Management Control Systems Prof. C . K . Sreedharan Unit No: 01
• In 2001, Enron Corporation, the global energy giant, collapsed in one of the largest cases of bankruptcy in US corporate history.• The news that WorldCom, the telecom giant indulged in deliberate enhancement of its earnings by $ 3.8 billion, rocked the corporate world.• In India it was Satyam Computers, which indulged in accounting irregularities with the active support by one of the leading financial auditing firms.
• All these examples show, the absence or ineffective control systems can lead to huge losses, and even to corporate bankruptcy.• Consider world-class companies like Microsoft, Colgate-Palmolive, Procter & Gamble, Infosys, Wipro etc.• Their long term success is not just because they have developed good strategies but also they execute and control the strategies effectively.
• What is MCS?• The term management control systems consists of three words, namely:1. Management2. Control and3. Systems
• Management:• It is broadly defined as planning, organizing, staffing, directing, evaluatin g and controlling (POSDEC) the activities of an organization in order to achieve the pre- determined goals within the allocated reserves.• Hence the management has to get the task performed in an efficient and effective manner and ensure the achievement of organization’s goals.
• Control:• In today’s dynamic and fiercely competitive world it becomes essential for the management to control the resources, namely- human, physical and financial.• Exercising control is one of the major functions of the management . It is required to ensure actual performance conforms to pre-determined standards.
• Control involves:a) Measurement of performance against predetermined goalsb) Identification of deviations from the goalsc) Initiating corrective actions to rectify the deviations andd) Influencing people to change their behaviour / action- Hence control is ensuring that the actual performance meets the desired level of performance.
• The main focus of this subject- Management Control Systems (MCS)- is strategy implementation.• This subject provides knowledge, insight and analylitical skills related to how a firm’s senior executives design and implement the management systems to plan and control the firm’s performance.
• System:• System can be defined as “ a group of elements, working together, in an integrated, interdependent and coordinated manner to achieve synergy and ultimate goal.
• Elements of MCS include:- Strategic planning - Responsibility center allocation - Transfer pricing- Budgeting- Resource allocation- Performance measurement- Evaluation and reward
• Management control is a must in any organization that practices “decentralization”.• One view argues that management control systems must fit the firm’s strategy.• This implies that strategy is first developed through a rational and formal process and this strategy then dictates the design of the firm’s management systems.
• Another view is that strategies emerge through experimentation, which are influenced by the firm’s management systems.• In this view, management control systems can affect the development of strategies.
• When firms operate in industries where environmental changes are predictable, they can use a formal and rational process to develop the strategy first and then design management control systems to execute the strategy.
• However, in a rapidly changing environment, it is difficult for a firm to formulate strategy first and then design management systems to execute the chosen strategy.
Simple example of a control• Press the accelerator, the car goes faster. Turn the steering wheel, the car changes direction. Press the break pedal, the car stops.• With these devices, one can control the speed and direction of the car.• If any of these devices is inoperative, the car does not do what it is expected to do.• In other words, the car is out of control.
• An organization must also be controlled-that is devices / systems must be put in place to ensure that its strategic goals and objectives are achieved.• But controlling an organization is much more complicated than controlling a car.
• Management Control System is a set of formal and informal systems to assist management in the coordination of various activities / functions of an organization and to steer the entire organization toward the achievement of overall goals and objectives.• A control system is so designed to bring unity out of the diverse activities of an organization to fulfill overall objectives.
• Types of management control systems:• MCS in an organization generally fall under two categories:1. Formal Control Systems (FCS) and2. Informal Control systems (ICS)
• Formal control system (FCS):• The controls are laid down by the management in writing to influence the behaviour of employees in achieving organization’s goals.• Examples:- Rules and regulations- Procedures- Work plan / work instructions.
• FCS establish well defined organizational structure, policies and procedures to be followed by the members of the organization.• FCS can be classified into three types:1. Input controls2. Process controls and3. Output controls.
• Input controls:• These involve taking action by the management at the planning stage .• These measures help the firm to select the right way to undertake an activity.• They include: – Selection criteria – Recruitment and training programmes – Strategic plans and – Resource allocations
• Process controls:• This involves monitoring certain variables or performance and taking corrective actions in case of any deviation.• Example: Under a feed-forward system of inventory control, the factors that affect inventory levels of finished goods, such as the rate of sales or dispatch delays are tracked.• When the sales begins to decline or there is a dispatch bottleneck, this information is fed- forward, and the level of the finished goods inventory is controlled by reducing production.
• Output controls:• Output control is exercised when performance standards are set and monitored, and the results are evaluated.• Output control takes place when the control activity is based on the comparison of actual and expected results.• Example:• Final Inspection and checking of products produced.
• Informal control system:• These are unwritten, people initiated mechanisms that influence the behaviour of individuals or groups in business units.• Example:- Group behaviour- Work culture- Organizational norms and beliefs.
• There are three types of informal controls:1. Self- control2. Social controls and3. Cultural controls.
• Self-control:• This refers to the establishment of personal objectives by the individual, monitoring their attainment and adjusting the behaviour in the organization to attain the goals.• Self-control can be beneficial to an organization if the organization’s goals are in congruence with the individuals goals.
• Social controls:• These are exercised through value system and mutual commitments between the employee and the organization towards achieving common goals.• Organization establishes certain standards, monitors conformity with the standard and takes action when deviations occur.
