 were, therefore, urging their section
managers to make as many decisions on their own and among themselves as possible. It was clear
that only in this way would the section managers learn to accept responsibility commensurate with
the authority which they had been granted.

Ilene Carter's Problem

In August 1979, Ilene Carter, manager of the Audio Products Section, recalled the president's
statement on the section manager's role, as she deliberated how to resolve a problem which had
arisen between her section and the Magnetic Materials Section. The Audio Products Section
manufactured and sold a wide variety of products related to sound amplification, such as: hearing
aids, phonograph pickups, microphones, and special-purpose amplifiers. In 1978 this section had net

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 Technotronics, Inc. 480-054

sales of slightly under $50 million and employed over 1,000 people. It had been operating profitably
since its organization as part of the Specialty Appliance Department in 1973.

The beginning of the problem facing Carter could be traced to 1974, when the Advanced
Development Laboratory of the company had developed the theoretical concept of a new kind of
magnetic material which would have properties that might permit the manufacture, for existing
products and processes, of magnets with considerably more strength than those now being made, but
in a smaller size and at less cost than any existing magnets. It was also anticipated that this magnetic
material might open up many new uses for magnets in products and processes where conventional
magnets could not now be used, and might also lead to the development of new products which
were not now commercially feasible.

In conformity with company policy, the facilities of the Advanced Development Laboratory
were completely committed to basic and theoretical research. The research laboratories within each of
the operating sections were responsible for developmental research on concepts and ideas passed on
to them by the Advanced Development Laboratory. Under the decentralization policy of the
company, each section had the authority to determine whether or not to go ahead with
developmental research on a particular idea that was referred to it by the Advanced Development
Laboratory. This decision was usually based on the anticipated feasibility of the idea for commercial
development and production.

The Magnetic Materials Section of the Materials Department was primarily engaged in the
manufacture of magnets and magnetic materials. By its charter it was responsible for the sale of all
magnets and magnetic materials to customers outside the company, and it also sold its products to
some of the other operating sections within the company which used magnets as component parts of
their own products. About three-quarters of its net sales of $40 million were to customers outside the
company. Like the Audio Products Section, the Magnetic Materials Section had operated at a profit
each year since its organization as part of the Materials Department in 1973.

It was natural, therefore, for the Advanced Development Laboratory to approach the
Magnetic Materials Section in 1974 as the proper operating section within the company to do the
developmental research on the new magnetic material. However, this section had then been engaged
in developmental research on a number of other magnetic products, and its engineers had seriously
questioned whether ADL's concept could be even developed into a magnetic material, let alone be
produced commercially. Therefore, the Magnetic Materials Section had declined the opportunity to
do developmental research on the new idea for a magnetic material.

The Audio Products Section used magnets as component parts in three-quarters of the 200
different products which it manufactured and sold. About half of these magnets were purchased
from the Magnetic Materials Section and the rest were manufactured in Audio Products' own
foundry. Because magnets were such an important component part to the Audio Products Section,
the Advanced Development Laboratory had offered this section the opportunity to do developmental
research on the new magnetic material concept after it had been turned down by the Magnetic
Materials Section. Carter, after reviewing the possibilities of the new material with her staff, agreed to
accept this responsibility.

Developmental research on the new material had continued in the laboratory of the Audio
Products Section over the next five years. After considerable trial and error and the expenditure of
$1.2 million dollars in developmental funds, the concept originated by the Advanced Development
Laboratory had proved valid, and a pilot plant established in the Audio Products Section clearly
indicated commercial applications of the new material far greater than those originally envisioned. It
appeared to Carter that the new material might eventually replace almost all other magnetic
materials now used by Technotronics, although she realized that it would be several years before all

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 480-054 Technotronics, Inc.

interested sections could make full use of the material. Most of Technotronics' products that used
magnets would have to be redesigned to take full advantage of the unique properties of the new
magnetic material, and Carter realized that the process of redesign would take considerable time.

Ilene Carter was faced with the problem of how best to exploit the commercial possibilities of
the new magnetic material called X-27. In attempting to resolve this problem, she recognized that all
of the operating sections of Technotronics that used magnets as component parts of their own
products should have complete access to X-27. At the same time, she was interested in protecting her
section against its audio products competitors outside the company by preventing them from buying
the new material, so that they could not match Audio's prices on products using the new material.
Lastly, Carter wanted to recoup the development costs of $1.2 million which, in accordance with the
company's decentralization policy, had been charged directly to her section.

