Definition of Control Levers

The Four Levers of Control

Mechanisms exist to ensure that four things happen in a company. We often hear people say that the company “is on track’. How do they know that? What mechanisms exist that guide the company, its people and its business to stay on track?

As a fast growing company in an ever-changing environment a company focuses on the effective utilization of - as R. Simons of the Harvard Business School calls it - the four levers of control.

Within the company, mechanisms exist to ensure that four things happen effectively:

Obtaining commitment to the purpose of the company

Staking out the territory

Getting the job done

Positioning for tomorrow

For each aspect there is a lever of control to ensure it “Stays on track”

The following diagram identifies the four levers of control and gives a holistic view of the dynamics of controlling strategy:

In his book “Levers of control: How Managers use innovative control systems to drive strategic renewal” (1995) Robert Simons introduced the four levers of control framework, giving managers in large companies a framework to manage the tension between (value) creation and control (managing and measuring value).

Four levers of control

The Four Levers of Control are

Core values (controlled by Belief systems, such as mission statements, vision statements, credos and statements of purpose)

Risks to be Avoided(controlled by Boundary Systems, such as Codes of conduct, predefined strategic planning methods, asset acquisition regulations, operational guidelines)

Strategic Uncertainties (controlled by Interactive Control Systems,such as incorporating process data into management interaction, face to face meetings with employees, challenging data, assumptions and action plans of subordinates)

Critical Performance Variables (controlled by Diagnostic Control Systems, such as output measurement, valuation standards, incentive systems and compensation systems).

I can see that we are dealing with four sets of systems - the four levers - that work together to ensure that the business strategy stays on track. I recognise some of the terms, but can’t you give me practical examples that will enable me to get a better picture of what the Four Levels of Control consist of in our company.

Let us explore the What, Why and How of the four levers of control in the company:

LEVER 1: Belief Systems

What: Explicit sets of belief that define basic values, purpose and direction,including

How value is created

Level of desired performance

Human relationships

Why: To provide momentum and guidance to opportunity

Mission statements

Vision statements

Credos

Statements of purpose

Vernon Smith, the experimental economist, has hypothesized the process of buildup of these beliefs. He says we can study them only through experiments on what would happen if the rules are forcibly alerted; much of his work, which won him the Nobel Prize, was based on such experiments and he still not sure if these processes could be consciously crafted.

Simons advocates proactive building up of belief systems to be worked into designing control systems. He provides practical examples where this has been done.

The better tuned are the belief systems, less cumbersome and expensive would be needed for diagnostic systems and risk-prone will it be to fall a prey to opportunistic behaviour.

The practical methods of building up belief systems are:

An explicit set of beliefs, defining values, are incorporated in vision statements and codes of conduct.
Senior managers are involved in drafting formal belief statements.

Feedback is obtained and awareness surveys are constantly conducted.

Top managers put themselves under constant scrutiny to adhere to the belief systems.

LEVER 2: Boundary System

What: Formally stated rules, limits and prescriptions tied to definedsanctions and credible threat to punishment

Why: To allow individual creativity within defined limits of freedom

Codes of business conduct.

Strategic planning systems.

Asset acquisition systems.

Operational systems

Boundary systems, as conceived by Simons, are the delineation of prohibited areas of behaviour. Thus, typically, prohibitions could be as below:

Indulgence in corruption

Breaking laws to make short term gains

Marketing below par goods even if it means profits and even if there are no legal bars from doing so.

Moving products to customers who are in the approved geographical area. This typically happened in India, in the licensees in the telecom sector poached into areas licensed to others. This shook the markets and brought reprisals from the government.

Indulgence in inappropriate behaviour with one’s colleagues, say typically, sexual harassment.

Keeping the task of accounting of transaction in the same hands as transaction operators, e.g., what happened in the Barings Bank scam.

Quite contrary to the understanding that boundary systems restrict the manager’s discretion, Simons argues that they enlarge it. Any innovative behaviour, which achieves desired goals and outcomes and which does not cross the boundaries of appropriate behaviour, would be encouraged, and this according Simons actually vastly increases one’s discretion. It also pins down accountability to results.

