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Introduction to Management Control Systems (MCS

Chapter 1 Session 1

Breaking the Ice
• Before 17th January 1995, Nick Leeson was a 28year old “successful trader” (of Japanese stock index futures and options) in Singapore for one of Britain’s oldest (233 years old) investment banks—Barings Plc. Within a few weeks, Leeson alone lost > US $ 1 billion of Barings’ money (i.e.,twice its available capital) and brought about the collapse of the firm. • 2001—The dark year of control lapses: 9/11 and WTC; Enron; Tyco International; WorldCom; Arthur Andersen

2 Important “ Laws”
• Murphy’s Law : “If anything can go wrong, it will” • Anderson’s Law: “If you have effective controls, it won’t”

Our Learning Objectives

• To study the significance of management control systems in different activities of organizations • To understand the nature of management control systems • To study the purpose and types of management control systems

The Discussion Themes
• Introduction to MCS—The importance of control in a managerial setting • Key Elements of a Control System • Nature of MCS • Purpose of MCS • Domain of MCS • Organizational Context of MCS • Types of MCS—Formal and Informal Control Systems

Managerial Control • • • • • • • • • • Automation Behaviour Correction Discipline Effectiveness Fear Goals Hierarchy Inspection Jeopardy The Many Images of .

Why do Managers need Control? • To provide reassurance to stakeholders that the organization is running smoothly. • To provide reassurance to managers that the organization is moving in the chosen directions. • To provide guidance to employees for channelling their behaviour in desired directions. • To provide guidance from higher management to lowerlevel managers to identify significant problems and opportunities .

5. and its basis is INFORMATION in the hands of managers”— Doug Sherwin (1956). control involves: Deciding acceptability of results Reference to what was planned Information for measurement and comparison Action for correction Effective use of capabilities to achieve goals • 1. 2. 4. 3. . which adjusts operations to predetermined STANDARDS.What is Control? • “The essence of control is ACTION. So.

What do Managers Control? Control efforts in 5 inter-related areas: • • • • • Money Operations Information Time Behaviour (of people) .

unstructured and summarized reports Short-term Detailed performance in structured reports .Levels of Control Strategic Linked to strategy formulation Top management Goal-oriented Management Involves translation of corporate goals into objectives Mid-level Resourceallocation oriented Medium-term Combination. summarized and exception reports Operational Ensures functional efficiency First-line supervisors Task-oriented Long-term Aggregate performance. ad hoc.

Dearden. It guides the behaviour of managers and employees (Horngren. . It aids and coordinates the process of planning and control decisions throughout the organization. 1992)  A management control system is a means of gathering and using information. (Anthony. Datar and Foster. Govindrajan.What is a MCS ?  A management control system is the process by which managers ensure that resources are used effectively and efficiently in the accomplishment of organizational objectives. 2003).

CF from operations.g. • Individual-facility level—e.g. time to respond to customer requests. revenue generated per salesperson . • Customer/market level—e.g.. units reworked on production line. • Individual-activity level—e.. net income. rates of accidents and absenteeism in various divisions/business functions. number of shipments per employee.General Electric (GE)— Levels of MCS • Total-organization level—e. community investment. materials costs. customer satisfaction. share price.g. labour costs. time taken and costs incurred for inbound logistics activities. total employment. pollution control. ROI... cost of competitor products.

MCS includes… Financial data Nonfinancial data Formal control system Informal control system .

Basic Elements of a Management Control System CONTROL DEVICE DETECTORObservation and reporting of facts ASSESSOR- Comparison with Standard EFFECTORBehaviour Modification ENTITY BEING CONTROLLED .

.setting  Collecting information on actual performance  Comparing actual performance with targets  Reporting the variations  Initiating suitable actions to ensure that the targets are achieved efficiently and effectively.Purpose of MCS  Assist in target.

Introduction to Management Control Systems (MCS) Chapter 1 Session 1A .

) • Nature of MCS • Organizational Context of MCS • Types of MCS—Formal and Informal Control Systems • Types of Formal MCS • Types of Informal MCS .The Discussion Themes (contd.