• Cultural controls:• These are exercised through work-culture and tradition of the organization.
• Goal congruence:• Although systematic, the management control process is by no means mechanical; rather, it involves interactions among individuals.• The main problem in the control is to induce the individuals to pursue their personal goals in such a way, that this pursuit will eventually lead to the attainment of organizational goals.• Goal congruence means that individual goals should be consistent and align with the organizational goals.
• Levels of controls in an organization: Top Strategic control / Mgt. planning Management control Middle Mgt. Lower level Mgt. Operational control
• Strategic control:• It is the function of the top management.• It involves strategy formulation for the entire organization, identifying goals, strategies and policies for the entire organization.• It is long term in nature.
• Management control:• It deals with the effective utilization of resources made available by the top- management for the accomplishment of organization’s objectives.• It is exercised by the middle management through interaction with the top management and lower level management.• It is medium term in nature.
• Operational control:• It is exercised by the lower level / shop floor level management.• It is short term in nature, the benchmarks are well defined and the outcomes are tangible and easily measurable.
• Hence strategic planning sets the guidelines for management control and management control sets the guidelines for operational control.• Hence the complete management function involves an integration of three processes: - Strategic planning / control - Management control and - Operational control
• Elements of a Control System:• Example No: 1• A thermostat controls the inside temperature of a refrigerator by switching on-off of a cooling system.• The thermostat compares the inside temperature of the refrigerator with the desired temperature and automatically switches on the cooling system.
• Example No:2• Human beings are born with a built-in standard body temperature of 98.6 degree F.• The sensory nerves(detectors) are scattered throughout the body.• The hypothalamus center in the brain (assessor) compares information received from detectors with 98.6 degree F standard.• The muscles and organs (effectors) reduce the body temperature when it exceeds the standard by making the body sweat, by opening the skin pores.• The entire nervous system acts as a communication system.
• Hence every control system has at least four elements:1. A detector or sensor: A device that measures what is actually happening in the process that is being controlled.2. An assessor: A device that determines the significance of what is actually happening by comparison with some standard or expectataion of what should happen.
3. An effector: A device that alters the behaviour if the assessor indicates the need to do so.4. A communication network : Devices that transmit information between the detector and the assessor and between the assessor and the effector.
• Elements of a control system: Control Device Assessor Detector Effector Entry being controlled Communication Network
• Framework for strategy implementation:• MCS help managers to move an organization toward strategic objectives. Thus, management control primarily focuses on strategy execution.• MCS is only one of the tools used for implementing desired strategies. Other tools listed below also are important for strategy implementation. - Organization structure - Human resource management and - Organizational culture.
• Organization structure:• It refers to the authority, responsibilities, reporting relationships and the decision making process in an organization.• Human resource management:• Selection ,training, evaluation, promotion and termination of employees so as to develop the knowledge and skills required to execute organizational strategy.
• Organizational culture:• It refers to the set of common beliefs, attitudes and norms that explicitly or implicitly guide managerial actions.
• MCS and behavioural considerations:• People are important assets for an organization.• Without the cooperation of the employees, managers can’t implement their decisions.• To manage people effectively, control systems are required for the following reasons:1. Lack of direction2. Motivational problems and3. Personal limitations
• Lack of direction:• Poor performance in organizations can be attributed to lack of direction among employees.• Giving employees the required support and direction to accomplish organizational goals is one of the important functions of MCS.
• Motivational problems:• Motivation is important to help employees to perform to their full potential.• Most of the organization’s problems are due to the fact that individual goals and organizational goals do not match.• This results in the demotivated performance by the employee.• At the managerial level too, lack of motivation will result in employees taking decisions that may be harmful to the organization.• Hence there is a need to control such a behaviour in an organization.
• Personal limitations:• This can have serious consequences for an organization.• Inspite of high motivation to perform, certain employees may be unable to perform because of their personal limitations.• The limitations could be due to inadequate training, lack of knowledge or information.• Appropriate training could be one of the solutions.• MCS may help in finding suitable tools for controlling such limitations.
• Relationship among various functions:• Management control needs to be distinguished from strategy formulation and task control.• While strategy formulation takes place at the highest level in an organization, task control takes place at the individual level.• Management control lies at the middle level between strategy formulation and task control.
• Boundaries of management control/ Relationship between various functions: Activity End result Goals, strategies and policies Strategy Formulation Management Control Implementation of strategies Task Control Efficient and effective performance of individual tasks
• Task control is the process of ensuring that specified tasks are carried out effectively and efficiently.• It involves the performance of individual tasks according to rules established in the management control process.
• Differences between strategy formulation and management control:• Strategy formulation takes place at the highest level of the management and involves formulation of new strategies, where as management control involves implementation of these strategies.
• Strategy formulation takes place in accordance with situations, both internal and external to the organization.• Hence strategy formulation may not always follow a clearly defined system, and involves only those at the highest level.• Management control process takes place in a systematic manner, and involves managers and staff at all levels in the organization.
• Differences between task control and management control:• Task control involves the control of individual tasks. These are carried out as per the rules and regulations laid down by the management control process. Task control techniques are based on operation research and management science.• The information important for task control is usually quantitative in nature. Example- the components used in a product, number of man hours etc.
• Whereas management control is oriented towards behaviour .• In task control, in some cases, such as automated processes, employees may not be involved, in other cases there may be interaction between a manager and a worker.• Management control involves interaction between a superior and subordinate.
