THE LEVERS OF CONTROL FRAMEWORK

BMAN 31040ADVANCED MANAGEMENT ACCOUNTING Semester 1

Lecture 3Friday, 15th October 2010

Dr. Androniki Triantafylli,Manchester Business School, UK

AIMS OF THIS LECTURE

To locate management accounting within the broader control framework used in organizations. This session uses Simons’ concept of levers of control. This is a technical/positivist frame. Within this frame, management accounting is a diagnostic tool

OLD AND NEW CONTROL PHILOSOPHIES

OLD CONTROLS Top-down strategy Standardization According to plan Keeping things on

track No surprises

NEW CONTROLS Customer/market

driven strategy Customization Continuous

innovation Meeting customer

needs Empowerment

MANAGEMENT CONTROL SYSTEMSDEFINITION (REVISION)

Management control systems are the formal, information-based routines and procedures managers use to maintain or alter patterns in organizational activities.

Control systems manage the tension between creative innovation and predictable goal achievement

THE FOUR LEVERS OF CONTROL

Aims/Direction

PositiveInspiration/Energising

NegativeConstraints/Compliance

Non-cybernetic

BeliefSystems

BoundarySystems

Cybernetic InteractiveControlSystems

DiagnosticControlSystems

APPLYING THE FOUR LEVERS

Belief systemsinculcate core values

Boundary systemsspecify risks to beavoided

Interactive controlsystems resolvestrategicuncertainties

Diagnostic controlsystems measurecritical performancevariables

BELIEF SYSTEMS

Controls the search for opportunities Provides values, purpose and direction Drives business strategy Inspires enthusiasm and commitment Energizes Focuses loyalties Creates an organizational identity

BELIEF SYSTEMS: EXAMPLES

Johnston & Johnston: Credo “We believe that our

first responsibility is to the doctors, nurses, and patients, to mothers and fathers and all others who use our products and services…..”

Boston Retail Clothing: Mission “Boston retail

clothing was founded to offer young-at-heart customers the best in fashion, value and fun….”

BOUNDARY SYSTEMS

Delineate the acceptable domain of business activity (business conduct boundaries)

Establish limits, based on defined business risks

Narrows possibilities to enable choice (strategic boundaries)

Designates an opportunity space that organizational members can exploit

BUSINESS CONDUCT BOUNDARIES:EXAMPLES

Business principle of an investment bank “Our assets are

our people, capital and reputation. If any of these are lost, the last is the most difficult to regain.”

GE institutes a code of business conduct Two lower-level

employees in its defense business misallocate project accounting costs, the US government suspends the company as a supplier.

STRATEGIC BOUNDARIES: EXAMPLES

In 1970s Chrysler refocuses its business on North American auto and truck production, sells off tank businesses and exits from leasing.

Jack Welch, then Chairman of GE states that the company will exit any business in which it cannot achieve a number one or two position.

DIAGNOSTIC CONTROL SYSTEMS

Identifies pre-determined standards Measures outputs from the system Measures any deviations of outputs

from standard Corrects any deviation from standard Monitors progress Predicts goal achievement

DIAGNOSTIC CONTROL SYSTEMS: EXAMPLES

Goals and objectives Business plans Project monitoring

systems Brand revenue/

market share monitoring systems

Human resource plans

P/L accounts Budgets Expense centre

budgets Standard cost

accounting systems ROI and RI ratios Cost/Volume/Profit

plans

INTERACTIVE CONTROL SYSTEMS

Scans and reports critical changes in the environment

Promotes internal dialogue on key external events

Allows the organization to seize on new opportunities

Drives adaptation and innovation Encourages the emergence of new strategic

initiatives Managers involve themselves regularly and

personally in the decisions of subordinates

CHARACTERISTICS OF INTERACTIVE CONTROL SYSTEMS

Focus on constantly changing information that top-level managers have identified as potentially strategic

The information is significant enough to demand frequent and regular attention from operating managers at all levels at the organization

The data generated by the interactive system are best interpreted and discussed in face-to-face meetings of superiors, subordinates and peers

Catalyst for an on going debate about underlying data, assumptions and action plans

USES OF INTERACTIVE CONTROL SYSTEMS

A senior manager’s decision to use a specific control system interactively sends a clear signal to the organization about what’s important. Through the dialogue and debate that surround the interactive process, new strategies emerge.

Only one MCS is used interactively at a time because it demands high levels of managerial attention

INTERACTIVE CONTROL SYSTEMS: EXAMPLES

Pepsi is facing a 7% share of the market against Coke’s 37%. Top management at Pepsi in dialogue with a Texas ad agency launch the “Pepsi Challenge” -one of the most devastating ad campaigns ever.

Turner Construction company uses an interactive project management team to monitor the strategic uncertainties of changes in owner psychology, loss of reputation in the trade and financial management risk.

