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INTODUCTION TO

MANAGEMENT CONTROLSYSTEM

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Focus of an Business Enterprise

An Enterprise has to use its resources effectivelyand efficiently for:

Maintaining Competitive edge over competitors.

Meeting the growing demands of stakeholders. A Management control system assist the

management in

formulating strategies,

coordinating the activities of the organization, and

steering those activities toward the achievement

of the overall goals and objectives

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INTRODUCTION Role of Management

PLAN, ORGANISE,

INTEGRATE & INTERRELATEorganizational activities to achieve objectives.

Control Points - To check whether Organizationis on right path

They compare desired state with actual state.

System - set of interrelated communicationstructure of gathering and monitoring thesecontrol points to achieve organizationalobjectives

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Controls

Control helps in guiding employees inaccomplishments of organizational goals

But increased control reduces creativity and

entrepreneurship

Control process at three levels

Strategic

Management

Operational

These levels are not mutually exclusive

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Strategic Control

Deals with

Domain definition

Direction setting

Issues that impact organizations long term

survival

Organizations objectives and

implementation & monitoring progress

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Controls

Management Control Deals with effective resource utilization

State of competitiveness of the unit

Translation of corporate goals into business unit

objectives Operational Control

Concerned with efficiency issues

At specific functional / departmental levels

Outcomes are tangible and easily measurable

Benchmarks are known and well-defined

Time horizon is short

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CONTROL SYSTEM

Control has elements

Detector / Sensor

Assessor

Effectors

A Communication Network

System is a prescribed, usually repetitive way ofcarrying out an activity or set of activities.

MCS are complex and judgmental.

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Management Control

MCS is concerned with implementation of strategies andattainment of goals

Traditionally CONTROL refers to activities of Establishing standards of performance

Evaluating actual performance

Implementing corrective actions

Market environment demands that Resources are used effectively and efficiently

Excel in operation

Maintain competitive edge

Management Control has been defined as a processwhereby management and other groups are able toinitiate & regulate the conduct of activities so that resultsare in line with the goals and expectations held by thesegroups

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Management Control System MCS is a set of interrelated communication structure

that facilitates the processing of information for thepurpose assisting managers in coordinating theparts and attaining the purpose of an organizationon a continuous basis

MCS is a collection of controls to address followingsituations

Employees are not clear about expectations fromthem

Employees are clear about the expectations butthey are not motivated

They are clear and motivated but goals are notattained

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Need for Management Control

Absence of control systems may lead to huge

losses and even to corporate bankruptcy.

Concerned with the attainment of goals and

implementation of strategies.

Help in assuring better quality

Help in coping with unanticipated change

Helps create faster cycles to market.

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Objectives of Management Control

Answer contextual issues that impact successand survival of the organization

Detect environmental variables that cansignificantly affect organization

Effective resource allocation

Sustaining competitive advantage

Transforming corporate goals into businessobjectives

Maintaining transparency and clarity in financial

reporting Conformance with relevant regulatory

requirements

Operational efficiency

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Classification of Objectives

Effectiveness and Efficiency of businessoperations Effectiveness is perceived when the purpose is

accomplished

Efficiency is achieving purpose with minimumresources

Reliability of Financial Reporting Should bring out true and fair picture of all financial

transactions

These reports should be understandable and relevant

Compliance with applicable regulatory and legalframework

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Contextual Factors Influencing

Management Control

Nature and Purpose of the Organization

Profit or Non-profit organization

In Non-profit organization, Donors play

important role in setting expectations

In Non-profit organization, surplus is utilized

for the benefits of the society

In Non-profit organization, rewards areintangible

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Management Control

Organization Structure and Size

Centralization/ Decentralization and span of control

are important for consideration of MCS

Large organizations call for higher degree ofdecentralization

Large organizations tend to have more influence over

the environment

In large-sized organizations, it is necessary todevelop controls such as rules, documentation of the

information, creation of specialized role of functions,

and a higher degree of decentralization

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Management Control

Corporate Strategy and Organizational Diversification

In terms of their corporate level strategies

companies can be classified in three categories.

Single Industry Firm

operates in one line of business.

Uses its core competencies to pursue growth

within that industry

Unrelated Diversified Firms

Operate in business that are not related to

one another; connection is purely finance

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Management Control

Related Diversified Firms

Operate in several industries and take benefitof common set of core competencies and

share common resources. They grow internally through research and

development

Related diversified firms depend more onstrategic controls while unrelated diversified firmsdepend more on financial controls to ensureperformance

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Management Control

Competitive Strategy

Three generic strategies to gain competitivesuccess are Overall cost leadership,differentiation and focus

For overall cost leadership, management controlsystems are designed to achieve its objective ofefficiency

For differentiation, management control systems

will work toward building value into the product For Focus, management control systems may be

used to ensure the right pricing policy for theproduct offerings

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Management Control

Managerial Styles

Autocratic

Democratic

Both of these can be Permissive or Directive ( interms of the way in which work should be carried

out

Autocratic manager generally takes decisions by

himself/herself, and the subordinates have to followthem

Democratic manager allows the subordinates to

participate in the decision-making process

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Management Control

Organizational Slack Occurs when organization under-exploits its

environment

This results in higher salaries than necessary

It acts as cushion against changing Provides resource for innovation and adaptation

Stakeholder Expectations Necessary for organization to determine goals and

objectives & performance measure for each of thestakeholder

Based on the relationship and the goals, control isexercised over stakeholders

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National culture

Management Control System of any organization isinfluenced by the national culture of the country.