• Differences between the management control process and simpler control processes:• In simpler control processes only planning will be present where as in management control both planning and control are present.• Simple control like controlling an automobile is automatic, but management control is not automatic. Management control involves interaction with human beings.
• In simple control ( controlling an automobile), the controlling function is done by a single individual, whereas management control requires coordination among individuals, since an organization consists of several departments.• In a simple control, control is through an external regulating device but in management control is through human control by a superior.
• Impact of internet on management control:• Internet provides the following advantages:1. Instant access2. Multi-targeted approach3. Cost economy and4. Ability to display images
• Internet cannot substitute the human element involved in the management control.• Implementing strategies through MCS involves human interaction, social and behavioural processes which can’t be automated.• MCS requires human judgement and intervention, which an internet cannot do.
• As discussed earlier, human element in MCS includes the following aspects:1. Understanding the individual goals2. Aligning these individual goals with those of the organization3. Setting performance measures for functional areas.4. Communicating strategy and specific performance objectives throughout the organization.
5. Evaluating the performance against the set standards6. Reviewing the performance and taking appropriate corrective actions7. Influencing the individuals to change their behaviour.- The above need human intervention and judgment, which cannot be replaced by the internet.
Management Control Systems Unit No:02 Strategies Prof. C.K.Sreedharan
• Management control systems are tools to implement strategies.• Strategies differ from organization to organization and the controls should be designed to meet the requirements of specific strategy.• Strategies are plans to achieve organization’s goals.
• Corporate goals are determined by the CEO or the top most person of an organization in consultation with other members of senior management.• There can be different types of goals depending on the strategy of the company, like:1. Profitability2. Maximizing shareholder value3. Risk and4. Multiple-Stakeholder approach.
• Profitability:• Also called as return on investment.• Profitability here refers to the long term profitability.• Maximizing shareholders value:• It refers to the market price of the organization’s stock.
• Risk:• Profitability of an organization is affected by the management’s ability to take risk.• The risk taking degree varies from managers to managers.• Some firm may explicitly state that the management’s primary responsibility is to preserve the company’s assets, with profitability considered as a secondary goal.
• Multiple Stakeholder approach:• A firm has the following multiple stakeholders:1. Shareholders2. Customers3. Employees4. Suppliers and5. Society / Community- The has a responsibility towards all these stakeholders.- The MCS should identify the goals for each of these groups and track the performance.
Concept of strategy• Strategy is defined as,” The general direction in which an organization plans to move to attain its goals”.• Every organization has two or more strategies depending on the SWOT analysis.• A firm develops its strategies by matching its core competencies with the industry opportunity.
• Classification of strategy: Can be classified as below: StrategyCorporate Level Business unit level
• Corporate Level Strategy:• Key strategic issues:1. Whether the present operation is in the right mix of industries?2. What industries or sub-industries the company should operate?• Generic strategic options:1. Single industry related diversification2. Unrelated diversification* Corporate level strategy is formulated at Corporate Office.
• Business Unit Level Strategy:• Key strategic issues:1. What should be the mission of business unit?2. How should the business unit compete to realize its mission?• Generic strategic options:1. Build, hold, harvest, divest2. Low cost differentiation.* Business unit level strategy are formulated by business units in consultation with Corporate Office.
• Corporate level strategy:• Based on the corporate level strategy firms can be classified as below:1. A single industry firm2. A related diversified firm and3. An unrelated business firm
• A single industry firm:• This type of firm operates in one line of business.• Example: Castrol- Lubricant industry.• A related diversified firm:• This type of firm operates in several industries, and the business units benefit from a common set of core competencies.
• Example:• Procter & Gamble is an example.• It has business units in detergent soap, toothpaste, shampoo and other branded FMCG products.• It has two core competencies:1. Core skill in chemical technology and2. Marketing and distribution expertise in FMCG branded products.
• An unrelated business:• This type of firm operates in businesses that are not related to one another.• Example:• ITC India Ltd- tobacco, paper, biscuits, hospitality, agricultur al products etc.
• Corporate level strategies- Graphical Representation High *Single Industry Degree of Relatedness * Related Diversification *Unrelated Diversification Low Extent of Diversification High
• The management control systems for different diversification strategies are quite different.• The structure and form of controls differ, which are explained subsequently.
• Business Unit / Strategic Business Unit / Divisional Structure: Chief Executive Officer StaffManager Manager ManagerBusiness Unit-1 Business Unit-2 Business Unit- 3 Staff Staff StaffPlant Marketing Plant Marketing Plant MarketingManager Manager Manager Manager Manager Manager
• A business units or SBUs act almost as if the units are separate companies, though they are part of the same parent company.• A SBU is responsible for all functions involved in producing and marketing a separate product line.• The performance of a SBU is measured by the profitability of the SBU.• Though SBU managers exercise broad authority over the SBUs, the headquarters holds certain key powers like allocating funds , approval of budgets and setting of the performance measures.
• Business Unit Strategies:• Business Unit Strategies deal with how to create and maintain competitive advantage in each of the industries in which the company has chosen to operate.• The strategy of a business unit depends on two factors:1. Its mission- its overall objectives and2. Its competitive advantage- how to compete in its industry to accomplish its mission.