Enter Sam Grant

While mulling over various courses open to her in her effort to resolve this problem, Carter
was approached by Sam Grant, manager of the Magnetic Materials Section. Grant congratulated
Carter on the outstanding success of the developmental research on X-27. He went on to say that he
eagerly awaited Carter turning over the techniques and procedures for manufacturing X-27 to the
Magnetic Materials Section as the best and most logical operating section of the company to exploit
all of the commercial possibilities of the new material. Carter replied that this action would allow the
outside competitors of the Audio Products Section and all other Technotronics operating sections
using magnets as components of their products to buy X-27 directly from the Magnetic Materials
Section. She asserted that this arrangement clearly would not be best for Technotronics and certainly
would not be acceptable to the Audio Products Section.

Thus began a series of discussions between Ilene Carter and Sam Grant on the actions to be
taken regarding the exploitation of X-27. They agreed in the initial stages that the focus of the
problem should be the question of what was best for their two sections within the framework of what
was best for Technotronics.

Carter argued that the Audio Products Section had taken a sizeable risk in accepting the
responsibility for developmental research on a concept which might easily have proven commercially
useless - a risk which the Magnetic Materials Section had not been willing to assume. Therefore, she
felt that Audio Products should reap the benefits of having taken this risk, by being given protection
against its competitors for a period of at least five years - a period during which Audio Products
could establish product leadership in the field. Moreover, Carter pointed out, Audio Products should
be allowed to recoup its developmental investment of $1.2 million by manufacturing X-27 itself and
selling it at a "profit" to those other operating sections of Technotronics that used magnets as
component parts of their products. She stated that Audio Products, because of its years of
development work with the new material, could manufacture it more easily and with less expense
than could Magnetic Materials, for the new manufacturing process was radically different from that
used for traditional magnets. While Audio Products did not have the facilities to produce X-27 for the
general magnet market outside the company, Carter said that it could easily supply the needs of the
operating sections of Technotronics.

Carter went on to point out that the decentralization policy of the company encouraged the
operating sections to take initiative and responsibility for new developments. She wondered whether
there would be any incentive for development if a section which took the initiative for development
ran the risk that another section might dispute its right to benefit from what it had developed. She
feared that a section which took such initiative not only might not benefit fully from any results
achieved, but might, in fact, be penalized.

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 Technotronics, Inc. 480-054

Grant argued, on the other hand, that the $1.2 million which Audio Products had spent in
developing X-27 was, in the final analysis, shareholders' money. Therefore, a particular section
incurring development costs should look upon them as its contribution to the total company effort.
Moreover, he suggested that a new product developed at shareholders' expense should be exploited
in such a way as to maximize profits for the company as a whole.

Grant then pointed out that Audio Products' sales of magnetic components within
Technotronics amounted to only $2 million, while Magnetic Materials' sales of magnets and magnetic
components within the company amounted to $10 million in addition to his section's $30 million in
sales outside the company. He called it to Carter's attention that only about $1.5 million worth of
magnetic materials were needed for the products that comprised the remaining $48 million of
Audio's sales. He further asserted that his section's variable costs on the manufacture of magnets
averaged only 60% of sales, and that its after-tax earnings were 5.5% of sales. Carter acknowledged
that Audio's earnings after taxes on magnets and magnetic components sold within the company
were 4.5% of sales and its earnings after taxes on products sold outside the company were 5% of
sales. Audio's variable costs on magnets sold within the company, Carter noted, were 65% of sales.

X-27, Grant continued, could be produced at about one-third the cost of traditional magnets
of similar strength, but he estimated that the demand for the new material would be so great, because
of its superior physical properties, that it could be sold at a price equal to that of traditional magnets.
He argued that the profits to Magnetic Materials would thus be far more than those which would
accrue to Audio Products. Grant added that this consideration did not even take into account the fact
that the sales volume of Magnetic Materials would undoubtedly be increased substantially because of
the anticipated demand for X-27.

Grant also questioned whether Audio Products was the best section to manufacture X-27 in
the long run. He pointed out that once Magnetic Materials had trained its personnel and set up
production facilities, the fact that its major business was magnets would undoubtedly enable it to
achieve more efficient and economical production in the long run. Furthermore, he noted, even if
Technotronics decided not to sell X-27 outside the company for a given period, such as the five-year
protection period that Carter wanted, production facilities would eventually have to be located in the
Magnetic Materials Section. This section, because of its charter, was the only section that would be
allowed to handle the anticipated long-run sales volume. Both agreed that under their section
charters, only Magnetic Materials could sell magnets to customers outside the company. It was also
clear to them that their section charters should not be changed (Exhibit 2).

Carter agreed that in the long run X-27 probably could best be produced by Magnetic
Materials, and she knew that the $1.2 million development cost now on Audio Products' books could
theoretically be transfered to Magnetic Materials' books. However, although Grant acknowledged
that a bookkeeping procedure of this sort was theoretically in accordance with general company
policy, he now raised the question of whether such a transfer would meet the facts of the present
situation. Grant doubted that, if Magnetic Materials did take over the exploitation of X-27, the
transfer of development charges would be a proper course of action under the circumstances. He
pointed out that, after all, it was Audio Products' decision to incur these development costs, and he
argued that Magnetic Materials should not be held responsible for the apparent fact that a section
other than Audio Products was better situated to exploit X-27's commercial possibilities for the
overall benefit of Technotronics.