Operational staff is closer to the markets; it does away with the need to consult their superiors at every stage, provided they are not crossing the boundaries. Boundary systems are usually spelt out in codes of conduct.

LEVER 3: Diagnostic Control System

What: Feedback systems that monitor organisational outcomes and correctdeviations from preset standards of performance like:

Profit plans and budgets

Goals and objectives systems.

Project monitoring systems.

Strategic planning systems.

Why:

To allow effective resource allocation.

To define goals.

How:

Set standards.
Measure outputs.

Link incentives to goal achievement.

These controls are the simplest and most easily understood of all the systems as they have traditional wisdom of authoritarianism which tends to treat human beings as machines. It was used extensively in feudal systems of all nations, including India. They are also most persuasive even in modern times particularly in bureaucratic organizations.

We can relate diagnostic systems to familiar practices in organizations.

The standard manner of monitoring outcomes in a diagnostic system is typically:

Profit plans and budgets

Balanced scorecards

Project monitoring through PERT and CPM

Brand revenue monitoring

Defining goals

The benefits that could come from these are:
Effective resource allocation

Clarity for defining goals

Strong motivation

Establishing corrective action
Allowing ex post facto evaluation

Freeing scarce resources

The processes involved in these are:

Process of setting standards

Processes of measuring outputs

Process of setting incentives with achievements
The stage at which action is necessary:

presetting standards

After outcomes are available

Feedback is given to correct people

The persons involved in the process are:

Senior managers who negotiate goals and receive reports

Staff groups who maintain systems, gather data and prepare reports

LEVER 4: Interactive control system

What: Those systems that teams use to advance and develop

Why:  To focus organizational attention on strategic uncertainties.

To provoke the emergence of new initiatives and strategies.

To ensure that the way we do business relates very closely.

To the changes in customer needs.

How: By ensuring that:

Information regarding changes in technologies, customer requirements, supplier strategy, competitor’s strategies and team skills are adequately and proactively incorporated into the strategy process.

The chosen strategy remains appropriate to the business reality and overall company objectives.

Better interaction between the different layers of management in an organization would improve controls. But there is special meaning for this in an era where technological advances are taking place by leaps and bounds and the knowledge of these is traveling swiftly across organizational boundaries aided, undoubtedly, by the revolution taking place in the field of information technology. Individual initiative and thirst for knowledge are increasing and personal aspirations are also soaring.

Example: Interactive Systems in the Music Industry

The erstwhile music company HMV (now called Saregama) was constantly bogged down by obsolescence of its products paradoxically co-existing with stock outs. The root cause of the problem lay with the quick changes in public taste. Thus any strategic plan made by the company soon becomes redundant. The answer to that lay only partly in shortening the production and distribution process. It primarily lay in top planners being in interactive control with the dealers, sales personnel and other forums so that the products are fashioned appropriately right from the planning stage.

But the wise management would be able to identify the areas and domains in which such interaction is important and the other areas were only diagnostic systems should be used. In such an approach, modification of strategies would emerge from the operating levels quickly.

Simons describes the several repercussions of this approach in different industries. The most novel of these is in the pharmaceutical and surgical instruments industries, where he quotes the practices in Johnson and Johnson, the pharmaceutical giant, in continuously reviewing their budgets with operating levels, which enables them to be in tune with the market and the strategic shifts it calls for. Similarly, in Xerox, the key planner, RaghunathanSachdev, popularly known as Sach, is constantly in telephonic contact with branches throughout the world, and talking is the key to their effective control, much more than formal reports. He was the hub of the interactive control which complimented the regular diagnostic systems.

Balancing the Four Levers of Control

Implementing strategy effectively requires a balance among the four levers of control. This balance permits the simultaneous balance of strategy as plan, pattern, position and perspective. The extent of application of a particular lever of control or an appropriate mix of them is highly situational and contextual. Thus, for an industry manufacturing a standard product, like supplies for defense establishment, diagnostic systems would be useful in most situations. But in a fashion industry an interactive system is essential.

In the advertisement or IT industry or in research and development or in the film industry, belief systems may be critical. Boundary systems may be important if the cost and risk of breaking the boundaries of proper behaviour are prohibitively expensive. The mix also depends on the organizational structure and cultural history of the organization. Organizations may often need a judicious and cost effective mix of all the systems.

