Suboptimisation
Suboptimisation happens when a division manager's rational response to a performance measure, such as ROI, leads them to reject a project that benefits the company overall. It is the core argument for using residual income instead of ROI.
What it is
See it move
Division Bravo's ROI is 22%; a new project would earn 18%, above the company's 12% hurdle rate but below Bravo's own average. Judged on ROI, the manager rejects it to protect the 22%. Judged on residual income, which only asks whether a project clears the hurdle rate, the manager accepts it.
Check yourself
Division Nova has an investment base of €1,000,000 and operating profit of €150,000. A proposed project needs €200,000 of extra investment and would add €26,000 of operating profit a year. The company's required rate of return is 10%. If the division manager is evaluated on ROI, what is the likely outcome, and is it suboptimisation?