In the continuing discussions, Carter emphasized the importance of X-27 as a component in

the development of new products. Its strength and stability so far surpassed magnets currently in use
that a whole new range of products, now commercially impractical, could be developed which would
take advantage of these properties. Moreover, many existing products could be radically changed by
X-27. Carter illustrated her argument by pointing out that hearing aids could not now help in many

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 480-054 Technotronics, Inc.

types and stages of deafness because the hearing aid could not be made powerful enough or small
enough to be practical. She further argued that Grant had forgotten that several other sections of
Technotronics besides Audio Products and Magnetic Materials used magnets as component parts of
their products and that magnets were used as component parts of some 20%–30% of Technotronic's
products. Magnetic Materials supplied $10 million worth of these magnets, and Audio $2 million
worth, but other sections of the company also purchased an additional $4 million worth of magnets
from outside souces, because the sections that needed them could get them at lower cost by buying
from outside specialty manufacturers than by manufacturing them in the sections' own facilities or by
purchasing them within Technotronics. The interests of these sections, Carter contended, would
surely be affected by the discovery of X-27. Carter noted that X-27 would certainly increase the
demand for, and sales of, all Technotronics products using magnets as component parts, regardless of
which section manufactured these products. She suggested that Grant had the responsibility for
protecting the interests not only of Magnetic Materials and Audio Products, but of all the operating
sections.

Carter further emphasized that, for many years, one of the corner-stones of Technotronics
policy had been to establish the company as a leader in the design, development, and improvement
of electrical products. Technotronics had sought to be regarded as making the most advanced and
refined electrical products on the market. To take full advantage of the benefits that X-27 could confer
in enhancing Technotronics' position of leadership in the industry by using the new magnet as a
component part in existing products and new products, Carter said, would take five years. A
considerable amount of design work and retooling would be necessary, she pointed out, to adjust the
products themselves to the unique properties of X-27, and Technotronics would then have to get
these products established in the market, before it could be sure that it had fully capitalized on X-27's
potentialities.

Grant agreed on the importance of product leadership to Technotronics, but pointed out that
such leadership was important not only in products using magnets as components, but in magnets
themselves. He suggested that while Audio Products was preparing to make magnets serve as
component parts for its own products, and thus retain its leadership in these products, Magnetic
Materials could also gain product leadership in magnets, and realize the resulting profits for the
company immediately, by selling X-27 to customers outside the company. With such an arrangement
there would be no need to wait for possibly five years for profits while design work was completed
on products using X-27 as a component. Grant also pointed out that some other operating sections
using magnetic components in their products had indicated that enough design works to give them a
head start on their competitors in developing some products using X-27 could be accomplished in 18
months. Grant suggested that these facts especially made the five-year protection period requested by
Audio Products seem unnecessarily long. Carter agreed that some progress toward developing new
products could be made in a shorter period of time, but argued that the maximum period of
protection would be in the best interests of Technotronics in the long run.

Grant suggested that perhaps part of their problem could be resolved if Magnetic Materials
agreed to sell X-27 only to customers whose product lines did not compete with Technotronics'
products using magnets as components. Grant added that, at this time, Magnetic Materials' sales
outside the company were primarily to industrial distributors of noncompetitive lines and to
wholesalers who sold directly to dealers and to magnet users. Most manufacturers competing with
Technotronics who used magnets as components of their own products preferred either to
manufacture their own magnets or to purchase them from a noncompeting company.

Carter questioned whether Technotronics' competition would wish to continue this policy in
view of the unique and highly desirable properties of X-27. She wondered also whether Magnetic
Materials' willingness to sell to some potential customers and not to others would not be construed as
restraint of trade. She knew that a company of Technotronics' size was under constant scrutiny by the

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 Technotronics, Inc. 480-054

Antitrust Division of the Department of Justice. Further, Carter was not sure that Magnetic Materials
could police its sales closely enough to avoid having X-27 finally reach one or more of Technotronics'
competitors who used magnets as component parts of their own products.

