Chapter

2. Chapter 16 Managerial Control

3. Learning Objectives • After studying Chapter 16, you will know: • why companies develop control systems for employees • how to design a basic bureaucratic control system • the purpose for using budgets as a control device • how to interpret financial ratios and other financial controls • the procedures for implementing effective control systems • the different ways that market control mechanisms are used by organizations • how clan control can be approached in an empowered organization

4. Introduction • Control • any process that directs the activities of individuals toward the achievement of organizational goals • planning and controlling are interdependent • effective planning facilitates control • control facilitates planning • three broad strategies for organizational control • bureaucratic - use of rules, regulations, and formal authority • market - use of pricing mechanisms to regulate activities • clan - employees share organizational values and act in accordance with them

5. Leadership Symptoms Of An Out-Of-Control Company Misplaced confidence Blame deflection Avoidance An eye to the past Blind optimism Setting a poor example Isolation

6. Characteristics Of Controls Features and requirements System control Bureaucratic control Uses formal rules, standards, hierarchy, legitimate authority. Works best where tasks are certain and workers are independent. Market control Uses prices, competition, profit centers, exchange relationships. Works best where tangible output can be identified and market can be established between parties. Clan control Involves culture, shared values, beliefs, expectations, and trust. Works best where there is “no one best way” to do a job and where employees are empowered to make decisions.

7. Measure performance Compare Determine deviation Standards Within limits Take corrective action No Yes Continue work progress The Control Process Set performance standards

8. Bureaucratic Control Systems • The control cycle • Step 1: setting performance standards • standard - expected performance for a given goal • target that establishes a desired performance level, motivates performance, and serves as a benchmark against which actual performance is assessed • can be set for any activity • should be specific, measurable, challenging, and established to improve performance • typically is derived from job requirements • set with respect to quantity, quality, time, and cost Dial Up User’s High Speed User’s

9. Bureaucratic Control Systems (cont.) • The control cycle (cont.) • Step 2: measuring performance • performance data obtained from three sources • written reports • oral reports • personal observation

10. Bureaucratic Control Systems (cont.) • The control cycle (cont.) • Step 3: comparing performance with the standard • evaluation of the performance • for some activities, small deviations from the standard are acceptable • for other activities, a slight deviation may be serious • principle of exception - control is enhanced by concentrating on the significant deviations from the standard • only exceptional cases require corrective action

11. Bureaucratic Control Systems (cont.) • The control cycle (cont.) • Step 4: taking corrective action • ensures that operations are adjusted where necessary to achieve the initially planned results • type of corrective action depends on the nature of the problem • higher-ups can take corrective action • operator at the point of the problem can take corrective action • specialist control - engineering specialist • operator control - multiskilled operators can rectify their own problems

12. Bureaucratic Control Systems (cont.) • Approaches to bureaucratic control • feedforward (preliminary) control - control process used before operations begin • future oriented • prevent problems before they occur • includes policies, procedures, and rules • concurrent control - control process used while plans are being carried out • the heart of any control system • directing, monitoring, and fine-tuning activities as they are occur • advances in information technology have created powerful concurrent controls

13. Bureaucratic Control Systems (cont.) • Approaches to bureaucratic control (cont.) • feedback control - control that focuses on the use of information about previous results to correct deviations from the acceptable standard • implies that performance data were gathered and analyzed • results used to make corrections • timing is an important aspect of feedback control • some feedback processes are under real-time (concurrent) control

14. Sigma level Examples of four sigma quality DPMO 2 308,537 3 66,807 4 6,210 5 233 6 3.4 Relationship Between Sigma Level And Defects/Million Opportunities 20,000 lost articles of mail per hour Unsafe drinking water 15 minutes per day 5,000 incorrect surgical operations per week 200,000 wrong prescriptions each year No electricity for 7 hours each month

15. Bureaucratic Control Systems (cont.) • Management audits • evaluation of the effectiveness and efficiency of various systems within an organization • external audit - evaluation conducted by one organization, such as a CPA firm, on another • may conduct external audit of a competitor for strategic decision-making purposes • useful for feedback and feedforward control • internal audit - periodic assessment of a company’s own planning, organizing, leading, and controlling processes • assess what the company has done for itself and its customers • reviews the company’s past, present, and future

16. Bureaucratic Control System (cont.) • Budgetary control • most widely recognized and commonly used method of managerial control • budgeting - process of investigating what is being done and comparing the results with the corresponding budget data • used to verify accomplishments or remedy differences • fundamental budgetary considerations - begins with an estimate of sales and expected income • budgeting information is supplied to the entire company or any of its units • not confined to financial matters • budgets prepared for a definite time period Dial Up User’s High Speed User’s

17. Bureaucratic Control System (cont.) • Budgetary control (cont.) • fundamental budgetary considerations (cont.) • budgetary control proceeds through several stages • establishing expectancies - starts with the broad company plan and sales estimates • ends with budget approval and publication • budgetary operations - find out what is being accomplished and compare the results with expectancies • taking corrective action (if necessary)