EXPLORING HOW ‘LEVERS OF CONTROL’ WORK IN ORGANIZATIONS

Widener (2007) looks at how strategic risk and uncertainty relate to ‘levers of control’ which in turn affect learning and attention and, ultimately, organizational performance. This study is also technical/positivist. It uses data from: A survey of 122 Chief Financial Officers

THE INTERDEPENDENCE OF CONTROL SYSTEMS- COMPLEMENTS OR SUBSTITUTES?

When firms emphasise beliefs systems they also emphasise the other three systems. Also when they use interactive performance measures they also use diagnostic ones. This suggests that the systems are complements rather than substitutes.

Control of business strategy is achieved by integrating the four levers of beliefs systems, diagnostic control systems, and interactive control systems. The power of these levers in implementing strategy does not lie in how each is used alone, but rather in how the forces create a dynamic tension (Simons, 2000)

Simons (1995) suggests that the four levers create tension in that two of the levers-the beliefs and interactive control system- create positive energy, while the remaining two levers create negative energy.

COSTS AND BENEFITS OF CONTROL SYSTEMS

There is an assumption that firms only implement control systems when the benefits outweigh the costs but, so far, there is little evidence to support this. Widener found that levers of control systems aid organizational learning but have a cost in terms of management attention. Overall, she found that they have a positive affect on firm performance

IS THERE AN ALIGNMENT BETWEEN ORGANIZATIONAL STRATEGY AND MCS?

Widener finds that both strategic uncertainties and strategic risk are associated with the use of levers of control

Internal strategic factors are associated with diagnostic controls

External strategic factors are associated with interactive controls

WHY IS THE USE OF BELIEF SYSTEMS ASSOCIATED WITH USE OF THE OTHER THREE?

It is important that all four ‘levers’ are balanced A mission statement is only a ‘starting point’ and

may not be effective unless it is supported by the other three levers

The boundary system constrains the exploration generated by the beliefs system so it ‘fits inside’

Diagnostic systems measure the appropriate critical success factors linked with the values of the company

Interactive systems can identify the potential threats and opportunities that stem from the communication of company’s strategy through beliefs systems

STRATEGIC UNCERTAINTY AND RISK (REVISION)

Strategic uncertainty equates to the emerging threats and opportunities that could invalidate the assumptions upon which the current business strategy is based

Strategic risk is an unexpected event or set of conditions that significantly reduces the ability of managers to implement their intended business strategy

SU/SR AND BELIEF AND BOUNDARY SYSTEMS Strategic uncertainty arises from changes in

competitive dynamics or internal competences Strategic risk stems from malfunctions in internal

operations or external disruptions to the customer base or sudden new competitor rivalry

Strong belief and boundary systems are intended to counteract undesirable behaviour and minimise the negative behavioural affects associated with strategic uncertainty and risk. For example, Merchant (1990)found that profit centre managers are more likely to manipulate earnings when there is strategic uncertainty

WIDENER PROPOSES THAT:

The extent to which firms face strategic uncertainty and strategic risk is positively associated with the emphasis they place on beliefs and boundary systems

The extent to which firms face strategic uncertainty and strategic risk is positively associated with the emphasis they place on performance measures in diagnostic and interactive systems (where measurements are available)

WIDENER USES THE FOLLOWING DEFINITIONS: Three types of strategic uncertainty:

Operating uncertainty (eg scale effects and internal product innovation)

Competitive uncertainty(eg new industry entrants) Technological uncertainty (eg new technology)

Three types of strategic risk:

Operating risk (eg safety of operations) Asset impairment risk (eg accounts receivable turnover) Competitive risk (eg marketplace factors)

WIDENER FINDINGS-1

Many of the controls in the levers of control framework are interdependent and complementary. So in order to realise the full value of performance systems they must be used diagnostically and interactively

The belief system positively influences all the other systems

WIDENER FINDINGS-2

Two types of strategic uncertainty (competitive and operational but not technological) are associated with a reliance on control systems

Operational uncertainty (which can be measured) has the largest effect on diagnostic and belief systems

Competitive uncertainty (which is difficult to quantify) has the largest effect on interactive controls

WIDENER FINDINGS-3

Her findings are consistent with other research that shows that firms implement mechanisms to process information. As uncertainty increases the information deficit increases leading to increased reliance on mechanisms that facilitate the processing of information.

WIDENER FINDINGS-4

One type of strategic risk (operational but not asset impairment or competitive risk) is associated with a reliance on control systems. Specifically, more emphasis is placed on the beliefs system and the performance management system is used both diagnostically and interactively where there is strategic risk.

WIDENER CONCLUSIONS

The four levers of control are NOT substitutes for one another

The benefits of control systems (organizational learning) outweigh the costs (consumption of managerial attention)

Control systems have a positive effect on performance