Management Control Systems

Part 2

Debasis Das Exemplar Consultancy

Designing The Control Process & Managerial Controls

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Attributes of Systems-1
System Association of parts related to each other Managerial Control System Interrelated communication structures that help managers achieve organization purpose. Sub units linked in a Macrostructure Autonomy Local decision making capabilities Feedback Positive & negative Controls/Homeostats(Self-regulating) Entropy (chaos & uncertainty) Systems to deteriorate and become chaotic

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Attributes of Systems-2
Control Through control of key variables, measure values, feedback to reduce chaos & uncertainty Cause & effect Measurements and changes Adaptive Not all responses could be defined beforehand Learning Find and learn to find answers

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Cybernetic Paradigm Of Control

Notunderstood processes

Inputs

Human brain

Outputs

Probabilistic, highly complex

Insights from Cybernetics used to design controls and control systems

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Cybernetic Paradigm Control Process

Environment Griesinger 1979

of

Decision maker

Goals

Value premises Feedback Sensor Perception Factual premises Behavior choice Effector
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Comparator

Behavior repertoire

Essential Elements of Repetitive Control System

Set goals and performance measures Measure achievement Compare achievement with goals Compute variances Report variances Determine causes of variance Take action to eliminate variance Follow up to ensure goals are met
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Designing Management Controls-1

Establishing controls is a constructive process Objectives should be measurable Controls should focus on objectives and key results, limited in number Controls should establish balance rather than financial alone Single point responsibility Compare projected performance to actual performance to derive control actions for the next period
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Designing Management Controls-2

Look for early warning predictors May be possible and desirable to sample the variable Establish an acceptable range of variations for variables Focus on exceptions to desired result and report to the person responsible ASAP Severity of problem should be confirmed independently monitor and confirm control is working Develop a discerning view of controls, apply judgment and interpreting results
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Means-Ends Analysis
1 G

G1

G2

G3

G4

3 G11 G12 G13 .. G43

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Control Process Relating Superior-Subordinate

Superior Control System Feedback from superior effector Behavior repertoire Subordinate Control System
Interconnection Between goals

Superior goal affects the subordinate goals Superior behavior repertoire can influence the subordinate effector Feedback from the superior enters the subordinate system through the sensor
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Decentralization, Loose Coupling & Organizational Slack

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Need For Decentralization

Decision making capability of humans is limited Limited to 7 + or minus 2 chunks of information Decentralizing decision making is a must, establish sub-goals, hold each decision maker to a small part of the organization purpose. Decision makers must find ways to deal with the complexity
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Loose Coupling
A multiplicity of goals & objectives A sub-units local set is derived from the means-end chain MCS must knit the sub-units together to bring unity in diversity Decentralization means profit, ROI and other corporate goals enter indirectly through the means-end chain indirectly

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Organizational Slack
If a firm is successful in achieving its goals & objectives, there may not be pressure for increasing coupling between goals & objectives of sub-units. Difference between total payments and necessary payments is the organizational slack. Includes costly support services, extra inventories and extra time to market. However, acts as cushion against variability, extra resources for innovation and adaptation Combined overreaching goals, mixed teams can help trim the slack
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Stakeholder Controls
One primary function of executive: take contributions of a stakeholder, convert to inducements sufficient to maintain their co-operation for org goals & objectives. Do it efficiently as competition exists. Identify stakeholders that are crucial. The ones that affect the org most and the ones the org affects most.
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Communication Structures Supporting the control Process

Formal/informal scanning of the environment of the sub-unit (both internal and external) Feedback from external scanning, performance measurement from internal accounting Internal accounting can provide comparison, provide reports Decision making procedures Planning processes Strategic planning Business planning Long-range planning (programming) Operating budget

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Impact of IT on Control Systems

Bringing unity out of diversity Order entry and inventory management Speadsheets for what-if scenarios Performance measurements Providing inputs to operational & strategic decision making Decrease in cost of information processing helping activity based costing (ABC) Improved inventory control makes monitoring of customer demands possible
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Micro, Intermediate, Macro Frameworks-1