Managers working in multinational corporations shouldbe aware of the culture that is prevalent in the country.

Four dimensions on which culture varies acrosscountries are power distance, Uncertainty avoidance,

individualism/collectivism and Masculinity/feminity

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Types of MCS

Two Broad Areas

Formal laid out in writing by management

also referred to as bureaucratic controls

Entails the delegation of tasks in a structured

manner

Policies, standard operating procedures (SOPs),

budgetary controls, financial reporting, audit,

performance measurement systems, and

incentive systems are examples of formal

controls

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Types of MCS

Formal Classified in three types

Input Control include selection, training, resource

allocation

Process Control applied to behavior or activities

rather than end results

Output Control performance standards are set

and monitored and results are evaluated.

Applicable when it is easy to measure the outputand there are few elements of uncertainty

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Types of MCS

Informal Control Arise out of employees behavior

Informal controls are not about to follow any fixed

rules and regulations

Interpersonal relationships or peer interactions

among individuals and groups at various levels

are encouraged

Co-exist with formal controls in a controlled

organization and the effect of the one is not

independent of the other.

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Types of MCS

Classified in three types

Self Control Can be beneficial if the organizations

goals are in congruence with those of individuals

Social Control Organization establishes certainstandards monitors and takes action when deviations

occur

Arise out of mutual commitments towards common

goals Cultural Controls can be realized social interaction,

rituals relating to the organization

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Subsystems and components of MCS

Formal Control Process Formal Planning Process

Strategic planning necessary to assist inprojects.

Helps to decide key objectives and goals &strategies

Operations Planning undertakes activitieswhich are short term in nature

Formal Reporting ProcessTo assess the progress and decide on nextset of actions

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Subsystems and components of MCS

Informal Control Process

Formed as a result of interaction between

people

Helps development of new goals andobjectives

One mechanism for control on this type is the

formation of Ad hoc teams to achieve

organizational change objectives and goals

Informal communication system develops as

people develop work relationships

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Factors Influencing the Design of MCS

Factors are Managerial style

Corporate Culture

Organization Structure

Organizational Slack Stakeholders Control

Communication Structure

Management style & Corporate culture are related toeach other

Culture consists of shared values and norms of theorganization

These values & norms influence prevailing style ofmanagement

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Other Factors &

Design of Control System

Corporate Culture

An important asset of organization

Control system should fit in existing culture Can be done by

stressing on the values management wants to

follow and

rewarding the employees for achieving goalsbased on these values

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Other Factors &


Decentralization By decentralizing, sub-goals are set

Control system connects all sub-units with

sub-goals to achieve organizational goals

So, centralized control system is required

Important issue is extent to which

decentralization should be carried out

Organizational Slack

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Other Factors &


Stakeholders Control

Based on the relationship and the goals, control is

exercised over stakeholders

Communication Structure

All formal and informal communications are important

for improving control process

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Impact of IT on


Data can be managed more easily and at a reasonablecost

Enables fast co-ordination & decision-making

Data can be collected for strategic and operating

decisions But technology should be used for making work easier

rather than indulging in complex and expensive systems

Reduced cost of information processing led to ABC(Activity Based Costing) system

These provide accurate cost data for operational &strategic decisions

Optical scanning devices help in Inventory Management,Market Research

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DESIGNING THE CONTROL

PROCESS AND MANAGEMENTCONTROL

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Approaches to MCS

Contingency Approach

Cybernetic Approach

Management Control Approach

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Contingency Approach to MCS

Design & use of control system depends uponorganizational setting

Universalistic approach suggested that there is

one optimal control design for all settings

So Contingency approach was proposed which

states that appropriateness of different control

system depends on the settings of the business

Contingency theory focuses on interactionbetween the organization and its environment

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Contingency Theory Need for Contingency Theory has arisen out of factors like

Technology, Organizational Structure and Environment

Technology

Influences design of control system

Helps to use data and resources more effectively

Organizational Structure should be capable of coping with high degree of

uncertainty

Organic structure which are complex, adapts easily tounstable conditions

Contingency approach helps in designing of ControlSystem for complex organization structure

Environment In order to survive organizations have toadapt to the demands of environment like competition

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Contingency Theory

Fisher identified five contingent control

variables

Uncertainty

Technology and Interdependence

Industry, firm and unit variables

Competitive strategy

Mission and observability factors

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Cybernetic Approach to MCS

Word Cybernetic is derived from the Greekword Kybernetics meaning Steersman.

According to definition by Norbert Weiner

who started the term Cybernetics,It is study of the entire field of control &

communication theory whether in machine

or in animal.

It deals with self-regulating principles in a

variety of systems

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Characteristics of Cybernetic System

Complex structure

Mutual interaction

Complementary

Evolvability System tends to evolve and growin opportunistic manner rather than beingdesigned and planned in optimal manner.

Constructivity System increases in size &complexity on its own through evolution

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Cybernetic Paradigm devised by

Griesinger It helps in designing the control process.

It helps in capturing following Essential elements ofrepetitive control process

Setting goals and performance measures

Measuring achievement Comparing achievement with the set standard

Computing the variance resulting from comparison

Reporting the variance

Identifying the causes of variations Taking the required actions to eliminate the variances

in future

Follow-up to ensure that the goals are met

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Cybernetic Paradigm Goal-oriented controls reflect cybernetic paradigm.

