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Introduction to Management Control Systems
In this chapter we will discuss: Importance of Control Systems Nature of Management Control Systems • • •
Types of Management Control Systems Subsystems and Components of Management Control Systems
O nl y
and the operational level. the nature of management control systems. types of management control systems. Establishing a control system in an environment of distributed accountability. direction setting. These are: the strategic level. the absence or malfunctioning of control systems can lead to huge losses. the state of competitiveness of the unit. the benchmarks are known and well defined. in order to inflate its cash flows. Each type of control occurs primarily at one of the three distinct levels of the organizational hierarchy. this mode of control generally conforms to traditional control models. Enron Corp. As these examples illustrate. Strategic control also deals with issues relating to general company objectives and the implementation and monitoring of progress. Defective products and poor coordination between departments also arise due to weak control systems.Principles of Management Control Systems In 2001. a diversified manufacturing and service company. because of doubts about its accounting practices. The time horizon of control is very short. the global energy giant. The accounting irregularities included transfers between internal accounts of $3. The stunning news that WorldCom. S U se A control system is a set of formal and informal systems to assist the management in steering the organization towards its goals. Operational control is primarily concerned with efficiency issues. and the translation of corporate goals into business unit objectives. Controls help in guiding employees effectively towards the accomplishment of the organization’s goals. had artificially inflated its earnings by $3. and even to corporate bankruptcy. Management control deals with effective resource utilization. Occurring at very specific functional or sub-departmental levels of the organizational hierarchy. • • rI B The control process in any organization can be undertaken at three levels. Tyco International.. and the subsystems and components of management control systems.06 billion in 2001 and $797 million in the first quarter of 2002. corporate history. O nl y C la s s IMPORTANCE OF CONTROL SYSTEMS of 20 09 . reengineered processes. collapsed in one of the largest cases of bankruptcy filing in U. Strategic control overlaps to some extent with the process of strategy formulation. had to abandon plans to split into four parts.8 billion rocked the corporate world and shook investors’ confidence in stock markets. and other issues that impact the organization's long-term survival. This chapter focuses on the importance of control systems. 4 Fo • Strategic control deals primarily with the broad questions of domain definition. and local autonomy and empowerment is a challenging task. the management level. WorldCom's accounting irregularities involved the deliberate mis-recording of expenses as capital expenditures. the telecom giant. expression of the organization’s purpose. and the outcomes are tangible and easily measurable.S.
Hence it is important for organizations to establish the tradeoff between the amount of control and the level of freedom for employees. If the tobacco business was consistent with the mission and values. the problem worsens. The detector analyzes the situation that is being controlled. the company did not act immediately once smoking related illness became common.1 Management Control at Kimberly-Clark Kimberly-Clark. They represent a nested arrangement. reconstituted tobacco-to-tobacco companies for use in cigarettes. Adapted from Veliyath. If the control process does not identify and deal appropriately with a problem occurring at a lower level. They are a detector or sensor. p2. and to choose the right mix of controls. The tobacco reconstitution process used by Kimberly-Clark enabled tobacco companies to manipulate nicotine levels in cigarettes. Increased control in an organization will result in reduced creativity and entrepreneurship. The strategic control failure was not making a conscious determination whether the tobacco business was consistent with the company's mission and values. the manufacturer of household and health products. At the management control level. Heather M. “Organizational control systems: Matching controls with Organizational levels” Review of Business. the company then needed to follow up by instituting proper operational and management control systems that protected the organization against legal liability. Elements of a Control System Any control system has four important elements. 18 Issue 2.1. The state of West Virginia in the US alleged that Kimberly-Clark conspired with cigarette companies to deceive the public about the hazards of smoking. an effector and a communications network. When the company realized that its tobacco business was becoming a legal and financial liability. Raj. An effector is used to reduce the gap between the actual and the 5 Fo rI B S U se O nl y C la s s of 20 09 . Vol. Hermanson. an assessor. At the operational control level.Introduction to Management Control Systems Exhibit 1. Winter97. the problem needs to be handled from the highest levels. as can be seen in Figure 1. threatening the organization’s survival. in terms of strategic control. Since 1950s. An assessor helps in comparing the actual results with the standard or expected results. it spun off the tobacco unit. The problem then gets kicked up to a higher level of control. The company has a good reputation as a manufacturer of household and health products. This can be illustrated through the example of Kimberly-Clark in Exhibit 1. it also started selling cigarette paper and sheets of pressed. In extreme cases. is an example of a company that mixed up operational and management control issues. when the issue gets more complicated. It is important to recognize that the three levels of control are not mutually exclusive.1. the company did not ascertain whether the advertisements claiming that the tobacco reconstitution process allows nicotine levels to be adjusted to a smoker’s individual requirement was indeed misleading.