Based on clear multiple. Minimizes control losses (i.. not assumptions 9. Accurate—avoids distortions 8. Timely—available when needed to take any corrective action .e. Future-oriented—seek opportunities 2. Realistic—based on facts. and objectives 4. Cost Effective 7. Multidimensional—fits any functional organization 5.Desirable Attributes of a MCS • An effective MCS ensures organizational success. • It enhances the ability and confidence of employees for high performance. balanced. TPP < REP) 6. 1. Derived from strategy—facilitates implementation 3.

MCS helps achieve efficiency (performance vs. performance).Organizational Context of MCS MCS helps managers to integrate efforts of internal stakeholders ( sub-units that perform activities) and external stakeholders (outsiders who have a stake and expectations of performance). • Organizations  Sub-units  Effectiveness and Efficiency • Stakeholders—Build strong relationships  Attracting and keeping the best employees  Mutually beneficial relationships with communities  To know the customers intimately  Trusting relationships with suppliers . Control systems must be adaptive. resource consumption) and effectiveness (purpose vs.

quotas) Management-initiated mechanism for achieving organizational goals.g. group norms.g. Policies and procedures to be followed by the members. budgets. Assists management in strategy implementation... unwritten. emergent roles activities engaged in by the members of the organization Increases organization’s ability to make adaptive responses • • • • • • . organizational culture) Originate with employees. affected by sociocultural factors Interpersonal relationships.Types of MCS • FORMAL MCS Arise out of documentation (e. rules. • INFORMAL MCS Arise out of employee behaviour (e.

Types of Formal MCS Classified as: 1. . Process controls: involves tracking of relevant variables and taking corrective action when there is a significant deviation from specified parameters of a variable (e. Output controls: involves evaluation of results when performance standards are set and monitored. Input controls:actions taken before implementation of planned activity (selection criteria. adjustment of inventory levels to reduce production due to decline in sales) 3..g. manpower allotments. strategic plans) 2.

. rituals. 2.Types of Informal MCS Classified as: 1. Cultural controls: involves reinforcing the stories. Self-control: involves setting personal objectives by individuals. Social controls: the prevailing social perspectives and patterns guiding interpersonal interactions within the organization. They require internalization of values and mutual commitment towards common goals. 3. monitoring their attainment and adjusting behaviour in the organisation to attain them. Self-control is effective if there is goal-congruence. legends and other norms of social interaction within the firm.

Components of Formal MCS • • • • • Management style and organizational culture Firm infrastructure Rewards systems Coordination and Integration mechanisms Control Process .

Components of Informal MCS • • • • Recognition and rewards Informal coordinating mechanisms Style and culture Informal control process .

elements of an MCS. purpose of MCS Day 2: • Attributes of MCS • Organizational context of MCS • Types of MCS • Types of formal and informal MCS . General Electric—typical hierarchy of MCS. why managers need control.Summary of Chapter 1 Day 1: • What is control.what do managers control • Levels of control • What is MCS.

• As the Head of an automobile production plant. you intend to institute certain control systems in your factory. which control system (s) would you implement in your organization? Why? .Questions for discussion • Identify organizations which have a proven record of building strong stakeholder relationships. What would be the major control systems that you would implement? • What control systems are needed by advertising agencies to survive fierce competition? • If you were the CEO of a management consultancy firm like McKinsey.

Design of Management Control Systems Chapter 2 .

Hewlett Packard case .Chapter Highlights • • • • • Various approaches to MCS implementation Cybernetic approach Contingency approach Strategic context and MCS design differences Strategy and MCS:Texas Instruments vs.

• Contingency approach: focuses upon a potential explanation for the diversity of MCS in practice. .Alternative Design Paradigms • Cybernetic or general systems approach: focuses upon design of essential elements of the control process in an economical way.

dealing with the self-regulating properties in different systems (machines. human body). radar control. computerized inventory systems). once it is put into operation it can automatically monitor the situation and take corrective action when necessary (thermostat. • Cybernetic control systems have built-in monitoring systems designed to alert if things are not progressing as intended. . • A cybernetic control system is a self-regulatory control system. AI and robotics.The Cybernetic Approach • Cybernetics is the science of communication and control.

Cybernetic System Characteristics • Goal-oriented—pre-determined goals ―steer‖ selfregulating system • Complex structures—heterogeneous interacting components • Mutual interaction—multiple interactions within and among sub-systems • Complementary sub-systems comprising multiple structures and processes • Evolutionary—grows opportunistically. not static • Constructive—increase in size and complexity result from incremental improvements in existing attributes and development of new attributes .