Environment Decision maker Micro framework Value premises Perception Factual premises Behavior choice JSB 606 Comparator Goals Griesinger 1979

Sensor

Behavior repertoire

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Micro, Intermediate, Macro Frameworks-2

Infrastructure Intermediate Framework

Management Style & Culture

Formal Control Process

Rewards
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Coordination & Integration

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Micro, Intermediate, Macro Frameworks-3

Initial Conditions
External Environment (Uncontrollable)

Management Systems Internal External

Improvements

ENTITY

Critical Success factors & impediments

Performance Measures

Status X

Stakeholders Goals & Strategies

Ideal

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Key Success Variables in MCS

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(Key Budgeting Factors)

Indicators or variables that influence business in a big way Small change in these factors causes big changes in business External Technology, environment, competitive situation internal
Tasks, strategy

Key Variable

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Interrelations-Internal & External factors

External Business Environment Internal Character Industry Character Significant Functions

Stakeholders

Objective of Business

Competitors

Corporate Strategy

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Key Variables & Sources

External factors ->nature of business, types of stakeholders, competitors Internal factors->task, industry character, significant function, strategy Nature of Business- environment Stakeholders-nature of stakeholders and risk taking Competitors-substitutes and complements Objective- competitive strategy Industry character- Business environment

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Identification of Key Variables

Identification through input-output analysis (classify variables)
Input Production Marketing & selling Liability management Asset management

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Input
QTC analysis Q for quality Time or time to availability Cost or cost of the input Product leadership (including support) depends on the QTC of the raw materials
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Production
Production processes Quality processes ensure product quality Technology Technology for superior product, technology transfer issues, easy and long time support Cost of production
Infrastructure cost, engineering cost, discretionary cost

Time schedule & delivery

Important in most industries, particularly for perishable goods

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Marketing & Selling

Selling information
Ordering position Maturity schedule of credit sales

Marketing information
Market share Ad & promotion expenses

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Liability Management
Cost of borrowing
Operating profit over cost of capital EAV, economic value added

Nature of capital
Risk is proportional to cost of participation Budeget needs to take the nature of capital into account

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Asset Management
Higher the turnover the better
fixed Current

Working capital turnover ratio is important Total asset turnover ratio

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Key Variable Classification

Environmental variables Determines scope, diversity, uncertainty associated with business Strategy variables Affects long term goals & values Process variables Variables affecting interaction between employees and the processes Structure variables
Centralized and decentralized reporting structure & how they affect processes
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Key Variables-Ensuring Control

Across the board control required Identify sufficient number of key variables to achieve that Easy to measure key variables may not be meaningful Multivariate techniques such as factoring or cluster analysis can lead to key variables
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Key Control Indicators & Control Mechanism

Ability of control mechanism is indicated by efficiency and effectiveness of key variables Effective Coordination necessary Businesses with multiple profit and responsibility centers must have key indicators representative of these centers
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Techniques to identify
Traditional techniques
Observation of deviation method Mean reduction techniques

Modern techniques (statistical methods)

Regression analysis Factor & cluster analysis

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Limitations of Key Variables Analysis

Absence of consensus among managers Absence of proper scale of measure, absence of clarity Dependence on quantitative data and ignoring qualitative information

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Designing MCS

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Introduction
Understand the environment Understand the hierarchy of control flow Leads to goal congruence Users should be able to appreciate & internalize the goals

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Process of Designing
Identify org hierarchy Understand the process of the business Establish linkages between stakeholders towards goal congruence Establish information flow between departments and sub-units Design the system Implement the system

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Identifying Hierarchy
Org hierarchy supports the control system Depends on org structure Often a standard is available in industry, study that There may be a need for changing the hierarchy

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 Centralized Decisions follow top down, operational data flow bottom up Decentralized Substantial decision making power at sub-unit Operational data and information flow, either way Matrix
Top down, bottom up and across op data and decision flow