Paradigm begins with the assumption that decisions are

made because of interaction between the decision-maker and the external environment.

Manager scans environment & collects data as sensor.

Based on data manager builds up certain assumptionsabout external environment & present performance of

the unit.These are termed as Factual Premises.

They can be formed on the basis of perception.

Factual premises are compared with organizationalgoals & performance measures (Value Premises).

Action is taken to bridge the gap. Alternative courses of action available are Behavior

Choice.

The best action is implemented.

After implementation, get required feedback to determine

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Management Control.

Management Control is the process by which managersat all levels

influence / ensure that people they supervise

implement their intended strategies.

The control may be tight or loose Budget is binding constraint in Tight Control

Budget is tool for planning in Loose control

Management Control Activities involve

Planning What the organization should do Coordinating - the activities of several parts of an

organization

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Management Control

Communicating information

Evaluating information

Deciding what, if any, action should be taken

Influencing people to change their behavior

Management Control is not automatic; it requirescoordination among individuals.

The connection from perceiving the need for action todetermining the action required to obtain the desired

result may not be clear. Much management control is Self-control i. e. it is not

by external regulating device

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Control ProcessSteps in basic Control Process

Determining areas to control It is expensive to control all areas

Employees may resent if all activities are controlled

Organizational goals and objectives form the basis for decidingcontrol area

Establish Standards Often incorporated into goals when they are established

Sometimes they are required to be developed

Should be set to achieve desired quality & quantity within aspecific cost and time frame

Helps employees to perform effectively Helps in identifying job difficulties, remove them or take

appropriate actions

To evolve standards and make them more effective participativeapproach may be followed

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Control Process

Measure Performance

Decide how to measure and how frequently to measure

Compare performance with standard

Reward performance and / or Take corrective action

Recognize and acknowledge good or positive performance

It helps sustain the performance and encourage furtherimprovement

For negative performance

Take corrective action

Sometimes goals may require modification

Clarify duties and responsibilities of sub-ordinates

Explain the job in detail

Train, recruit or remove inefficient sub-ordinates

Implement corrective actions properly44

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Control Process

Adjusting Standards and Measures whennecessary

Unrealistic and inappropriate standards inview of dynamic conditions need modification

Review standards periodically to meetcompliance with future needs

Review or change may be required if it callsfor more resource consumption compared to

the benefits it generates Review may involve

Changing organizational objectives

Changing technology45

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Designing Management ControlsPoints to care

Establishing controls should be a constructive process

Should help enhancing the performance

Standards should be challenging but attainable

Objectives should be measurable for the purpose ofevaluation

There should not be too many objectives

There should not be too much focus on easilymeasurable and short term variables

Responsibility for results should be with single individual

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Designing Management Controls

It is advisable to take samples of the variables to be

controlled

Acceptable range of variation should be developed for

each variable

Exceptions to desired results should be reported

Severity of the problem should be determined by

analyzing the causes of the problem

A system of control requires judgment and insight

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Designing MCS

MCS A set of interrelated communication structure Control system should be effective contributor to

implementation of strategies

Steps in designing MCS

Require to know what an organization wants from eachemployee (Role Demand)

Identify Key Areas (KA) for each employee

Understand Key Actions to be controlled (Called asAction Control)

Role Demand can also be identified through Key Results(KR)

KR change according to the prevailing internal & externalenvironment

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Choice of Controls

Choice of Controls- Personal or Cultural Control

First consideration

Lesser cost & consequencesUseful for small organization

Work only when employees have clearlydefined roles

Understand their goals and performancelevels

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Choice of Controls Action Control - Works on standard sets of procedures

and policies

Advantages are

Directly linked to task being performed

Direct managerial attention to actions being taken

Uniform application in the organization, so aids in

coordination Being standardized procedures, key persons leaving

the organization does not affect CS

These controls are means of attaining efficiency

Disadvantages are Useful only for highly routine jobs

Do not promote creativity, resulting in more employeeturn-over

Because of rigidity of rules, difficulty in adapting to

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Choice of Controls

Result Controls They inform employee what is expected & to

achieve and what they should do

They control behavior of employees and are

effective in addressing motivational problems First step is to define the dimensions on which

controls have to be set

Measure performance based on these

dimensions Final step is setting performance targets and

providing adequate incentives

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Choice of Controls

Result Control

Advantages Controls are feasible even when knowledge about

desired action is lacking

Provide on the job training

Motivates employees & make them more committed

because of more autonomy Disadvantages

Many times effective measure of performance is notpossible

B

ad results are attributed to employees mistakes Tightness of Control Depends on Benefits, Cost &

side-effects

Limits adaptability leading to difficulty in adjusting tochanging environment

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Design of MCS Management Style & Design of MCS

The different management styles are

External control

Internal control

Mixed control

External control Works on the premise that sub-ordinates

can be motivated through rewards This style is authorative and mechanical

Goals are set by top management

The style establishes that to achieve the goals it is

necessary to

Set difficult goals so that employees need to stretch

Form strict regulations so that employees are not able

to manipulate their tasks

Embed adequate incentives in performance

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External Control

Advantages

Motivation because of reward system

Because of high level of control no manipulation bysub-ordinates

Disadvantages

No commitment to organizational goals

Concentration only on one aspect and balance is

ignored Only positive outcomes are informed; negative are

hidden

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Internal Control Works on the premise that sub-ordinates are motivated

and committed to organization if they are involved in

decision-making process Style assumes that employees will experience a sense

of achievement, recognition & self-esteem if they areinvolved in decision-making process