• Business Unit mission:• In a diversified firm one of the important tasks of senior management is resource deployment- that is to make decisions regarding the use of the cash generated from some business units into other business units.• Several models have been developed to help diversified firms to effectively allocate resources.
• There are two planning models, which are widely used to develop the most appropriate missions for the various business units.• Both the models have the same set of missions to choose namely- Build, Hold, Harvest and Divest.• The models are:1. Boston Consulting Group’s two-by-two growth-share matrix and2. General Electrical Company / Mckinsey & Company’s three-by-three industry attractiveness-business strength matrix.
• BCG Model: High “Star” “Question Mark Hold Build Market Growth Rate “Cash Cow “Dog” Harvest Divest Low Relative Market Share Low High
• In the BCG model, every business unit is placed in one of the four categories- Question mark, star, cash cow and dog.• BCG views industry growth rate as an indicator of relative industry attractiveness and relative market share as an indicator of the relative competitive position of a business.
• BCG considers market share as one of the important strategy parameters because of the impact of experience curve.• AS per BCG, cost per unit decreases with the number of units produced over time.• Since the market share leader will have the greatest accumulated production experience, such a firm should have the lowest costs and highest profits in the industry.
• Interpretation of BCG model:• Question mark:• Business units fall in this quadrant are assigned the mission: “Build Market Share”.• By building market share early in the growth phase of an industry, the unit will enjoy low- cost position.• These units consume significant cash.
• Star:• Business units falling under this quadrant are assigned the mission: “ Hold” market share.• These units already have a high market share in their industry, and the objective is to invest cash to maintain that position.• These units generate significant amount of cash, but they also need significant cash to maintain their competitive strength in the market.
• Cash cow:• These units are the primary source of cash for the organization.• Because these units have high relative market share, they have the lowest unit costs and hence high profits.• Since these units operate in low growth or declining industries, they do not need to reinvest all the cash generated.• Hence these units generate a significant amount of cash flows.• Such units have “harvest” mission for cash flows.
• Dog: Units in this quadrant have a weak competitive position in unattractive industries.• They should be divested unless there is a good possibility of turning them around.*** The firm should identify cash cows with positive cash flows and redeploy these resources to build market share in question marks.
• Business Unit Competitive Advantage:• Michael Porter has described two analytical aids for developing a superior and sustainable competitive advantage. They are: 1. Industry Analysis or Porter’s Five Forces Model and2. Value Chain Analysis
• Porter’s Five Force Model:• Industry conditions play an important role in the performance of individual firms.• According to Porter, the structure of an industry should be analyzed in terms of the collective strength of five competitive forces.
Threat of new entrantsBargaining Intensity ofPower of Competition Bargaining powerSuppliers & Of Customers Rivalry Threat from substitutes
1. The more powerful the five forces are, the less profitable an industry is likely to be. In industries where the average profitability is high (Example- Pharmaceuticals), the five forces are weak. In industries where average profitability is low ( Example- Steel), the five forces are strong.(in steel industries, threats from substitutes is very high).
2. Depending upon the relative strength of the five forces, the key strategic issues facing the business unit will differ from one industry to another.3.Understanding the nature of each force helps the firm to formulate effective strategies.
• Generic competitive advantage:• The five- forces analysis is useful in developing a competitive advantage since it helps to identify the opportunities and threats in the external environment.• With the understanding of the five forces, Porter says that a business unit can respond to the external opportunities in two generic ways and develop a sustainable competitive advantage:1. Low cost and2. Differentiation
• Low cost:• Cost leadership can be achieved through economies of scale, tight cost control and cost minimization.• Differentiation:• The focus of this strategy is to differentiate the product offered by the business unit, creating a perception as something unique.
• Value Chain Analysis:• As explained earlier business units can develop competitive advantage based on low cost, differentiation or both.• The best choice to attain competitive position is to achieve cost-cum-differentiation.• Ultimately competitive advantage is derived from providing better customer value at a lower cost.
• Value Chain is a complete set of activities starting from raw material sourcing to post delivery support to customers.• Value Chain analysis tries to identify the activities of the firm- from design to distribution- customer value can be enhanced or costs lowered.• By systematically analyzing costs, revenues and customer value in each activity, the business unit can achieve cost –cum- differentiation advantage.
• Typical value chain of a business: Primary Activities Product development / Manufacturing / Marketing / Logistics Support Activities: Finance / HRD / IT
Management Control Systems Organization Hierarchies and Behaviour in Organizations Prof. C. K. Sreedharan Unit No: 03
• The management control systems should ensure that individual goals of the employees align with the organizational goals.• The process of alignment of individual goals with the organizational goal is called as “ Goal Congruence”.• A good management control system influences the behaviour of the organizational members in a goal congruent manner.• Hence MCS should ensure that individual actions taken to achieve personal goals also help to achieve the organizational goals.
• Both formal and informal systems influence human behaviour in an organization.• They also affect the degree to which goal congruence can be achieved.• The MCS designers should consider the impact of informal processes ( work culture, management style etc)along with the formal processes.
• Influence of informal factors on goal congruence• Informal factors can be classified as:1. External factors and2. Internal factors.
• External factors: These are norms of desirable behaviour that exist in the society.• These norms affect an organization since it is also part a society.• These norms include a set of attitudes, often selectively called as “ Work Ethic”.• Work Ethic is manifested in employee’s loyalty to the organization, their spirit , pride in doing the job etc.