2. 8. 3. Setting goals and performance measures/indicators Measuring achievement Comparing achievement with results Computing variances Reporting variances Identifying causes of variances Implementing action to eliminate variances in future Feedback to ensure goal achievement . 6.Cybernetic Control Process 1. 4. 7. 5.

The Cybernetic Paradigm Source 1 Initial Data Predictions and Inferences Values and Choice Target Values and Choice Target Initial Action Source 2 Feedback Data Predictions and Inferences Action .

Learning from the Cybernetic Approach When designing MCS: • Challenging and attainable standards—control is a constructive exercise to enhance employee performance. • Measurable objectives—enabling performance evaluation • Focus on few prioritized objectives and key results • Balanced focus on short-term and long-term performance variables • Uni-focal responsibility to avoid work duplication • Acceptable range of variation for value of each variable • Good feedback mechanism for early prediction • Exception reporting • Judgment of seriousness of the problem • Human insight for interpreting results .

5. interaction of organization with environment is important. MCS process differs according to firm’s strategy selection. 2. 4.The Contingency Paradigm • • • • • 1. Contradicts the universalistic and mechanistic approach of an optimal design applicable to all settings. A continuum exists of firm’s strategy selection— from single industry firms to conglomerates at the two extremes. Major contingency variables: Technology Organizational structure Unique external environment Top management style Culture . Design of control systems is contingent upon strategic context. 3.

• Thus. • Different strategies require different task priorities.The Logic of the Contingency Approach • Different organizations operate in different strategic contexts. MCS design should be based upon a concern whether control system induces behaviour that is consistent with strategy. key success factors. . perspectives and behaviours for execution. • A management control system must influence the behaviour of people whose activities are being measured.

business unit. • The MCS is a tool that enables such integration in terms of strategy execution. . and functional.Learning from the Contingency Approach • Strategy and control are interrelated. not separate organizational functions. • MCS design must be adapted to the level and type of strategy—corporate (organization as a whole). the two must be integrated. • To gain competitive advantage.

Levels of Strategy Characteristic Type Frequency Corporate Conceptual Periodic/sporadic Business unit Mixed Functional Operational Periodic/sporadic Periodic Measurability Adaptability Risk Value judgment based Low High Semi-quantifiable Usually quantifiable Medium Moderate Medium High Low Small Profit potential Large Cost Time horizon Relation to present Need for flexibility Cooperation required Major Long-range Innovative High High Medium Medium-range Mixed Medium Medium Modest Short-range Supplementary Low Low .

use of arm’s length market pricing Incentive compensation criteria Bonus determination approach Based on financial & Based primarily on non-financial criteria financial criteria Primarily subjective. Primarily formulabased on corporate based. emphasis on meeting budgetary requirements Importance of transfer pricing Sourcing flexibility High Constrained. based on performance SBU performance .MCS Implications for Different Strategic Contexts Single-industry Strategic planning systems. synergies important Unrelated diversification Vertical only. low High Low High. high Dependence on budgeting as a Low control tool. Vertical-cumlevel of interdependencies horizontal.

Hewlett Packard (1) • Competitive advantage for to performance • Manufacturing strategy— quality & delivery driven. rapid growth. standard markets based on long-run cost position • Marketing strategy—high volume/low to cost • Manufacturing strategy— scale economies & learning curve.Texas Instruments vs. large low-cost locations • Financial strategy— aggressive. customized products • R&D strategy—product only. no-debt . products • R&D strategy—process and product. std. high-debt • Competitive advantage for selected small markets based on unique high-value/high features product • Marketing strategy—high value/high price.cost driven.quality & features driven. controlled growth. small attractive locations • Financial strategy— conservative.

mature large ―cash cow‖ businesses provide resources for young high-growth ones low-growth businesses with dominant market shares • Product life cycle–create new markets for new products. standard product needs • Portfolio analysis— balanced portfolio. cost-effective production processes ( continuous flow/ assembly line) to match high-volume. targeted higher margins. reallocation of resources only to fund new business. then expansion & consolidation. followed by market exit or introduction of new products at maturity • Costs and prices (learning curve)— less emphasis on manufacturing cost improvements. high-margin businesses with dominant market shares to meet own resource needs. new products-new business oriented. dominant market share at maturity • Costs and prices (learning curve)—aggressive cost improvements with equally aggressive price cuts • Product/process matrix—capital intensive.Texas Instruments vs. held prices longer • Product/process matrix—flexible production processes (batch/job shop) to match low-volume. customized product needs • Portfolio analysis— high growth. . high-growth. Hewlett Packard (2) • Product life cycle–early entry.