18. Types Of Budgets Sales (prepared by month, area, or product) Master (all major business activities) Production (expressed in physical units) Cash (anticipated receipts and expenses) Cost production (compare costs with sales price) Budget focuses on:

19. Bureaucratic Control System (cont.) Accounting audits procedures used to verify accounting reports and statements performed by an outside firm of public accountants Activity-based costing (ABC) cost accounting method that identifies streams of activity employees break down what they do to define basic activities total expenses computed by traditional accounting total amounts spread over the activities according to time spent on each provides an accurate picture of how costs should be charged highlights where wasted activities are occurring

20. How Dana Discovers What Its True Costs Are Fixed Costs Supplies Salaries Fringes Old way Process sales orders $144,846 Source parts $136,320 Expedite supplier orders $ 72,143 Expedite internal processing $ 49,945 Receive supplier quality $ 47,599 Reissue purchase orders $ 45,235 Expedite customer orders $ 27,747 Schedule intracompany sales $ 17,768 Request engineering change $ 16,704 Resolve problems $ 16,648 Schedule parts $ 15,390 Salaries $371,917 Fringes $118,069 Supplies $76,745 Fixed costs $23,614 New way Activity- based costing Total $590,345 Total $590,345

21. Bureaucratic Control System (cont.) Financial controls balance sheet - report that shows the financial picture of a company at a given time itemizes: assets - the values of various items the corporation owns liabilities - the amounts the corporation owes to various creditors stockholders’ equity - amount accruing the corporation’s owners shows trends over time gives managers insight into overall performance identifies areas which require adjustments Assets = Liabilities + Stockholders’ equity

22. Bureaucratic Control System (cont.) Financial controls (cont.) profit and loss statement - itemized financial statement of the income and expenses of a company’s operations comparisons of profits and losses can identify trouble areas a common control for the enterprise as a whole may be used at the division and department level

23. Comparative P&L Statements For The Years Ending June 30 Increase of decrease This year Last year Income: Net sales $253,218 $257,636 $ 4,418 Dividends from investments 480 430 50 Other 1,741 1,773 32 Total 255,439 259,839 4,400 Deductions: Cost of goods sold 180,481 178,866 1,615 Selling and administrative expenses 39,218 34,019 5,199 Interest expense 2,483 2,604 121* Other 1,941 1,139 802 Total 224,123 216,628 7,495 Income before taxes 31,316 43,211 11,895* Provision for taxes 3,300 9,500 6,200* Net income $28,016 $33,711 $5,695* *Decrease

24. Bureaucratic Control System (cont.) Financial controls (cont.) financial ratios - indicate possible strengths and weaknesses calculated from selected items on the profit and loss statement and the balance sheet liquidity ratios - indicate the ability to pay short-term debts current ratio - indicates the extent to which short-term assets can decline and still be adequate to pay short-term liabilities leverage ratios - show the relative amount of funds in the business supplied by creditors and shareholders debt-equity ratio - indicates the company’s ability to meet its long-term financial obligations

25. Bureaucratic Control System (cont.) Financial controls (cont.) financial ratios (cont.) profitability ratios - indicate management’s ability to generate a financial return on sales or investment return on investment (ROI) - ratio of profit to capital used rate of return from capital using financial ratios - exclusive reliance on financial ratios can have negative consequences including: management myopia - focus on short-term earnings and profits at the expense of longer-term strategic obligations relegating other important considerations to a secondary position ratios should be supplemented with other control measures

26. Bureaucratic Control System (cont.) Downside of bureaucratic control control system can lead to dysfunctional behavior rigid bureaucratic behavior - acting in ways that make one look good on the control system’s measures may result in rigid, inflexible behavior geared toward doing onlywhat the system requires stay out of trouble by following the rules tactical behavior - behavior aimed at “beating the system” manipulate or falsify performance data falsify their predictions or requests for the future concern about individual rather than organizational performance

27. Bureaucratic Control System (cont.) Downside of bureaucratic control (cont.) control system can lead to dysfunctional behavior (cont.) resistance to control control systems increase the accuracy of performance data and make employees more accountable for their actions control system can change expertise and power structures control system can change the social structure control system may be perceived as an invasion of privacy

28. Bureaucratic Control System (cont.) Designing effective control systems establish valid performance standards most effective standards expressed in quantitative terms measures should not be easily faked or sabotaged system should incorporate all important aspects of performance too many measures create overcontrol and employee resistance system has stated tolerance ranges provide adequate information employees must understand the importance and nature of the control system people need feedback about performance information should be accessible

29. Bureaucratic Control System (cont.) Designing effective control systems (cont.) ensure acceptability to employees systems have useful performance standards overcontrol is not an issue believe the standards are possible to achieve emphasize positive behavior rather than focusing on controlling negative behavior alone standards are established participatively use multiple approaches include both financial and nonfinancial performance goals incorporate aspects of feedforward, concurrent, and feedback control