Balancing the Tensions in Control Systems

So far a somewhat optimistic projection of the use of control systems in organizational achievement has been made. But the path to operationalise control systems does not always justify such optimism. The means to implementation of control systems have to contend with several conflicts of choices and conflicts of interests. We will deal now with these conflicts and suggest ways to resolve them since management control systems of modern times are knotted up in tensions. According to the poetic analogy of the Indian philosophic work, the Katho Upanishad, it is veritably like walking on the razors edge.

How can managers:

Lever potential for innovation and ensure adequate control?

Drive growth that enhances profitability?

Communicate strategy and goals to employees?

Organize resources in support of strategy?

Measure and track performance toward achieving strategy?

Ensure that they are not exposed to undue risk?

Link information from employees to strategy makers?

Six Sources of Tensions in Control Systems

Simons lists the six tensions of management control systems. These can be grouped into three categories A, B, and C. They are:

Tensions arising due to the need to make strategic choices

The tension between profit, growth and control

The tension between long-term and short-term needs

Tensions due to goal divergence among stakeholders and the efforts needed to imaginatively establish goal congruence.

The tension between the several stakeholders all of whom want a bigger share of the pie. Organizations must seem to benefit all those who have a stake in it. Conflict of interest is built into this situation.

The tension between the varying and often conflicting motivation of the employees.

The tension between different professional aspirations, propensities and functional skills of the different segments of an organization.

Tensions due to limitations managerial of cognitive powers.

The tension between the need and desire to seek opportunities and the constraint due to limitation of the span of attention.

Each of these pulls and pressures can be compounded by the fact that the responses to these are spread over different centres of power. The organizations have to ensure that they are in mutual harmony.

Profit, Growth and Control

The  starting  point  is  learning  the  basic tensionbetween growth, profit, and control. Firms in the past have focused on growth with little talk about profit. Then there became a huge awakening that resulted in a shift to being profitable. “It is no accident that the Enron failure occurred during this time of heightened scrutiny of profitability,” Simons said. “And this is why they have taken risks with company assets to create profit that is not sustainable.”

Profit, growth and controls are sometimes poised in opposition to each other and the three have to be balanced carefully. This involves judgement. These three are represented as the three corners of a pyramid as shown in the above figure.

Some companies see growth and market share as the ultimate end of their control systems. Growth can be stimulated by heavy advertisements and abnormally low pricing which may be less than the variable costs. The organization gears all its reporting systems to observe growth with little effort to be directed towards profitability after sustainability.

Simons predicts that organizations will now enter an era where the focus will be on controls. This is backwards, he said. Organizations should first build a control infrastructure. Once the infrastructure is in place, then management can push people hard on profits because the controls are in place as a safety net. After a business is making money it should then push people to grow the business. “It amazes me how many companies forget this very basic progression,” he said.

Example: Amir Khan Imagination and daring is not always followed bybankruptcy. The popular Indian actor, Amir Khan, was more cautious. His ventures were well planned and even if they aimed at striking achievement and growth, they maintained effective controls even in an environment of uncertainty. He was able to integrate his central control with freedom provided to all the members of the team. Thus, he is an example of effective harmony between the single focus, and dual focus and profit and growth approaches to control.

Recognising the Conflict

The balance between profit, growth and control can be struck only by gauging the turbulence in the organization and some early warning signals. The signals can be qualitative or quantitative and it would require some fine tuning to restore the balance.

Conflicts Between Long Term and Short Term

Typical features of modern businesses are that, there is a gestation period between the conception of a product and service and its full implementation. Secondly, the rates of obsolescence of many products are high. They have, therefore, product life cycles in which high growth and high initial profits from comparatively smaller volumes is followed by larger volumes with lower individual profit margins but better overall profits, which in turn is followed by a period of declining profits. This cycle is described as the build, hold, and harvest phases of the product life cycle.

In a parallel manner, the groups of people and departments who are involved in the phase of product conception, product launch, and production would be different. The time horizons and control systems for each of these phases of the product life cycle and functional departments would be different.

