Harvard Business School

CHEMICAL BANK
Allocation of profits

Chemical Bank
Sixth Largest U.S. commercial bank in 1983
With 20,000 employees Having $ 46.9 billion in assets

Offered 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 controversy

Personal and Banking Services group
Metropolitan Division Trust and Investment Division

Treasury Group
Government Trading segment

Finance Division

Treasury Division
Looked after the funding needs of Chemical bank. Bonus Pool: (10-15)% of net earnings before taxdirect & allocated costs
Foreign Exchange

Government Trading

Treasury

Money Market Trading

Municipal 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
Retail branch network

VISA

Metropolitan

Master Card

Chemical consumer Finance corporation

Metropolitan Division (Contd.)

Evaluation Criteria: Senior Manager: Profit center basis Branch Manager: Goal System Goal System 1. Budget: Expected performance level. 2. Base Accounting level: minimum performance level 3. Goal: Target level to achieve

Trust and Investment Division

Services offered: Money management services to individual and institutional investors International banking services Set up Due bills accounts and provide data processing services

Finance Division
Major 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 Bills
An 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 $26.50 Reason: i) T&I was charging Metro for cost of processing Due Bills ii) Metro was receiving no credit for Due bills iii) Treasury was credited with all Due Bill revenue.

Metros suggestion: Treasury should charge additional fee of $25 along with the transaction fee for Due Bills

Treasurys 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 customers needs and not pushing it Treasury doing a favor by providing its customers with this service

Market condition in 1982

Profit declined in late 1980s Reasons: 1. A drop in interest rates 2. Advent of bank offered money market accounts

Implications: 1. Treasurys funding spread decreased 2. Trading profits from Due Bills decreased 3. Attractiveness of T-Bills decreased 4. Decrease in volume of Due bills sold

Steps taken by Metro division to retrieve the market share

Incentive 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 division

Observation: Due Bills were more profitable than Super Saver (new money market accounts) Allocation of profits made the profits less profitable for Metro Problem: 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 system

Others?

Treasurys 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.

Metros recommendation Sharing the fees which would be reduced to $30 and the cost of processing

Conclusions
By increasing $5 they might lose some new customers
Extra $5 increase in revenue could improve their

bottom line as well Anyways there is no point in gaining profit at the expense of the loss to a particular unit