Fundamentals of Management Control

Chapter-I

Management Control Systems 1

Discussion Points

• Need for Management control

• Cybernetic process of Management control

• Objectives of Management control

• Schemes for classifying Management control

• External and Internal contextual factors

Management Control Systems 2

Focus of an Business Enterprise

• An Enterprise has to use its resources effectively and efficiently for:

Maintaining Competitive edge over competitors.

Meeting the growing demands of stakeholders.

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A Management control system assist the management in A Management control system assist the management in

formulating strategies, coordinating the activities of the formulating strategies, coordinating the activities of the

organization, and in steering those activities toward the organization, and in steering those activities toward the

achievement of the overall goals and objectivesachievement of the overall goals and objectives

Need for Management Control

• Absence 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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Cybernetic Approach to Management Control

• The term ‘Cybernetics’, coined by Norbert Weiner

in the 1940s, has its origin in the Greek word ‘Kybernetes’.

• According to Weiner, “cybernetics is the study of the entire field of control and communication theory, whether in the machine or the animal”.

• Even though control systems are tailored to suit specific situations, they often involve basic process.

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Basic Control Process

• Determining areas of control

• Establishing Standards

• Measuring performance

• Comparing actual performance against standards

• Rewarding performance and/or taking corrective action

• Adjusting standards and measures when necessary

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Determining areas of control

• Quite expensive and virtually impossible to control

every activity in an organization.

• Determined based on the Organizational goals and

objectives defined during the planning process

• Exercising control over critical areas helps manage

a large number of subordinates effectively,

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Establishing standards

• Standards state the criteria on the basis of which employee performance and related behavior can be evaluated.

• Standards are often incorporated into goals when the goals are established during the planning process.

• Helps employees understand what is expected of them and how their work will evaluated.

• Provides a basis for identifying job difficulties with reference to personal limitations of employees.

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Measuring performance

• Once standards have been established, the actual performance must be measured.

• Performance standards are clearly established evaluating the expected or actual performance becomes fairly easy.

• Qualitative performance measures may include qualitative judgment by peers.

• Managers has to decide how frequently performance is measured.

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Comparing actual performance against standards

• Performance measured in step 3 is compared with the standards established in step 2.

• Comparison enables managers to determine whether the actual performance meets the standards earlier.

• Computerized information systems give supervisors direct access to real time, unaltered data and information.

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Rewarding performance and/or taking corrective action

• Managers should recognize and acknowledge good or positive performance by their employees.

• When the negative discrepancy occurs between the actual output and predetermined performance standards, specific corrective actions must be taken to correct the situation.

• Managers redraw their plans or modify their goals to correct deviations.

• The control process fails when the recommended corrective actions are not implemented properly.Management Control Systems 11

Adjusting standards and Measures when necessary

• Established standards may not be realistic.

• To ensure that standards and their associated performance measures meet future needs, managers must periodically review the standards.

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Management by Objectives (MBO)

• Management by Objectives was a concept

popularized by Peter F.Drucker in 1954.

• Key feature: setting of goals/objectives jointly by

the supervisor and the subordinate.

• Objectives should be SMART (Specific, Measurable,

Achievable, Realistic and Time Specific) Management Control Systems 13

MBO Process

Develop Overall Organizational Goals

Establish specific goals for various departments, subunits, and

individuals

Formulate action plans identifying the problem areas

Implement and Maintain self-control

Conduct periodic review of the plans

Appraise performance of the subordinate

FEED BACK

MBO as a Control Tool

• MBO is an important control tool that facilitates the integration of individual, group and organization objective.

• MBO forces the management to clearly state objectives, it leads to the development of effective controls.

• MBO helps in evaluation and control and in turn in better management.

• MBO Facilitate impartial performance appraisal.Management Control Systems 15

Limitations of MBO

• Failure to understand and make the others understand the philosophy of MBO leads to failure of the MBO process itself.

• MBO process will fail if adequate guidelines are not provided to those who are expected to set goals.

• Failure to set verifiable goals against which performance can be measured will lead to the failure of the MBO process.Management Control Systems 16

Limitations of MBO-Cntd..

• Successful implementation of MBO is based on the revision of individual goals.

• It takes too much time and effort and involves too much paperwork.

• Organization may incur high costs for managerial training.

• It tends to falter without strong and sustained commitment.

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Objectives of the Management control

• Effectiveness and efficiency of business operations

• Reliability of financial reporting

• Compliance with applicable regulatory and legal frame work

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Schemes for classifying Management Controls

Classification BasisClassification Basis ClassificationClassification

Object of ControlObject of Control

Action controlsAction controls Behavioral restrictions Behavioral restrictions Pre-action appraisalsPre-action appraisals Action accountabilityAction accountability

Results controlsResults controls

Personnel /Cultural controlsPersonnel /Cultural controls

Extent of Extent of Formulation Formulation

of Controlof Control

Formal controlFormal control

Informal controlInformal control

Time of Time of implementation of implementation of

controlscontrols

Open loop controlOpen loop control

Closed loop Closed loop Feedforward controlFeedforward control Feedback controlFeedback control

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Action Controls

• Tries to ensure that all actions being taken by the personnel in an organization are aimed at achieving organizational objectives.