Understanding Business Process

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Establishing Linkages
toward goal congruence
General goals Profit, profitability, wealth creation Specific goals Specific to business Keep stakeholders informed Establishing goals Establish general purpose Establish specific modalities Identify exact goals to deliver above two Enabling congruence
Task & job description
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Formal Info System Flow

Proper information flow essential between subunits
Designing information system
Requirement study, Analysis, design & develop the info system, test and implement

Form design (info report)

Understanding the purpose, compressing data to fit, delivering the form, enabling tabulation facility

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Designing the Control System

Open end control system
The control system loop is such that info flow between subsystems, particularly assessor and feedback systems

Closed end control system

Correction in one direction No interaction between feed back system and assessor system independently

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Open End Control

Input System

Assessor

Control device/System

Feedback device/system

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Closed End Control

Input System

Assessor

Control device/System

Feedback device/system

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Implementation Techniques
Sharp Cut-off Parallel run Phased implementation

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Implementation Process
Develop Control system Build Control System Use Control System

Is it Adequate ?

Yes

Implement Control system

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Organizing, Strategy & Control

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Introduction
Control system helps goal congruence System should help implement strategy

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 Goal & Objectives are the boundary conditions Goals & objectives may change These reflect short term as well as longterm needs. Design needs to take into account both. Goals & objectives may translate into conflicts. Design must take care these do not cause problems
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Goals & Objectives-Boundary Constraints

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Strategy-Pathway
Strategies-processes through which internal/external environment changes are dealt with Strategy-broken down into tasks. Operational strategies make them realizable. Strategy is the blueprint used to design the control system System corrects itself through multiple feedback mechanisms.
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Strategy Evaluation
Criteria to evaluate strategy
Internal consistency External and environmental consistency Applicability in view of resources available Risks associated Time frame of implementation and result orientation usefulness
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Behavioral Aspects
Perception Attitudes & beliefs Motivation Goal congruence Sub unit conflict and resolution Managerial styles Resistance to change Entrapment Compromising & sacrificing Socio-cultural influences
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Perception
Interaction by personnel and managers with the control system generates a perception of the system Seriousness of management is gauged from this perception

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Attitudes & Beliefs

Attitudes and beliefs of managers and employees are the result of the culture and background they come from These attitudes and beliefs serve as reference and benchmark for the system in the long run

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Motivation
Motivation of managers decide the drive to use the system Motivation comes from two sources
Personal factors (Maslow) Power centric needs People seek positive affirmation of performance

Control system must have positive reinforcement built-in to succeed

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Goal Congruence
Individuals work towards their own goals Organization needs to fulfill its own To ensure the two synergize, strong motivation and clear roadmaps are needed Success of the control system hinges on how close these two could be brought
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Sub unit Conflict & Resolution

Sub units may have conflicting goals Competition for resources exist Cannibalization by sub units may happen Transfer pricing and ERP solutions mitigates the problems Coordination committees can help
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Managerial Styles
Style can range from autocratic to participative/democratic An effective blend is used in practice. The business determines what blend is

to be used

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Force Field Analysis

According to Kurt Lewin two forces create conflicts in an individual Facilitating force enable an individual Inhibiting force opposes the facilitating force These conflicts need to be resolved by review meetings at sub unit levels

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Resistance to Change
A large organization does not like to change It is apprehensive of change Control system designer needs to be

aware of this and minimize the same

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Entrapment
Being trapped due to own decision Sometimes bad decisions taken is not reversed as it will show the manager took a bad decision Multiple feedback mechanism enables the system/organization to weigh good and bad side and take a balanced view
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Compromising & Sacrificing

Sometimes compromising decisions (most satisfying) are taken due to pressure groups. These decisions may not be the most effective Sometimes a sacrificing attitude is necessary to change the course of business or to develop a business

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Socio-Cultural Influences
Social and cultural influences the workers grew up with influences the attitude to work These influences affect the way a control system works

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Joint Goals through Responsibility Centers