responsibility assigned for cost control Performance evaluation—frequency. frequency of feedback. revisions to budget during the year. importance of meeting budget. investment appraisal methods. grouping of expenses and revenue generation. behaviour control Incentive compensation—bonus criteria. linkage with incentives 1. 4. tiers of evaluation. proportion of bonus compensation. .Texas Instruments vs. 3. output vs. bonus determination approach Reporting system—frequency of reporting. formalization of capital expenditure decisions Budgeting—role of budgets. 5. 2. Hewlett Packard (3) • Do differences in strategy of TI and HP call for differences in design of MCS? Differences might arise in the following areas: Strategic planning—importance of SP. capital projects evaluation criteria. performance indicators. frequency of bonus payment.

MCS Design Process Chapter 3 .

culture and MCS design Impact of IT on MCS design A TQM-focused culture for MCS .Chapter Highlights • • • • • Pre-requisites of MCS design Factors influencing design of MCS Relationship between style.

. • Identification of possible causes of MC problems (what is likely is different from what is desired)— 1. lack of direction (lack of knowledge of what is desired). motivational problems (self-interest.Designing MCS—The Pre-requisites • An understanding of what the organization wants from each individual employee • Role identification of each individual employee (at all levels) in achieving organizational goals. fraud and theft) and 3. personal limitations (lack of intelligence. stamina. • Specification of choice of controls (standards) for employees . KAs are firm-specific and person-specific. 2. experience. use of Key Results (KRs) • Identification of key actions (KAs) to be controlled. knowledge of assigned tasks. training.

employee actions are the focus of control. most popular and direct form of controls. involves rewarding individuals / groups for generating good results / punishing them for poor results. . encourages talent discovery and development. • Personnel and culture controls: complement imperfections in action and results controls. sometimes dominant form of control. • Results controls: encourages desirable employee actions by focusing on their consequences.Choice of Controls • Action controls: ensures employees perform / do not perform certain actions known to be beneficial / harmful to the organization. They take steps to ensure employees will control their own behaviour / each other’s behaviour . employees empowered to take necessary action for desired results.

limits on access. Can be applied physically ( locks. frustrating. pre-action reviews. • Pre-action Reviews—involve formal (approval for expenditures. fingerprint/voicepattern/eye-ball pattern/ magnetic identification-card readers) or administratively (restriction of decision-making authority. • Redundancy—involves assigning more people or machines to a task than is theoretically necessary (have a back-up task force for security and computing facilities) to ensure task accomplishment. expensive. redundancy. Prevention-based. Reviewers approve/disapprove proposed actions. . detection based • Behavioural constraints—negative form of control making it impossible/ difficult for people to do things that should not be done. ask for modifications/ careful consideration before approval. passwords. Prevention vs. Prevention-based. action accountability.Action Controls • 4 basic forms: behavioural constraints. • Action accountability—involves holding employees accountable for actions they take. conflicting. budget process)or informal (discussion to check project progress) scrutiny of action plans of individuals being controlled. rewarding acceptable (good) actions and punishing unacceptable actions. separation of duties). Prevention-based.

3. 2. providing rewards and punishments . measuring performance. Used for employees at many organizational levels In decentralized organizational structures Elements of results controls— defining performance dimensions.Results controls • • • • 1. Create meritocracies. setting performance targets. 4.

3. Result controls: Managers know what results are desired in the area controlled Individuals being monitored have significant influence on results in the desired performance dimensions. Managers can measure results effectively. • 1. Action Controls: Managers know what actions are desirable/undesirable. Managers can ensure that desirable actions occur and undesirable actions do not. 2. 2. .Effectiveness of Controls • 1.

cost incurrence. and adverse side-effects.Control Tightness/ Looseness • Major management decision • Tightness of controls is a function of knowledge. need for adjustment to change • Right balance of tightness/looseness of controls ensured by combination of control forms .

Factors influencing MCS Design • • • • • Managerial style Corporate culture Organizational structure Organizational slack Stakeholders’ control and communication structures .