30. The Other Controls: Markets And Clans Market control involves the use of economic forces - and the pricing mechanisms that accompany them - to regulate performance where output from any organizational unit has value to others, a price can be negotiated for its exchange as a market for these transactions becomes established: price becomes an indicator of the value of the product or service price competition effectively controls performance market controls at the corporate level used to regulate independent business units business units treated as competing profit centers profit and loss data used to evaluate performance

31. The Other Controls: Markets And Clans (cont.) Market control (cont.) market controls at the business unit level regulates exchange among departments and functions transfer price - price charged by one unit in the organization for a product or service that it supplies to another unit of the same organization ideally, reflects the price that the receiving business unit would have to pay for that product or service in the marketplace provide natural incentives to keep costs down when organization has the option to outsource products and services to external partners

32. The Other Controls: Markets And Clans (cont.) Market control (cont.) market controls at the individual level market rate is often the best indicator of an employee’s potential worth provide a natural incentive for employees to enhance their skills and offer them to potential firms boards of directors use market controls to manage CEOs incentives on top of base salary include: bonus tied to short-term profit targets long-term incentives linked to the firm’s share price, usually through stock options

33. Examples Of Market Control Business unit manager Business unit manager Business unit manager Business unit manager CEO uses market controls to evaluate performance of business unit heads CEO/ President Managers use transfer pricing to establish values for internal transactions among units Market rates determine the base wage/salary for managers and employees

34. The Other Controls: Markets And Clans (cont.) Clan control: the role of empowerment and culture bureaucratic and market controls are no longer sufficient because: employees’ jobs have changed the nature of management has changed the employment relationship has changed empowerment - has become a necessary aspect of a manager’s repertoire of control employees trusted to act in the best interests of the firm does not mean giving up management control clan control - create relationships built on mutual respect encourage each person to take responsibility for her/his actions

35. Management Control In An Empowered Setting 1. Put control where the operation is 2. Use “real time” rather than after-the-fact controls 3. Rebuild the assumptions underlying management control to build on trust rather than distrust 4. Move to control based on peer norms 5. Rebuild the incentive systems to reinforce responsiveness and teamwork

36. The Other Controls: Markets And Clans (cont.) Clan control (cont.) understanding culture’s role in control organization culture - the foundation of clan control set of important assumptions about the organization and its goals and practices that members of the company share provides a framework that organizes and directs people’s behavior on the job strong culture - everyone understands and believes in the firms’ goals, priorities, and practices weak culture - different people hold different values confusion about corporate goals

37. The Other Controls: Markets And Clans (cont.) Clan control (cont.) diagnosing culture - clues about culture corporate mission statements and official goals business practices symbols, rites and ceremonies the stories people tell cultures can be categorized according to whether they emphasize flexibility versus control and whether their focus is internal or external to the organization

38. Competing Values Model Of Culture Flexible Processes External Positioning Internal Maintenance Control-Oriented Processes Group Adhocracy Rational Hierarchy

39. The Other Controls: Markets And Clans (cont.) Clan control (cont.) diagnosing culture (cont.) general cultures can be categorized group culture dominant attribute: cohesiveness, participation, teamwork, sense of family leadership style: mentor, facilitator, parent-figure bonding: loyalty, tradition, interpersonal cohesion strategic emphasis: toward developing human resources, commitment, and morale

40. The Other Controls: Markets And Clans (cont.) Clan control (cont.) diagnosing culture (cont.) adhocracy dominant attribute: entrepreneurship, creativity, adaptability, dynamism leadership style: innovator, entrepreneur, risk taker bonding: flexibility, risk, entrepreneur strategic emphasis: toward innovation, growth, new resources

41. The Other Controls: Markets And Clans (cont.) Clan control (cont.) diagnosing culture (cont.) hierarchy dominant attribute: order, rules and regulations, uniformity, efficiency leadership style: coordinator, organizer, administrator bonding: rules, policies and procedures, clear expectations strategic emphasis: toward stability, predictability, smooth

42. The Other Controls: Markets And Clans (cont.) Clan control (cont.) diagnosing culture (cont.) rational dominant attribute: goal achievement, environment exchange, competitiveness leadership style: production and achievement-oriented, decisive bonding: goal orientation, production, competition strategic emphasis: toward competitive advantage and market superiority

43. Clan control (cont.) managing culture to reinforce clan control approaches to managing culture corporate leadership should espouse lofty ideals and visions for the company that will inspire the organization’s members executives must be attentive to the mundane details of daily affairs top management must behave appropriately during moments of truth when hard choices have to be made top management must celebrate and reward those who exemplify the new values clan control is a “double edged sword” takes a long time to develop and even longer to change if change is advisable, must unlearn old values and embrace the new The Other Controls: Markets And Clans (cont.)