1 Elements of the Control Process Control device 2. The difference between tight and loose control thus relates to the degree to which the management monitors the 1 6 Fo Robert N Anthony and Vijay Govindarajan. They are: • • • Implementing the programs or policies. A management control system is the means by which senior managers ensure that subordinate managers. (USA: Irwin. plan. rI B S NATURE OF MANAGEMENT CONTROL SYSTEMS U se O nl y C • Identifying the goals or objectives. efficiently and effectively. of 20 Source: Robert N. Management Control Systems. Management Control Systems. Limited monitoring of the business units’ activities can be termed as loose control. la s s standard result. and Analyzing whether the achieved targets are in accordance with the goals or objectives. Observed information about what is happening Entity being controlled 3.Anthony. Assessor. 1995) 5. integrate and interrelate organizational activities to achieve organizational objectives. According to Anthony. If the management monitors the activities of the business units frequently. strive to attain the company's objectives. A management control system is designed to assist managers in planning and controlling the activities of the organization. 09 . Comparison with standard 1. if needed The process of control usually involves four important steps. Measuring and comparing outcomes against targets. The achievement of these activities is facilitated by management control systems. Effector.Principles of Management Control Systems Figure 1. Govindarajan. the assessor and the effector. Detector. The communication network transmits information between the detector. Eight Edition Irwin Publications. Behavior altering communication. management control is “the process by which managers ensure that resources are used effectively and efficiently in the accomplishment of the organization's objectives”. The role of the management is to organize. then it is exercising tight control. Dearden and Govindarajan1 (1992).
When there is tight control by the management. the budget is regarded more as a tool for planning and communication than as a binding commitment. and finally. The budget is considered a binding constraint with a strong emphasis on meeting the budgeted targets. Management control decisions also take into account the quantity and quality of resources available. Plans developed for a unit must encompass the whole organization. organizational structures. 7 Fo rI B Decisions are systematic and rhythmic S U Management control decisions are based on the framework established by the organization's strategies.2 explains how strategies are implemented through management controls. but their actual implementation may require some time. Under loose control. and culture. All these are influenced by the system of management control. Strategy implementation tool Management control helps an organization to move towards its strategic objectives. there is extensive involvement of the management in the day-to-day operations of the business unit. Within the constraints of the available resources and the policies of the organization. operations and distribution should be balanced with the sales program. se O nl y C la s Nature of decisions s of 20 09 Evaluating information and deciding the various activities. human resource management and culture. and hence it is an important aspect of strategy implementation. For instance. employees need time to adapt to a new technology. Effective execution can take place with the help of an efficient organizational structure. and the plans for each of the organization’s units must be coordinated with one another. Deviations from the budget are generally not considered acceptable. Figure 1. It is an important vehicle for the execution of strategy. a manager should be able to implement activities that are best suited for a particular business unit. Decisions are made at the highest level. For example. Loose control is characterized by limited involvement by the management in day-to-day operations. human resource management. Important Features of Management Control Systems Decisions in management control process are systematic and rhythmic i.Introduction to Management Control Systems activities of a unit. Management control systems involve a number of activities in an organization. .e. including: • • • • Planning the future course of action Coordinating and communicating the various activities of the organization to different departments Influencing people to work in accordance with the goals of the organization. so that there is a balance between different activities. they are in accordance with the strategies and procedures laid down by the top management.