Important Strategies for implementation

Participative Management; more emphasis is on howgoals are set, rather than achieving the goals

Problems are solve jointly; rather than blamingparticular individual

Work in positive direction to analyze problem at anearly stage

Rewards are on overall performance

Always look forward for improvement in performancein future 55

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Internal Control Advantages

Induce high level of commitment & motivation

Because of participative management employees are

more focused on achieving the targets

Encourages accountability towards work

Open work atmosphere

Disadvantages

Loose control

Information is for problem identification and correctiveaction but not for performance evaluation

Employees who are not willing to participate, may not

perform well

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Mixed Control

Both Internal & External Controls have their own

advantages & disadvantages

Mixed Control is evolved balancing both types. The

important issues are

Congruency between control & managerial style

Analyzing the climate, structure & reward system of

the organization they determine employee behavior

Reliability of job performance measure particularly

important for External control system

Individual differences among sub-ordinates like

participative nature

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Control Process Hierarchy

Control Process involves relationship betweenSuperior and subordinates

Superior decides on target for subordinates

Negotiates the targets to acceptable level

Ensure that goals of subordinates and superiorsare in congruence with organizations goals

Track the performance at periodic interval

If performance is unsatisfactory, find reasons

Device plan of correction and implement

Set targets and course of action for next period

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Key Success Variables and

Measures of Performance

xxxxxxxxxxx

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Key Success Variables as

Control Indicators

Key Success Variable is a significant indicator ofbusiness activity

Success of strategy depends on how well anorganization addresses these

Sudden and unpredictable changes in key variablerequire immediate action from management

Small changes in key variable will have significantimpact on performance of organization

They are limited in numbers Top management should analyze the reasons for

significant changes in key variable

Key Variables have certain characteristics in common

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Common CharacteristicsKey variables

Are important in explaining success or failure ofa business unit

Require examination & in-depth evaluation

Must be measurable either directly or viasurrogate or substitute

Are volatile; change rapidly

Changes are not easily predictable

Management action is required when significantchanges occur in key variables

Do not select more than six Key variables

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Identifying Key Variables

Most common method is Input through

Output model

Input variables are related to Raw Material

Throughput variables are related to production,

processing and manufacturing

Output variables are related to marketing

Input Variables

Raw material availability

Raw material quality Raw material cost very important when it constitutes

large percentage of total cost

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Production Variables

Capacity utilization

Losses in process of manufacturing

Monitor yield closely

Quality control

Measures can be number of complaints & quantity of goods

returned

Maintenance

To ensure smooth production & better capacity utilization

Production hours lost can be a measure

Cost

Delivery

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Marketing Variables important in competitive economy Order book position

Market share

Institutional sales

Asset Management Variables Management of Fixed andcurrent assets

Asset Turnover

Relation between total assets and Sales

Decrease in asset turnover is not a good sign

Working Capital turnover

Inventory turnover and accounts receivable turnover

can help in analysis of working capital turnover

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Sources of Key Variables

Industry Characteristics These are certain general requirements for

success, which apply to all firms

Environmental factors

Competitive Strategy

The strategy adopted by the company

determines variables that must be monitored

Stakeholders

Significant Functions

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Types of Key Variables Classified in following categories

Strategy Refer to the long-term program, goals, policies and

action plans formulated by the organization

Structural

Concerning organizational arrangements &relationship and distribution of authority &responsibilities

Process

Which influence the behavior of employees

towards achievement of organizational goals Environmental

Performance of the organization improves if there is acongruence between the different variables

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Dynamics of Control Process

Control systems have two sets of dynamic interactions

Reinforcing Interactions Balancing Interactions

Interactions are cause & effect relationships inorganizations

Usually last reaction links back to the initial action and is

called causal loop Systems Theory A change in one variable causes

changes in the secondary variable

Change in one sub-system or element influencesnumber of other sub-systems in the organization calledas secondary effect

When a reinforcing process is set in motion, secondaryeffects are generated which slows down the process ofwork

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Learning Organizations

Dynamic Control problem can be

minimized by creating aLearning / Adaptive Organization

An organization which is

Open to new ideas andEncourages employee creativity &Continuous learning is LearningOrganization

Participative management style supportsthis Learning organization

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Controlling Management Team

Dynamics of controlling management team

Team members should develop shared vision for

goals and objectives

Reinforcing system of informal activities enables

successful teams to achieve their goals

Level of trust and openness reduces the gap between

performance and goals known as Creative Tension

When team members are unable to achieve

organizational goals because of distractions onaccount of their ambiguous roles this is called as

emotional tension

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Identify and monitor Key variables that influencethe success at each level for each responsibilitycenter

Key variables in Selected Industries Insurance No. of claims settled, policies

Hotel Room occupancy, complaints

Training Institute No. of students for

admission, passing, students score Manufacturing Product cost, Capacity

utilization, Lead time

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Performance Indicators

Indicators Used to understand current status Initiate corrective action

There should be consensus about their meaning and theirindication (e.g. manpower turnover)

Limitations of Indicators Absence of consensus about their use Problems in the measurement of them

Lack of consistent information leading to wrong conclusions

Precautions with regard to the measurement of

performance Variables should correspond with the goals

Only crucial variables should be measured

Measurements should take account of short term and long termgoals

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Performance MeasurementMeasure can be of three types

Performance Indicators Indicates performance of the organization

Key Performance Indicators Deal with the aspects which when improved upon

lead to radical performance improvement They are generally non-financial and can be

measured any time

Every one should understand and utilize themeffectively

Key Result Indicators They are indicator of the quality of the result achieved

Useful for governance aspect and are generallyreported to top management

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Measuring Performance

Three methods of measuring performance ofResponsibility center

The Efficiency Measure

The Process Measure

Effectiveness Measure Overall effectiveness measure is ROI

ROI = Net Profit / Invested Capital

= Profit Margin * Investment Turnover

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Types of Profitability MeasuresParameters used to measured profitability are

Contribution Margin

Direct Profit

Controllable Profit

Income before Income Tax

Net IncomeContribution Margin

This is difference between revenue and variableexpenses.