The methods of measurement of performance regarding short term goals are simpler and may be strongly governed by financial results. Long term projections also rely on financial projections, but evaluation and monitoring of present performance from the point of long term benefits, is an extremely uncertain and difficult task. One has to accept a proxy, which may be only the second or third best measure because it may be easier to handle.

Example: Smart Information Services

Smart Information Services employs very intelligent young IT specialists. They have a scheme of rewarding executives by the profits they rake in for the company. The executives are generally allotted jobs to suit their individual and taste and temperament. Lara was chosen to work on projects which involved modification of standard programmes for the tailor made needs of clients.

This was an easy and well paid job. Rohan on the other hand chose to work for developing independent programmes for a large network of banking activities. This was an intricate and original work and the outcome would take considerable time. They needed repeated testing and lot of bugs had to be removed all the way along. In the last few years, every year Lara’s projects generated high profits and she was given a share.

Rohan felt discouraged and left the company and joined Creative Services Ltd., which was more tuned to long-term achievement. In a year he came out with a brilliant idea, which was difficult for competition to imitate. Creative Services, which was a software designing firm became invincible and was assured of monopoly position for the next ten year. Smart lost the race ultimately.

Link with the ‘dual focus’ concept:

Creative Services believed that its executives could be motivated on their own without short term financial rewards. They may have an inherent desire to innovate and self-actualize. It is therefore, not necessary to push them. A wise system of management control would recognize it and use it for overall good.

The Concept of Goal Congruence

Goal Congruence means consistency or agreement of actions with organizational goals. It identifies the managerial principle that all of a firm’s sub goals must be congruent to achieve one central set of objectives.

Integration of goals and effectiveness when team building

The extent that individuals and groups perceive their own goals as being satisfied by the accomplishment of organizational goals is the degree of integration of goals. When organizational goals are shared by all, the term goal congruence can be used.

To illustrate this concept, we can divide an organization into two groups, management and subordinates. The respective goals of these two groups and the resultant attainment of the goals of the organization to which they belong are illustrated in the following Diagram.

To illustrate this concept, we can divide an organization into two groups, management and subordinates. The respective goals of these two groups and the resultant attainment of the goals of the organization to which they belong are illustrated in the following Diagram.

The result of the interaction between the goals of management and the goals of subordinates is a compromise, and actual performance is a combination of both. It is at this approximate point that the degree of attainment of the goals of the organization can be pictured.

This situation can be much worse when there is little accomplishment of organizational goals, as illustrated in the following Diagram.

In this situation, there seems to be a general disregard for the welfare of the organization. Both managers and workers see their own goals conflicting with those of the organization.

Consequently, both morale and performance will tend to be low and organizational accomplishment will be negligible. In some cases, the organizational goals can be so opposed that no positive progress is obtained.

The result often is substantial losses, or draining off of assets (see Diagram). In fact, organizations are going out of business every day for these very reasons.

The hope in an organization is to create a climate in which one of two things occurs. The individuals in the organization (both managers and subordinates) either perceive their goals as being the same as the goals of the organization or, although different, see their own goals being satisfied as a direct result of working for the goals of the organization.

Consequently, the closer we can get the individual’s goals and objectives to the organization’s goals, the greater will be the organizational performance, as illustrated in the following Diagram.

One of the ways, in which effective leaders bridge the gap between the individual’s and the organization’s goal is by creating a loyalty to themselves and among their followers. They do this by being an influential spokesperson for followers with higher management. These leaders have no difficulty in communicating organizational goals to followers and these people do not find it difficult to associate the acceptance of these goals with accomplishment of their own need satisfaction.

The next three sources of tension are central to the problem of control systems. The issues directly emanate from our philosophic understanding that every person has a right to choose to live one’s life. Secondly, it is incorrect to attempt to govern the personal thinking of any person.’’

Most achievement arises from the combining efforts of people. Different sets of stakeholders in an organization have goals and values which have to be respected. Efforts must be made to identify and operate in areas where we find congruence of goals. It would then operate on the overlapping belief systems of the different constituents who have to cooperate in the organization to keep it under control. Occasionally, one may want to set up boundary systems to discipline the constituents. This integration of belief systems and boundary systems is the articulation of the harmony between the two foci of control and coordination.