lack of motivation will result in employees taking decisions that are harmful to the organization. motivational problems and personal limitations. control systems are required for the following three reasons. These limitations are specific to individuals. and could also be because of inadequate training. computer-related crime can result in huge losses for the organization. Behavioral considerations Motivation is important to help employees perform to their full potential. and inexperience. This can lead to accidents and errors in decision-making. In spite of high motivation to perform. In extreme cases. 1995) 11. this could lead to employee fraud and theft. In IT companies. Giving employees the required support and direction to accomplish organizational goals is one of the important functions of management control systems. C la s s of 20 09 Culture . To manage people effectively. managers cannot implement their decisions. The decisions may be made in order to advance the personal interests of the employees involved. Some jobs are designed in a manner that creates stress. Hence. Another behavioral problem that can have serious consequences for an organization is personal limitations.lack of direction. Training plays an important role in reducing 8 Fo rI B S Poor performance in organizations can be attributed to lack of direction among employees.Principles of Management Control Systems Figure 1. lack of knowledge or information. Management Control Systems (USA: Irwin. there is a need to control such behavior in an organization.2Framework for Strategy Implementation Implementation mechanisms Management Controls Strategy Organization Structure Human Resource Management Performance Source: Robert N Anthony and Vijay Govindrajan. Most of the organization’s problems occur because individual goals and organizational goals do not match. This results in demotivated performance by the employees. U se O nl y People are important assets for an organization. Job design also plays an important role in performance. Without the cooperation of the employees. certain employees may be unable to perform because of their personal limitations. At the managerial level too.
Finally.Introduction to Management Control Systems the severity of limitations at the individual level. they have to be motivated. Management Control Process The management control process involves three interrelated activities – communication. control devices should be put in place only when the economic benefits exceed the costs. An organization does not usually have perfect control. it involves communication between the superior and the subordinates. have to be measured. quality and asset management. and that the employee is confident about performing his tasks well. to assess the control system relating to production. For example. So. The superior should make sure that the subordinates understand what the organization expects of them. The organization should be focused on the future. For perfect control all the employees should be working in the best possible way. motivation and evaluation. Finding effective tools for control of such limitations is an important part of control systems. Employees should be encouraged to be flexible so as to respond effectively to change. Communication helps the subordinates understand the goals of the organization. Characteristics of a Good Management Control System Fo Clear Objective Good control cannot be established unless the multiple objectives of a particular task are considered separately. First. The difference between the performance that is theoretically possible and one that can be reasonably expected is called “control loss. S U Future-oriented se A good management control system ensures success for an organization. Minimum control losses Control devices are costly and not always economically feasible. for the subordinates to put in their best efforts to achieve organizational goals. Second. good inventory control means that employees have information about the quantity of inventory present and its availability at different locations. Good control can be achieved in the following ways: O nl y C la s s of 20 09 9 . For example. Good management control here implies that the goals of the organization are clearly communicated to the employees. But this is not always possible as employee behavior is not stable. all major performance parameters like efficiency. rI B Planning is always oriented to the future. It is essential for the superior to evaluate the performance of subordinates without any bias.” An organization achieves optimal performance when control losses are minimized. for effective performance. superiors should evaluate the work of the subordinates and give them feedback periodically. It is the responsibility of the superior to motivate the subordinates.
while others remain unaffected. While strategy formulation takes place at the highest level in an organization. In contrast. strategies and policies Implementation of Strategies Efficient and effective performance of individual tasks 20 09 . management control C la s Activity Fo Strategy formulation Management control Task control Source: Robert N. Task control involves the control of individual tasks. There may be changes in one or a few strategies. 1995) 9. whereas management control involves implementation of these policies. Figure 1.Principles of Management Control Systems Distinction between Strategy Formulation. Hence. management control and task control. Distinction between strategy formulation and management control Strategy formulation takes place at the highest level of the management and involves formulation of new strategies. strategy formulation may not always follow a clearly defined system. Management Control Systems. These tasks are carried out according to the rules and regulations laid down by the management rI B S U Figure 1. Management control needs to be distinguished clearly from strategy formulation and from task control. Govindarajan. Management Control and Task Control It is important to analyze the differences between management control and other types of control. the management control process involves the whole organization. both internal and external to the organization. Management control lies at the middle level between strategy formulation and task control. Strategy formulation takes place in accordance with situations. Therefore. The management control process takes place in a systematic manner. a high level of coordination is required. Strategy formulation usually involves only those at the highest level of the organization. and involves managers and staff at all levels in the organization. and changes affect all the parts since they are linked with one another. (USA: Irwin.Anthony. task control takes place at the individual level. 10 s of Nature of End product Goals.3 General Relationship among Planning and Control Functions se O nl y Task control vs.3 explains the distinction between strategy formulation.