This is good when fixed expenses are not in control of

Profit-center manager. Fixed expenses are discretionary expenses and PC

manager should keep them in line with budgetedamounts. A focus on Contribution Margin tends tooverlook this issue.

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Types of Profitability MeasuresDirect Profit

Reflects contribution to general overheads & profit of thecorporation.

Incorporate all expense incurred or directly traceable,irrespective of whether they are under control of Profit-center manager.

Expenses incurred at HQ are not included. Weakness of

this method is that it does not recognize motivationalbenefit of charging HQ cost.

Controllable Profit

Here HQ expenses are divided into two categories Controllable and Non-controllable.

Profit is taken as what remains after deduction of allexpenses that may be influenced by PCM.

Disadvantage of the system is that since it excludes non-controllable expenses from profit, the profit figures cannot be directly comparable with others

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Types of Profitability Measures

Net Income

This is Income after tax i.e. Bottom Line.

Arguments against this are It may not give any additional advantage as

pre-tax and after-tax income has often a

constant ratio.

Many decisions which affect income-tax aremade at HQ, so PCM can not be responsible

for those.

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Economic Value Added (EVA) This is an amount rather than a ratio.

EVA is a measure of wealth creation for theshareholders

It is obtained by subtracting a capital charge from netoperating profit.

EVA =Net Operating Profit after tax (NOPAT) Capital charge

Capital charge is found by multiplying the amount ofcapital employed by Cost of capital

Cost of capital is the opportunity cost of all the capitalinvested in the business

Cost of Capital is the weighted sum of the cost of debtand cost of equity

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Comparison of ROI and EVA

ROI is a comprehensive measure as anything that affect financialstatements is reflected in this ratio

ROI is simple to calculate and easy to understand and meaningful inan absolute sense

Since ROI is a ratio, irrespective of the sizes of different units,performance can be compared.

ROI creates bias toward little or no expansion in high profit businessunit

With EVA all business units have the same profit objective forcomparable investments

If performance is measured by EVA, then an investment thatproduce a profit in excess of a cost of capital, will increase EVA and

therefore will be economically attractive Different interest rates may be used for different types of assets to

calculate EVA and decision can be taken on investment in newassets

EVA has stronger positive correlation with changes in thecompanys market value

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Key Success FactorsNon-Financial Measures

Customer focused Key Variables Bookings (Sales orders booked)

Back orders

Market share

Key Account orders Customer Satisfaction measured by customer

surveys

Customer Retention measured by length ofcustomer relationship

Customer Loyalty measured in terms of repeatpurchases, customer referrals and sales to customeras a % of customers total requirement for the sameproduct or service.

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Key Success Factors

Key Variables related to Internal Business Process

Capacity utilization important when fixed costs are

high

On-time delivery

Inventory turn-over

Cycle Time

Ct = processing Time + Storage Time + Movement

Time + Inspection Time

Value addition is done only by processing time

So for other activities efforts should be made to

reduce cost

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Key Success Factors

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Key Success Factors Key Variables related to Internal Business Process

Quality includes

Number of defective units delivered by eachsupplier

Number and frequency of late deliveries

Number of parts in a product

% of common versus unique parts in a product

% yields, first-pass yields, scrap, rework

Machine break-down

Number and frequency of times production anddelivery schedules were not met

No. of employees suggestions No. of customer complaints

Level of customer satisfaction

Warranty claims, field service expenses

Number and frequency of product returns82

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Design, Style and Culture of

Control Systems

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Managerial Styles

Managerial Styles Autocratic

Generally takes decisions by himself/herself, and the

subordinates have to follow them

Democratic

Allows the subordinates to participate in the decision-makingprocess

Both of these can be Permissive or Directive ( in terms of the

way in which work should be carried out)

Management Style

The different management styles are

External control

Internal control

Mixed control84

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Corporate Culture

Corporate Culture

An important asset of organization

Control system should fit in existing culture

Can be done by

stressing on the values management wants to

follow and

rewarding the employees for achieving goalsbased on these values

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T t l Q lit C lt

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Total Quality Culture

Due to competition , it is essential to concentrate

on customer satisfaction

TQM ensures that organization attains required

level of efficiency targets as well as satisfy

customers TQM emphasizes customer satisfaction and

continual improvement in products and services

TQM requires empowerment and active

involvement of all staff

TQM follows cybernetic paradigm in solving

problems86

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Organization Structure for

Adaptive Control

..