Three sets of stakeholders commonly encountered in organizations

Conflict Among Stakeholders

Several group of stakeholders work together in order to contribute to the success of the organization. Often stakeholders are considered a homogenous category juxtapose to shareholders. In reality stakeholders can be strongly conflicting as much as or even more than shareholders. Stakeholders could be described as people having stakes (i.e. interest) in the operations of the organisation. They will include shareholders, managers or employees, customers, suppliers, lenders or government agencies and the public at large.

But working together also inevitably results in conflict on interests between them and a clash of their perceptions during acceptable risk taking. Control systems will have to take all this into consideration. Some people have argued that control systems ought to have a simplified philosophy and that maximizing shareholders’ wealth should be the prime objective of any control system. Further, they argue that if shareholders’ wealth is maximized, automatically other stakeholders would also benefit.

Example ANon Banking Financial institution (NBFI)

A NBFI with a shareholding of 12% of its assets, collected deposits from various persons with a promise of high interest returns. The depositors were not aware that the organization was investing in risky ventures. Once they came to know of it, they called for a meeting of the trustees of debts who negotiated that they would accept lower rates of interest but they would not indulge in risky ventures. The Indian Companies Act, 1956 provides for the institution of trustees who would perform this negotiation function. However, such transparent working methods are an exception and not the rule.

Further, it must be noted that the shareholders themselves have a floating contract with the organization, and can and do play an opportunistic game of selling off the shares to others in an effort to escape from an organization which they do not like or which does not conform to their risk-reward profile. Thus, in this example, the shareholders might have invested in organizations in which they were personally interested. If the venture made profits they would have gained but if it ran into losses, the losses would have been that of the depositors.

Thus, the act of balancing the interests of different stakeholders is a continuous one and can and does cause tensions in control systems. In such situations, dual foci of controls would provide a whistle blowing who would bring out the truth and help in resolving the conflict.

Complexities of Employee motivation

All organizations need highly motivated employees so that they work at their maximum potential to work as group to achieve the organizational goals. Employee motivation is complex because employees differ in their own personalities and they are motivated by different factors. That is any manager who wants to motivate employees must recognize the complexity of employee motivation.

Organizational theorists thought that the prime motivating factor at work is money for majority of employees. However, after the Hawthorne experiment it came to light that some group factors and social and work factors also have an effect on employee motivation. However, the degree of the above factors varied from one employee to the next. That is some are mostly motivated by money and some are motivated by recognition, social factors and group factors at work than money. As well, it differs from one organization to the next given the same profile of employees because of the organizational cultural factors and nature of tasks and decision making process and reward equity.

The above discussion shows the complexity of human motivation at work and the factors which affect employees’ motivation at work. The managers must be aware that employee motivation theories are only guides and they must use their own information and observation given the context and situation of their organizational internal and external environment to motivate employees effectively to achieve organizational goals. As well, they must thoroughly examine the theory that employees are only motivated by money doing their own research and observation. This is because, due to complexity of tasks undertaken by employees in modern organization and skill spread and the interdependent nature of tasks. That is, they may be motivated by variety of tasks performed and their work itself and the participation in decision making process. In addition the employees’ motivation is affected on the bias of whether their issues are listened by management particularly, when there are changes implemented in the organization.

Every control system has to make assumptions on how managers are motivated. Obviously, a tremendous amount of subjective judgment is involved in this. But one certain thing is that, managers who work on the assumption of neoclassical economists that everyone is a rational economic maximiser, would surely fail in designing control systems. Secondly, there could be strong cultural differences between organizations and between different ethnic groups. Lastly, the history of every organization leaves behind its traces on the employees and what would work in an organization may not work in any other organization. According to the opinion of Vernon Smith, the economist, social groups, if allowed some autonomy would be on their own evolve patterns of ecological rationality which would judiciously co-exist, support and supplement economic rationality.

Example

The management of Pragmati coal mine had a system of manual cutting and loading of coal in coal tubs and payment to workers was based on the number of full tubs they filled. This system had a clear economic rationality. The community of coal miners all came from the same village and were used to working in groups in agricultural fields. They noticed that the overall productivity and earnings would go up in the system introduced by the management, if they distributed their work among groups, with some working on only cutting and some only on loading, some in pushing the tubs and some others removing the water from the site.