• Internal factors:• The various internal factors are:1. Culture2. Management style3. The informal organization and4. Perception and communication
• Culture:• It is the most important internal factor which may impact the goal congruence.• It is a set of common beliefs, norms of behaviour and assumptions which are prevalent throughout the organization.• A company’s culture exists unchanged for many years.• Certain practices become rituals, carried out automatically because of the belief that" This is the way things are done here”.
• Management style:• Management styles like charismatic, autocratic, democratic, participative etc play major role in achieving goal congruence.• Example:• Reginald Jones was appointed CEO of General Electric Company in 1970. During that time the company faced many problems like price-fixing scandal that sent several executives to jail and also the company had to wind up its mainframe computer business.• Jones was formal, dignified, refined bright and willing to delegate enormous amount of authority.• Jones management style was well suited for bringing more decipline to the company.
• He instituted the formal strategy planning and built up one of the first strategic planning units in a major corporation.• Jones retired in 1980, the GE Board deliberately selected Jack Welch, a man with a very different management style.• Welch was outspoken, impatient, informal and an entrepreneur. These qualities well suited for the company for growth.• During his tenure, mega acquisitions, rapid expansion into Europe and Asia and implementation of concepts like six sigma – put GE in a growth trajectory.
• The informal organization:• The organizational chart shows a formal relationship- that is, the official authority and responsibilities.• An informal organization relationship exists between various members of the organization.
• Example: Production Manager Division A reports to the General Manager of division A. But in the course of fulfilling his responsibilities, the production manager actually communicates with many other people in the organization, as well as with other managers, support units and other people who are simply friends.• The MCS should give due importance to the informal relationships that exist in an organization.
• Perception and communication:• In order to achieve goal congruence, operating managers should know about organizational goals and the actions that are supposed to be taken for achieving them.• Clear communication should be given to every one in the organization so that there is absolute clarity in the perception.
• Formal Control System:• It is already seen that informal factors have a major influence on the effectiveness of an organization’s management control system.• The other major influence on MCS is the formal systems.
• The formal control systems can be classified into two types:1. The management control system itself and2. Rules. - Formal control systems we have already studied (Input control, process control, output control).- Rules can be implemented through manuals, work instructions, procedures etc.
• Rules:• Rules indefinitely exist unless modified• Rules can be modified depending upon the circumstances and in the best interest of the company.• If there is a rule of giving 2 months credit to customers, it can be changed by the Sales Manager for a large value customer.• Some rules can be positive requirements, like using protective equipments while others can be prohibition of undesirable actions like paying bribes etc.
• Hence the factors that influence goal congruence in an organization are:1. Informal factors - External factors - Internal factors2. Formal factors
Types of Organizations• The organization structure influences the design of the organization’s management control systems.• Organization structures can be generally classified into three categories:1. Functional organization2. Business Unit structure organization or Divisional structure and3. Matrix structure.
• The structure of any organization depends on:1. Nature of business, its size and complexity2. Inter-functional relations and3. Extent of control needed.
• The functional structure is based on the principle that a manager has a specialized knowledge on a specific function and can take better decisions regarding his function.• A skilled manufacturing manager or a skilled marketing manager are likely to make better decisions in their respective field than would a manager responsible for both functions.
• Advantage:• Since a specialist supervises his people, skilled higher level managers supervise the lower level managers, this type of structure ensures efficiency.
• Disadvantages:1. It is difficult to measure the effectiveness of different functional managers( marketing, production etc), since each function contributes jointly to the organization’s final output.
2. The structure consists of managers in one function who report to higher level managers in the same function, who in turn report to the still higher level manager in that function. - When a dispute arises between managers of different functions, it can be resolved only at the top, even though it may have originated at a much lower organizational level.
3. Functional structures would not be effective for a firm with diversified products and markets.4. This type of structure prevents cross- functional coordination in certain areas like new product development.
• Business Unit structure has already been discussed in Unit No: 02.• Advantages of SBU Structure:1. It provides a training ground for managers who can be considered for heading the entire organization.2. The SBU also reacts faster to the threats and opportunities in the market more quickly.
• Disadvantages:• There is a duplication of work, since some of the staff may duplicate some work that is being carried out in head quarters.• There is a possibility of dispute between SBUs where one SBU supplies some products to another SBU.
• Matrix Structure: Chief Executive officer Staff Function A Manager ( Production) Project X Manager Function B manager Project Y Manager (Quality) Function C Manager Project Z Manager (Finance)
• The matrix structure tries to integrate the desired features of the functional structure and the SBU structure.• This structure was first implemented successfully in NASA, USA in 1970’s• This structure is commonly used in Project based organizations and for new product development.• In this structure an employee reports to two different managers- one reporting manager is functional manager and the another one is the project manager.• Examples: P & G, L & T, Bharati Airtel – some of the organizations which have adopted Matrix Structure.
• The functional aspect in the matrix structure helps in the utilization of skilled knowledge of the functional experts and the SBU / divisional aspect helps in customer focus.• This structure is commonly used in project based organizations and for new product development.
• Advantages:• Functional aspects of the structure brings in specialization and SBU aspects brings in more focus and hence helps in improving profitability and customer oriented approach.• This is useful in organizations which have a limited product range.• Very useful where the products require close coordination among many specialists.• Useful when the markets are too small to justify separate divisions for each product.