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Types of Organizational Structure

Functional People are grouped based on their expertise and

skills

Vertical hierarchy is stronger

Calls for centralization

Cannot adapt easily to environmental changes Divisional Also known as Product Structure or

Strategic Business Unit (SBU) Based on Product range/specific market/geographical

location, divisions are formed

Higher adaptability to change Higher decentralization and hence quick response

Possible negative impact of action of one division onother

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Organizational Structure

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Organizational Structure

Organization can be Centralized or Decentralizes Decentralization means delegation of authorityto the lowest feasible level of decision-making

Growth in size of organization requiresDecentralization

Centralization pertains to geographicconcentration or concentration of specializedactivities

Centralization restricts the delegation of

decision-making authority

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D t li ti

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Decentralization

Advantages of decentralization Information processing becomes simpler as

analysis of trade-offs between cost etc. is doneby lower levels of management

Closer control & supervision of sub-ordinates

Being decision-maker, managers are motivatedto perform better

Helps in evaluation of performance of various

units Managers get right environment and autonomy

to get trained in making right decisions

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T f O i ti l St t

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Matrix Integrates desired features of Functional andDivisional structure

Along with hierarchy, there is some form of lateralauthority, influence or communication

Employee reports to two supervisors simultaneously

Managers share the resources Promotes interaction between functions and so useful

where such interactions are necessary or desirable

Lot of time is consumed in conflict resolution

Matrix organization has advantage of motivation andcoordination

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Horizontal Emphasis is on teams which directthemselves

Team members are multi-skilled

Employee empowerment and customer-centricapproach are main characteristics

Adapts easily to changing environment

Employee requires great deal of training

Functional specialty is hampered

Hybrid also called as flexible or Adaptive structure

The organization adapts itself to rapidly changingenvironment, by fast decision-making and realigningthe resources rapidly

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Factors creating need forHybrid / Adaptive Organization

Environmental uncertainty leads to more informalorganizations

Environmental complexity may lead todecentralization in focused market segment

Environmental diversity leading segmentation; may

result into development of business unit Environmental hostility may lead to centralization of

decision-making

Adaptive organization requires High level of awareness,Skill and Integrity within the work group

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Evaluation of Organizational Design

Each design must be evaluated on the basis of efficiency andcoordination

It should operate with minimum cost per unit of output

Matrix organization helps avoid problems in coordination and

integration

But the incremental cost of matrix organization is more than that of a

functional organization

There are certain organizational problems in the implementation of

matrix structure

Difference in orientation between program manager and

functional manager

Diffuse responsibility

Program personnel in temporary assignments

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Controllers Organization

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Controller s Organization

The person who is responsible for designing and operating

MCS is Controller.The Controller performs following functions

Designing and operating information and control systems

Preparing financial statements and financial reports forshareholders and other external parties

Preparing and analyzing performance reports, interpretingthese reports and analyzing programs and budget proposalsfrom various segments of the company & consolidating them

Supervising internal audit and accounting control proceduresto ensure the validity of information, establishing adequatesafeguards against theft and fraud, and performingoperational audits

Developing personnel in the controller organization

To advice management on financial implication of decisionsunder consideration

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Controllers Relation to Line

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Controller s Relation to Line

Organization

Controller sometimes acts as line manager but their

decisions can be overruled by actual line managers.

The Business Unit Controller

He has divided loyalty between corporate controller &

Unit Manager.

If he reports to Corporate Controller, he is treated as

spy rather than trusted aide by unit manager.

And if he is reporting to unit manager, he may not

give objective reports on Business Unit.

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Controller

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Controller

Controllers involvement in managerial function dependsupon

Financial orientation of the company

Importance of planning, budgeting and reporting inthe organization

The extent to which controller is involved

in business decisions Characteristics of a good controller

Personal integrity and professional commitment

Accounting knowledge and analytical skills

Understanding business problems andrecommending actions

Building effective interpersonal relationships

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Organizational structure should be designed insuch a manner that it facilitates informationprocessing, communication, alliance and co-operation

Dimensions which are internal to organization

are called Structural dimensions Different Structural Dimensions to be considered

for control are Formalization

Specialization Hierarchy of Authority

Centralization

Professionalism

Personal ratios 98

Dimensions of Organizational Design

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Degree of Formalization The extent to whichwritten rules and records are maintained

MCS requires detail reports

Formal reward systems exist

Professionals may get de-motivated Degree of Specialization Dividing

organizational activities into sub-groups

Person can perform small range of activities

Control system usually consists of explicit rules andprocedures establishing standard actions & results

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Hierarchy of authority

For effective control management needs to determineoptimal span of control depending on the task beingperformed

Degree of Centralization How much is theconcentration of decision making authority at top

Decentralization fosters innovation, responsiveness tocustomer needs

Centralization helps in strict adherence to plans

Degree of Professionalism - The level of formaleducation and training Professionals may not require very close supervision

Personal Ratios No. of employees in a particular function to total

employees100

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Autonomy and Responsibility

Organizations require flexibility, innovation and

creativity

This calls for decision on level of autonomy or

the level of decentralization of decision-making Three groups of variables that influence

autonomy in the organization

Management style and process

Responsibility structure

Measurement of reward systems

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Management Style and Process

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Personal variables that influence the levelof autonomy

Level of involvement of corporate manager in

the business Interactions of corporate managers with other

managers

The level of trust and confidence of the

manager in the ability of the sub-ordinates Management style influences the

decentralization process

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Management Policies and Procedures help

maintaining uniform behavior among profit

centers that determines the extent of autonomy

Diversification Strategy In a single business firms managers autonomy is

restricted

In unrelated business firms, the extent of autonomy is

high Business Strategy The type of business

strategy chosen influences the autonomy

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Variables influencing Autonomy