A little later, the management introduced mechanized mining, which employed large machines and several people had to work together, some on operation, some on maintenance and some on moving the machines. The miners negotiated the rates related to performance as a group incentive payment and distributed the earnings among themselves. Pragmati recorded one of the highest productivity levels among the mines in India. Thus without a conscious and deliberate attempt of the management to discipline the miners, the latter found ways of helping themselves and the company as an extension of the cultural traditions they had grown up with. This is a striking illustration of the dual focus of control.

Inter-Departmental Conflicts and Politics of Control Systems

Lastly, different organizations need varied types of skills and knowledge and they may be required to work in departments, teams, segments or task groups. Their performances are not measurable in the same way. The geographical spread of organizations also requires regionalization of their working. This inevitably results in conflicts between different groups. This is a major control problem in most large organizations and gives rise to politics of control systems. If social groups could learn to be supportive of each other and creatively self regulate their activities, the splintering of activities and skill groups in modern complex organizations, may contrarily set one group against another. Designers of control systems will have to control the reality of this and devise ways to cope with it.
Example

Adithya iron ore mines were one of the earliest in India to have mechanized operations. But this gave rise to a unique problem that necessitated great cooperation between the mechanical engineers who maintained the machines, the mining engineers who did the mining and the geologists who enabled the mining patches to be chosen intelligently to improve their quality. Sharp measurement techniques to indicate the performance of each of these groups was attempted. But, that was seen to be only a part of the solution.

The repeated persuasive attempts to induce cooperation were not only based on economic incentives but also on appeals to self esteem. The standard cost reports, pinpointing the performance of every department and quantifying it with financial figures, only resulted in mutual accusation. On a particular occasion, it became a matter of national honour to supply the best quality ore to Japan, and in time. The needs for self esteem egged them on to get together and succeed in achieving what appeared to be an impossible task.

Span of Control

Span of control is a term originating in military organization theory, but now used more commonly in business management, particularly human resource management. Span of control refers to the number of subordinates a supervisor has.

In the hierarchical business organization of the past it was not uncommon to see average spans of 1 to 10 or even less. That is, one manager supervised ten employees on average. In the 1980s corporate leaders flattened many organizational structures causing average spans to move closer to 1 to 100. That was made possible primarily by the development of inexpensive information technology. As information technology was developed capable of easing many middle manager tasks – tasks like collecting, manipulating and presenting operational information – upper managers found they could hire fewer middle managers to do more work managing more subordinates for less money.

The current shift to self-directed cross-functional teams and other forms of non-hierarchical structures have made the concept of span of control less salient.

A limitation of the span of control theory is the assumption that narrow span of control means more time for managers to provide support and encouragement to their staff.

Any control system would have to be geared to spot opportunities for the organization and make full use of them. Unfortunately, it is quite impossible for managers with their limited talent and time to tackle every such opportunity competently. Robert Simons covers this dilemma by an omnibus concept of managers being driven by bounded rationality and not absolute rationality. Simon’s ideas were based on the practical reality that information was too voluminous and too complex to be available on the turn of a tap to the operating executive. Nevertheless, they have to take decisions on the basis of the limited information with them. Their decisions are therefore described as ‘bounded rationalities’. Absolute rationality can never be practically achieved as information can never be perfect. This concept can be tackled by using the concept of ‘Return on Management’.

Return on Management (ROM)

The classic business ratios for measuring performance--return on equity, return on assets, and return on sales, to name a few--may be useful. But none is designed specifically to reflect how well a company implements its strategy. Enter return on management (ROM), a new ratio that gauges the payback from a company’s scarcest resource: managers’ time and energy. Unlike other business ratios, ROM is a rough estimate, not an exact percentage. Still, it is expressed like other business ratios by an equation in which the output is maximized by a high numerator and a low denominator: Knowing which organizational factors conspire against or work to maximize an organization’s productive energy will help managers calculate a rough measure for this equation. Harvard Business School Professor Robert Simons and HBS doctoral student Antonio Davila offer five “acid tests” to help managers measure their company’s ROM.