Set up goals jointly by management and workers Management by objective (MBO) Set up business centers that are

responsibility of individual managers

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Responsibility Centers
Revenue centers Where revenues are generated Expense centers Difficult to assess monetary value of output, costs of inputs available Profit centers Input and output value can be assessed, maximize profit Investment centers Assets are created, control on input and output available
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Cost Patterns
Discretionary costs Management related costs, discretion of management, 40 to 60 percent of cost of business Engineered costs About 30%, input, output relationships can be measured (profit centers) Infrastructure costs Costs that have concrete outcome in the long term

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Costs Across Value Chain

R&D Design Production Marketing

Discretionary Costs Infrastructure costs Engineered Costs

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Benchmarking
Checking against other businesses for implementing best practices Compare processes Could be one time or a continuous process

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Advantages of Benchmarking
Better understanding of wants (expectations) of customers Better economic planning of purposes Increase in productivity Better current practices and search for change Better competitiveness
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Collaborative Benchmarking
Identify problem areas Identify other industries that have similar processes Identify organizations that are leaders Survey companies for measures & practices Visit best practices companies, identify leading edge practices Implement new and improved business practices
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Cost of Benchmarking
Visit costs Time costs Benchmarking database costs

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Organizational Infrastructure, Organizational Design and Control Systems

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Centralization vs. Decentralization

Depends on size of organization and span of control Decentralized organization works better in terms of goal congruence A manager operates better in decentralized form as it provides continuous learning & improvement

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Control Factors in Organizational Design

Three factors that decide organizational design are Coordination
Centralized organization is best in terms of coordination, in decentralized organization functional managers handle the extra cost and bottlenecks, Matrix organization functional managers collaborate to develop coordination

Cost Effectiveness
Multiple channels in decentralized system increases efficiency, centralized system costs increase due to rework, making decisions repeatedly. Matrix works best in keeping costs optimal. Flat organization, motivation, coordination

Communication
Decentralized: bottom up, loaded with market reality but devoid of strategy. Centralized: top down, devoid of market reality, Matrix: most effective

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Adaptive Control & Adaptive Organization

Environmental uncertainty Environmental complexity Environmental diversity Environmental Hostility

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Characteristics of Adaptive Organization

Implicit Control System Training & Development Integrity of individual & Organization Global standards

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Divisional Autonomy
Flexibility, creativity and innovation in operation and execution Degree & dimension of the autonomy is decided by style of management & processes used Involvement of functional managers, trust and confidence

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Responsibility Centers & Performance Measures

Measure efficiency and effectiveness
Efficiency is like measuring productivity Effectiveness measure is measuring against targets, goals

Measuring efficiency by ROI Establishing an inter-profit center Relationship

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Approaches to MCS

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Theory of Contingency, Theory of Universalism

Technology Organizational structure Environment

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Strategy & Control Systems

Without strategic plans With strategic plans

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Business w/o Strategic Plans

Option a Option b Option c Option d

Budget The Business

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Business with Strategic Plan

Option a

Option b

A Plan

Budget Of The Business

Option c

Option c

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Strategy & Control

Vision & Mission

Reward

Strategy

Plan

Budget

Deviation/ measurement

Feedback to the system

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Corporate strategy & Diversification

Single Business Firm Related diversification Unrelated diversification

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Response of Control System to Corporate Strategy

Response of control system will depend on diversification sought
Unrelated: higher decentralization & training Related: competency to be controlled, control deviation in production process & prompt delivery

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Strategies Available for Business Unit

Deciding market opportunities, deciding competence level, understanding internal & external strengths Understanding that competitive strength of one business unit to another will vary, allocate resources separately Level of attractiveness in which the business unit exists

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Strategic Choices
Build Potential exists, increase market share Hold High market share, Hold market share, even when just breaking even Divest Low market share & growth Harvest
Maximum short run earning, make the most of it

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Five Forces Theory & Competitive advantage

Course of control action depends
Intensity of rivalry between competitors Bargaining power of customers Bargaining power of suppliers Threat from substitutes Threat of new entrants
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