Management Control Systems

Management ControlSystems

Part 2

Debasis DasExemplar 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 ParadigmOf Control

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HumanbrainInputs

Outputs

Not- understood processes

Probabilistic, highly complex

Insights from Cybernetics used to design controls and control systems

Cybernetic Paradigmof

Control Process

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Perception

Goals

Behaviorchoice

Comparator

Behaviorrepertoire

Valuepremises

Factualpremises

Effector

Sensor

EnvironmentDecisionmaker

Feedback

Griesinger 1979

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

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G

G4G3G2G1

1

2

3

G11 G12 G13 G43…………………………………………………………………..

Control Process Relating Superior-Subordinate

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Superior Control System

Subordinate Control System

Interconnection BetweengoalsBehavior repertoire

Feedback from superior effector

Superior goal affects the subordinate goalsSuperior behavior repertoire can influence the subordinate effectorFeedback from the superior enters the subordinate system through the sensor

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

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Micro framework

Perception

Goals

Behaviorchoice

Comparator

Behaviorrepertoire

Valuepremises

FactualpremisesSensor

EnvironmentDecisionmaker

Griesinger 1979

Micro, Intermediate, Macro

Frameworks-2

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InfrastructureManagement

Style & Culture

Coordination & Integration

Rewards

Formal Control Process

Intermediate Framework

Micro, Intermediate, Macro

Frameworks-3

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Improvements

Status

PerformanceMeasures

ExternalEnvironment

(Uncontrollable)

External

Internal

CriticalSuccess factors& impediments

IdealStakeholders

Goals & Strategies

ENTITY

X

++

ManagementSystemsInitial

Conditions

Key Success Variables in MCS

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Key Variable(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

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Interrelations-Internal & External factors

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External BusinessEnvironment

InternalCharacter

StakeholdersIndustry

Character

Significant Functions

Objective of Business

CorporateStrategy

Competitors

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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Understanding Business Process

• 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

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Establishing Linkagestoward 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

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Input System

AssessorControl

device/System

Feedback device/system

Closed End Control

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Input System

AssessorControl

device/System

Feedback device/system

Implementation Techniques

• Sharp Cut-off

• Parallel run

• Phased implementation

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Implementation Process

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DevelopControlsystem

Implement Controlsystem

BuildControlSystem

UseControlSystem

Is itAdequate?

Yes

Organizing, Strategy&

Control

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Introduction

• Control system helps goal congruence

• System should help implement strategy

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Goals & Objectives-Boundary Constraints

• Goal & Objectives are the boundary conditions

• Goals & objectives may change• These reflect short term as well as

long-term 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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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

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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

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R&D ProductionDesign Marketing

Discretionary Costs

Infrastructure costs

Engineered Costs

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

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Option a

Option b

Option c

Option d

BudgetThe

Business

Business with Strategic Plan

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Option a

Option b

Option c

Pla

n

B

A BudgetOf

TheBusiness

Option c

Strategy & Control

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Vision& Mission

Reward

Strategy Plan BudgetDeviation/

measurement

Feedback to the system

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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