each task requires a different task control system (a production control system is different from a cash management system). budgets. strategic plans and resource allocations. In task control. Informal controls include group norms and organizational culture. the number of items ordered by the customers. Formal controls are framed by the managers. Formal controls can be classified into three types. the factors that affect inventory levels of finished goods. the components used in manufacturing the products. These measures help the company to select the right way to undertake the activity. manpower allotments. Input controls include selection criteria. the number of man-hours used in a particular process. such as the rate of sales or 11 rI B Formal control systems are written. it can be concluded that task control is quantitative in nature whereas management control is oriented towards behavior. in other cases. Thus. whereas informal controls arise as a result of employees’ behavior. Usually the techniques in operations research and management science focus on task control. etc. under a feed-forward system of inventory control. In task control. The information important for task control in an organization is usually quantitative in nature e. in some cases. recruitment and training programs. regulations and quotas. C la s s of 20 TYPES OF MANAGEMENT CONTROL SYSTEMS 09 . For example. Process control is exercised when the firm attempts to influence the ongoing activity to achieve the desired ends. The control action takes place before the process of transformation is completed and the output is produced.g. there may be interaction between a manager and a worker. They are: S U se O nl y Control systems in an organization fall under two broad areas: formal and informal. Formal controls are laid out in writing by the management. employees may not be involved.Introduction to Management Control Systems control process. whereas informal controls often originate with employees and are affected by general socio-cultural factors. Examples of formal controls are plans. such as automated processes. The devices used for task control include programmable machine tools. The control is applied to the behavior or activities rather than the end results. Management control involves interaction between two managers or between a superior and subordinate. management-initiated mechanisms that influence the behavior of employees in achieving the organization’s goals. Process controls Process controls involve tracking certain variables and taking corrective action whenever there is any deviation from specified parameters in the variables. based on the nature of management intervention. Formal Control System Input controls Fo These are the actions taken by the company before a planned activity is implemented. process control computers and robots.
In this type of control. Social controls Social control refers to the prevailing social perspectives and patterns of interpersonal interactions within subgroups in the firm. They are: O nl y Informal Control System C la s s of 20 09 . Thus. and the level of the finished goods inventory is controlled by reducing production.” Cultural control can be realized by norms of social interaction. in a suitable manner. The management may direct the salesperson to follow certain procedures for new market development. When the sales begin to decline or there is a dispatch bottleneck. typically worker-initiated mechanisms that influence the behavior of individuals or groups in business units. which leads to the inventory objectives or plans being updated.e. It deals with the establishment of the personal objectives by the individual. monitors conformity with the standard and takes action when deviations occur. but may not hold the salesperson responsible for the extent of new business generated i.Principles of Management Control Systems dispatch delays. the managers may realize that the original standards for sales or dispatch delays are no longer appropriate and must be revised. Output control takes place when the control activity is based on the comparison of actual and planned outcomes. and stories. and the results are evaluated. culture is “the broader values and normative patterns that guide worker behavior within the entire organization. Cultural controls According to William G Ouchi. and to complete the assigned task without management intervention. the management expects the employee to perform in a result-oriented way. the end result. 12 Fo rI B S U Self-control se These are unwritten. Self-control can be beneficial to an organization if the organization’s goals are in congruence with the individual’s goals. In this type of control. Such controls are applicable when it is easy and inexpensive to measure the output and when there are few elements of uncertainty. Social control arises out of the internalization of values and mutual commitment towards some common goals. this information is fed forward. But if the goals do not match then the performance of the employee can suffer. monitoring their attainment and adjusting the behavior in the organization to attain the goals. Alternatively. are tracked. In such a case. an organization establishes certain standards. the inventory levels are prevented from exceeding required levels. Output controls Output control is exercised when performance standards are set and monitored. This again feeds into a loop. as it believes that the employee has the requisite knowledge to undertake the activities required. rituals and legends relating to the organization. Process control can also be illustrated using the example of a salesperson’s job. There are three types of informal controls. process control has been exercised.