• Disadvantages:• It calls for a high degree of cooperation and coordination among managers.• Due to the presence of dual authority, there is a possibility of conflicts arising between managers.• Individuals involved require strong interpersonal skills.• This structure will not be successful if the members of the organization are not mutually respectful.• Establishing MCS is more difficult than other two structures.
• Criteria for design of MCS:• We have seen that every structure has inherent advantages and disadvantages.• The senior management should carefully evaluate the suitability of each structure against its nature of business and other considerations before selecting a particular type.• System designer must always fit the system to the organization rather than the other way around.
Functions of the Controller• A controller is the person who is responsible for designing and operating the management control system.• In many organizations the Chief Financial Officer performs the role of a Controller.• Presently many companies have Chief Information Officer (CIO) who carries out the activities of a Controller.
Functions of Controller• Designing and operating MCS.• Preparation of financial statements, financial reports (including tax returns) for shareholders and external parties.• Preparation and analysis of performance reports, interpretation of these reports, analysis of budget proposals from various departments and consolidating them into overall annual budget.
• Supervision of internal audit and accounting control procedures and establishing adequate control over fraud.• Identification and imparting appropriate training to personnel in the organization regarding MCS.
• Relation of Controller in functional / line organization:• The controllership function is a staff function(advisory in nature).• The use of the information is the responsibility of the line management.• Controller is responsible for developing and analyzing the reports and to recommend necessary actions to the management.
• Controllers also play an important role in the preparation of strategic plans and budgets.• They may also asked to scrutinize performance reports and draw the attention of line managers.• Hence controllers also act as line managers.
• Business Unit Controller:• Business Unit Controllers inevitably have divided loyalty.• On the one hand, they report to Corporate Controller, who is responsible for the overall operation of the MCS.• On the other hand, they also report to the manager of the SBU, for whom they provide staff assistance.
• Based on the relationship of the Controller with the SBU manager and Corporate Controller , there are two possible types of relationships:1. Dotted Line Relationship and2. Solid Line Relationship.
• Dotted Line Relationship Solid Line Relationship Corporate Corporate Controller Controller Business Unit Manager Business Unit Manager Business Unit Business Unit Controller Controller
• Dotted Line Relationship:• Business Unit Controller reports to the business unit manager, who is his immediate boss.• He has also a dotted line relationship ( indirect reporting) with the Corporate Controller.
• Solid Line Relationship:• In this type, business unit controllers report directly to the corporate controller. This type of relationship is shown by the solid line.• They also indirectly report to the business unit head.
• There are problems with each type of relationship.• If the business unit controller reports to the business unit head, he may not provide correct reports regarding unit’s performance to senior management.• On the other hand, if business unit controller directly reports to the Corporate Controller, the business unit manager may treat him as a spy from the Corporate Office.
• Regardless of the reporting relationships, it is expected that the controller will not report misleading information or conceal unfavourable information.• He is expected to ethically perform his duties in the overall interest of the organization.
Management Control Systems Responsibility Centers Unit No: 04 Prof. C K Sreedharan
• An organization is meant for achieving certain predefined objectives.• In a small organization all decisions required for achieving the objectives can be made by one person.• However, when the organization grows and becomes complex, it may become impossible for one person to make all decisions.• In this scenario decision making is delegated to managers by giving them authority over a part of the organization’s operations.
• One important implications of this delegation of authority is that managers to whom the authority is delegated are held responsible for the consequences of their decisions.• Delegation of authority and responsibility brings in a degree of accountability.• Hence organizations assign specific authority and responsibility to different levels of the organization and evaluates the person in charge of each level on the basis of achievement of results.• Any such level is called as “Responsibility Center”
• Each unit or sub-unit thus becomes a responsibility center.• A firm is a collection of responsibility centers, each of which is represented by a box on the organization chart.• These responsibility centers form a hierarchy.• MCS is required to assess the performance of each of these responsibility center.
• A responsibility center exists to accomplish one or more purposes- termed as its objectives.• The firm as whole has goals, and senior management decides on the action plan to achieve these goals.• The objectives of the company’s various responsibility centers are to help implement the strategies of the organization.
• Every organization is the sum total of its responsibility centers.• If each responsibility center meets its objectives, the ultimate goal of the organization will have been achieved.
• Types of delegation:• One of the first steps required in implementing the concept of responsibility center is to have a clear understanding of the strategy to be followed by the company.• It is not possible for all the organizations to follow a particular pattern.• Authority and responsibility can be delegated in a number of ways.
• It is determined by the following:a) Nature and complexity of the organizationb) Environmental factorsc) Nature of businessd) Philosophy of the management.
• Based on these factors, organization’s have different structures.• Some of the popular structures are:1. Functional organization2. Business Unit structure organization or Divisional structure and3. Matrix structure.
• Core operation of responsibility center Inputs Transformation Outputs Processes (Work) Resources used Goods or Services Measured by cost Revenue Generation
• Responsibility centers receive inputs in the form of raw materials, labour and using working capital, equipment and other assets, the responsibility centers transform the inputs into outputs, which are either tangible (goods) or intangible( services).• Revenues are earned by these outputs.
• Relation between inputs and outputs:• Management is responsible for ensuring optimum relationship between inputs and outputs.• In some centers , like in a production department, the relationship is direct. Here the inputs of raw material become a part of the finished goods.• Here control focuses on using the minimum input necessary to produce the required output, as per correct quality requirements and in right quantity.