Behavioral Behavioral restrictionsrestrictions

These are limitations placed on the behavior of These are limitations placed on the behavior of organizational personnel and are a form of negative organizational personnel and are a form of negative disciplinediscipline

Pre-action Pre-action appraisalappraisal

This form of action control involves a supervisor This form of action control involves a supervisor reviewing a subordinate’s plans of action.reviewing a subordinate’s plans of action.

Action Action accountabilityaccountability

This form of action control entails making employees This form of action control entails making employees responsible for their actions and in essence is responsible for their actions and in essence is applicable after an action has been carried out.applicable after an action has been carried out.

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Result Controls

• Focused on the consequences of action taken rather than on the actions themselves.

• Individual rewards often accompany results controls to motivate individuals.

• Used at various levels of an organization.

• Used in conjunction with action controls.

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Personnel/cultural controls

• Aim at encouraging employees to monitor themselves and others with whom they work.

• co-exist with action and results controls.

• established in a manner that certain culture, values, beliefs, and norms of behavior become intrinsic to the organization as a whole.

• Establishing a reward system which commends group achievement is suitable for personnel/cultural controls, rather than rewards based on individual performance.Management Control Systems 22

Formal controls

• Formal controls 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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Informal controls

• 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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Open loop control

Open loop controls are said to exist when an organization has a predetermined plan for achieving a set goal/objective, but does not have a system for modifications or adjustments to its plan once the planned activities have commenced.

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Open loop control-Cntd..

• Involves monitoring of (expected) outcomes at regular intervals and taking corrective action if a deviation is expected to occur, or has actually occurred.

• Closed loop controls mechanisms are further classified into feedback control and feedback forward control.

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Feedback control

• Deviation from the plan occurs first and corrective actions taken after the deviation is measured.

• Comparison of actual performance with planned performance is done after the activity has been carried out and deviations identified, it is termed Feedback control process.

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Feed forward control

• Entails continuously scrutinizing and monitoring the various processes.

• Organizations often use feedback control in cashflow forecasting and management.

• In contrast to feedback control, feedforward control detects deviations before they occur.

• Feedforward control is an anticipatory control, whereas feedback control is a follow-up control.

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Contextual factors influencing Management control

• Nature and purpose of the organization

• Organization structure and size

• National culture

• Strategic mission and competitive strategy

• Corporate strategy and organizational diversification

• Competitive Strategy

• Managerial styles

• Organizational slack

• Stakeholder expectations and controls Management Control Systems 29

Nature and purpose of the organization

• Nature and purpose of an organization, for instance, whether it is for profit or a non-profit organization, largely determines the design of its management control systems.

• Unlike a for-profit organization, a non-profit organization operates for the well-being of society.

• Controlling employees, systems, and processes in a non-profit organization is different from controlling them in profit-seeking organizations

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Organization structure and size

• Organization structure like centralization/decentralization and span of control are important characteristics to be considered while designing the control systems.

• Control systems should be designed as to meet the demands of the complex organization structures.

• In large-sized organizations, it is necessary to develop controls such as rules, documentation of the information, creation of specialized role of functions, and a higher degree of decentralization.Management Control Systems 31

National culture

• Management Control System of any organization is influenced by the national culture of the country.

• Managers working in multinational corporations should be aware of the culture that is prevalent in the country.

• Four dimensions on which culture varies across countries are power distance, Uncertainity avoidance, individualism/collectivism and Masculinity/feminity.

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Corporate Strategy and Organizational Diversification

• Controls at the corporate strategy level help in giving a strategic direction to the organization.

• Management Control systems have a good fit with the corporate strategy.

• Designing and implementing management control systems for a diversified firm is more difficult than designing control systems for a single business firm.

• Related diversified firms depend more on strategic controls while unrelated diversified firms depend more on financial controls to ensure performance.Management Control Systems 33

Competitive Strategy

• Three generic strategies to gain competitive success are Overall cost leadership, differentiation and focus.

• For overall cost leadership, management control systems are designed to achieve its objective of efficiency.

• 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 the product offerings.

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Managerial Styles

• Management Style plays an important role in influencing the behavior of the employees.

• Two common managerial styles are Autocratic and Democratic.

• Autocratic manager generally takes decisions by himself/herself, and the subordinates have to follow them.

• Democratic manager allows the subordinates to participate in the decision-making process.

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Organizational Slack

• Refers to that capacity in an organization which is in surplus what is required for normal operations.

• Creation of slack may be voluntary or involuntary and the effect of slack on the organization may be good or bad.

• Slack is important in designing management control systems and its existence, to some extent.

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Organizational Slack-Cntd..

• Management control systems in diversified firms should include tight budgetary controls.

• Control systems should not curtail to the extent that innovation and search for newer opportunities are throttled.

• Control systems may be so designed as to tolerate slack with the objective of reducing information overload at the strategic management level.

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Stakeholders expectations

• Stakeholders are defined as individuals or groups of people who are impacted and who impact the activities and operations of the organizations.

• It is necessary for the organization to consider what the stakeholders want while designing its management control systems.

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End points

• Need for Management control

• Cybernetic process of Management control

• Objectives of Management control

• Schemes for classifying Management control

• External and Internal contextual factors

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