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Responsibility Structure


Represents the Physical, Financial and

Human resources entrusted to profit center

manager These resources represent functional

authority

Resources in the custody of manager

influence his decision making authority

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Measurement and Reward Systems

Measurement methods show level of concern

about cost and assets assigned

The common method of measurements Proration refers to allocating resources based onstandard rules of the organization

Negotiation more autonomy

Metering more autonomy Reward system depends on managers

autonomy

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Responsibility Structure consists ofResponsibility Center and related

Performance Measurement System

Responsibility centers work towards

achievement of organizational goals

Performance measurement of

responsibility center is done through cost,

profit, revenue, investment and qualitygoals

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M i P f

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Measuring Performance

Three methods of measuring performance of

Responsibility center

The Efficiency Measure

The Process Measure

Effectiveness Measure

Overall effectiveness measure is ROI

ROI = Net Profit / Invested Capital

= Profit Margin * Investment Turnover

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RESPONSIBILITY CENTER

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Responsibility Center is an organizational unit that isheaded by a manager who is responsible for itsactivities.

Company is a collection of responsibility centers. Thisterm is used to refer units within the company.

Company has goals & to achieve these it has strategies.

Objective of responsibility center is to help inimplementation of these strategies.

R.C. receives inputs, transforms into output and supplies

it to other responsibility centers or market. Resources used are the inputs & Revenues are amounts

earned from providing the outputs.

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Optimum relationship between input and output isimportant.

In case like Production Dept., input is directly related tooutput; but in advertising or R & D they are not. Therelationship is indeterminable.

Many of the inputs can be measured and converted intomonetary terms for combining or comparing.

Cost is a monetary measure of amount of resourcesused by a responsibility center.

It is easier to measure cost than calculate value of output

EFFICIENCY & EFFECTIVENESS These are the twocriteria for judging the performance of a responsibilitycenter.

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. Efficiency is the ratio of outputs to inputs or the amount

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Efficiency is the ratio of outputs to inputs or the amountof output per unit of input.

Other way of measuring efficiency is by comparing

Actual Cost with Standard CostProblems in this case are

Recorded cost may not be precise

Standard cost may be approximate and may be underdifferent conditions

Effectiveness is determined by the relationship betweena responsibility centers output and its objectives.

Both are difficult to quantify hence Effectiveness isexpressed in subjective terms.

A responsibility center is

Efficient if it does Things right andEffective if it does the Right things.

Profit is important measure of effectiveness. It alsomeasures efficiency relation between Output(Revenue) and Input (Cost) 110

TYPES OF RESPONSIBILITY

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CENTERS

Revenue Center

Expense Center

Profit Center

Investment Center

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REVENUE CENTER

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REVENUE CENTER

Output is measured in monetary terms

But no formal attempt is made to relate

input (i.e. expenses or cost) to output

Ex. Marketing / Sales Unit.

Here actual sales or orders booked are

measured against budgeted

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EXPENSE CENTER

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EXPENSE CENTER

Inputs are measured in monetary terms but

outputs are not.

Two types of expense centers

1. Engineered 2. Discretionary

These types are based on types of cost. Engineered costs are those which can be

estimated with reasonable reliability.

Discretionary costs (managed costs) are those

where engineered estimate is not feasible. Cost

depends on managements judgment.

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Engineered Expense Center

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Engineered Expense CenterTheir characteristics are

Inputs can be measured in monetary terms Outputs can be measured in physical terms

Optimum amount of input required to produce one unit ofoutput can be determined

Generally found in manufacturing operations.

Engineered expense centers are usually located withindepartments which are discretionary expense centers

EEC have other important tasks like

Quality of product,

Quantity & efficiency, Training and development of employees who are not

related to current production.

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Discretionary Expense Center

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Discretionary Expense Center

Includes Administrative and Support Units (Accounting,

Legal,H

R), R & D and most marketing activities The term discretionary reflects managements decisions

regarding certain policies like marketing efforts, servicelevel.

Managements views as to proper level of discretionary

cost is always subject to change In discretionary expense center, the difference between

budget and actual expense is not a measure ofefficiency.

Living within the budget i.e. actual expenses notexceeding budgeted amount does not necessarily meanefficient performance.

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Control Characteristics for Expense Center

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p

Budget Preparation For Engineered Expense Center management decides

whether the proposed operating budget represents theunit cost of performing its task efficiently.

Its volume is not main concern.

For Discretionary Expense Center budget is formulatedby determining the magnitude of the job that needs to bedone.

Work done by DEC falls in two categories

1.Continuing - Continuing work is done consistentlyfrom year to year such as preparation of financialstatements

2.Special - . Special work is one-time project.

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Management by Objectives is a useful technique forpreparation of budget in DEC

Here Budgetee proposes specific work to beaccomplished

And suggests measurements to be used inperformance evaluation.

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Cost Variability Cost in engineered Expense Center are strongly

affected by short-run volume changes;

whereas cost in Discretionary Expense Center

are comparatively unaffected by short-termfluctuations.

In most DEC personnel or personnel relatedcosts are largest expense items.

These are budgeted on expected sales volume and normally thereafter budgeted manpower iskept unchanged over the budget period

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Financial Control

In EEC objective is to become cost competitive

by setting a standard and measuring the actual

cost. In DEC while forming the budget, manger is

allowed to participate in planning of the tasks to

be undertaken &

control cost at planning stage rather than after it

is incurred

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Measurement of Performance

In DEC, job is to obtain desired output

Financial report is not a means of evaluating

efficiency of a manager Control over spending should be exercised.