• However, in many situations, inputs are not directly related to outputs.• Advertising expense is an input that is intended to increase sales revenue.• But revenue is affected by many factors other than advertising, the relationship between increased advertising and any subsequent increase in revenue is rarely measurable.• Management’s decision to increase advertisement expenditure is based on judgment rather than data.
• Measuring inputs and outputs:• Responsibility centers input is generally expressed in terms of Cost.• It is the monitory measure of resources used by a responsibility center.• Annual revenue earned by the responsibility center is often used as a measure of output of a responsible center.• However it is always not possible to measure the outputs of a responsibility center.• Examples: Quality control department, PR department.
• Efficiency and Effectiveness:• These are the two criteria by which the performance of a responsibility center is judged.• Efficiency: It is the ratio of outputs to inputs.• Efficiency = Output / Input
• Responsibility center “A” is more efficient than responsibility center “B” if:1. It uses fewer resources than “B” but produces the same output.2. If “A” uses the same amount of resources but produces a greater output.
• Effectiveness:• It is determined by the relationship between a responsibility center’s output and its objectives.• The more the output contributes to the objectives, the more effective is the unit.
• Efficiency and effectiveness are not mutually exclusive. Every responsibility center ought to be both efficient and effective.• Hence each responsibility center should meet its goals in an optimum manner.
• The role of profit:• A major objective of any profit oriented organization is to earn a satisfactory profit.• Thus profit is an important measure of effectiveness.• Further, since profit is the difference between revenue ( a measure of output) and expense ( a measure of input), it is also a measure of efficiency.• Hence profit measures both effectiveness and efficiency.
• Types of responsibility centers:• Any business organization is concerned with four major elements and they are:1. Expenses2. Revenue3. Profit (Revenue minus expenses) and4. Investment.
• Thus, conceptually there are four subsets of responsibility center:1. If the manager in charge of a responsibility center has control over expenses, his sphere of control can be termed as “Expense Center”.2. If a manager has control over revenue, that area can be termed as “Revenue Center”.
3. If a manager is responsible for profits by controlling both revenue and expenses, that responsibility area may be referred as a “Profit Center”.4. If a manager controls investments, that responsibility area may be referred as an “Investment Center”.
• Hence there are four types of responsibility centers classified according to the nature of the monetary inputs and / or outputs that are measured for control purpose.• Classification is also based on the scope of responsibility and decision making authority given to managers.• They are:1. Revenue centers2. Expense centers3. Profit centers and4. Investment centers.
• Characteristics of a Responsibility Center:• An effective responsibility center shall have the following characteristics:1. It is a clearly defined segment of an organization2. A designated individual is responsible for its performance, namely, the output produced by the segment as well as inputs consumed by the segment.3. The designated individual has the necessary authority to discharge the assigned responsibilities.
• Example:• Raj Apparels is organized with clear delegation of responsibilities.• The Production Manager is responsible for all the activities related to production.• Marketing Manager is responsible for all activities related to the marketing of products.• Vice-President, Apparel Division is responsible for the profits of the division.• Only the President is responsible for the investment decisions for the different divisions
Investment President CenterProfit Center Vice-President Vice-President (Apparel Div.) (Other Divisions) Production Marketing Manager Manager (Apparels) (Apparels) Expense Center Revenue Center
• In this organization the various responsibility centers are:• Production manager: Expense Center• Marketing manager: Revenue Center• Vice President (Apparel Division): Profit Center• President: Investment Center
• Expense centers or cost centers:• A cost or expense center is a segment of an organization in which the managers are held responsible for the cost or expense incurred but not for revenues.• Example: Manufacturing function• For planning purpose cost estimates are given by budget estimates.• Performance evaluation is done by cost variance, that is the difference between the actual and budgeted costs for a given period.
• Revenue center:• A revenue center is a part of the organization which is primarily responsible for generating sales revenue.• Example: Marketing function.• The performance of a revenue center is evaluated by comparing the actual revenue with the budgeted revenue and actual marketing expenses.• Hence the primary measurement of performance is revenue generated.
• Profit center:• It is the segment of an organization whose manager is responsible for both revenue and cost.• Managers have control over both costs and revenues.• Managers have authority and responsibility to make decisions regarding both costs and revenues.• Example: SBU / division of a company.
• The main objective of a profit center is to earn profit.• The performance of a profit center is evaluated in terms whether the center has achieved its budgeted profit.• Profit center manager determines selling price, marketing programmes and production policies.
• Investment Center:• An investment center is a part of the organization which is primarily responsible for investment decisions and hence to be evaluated on the basis of performance of Return on Investment(ROI).• Hence an investment center is responsible for both profits and investments.• The manager of an investment center has more authority and responsibility than the manager of an expense center or a manager of a profit center.
Management Control Systems Expense Centers Unit No: 05 Prof. C K Sreedharan
• Expense center:• These are responsibility centers whose inputs are measured in monetary terms, but outputs are measured in terms of number of units. Inputs Outputs Work Cost in rupees Number of units Manufacturing Cost Center- is an example of expense center.
• Expense centers can be classified as below: Engineered Expense Center Discretionary Expense Center Proper estimation of input costs Output of these centers can’t be Can be done with reasonable degree Measured in monetary terms. of accuracy. Example- HRD, legal department, Output can be measured. PR depat. etc Example- Material, labour etc
• Engineered Expense Center:• They have following characteristics:1. Their input can be measured in monetary terms2. Their output can be measured in physical terms and3. The rupee equivalent of input required to produce one unit of output can be determined.4. Standard cost estimations can be made.