Grant then raised the possibility that Magnetic Materials, besides manufacturing X-27 itself,
might license the manufacturing process of X-27 to competing companies. He pointed out that the
royalty payments would reimburse Technotronics, and perhaps Audio Products directly (under a
spcial agreement which Audio Products could make with Magnetic Materials), for the development
costs. Further, production costs to Technotronics' competitors would be higher than they would be
for Technotronics because of royalty payments, and this situation would give Technotronics the kind
of protection and competitive position it wanted. Carter was not convinced of the validity of this
argument as it described the consequences of the licensing arrangement for Audio Products and
other operating sections using magnetic components. She pointed out that the magnetic component
was a relatively insignificant cost factor in most products using it. She argued that product leadership
was the important determinant to the success of her operation. On the other hand, Carter recognized
that for Magnetic Materials, whose major product was the magnet itself, the cost differential due to
royalty payments could be a significant competitive factor.

While Carter was fairly sure that licensing the manufacturing process of X-27 would not give
Audio Products the protection it wanted, she confessed some doubts as to whether Technotronics
could long resist the pressure from its competitors for licensing if Technotronics refused to sell X-27
to them directly through Magnetic Materials. Carter thought that competitors could publicize
unfavorably the refusal of Technotronics to license or sell the product; they could make it seem as if
Technotronics, by withholding X-27, was arbitrarily preventing others from manufacturing and
selling products. Carter wondered how long a company like Technotronics could, regardless of such
pressures, keep a revolutionary product like X-27 under wraps and out of the mainstream of
competition. She recalled that both Technotronics and many of its competitors had large defense
contracts involving products with magnetic components. Carter admitted that she thought
competitors would prefer licensing to direct purchase from Technotronics, since the former
procedure would give them control over their own supply of X-27.

At the conclusion of several discussions Carter and Grant agreed that they had raised most of
the important considerations bearing on their problem. It did not appear possible for them at the time
to make a detailed analysis of potential sales and profits for Technotronics or for their sections that
would result from the exploitation of X-27, because at that stage the obvious potential of X-27 in new
and existing products in the industry could not be accurately forecast. Moreover, they agreed that the
product leadership which the successful exploitation of X-27 would bring to Technotronics could not
at this time be translated accurately into anticipated increases in sales and profits. They knew from
past experience that similar new products developed by Technotronics had indirectly enhanced the
prestige and reputation of the company in the electrical industry, thereby improving the overall
competitive position of the company in a variety of ways not directly associated with the specific
development.

They were not in agreement, however, on the relative importance and significance of the
considerations they had discussed in searching for the decision on how best to exploit X-27. Grant
pointed out that he and Carter were naturally looking at the problem from the point of view of what
was best for their respective sections, and that this preoccupation probably slanted their opinions of
what was best for Technotronics. Carter wryly recalled that a few years earlier, before the company
had been reorganized to carry out the decentralization policy, they both might have been reporting to
the same vice president who would have resolved their problem for them. Both agreed, however, that
if the effort to push decentralization down to the operating sections was to be successful, they should
do their best to resolve the question themselves. They knew that, as managers of the two operating
sections most concerned with the new material, they had the authority to act in this matter as they

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 480-054 Technotronics, Inc.

thought right, if in their decision they took properly into account what was best for Technotronics.
Carter, looking at the organization chart of operating divisions within the company, noted that their
respective department vice presidents would be faced with the same problem if it were passed up to
them.

Carter and Grant agreed to give the matter further study and to meet again the following
week. They knew that there was no precedent in the company for their decision, since they were
confronted with a problem related to an aspect of the company decentralization policy which had not
as yet been clarified. Each of them promised to bring to the next conference a recommendation
concerning the action they might take.

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Technotronics, Inc. 480-054 -9-

Exhibit 1 Organization Chart of Operating Divisions*

*This is a partial organization chart, designed primarily to emphasize the relationship of the Magnetic Materials Section and the Audio Products Section to the rest of the operating
divisions.

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 480-054 Technotronics, Inc.

Exhibit 2 Audio Products Section Excerpts from Charter

I. General Area of Product Interest

The general area of product interest of the Audio Products Section consists of devices
and systems, including components thereof, that are used for the amplification of sound and for
the improvement of audio transmission and reception.

II. Specific Product Responsibility

Within the general area of product interest described in Part I, product responsibility of
the Audio Products Section includes the following products and components thereof:

A. Hearing aids

B. Phonograph pickups

C. Loudspeaker systems

D. Microphones

E. Special purpose amplifiers (etc.)

Product responsibility for these products means that only the Audio Products Section
may sell these products to customers outside the company.

III. Component Interrelationships

Where a product, for which responsibility has been assigned to another section, is
included as a component in any of the products covered by the Audio Products Section's
"Specific Product Responsibility," it will not be offered for sale to customers outside the company
by the Audio Products Section except as an integral and component part of the section's products
or as required in maintenance and repair service. The Audio Products Section may manufacture
its own component parts, purchase them from other sections within the company, or, within the
limits of company policy, purchase them from sources outside the company. The Audio Products
Section is responsible for determining the best source of supply for its component parts, and is
held accountable for this decision in terms of the best interest of the company as a whole.

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