In most organizations there are two budgets. 13 Fo rI B S U se O nl y Formal reporting process C la s s of 20 09 . Informal control processes are formed as a result of interaction between people. intuition and feeling. Strategic programs are funded out of current operations and grow out of current activities.Introduction to Management Control Systems SUBSYSTEMS AND COMPONENTS OF MANAGEMENT CONTROL SYSTEMS The subsystems and components of control systems can be discussed on the basis of formal and informal processes. there are two sets of reports . Further. and should be supported by the infrastructure. the rewards. There are a number of mechanisms for control through informal systems. A strategic planning system is necessary to assist the organization in the planning and control of projects. Formal Control Process The formal control process has two dimensions. Formal planning process The formal planning process has two dimensions: strategic planning and operations planning. and to decide on the next set of programs to be undertaken. Although planning and reporting appear to be two distinct processes. Informal communication systems evolve as people develop work relationships. Detailed reports help the organization to assess the progress of its strategic and operational planning. improve productivity and achieve organizational change.one for strategic projects and one for operating activities. there should be a certain degree of integration. Monthly.formal planning and formal reporting. The formal planning and control process should support the style and culture of the organization. product or market. An operational planning system undertakes activities that are short term in nature.one for operations and one for strategy. Informal teams usually consist of cross-organizational groups which work in coordination to solve problems related to a particular client. these strategic plans should be adjusted from time to time in line with their effect on operations. quarterly or yearly reports help the organization to analyze its performance periodically. It helps the organization to decide its goals and objectives. and the communication systems in the organization. Fostering informal communication is critical to the development and maintenance of effective informal controls. and key strategies. strategic plans and programs have a great impact on current operations and so. Informal Control Process Management decisions are based upon experience. and. The informal control process helps in the development of new goals and objectives. One mechanism is the use of ad hoc teams to solve problems. Informal communication is helpful in supporting the key values of the organization.
and reliable information centers are essential for management control systems to be successful. task control and management control. It helps in the implementation of the desired strategies. Management control lies at the intermediate level between the levels of strategy formulation and task control. Any control system in an organization has four important elements that help in synchronizing the organization’s various activities. They are – the detector (which provides information about the situation). well-defined centers of responsibility. Managerial style and organizational culture play an important role in determining which components are used. It is important to analyze the distinction between strategy formulation. Formal control systems can be classified as input controls. the effector (which tries to bridge the gap between the actual situation and the standard required). It is the means by which senior managers effectively and efficiently strive to attain company's objectives. Communication systems are not highly guarded in informal systems. process controls and output controls. In recent times. corporate structure. the assessor (for comparison with benchmarked standards). and task control involves the control of individual tasks. and whether the formal or informal processes are dominant. Management control systems are considered essential for the successful attainment of corporate objectives. The respect an individual is shown is an informal reward for performance. the communication systems (that help in passing the information between the other three elements). 14 Fo rI B S U se O nl y C la s s of 20 09 .Principles of Management Control Systems Informal rewards and recognition are conferred upon the key team members within the informal system. The subsystems and components of control systems can also be divided on the basis of their use in formal and informal systems. Control systems can be divided into formal and informal controls. A clear corporate strategy. A good management control system is oriented towards the future. and minimizes control losses. has clear objectives. Strategy formulation takes place at the higher level of the management. several companies have lost billions of dollars because the necessary controls were absent. Informal control systems can be classified into selfcontrol. social control and cultural control. SUMMARY The purpose of control is to ensure that an organization meets desired objectives and that individual members behave in a manner consistent with organizational objectives. and finally.
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