• In an engineered expense center, output multiplied by the standard cost of each unit produced measures what the finished product should have cost.• The difference between the theoretical and actual cost represents the efficiency of the expense center being measured.
• Discretionary Expense Centers:• These are administrative and support unit like- HRD, PR department, legal department etc.• The output of these centers can’t be measured in monetary terms.• Discretionary means that it is the management’s decision to decide how much to spend
• In these units expenses (inputs) are expressed in monetary terms but outputs can’t be measured in monetary terms.• Discretionary expenses are those expenses which are incurred as per organization’s policies, which are derived from strategic planning, its goals and objectives.
• In a discretionary expense center, the difference between budget and actual expense is not a measure of efficiency.• If actual expenses do not exceed the budget amount, it can be said that the manager has "Lived within the budget”.• Living within the budget does not necessarily indicate efficient performance.
• MCS for discretionary expense centers:• Features of budget process for discretionary expense centers:• Budget preparation:• Budgetary preparation for discretionary expense center is different from engineered expense center.• In an engineered expense center, budget is based on unit cost of performing the task efficiently.
• By contrast, management formulates the budget for the discretionary expense center by determining the magnitude of the job that needs to be done.• The work done by discretionary expense center falls under two general categories:1. Continuing work and2. Special work
• Continuing work: This is done consistently from year to year.• Special work: This is only one time work.• A technique often used in preparing a discretionary expense center’s budget is “Management by Objectives”- a formal process in which a budgetee proposes to accomplish specific tasks and suggests the measurements to be used in performance evaluation.
• The planning of discretionary expense center is usually carried out in one of the following two ways:1. Incremental budgeting or2. Zero- Base Review.
• Incremental Budgeting:• The discretionary expense center’s current level of expenses is taken as a starting point.• This amount is adjusted upwards for inflation and other cost increases.
• Incremental budgeting has two drawbacks:1. The discretionary expense center’s current level of expenses is accepted and not examined whether this cost is really justified.2. Managers of these centers typically tend to request additional resources, which are generally provided.- Despite these limitations, most budgeting in discretionary expense center is incremental budgeting.
• Zero-base review:• This is an intensive review, ascertains from the scratch, the resources actually required to carry out each activity within the expense center. This expense level is fixed as the base level. This level remains as the base level.• The expense center attempts to keep the costs reasonably within this base level.• Again a thorough review is carried out after a fixed interval of time, say after five years. This level is set as a new base year.
• Zero base budgeting is time consuming and are traumatic for the managers whose operations are being reviewed.• Also the managers will always try to justify their current level of spending and will try to stop the process of zero-base review by stating some reason or the other( Example: Have some other important work to do, very busy etc).
• Companies generally carry out this zero- base review, whenever there is a significant erosion in profitability.• These efforts are called as:a) Downsizing orb) Rightsizing orc) Restructuring ord) Process Reengineering.
• Measurement of performance of discretionary expense center:• The primary job of a discretionary expense center’s manager is to ensure that the desired outputs are achieved within the allocated budget.• Spending more than the budget may be cause of concern; spending less may indicate that the planned work is not being done.
• Control over spending can be exercised by requiring superior’s approval before the budget is overrun.• Sometimes, a certain percentage of overrun (say, 5%) is permitted without any special approval.
• Other types of discretionary expense centers:1. Administrative and support centers2. Research and development centers
• Administrative centers include senior corporate managers with support staffs.• Support centers are units that provide services to other responsibility centers.
• Administrative and support centers have the following control problems:1. Difficulty in measuring the output2. Lack of goal congruence
• Difficulty in measuring output:• Activity such as payroll preparation- it is difficult to quantify output.• Also other activities involve- advice and service functions that are impossible to quantify.• Since output can’t e measured it is difficult to set cost standards.
• Lack of goal congruence:• The staff may want to develop an ideal system, but an ideal system will be too costly.• The organization may accept minor flaws in its system rather than having a perfect system which may be too costly.
• Budget preparation:• The proposed budget for an administrative or support center usually consists of a list giving the details of expenses that would be incurred, which would be compared with the current year’s actual expenses.
• Research and development centers:• They have the following control problems:1. Difficulty in relating results to inputs and2. Lack of goal congruence
• Difficulty in relating results to inputs:• The results of R&D activities are difficult to measure quantitatively.• Compared to administrative activities, some of the activities of R&D have a semi tangible outputs in the form of patents, new products or new processes.• But it is difficult to correlate output to input on an annual basis because the completed product or process may involve several years of effort.
• Lack of goal congruence:• The goal congruence problem in R&D centers is similar to that in administrative centers.• The research manager may like to build the best research facility money can buy, even though that may be too expensive than the company can afford.
• R&D Programme:• There is no scientific way of determining the optimum size of an R&D budget.• Many companies allocate a certain percentage of revenue towards R&D.• The R&D programme consists of a list of programmes plus a small allowance for unplanned work.
• Measurement of performance:• At regular intervals, usually on a quarterly basis, companies compare actual expenses with the budgeted expenses.• The R&D center also submits regular progress reports which helps the management to assess the effectiveness of a R&D project.