All the above are financial controls;

But total control over DEC can be achievedthrough non-financial performance measures

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DIFFERENT TYPES OF

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EXPENSE CENTERSAdministrative And Support Centers

Administrative includes senior corporate managementand Business Unit manager and their supporting staff.

Support Centers are units providing services to otherresponsibility centers.

Control Problems Control of administrative expenses is difficult because of

Problems inherent in measuring output

Frequent lack of goal congruence betweendepartmental staff and company as a whole

The severity of these two problems is directly relatedto size and prosperity of the company.

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DIFFERENT TYPES OF

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EXPENSE CENTERS

Support Centers often charge other

revenue Centers for the services they

provide.

Budget Preparation

It normally contains list of expense items

with proposed budget which is put in

comparison to current years actualexpenses.

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DIFFERENT TYPES OF

EXPENSE CENTERS

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EXPENSE CENTERSR & D Centers -

Control Problems

Difficulty in relating results to input

There are semi-tangible outputs but relationshipbetween outputs to input is difficult to establish as

inputs are spread over longer period of time. Secondly reliable estimates of values of output may

not be possible.

Moreover technical nature of R & D function maydefeat measurement of efficiency like mediocre effort

by luck may result in great success. Lack of Goal congruence People in research may not

be having sufficient knowledge of business to determinethe optimum direction of research effort.

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DIFFERENT TYPES OF

EXPENSE CENTERS

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EXPENSE CENTERSMarketing Centers Two types of activities

Related to Order filling or Logistics These take place after receipt of order.

Involves moving goods from company to customer and collectamounts due in return.

Activities include transportation etc.

These responsibility centers are similar to EEC

Related to Order getting True marketing activities.

Take place before receipt of order.

Include Test Marketing; Sales force Development andManagement; Advertising; Sales Promotion.

Sales target is a critical factor

One more activity that can be split from logistics isgenerating revenue

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PROFIT CENTERS

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PROFIT CENTERS

Here financial performance of responsibility center is

measured in terms of profit. Profit is one comprehensive indicator.

As the companies delegate more and more authority tomanagers a business unit gets evolved andresponsibility and authority to generate profit comes into

existence. While delegating profit responsibility

Manager should have access to relevant informationneeded for making decision

There should be some way to measure effectiveness

of decision Delegation of authority can go upto such a lowest level

where these two conditions exist.

These units then become Profit-Center

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PROFIT CENTERS

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Advantages of Profit-Center

Quality of decision improves as decision makers areclosest to the point of decision

Speed of decision increases as no referrals to higher-ups

HQ management can concentrate on broader issues

Managers can use their imagination & initiatives

Provides good training ground

Profit consciousness is enhanced

Profitability of individual component of company is

readily available Profit centers become responsive to improve competitive

performance

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PROFIT CENTERS

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PROFIT CENTERS

Difficulties with Profit-Centers Loss of control to some extent

Quality of decision may be reduced depending oncapability of managers

Friction may increase because of common issues

Competition within may lead to diversion from goalcongruence

Divisionalization may impose additional cost

May put more emphasis on short-term profitability

Profit-optimization of individual centers does not ensureprofit-optimization of organization as a whole

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Other Profit-Centers

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Functional Units

Multi-business companies are divided into business unitsas profit generating unit.

Managements decision as to whether a particular unitshould be a profit-center is based on amount of influencethe unit manager exercises over activities that affectbottom line

Marketing

It can be turned into profit center by charging it with thecost of products sold

Marketing activity can be given profit responsibility whenmarketing manager is in a best position to make principalcost/revenue trade-offs.

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Manufacturing

This is usually an expense center and

Performance is measured against standard cost.

It also requires evaluation of activities such asQuality Control, Production Scheduling and

Make/Buy decision

To measure entire activity, one way is to make it

as profit-center and give credit for selling priceless estimated marketing expenses.

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Measuring Profitability

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g y

Profit-center is evaluated in two ways

Measuring Management Performance

used for planning, coordinating & controlling the

activities and as a device for providing motivation

Measuring Economic Performance

Management reports are used frequently while economic

reports are prepared when required for decision-making.

Systems should be designed to measure management

performance routinely and economic information isderived from these reports and other sources

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Types of Profitability Measures

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yp y

Parameters used to measured profitability are

Contribution Margin

Direct Profit

Controllable Profit

Income before Income Tax Net Income

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INVESTMENT CENTERS

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INVESTMENT CENTERS

An Investment Center has control over

sales revenues, operating costs and

assets used to generate profit.

The objective of this center is to maximize

the profit, given the amount of investment

required to generate the profit

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Performance Measurement of

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Decentralized Operations

When there is decentralization and multi-

divisional operations, main issues in

performance measurement are

Profit and Investment Performance Setting transfer price for inter-divisional

transactions

Divisional Performance can be measured on the

basis of ROI

But incase Interdivisional transactions it also

depends on Transfer Price133

Transfer Pricing

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When there is decentralization, transfer of

goods and services from one PC to anothertakes place

Transfer Price is the mechanism for distributingthe revenue generated by combined efforts ofdifferent PCs.

Transfer price is the internal price charged byselling department to buying department in anorganization

Transfer Price should be determined by twocriteria

Goal Congruence

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