Definition of Differentiated Controls for Different Situations

Management control process is influenced by various factors in an organization. The various factors that determine the control systems are

Environment

Technology

Size of the Organization.

The control system is normally linked to strategy because

Different organizations generally operate in different strategic contexts.

Different strategies require different tasks priorities, key success factors, skills, perspectives and behaviour for effective execution

Control systems are measurement systems that influence the behaviour of the people whose activities are being measured.

Thus, a continuing concern in the design of control systems should be whether the behaviour induced by the system is consistent with the strategy.

Role of the Organization Structure

The size and structure of an organization influences the organization strategies and strategies influence the control systems. When an organization functions as single industry, then the top management, usually a Manager is responsible for developing strategy as well as control systems.

When the organization grows into a diversified industry it tends to change its strategy. The top management will now concentrate on the financial side of the industry and will delegate the development side to the next level of managers. Hence, the control systems dilutes and gets distributed, influenced by the factors of the business units. Basically, the control system gets affected by the environment, location of the unit, technological factors etc.

The corporate level managers are less involved in business unit operations, the size of the conglomerate’s corporate staff, compared to that of a same sized single industry firm, tends to be low.

Let us see the different factor levels affecting strategies and control systems with the base of organization structure in the following table.

Management Control

Any organization, however well aligned its structure is to the chosen strategy, cannot effectively implement its strategy without a consistent management control system. While organization structure defines the reporting relationships and the responsibilities and authorities of different mangers, it needs an appropriately designed control system to function effectively.

When the organization structure gets wider and bigger, the experience and knowledge level of the top-level managers will not be sufficient enough to handle the diversified functions. Top-level managers for highly diversified firms cannot expect to control the different businesses on the basis of intimate knowledge of their activities, and performance evaluation tends to be carried out at arm’s length.

Strategic planning

Given the low level of interdependencies, conglomerates tend to use vertical strategic planning systems – that is, business units prepare strategic plans and submit them to senor management to review and approve. Because of the high level of interdependencies, strategic planning systems for related diversified and single industry firms tend to both vertical and horizontal. The horizontal dimension might be incorporated into the strategic planning process in a number of different ways.

First, a group executive might be given the responsibility to develop a strategic plan for the group as a whole that explicitly identifies synergies across individual business units within the group.

Second, strategic plans of individual business units could have an interdependence section, in which the general manager of the business units identifies the focal linkages with other business units and how those linkages will be exploited.

Third, the corporate office could require joint strategies fir interdependent business units. Finally, strategic plans of individual business units could be circulated to mangers of similar business units to critique and review.

For example, NEC Corporation, a related diversified firm, adopted two planning systems: a normal business unit planning system and a corporate business plan system. Strategic plans in the Corporate Business plan system were prepared for important programs that cut across business units. It forced interdependent business unit managers to agree on a strategic plan for exploiting such linkages. In effect, the system required a special plan for important horizontal issues.

Budgeting

In a single industry firm, the chief executive officer may know the firm’s operations intimately and corporate and business unit managers tend to have more frequent contact. Thus chief executives of single industry firms may be able to control the operations of subordinates through informal and personally oriented mechanisms, such as frequent personal interactions. If so, this lessens the need to rely heavily on the budgeting system as the tool of control.

Transfer Pricing

Transfers of goods and services between business units are more frequent in single industry and related diversified firms that in conglomerates. The usual transfer pricing policy in a conglomerate is to give sourcing flexibility to business units and use arms –length market prices. However, in a single industry or a related diversified firm, synergies may be important.

Incentive Compensation

The incentive compensation policy tends to differ across corporate strategies in the following ways:

Formulae are used generally in big firms as top level managers usually are not familiar with the happenings in a variety of disparate businesses. They calculate incentive compensation as bonus on actual economic value added (EVA) in excess of budgeted EVA.

On the other hand, Managers of Single industry calculate compensation on subjective factors.

In diversified firms, the incentive bonus of the business unit mangers is determined on the profitability of those units, rather than the profitability of the entire organization. This will motivate the unit managers and gives them a feeling that they are also owners of the units.

Competitive Advantage

A business unit can choose to compete either as a differentiated player or as a low-cost player. Choosing a differentiation approach, rather than a low-cost approach, increases uncertainty in a business unit’s environment for the following three reasons.

Product innovation is more critical for differentiation business units. This is partly because a differentiation business unit focuses primarily on uniqueness and exclusivity, which require greater product innovation, whereas a low-cost business unit, with its primary emphasis on reducing cost, typically prefers to keep its product offerings stable over time. A business unit with greater emphasis on new product activities tends to face greater uncertainty, since the business unit is betting on unproven products.

Smaller firms have narrow product lines to minimize the inventory carry costs. Differentiated business units, on the other hand, tend to have broader set of products to create uniqueness. Product breadth creates high environmental complexity and higher uncertainty.

Smaller units succeed with their products as they are priced lower.

Performance Measurement Systems

The goal of performance measurement system is to implement strategy. In setting up such systems, a senior management selects measures that best represent the company’s strategy. These measures can be seen as current and future critical success factors; if they are improved, the company has implemented its strategy. The strategy success depends on its soundness. A performance measurement system is a simply a mechanism that improves the likelihood the organization will implement its strategy successfully.

The following figure gives the frame work for designing a performance measurement system.

Framework for Designing Performance Measurement System

Source: This chart was suggested by Craig Schnier

A performance measurement system attempts to address the needs of the different stakeholders of the organization by creating a blend of strategic measures; outcome and driver measures, financial and no financial measures, and internal and external measures.

Outcome and Driver Measures

Outcome measurement indicates the result of a strategy (e.g. increased revenue). These measures typically are “lagging indicators”; they tell management what has happened. By contrast, driver measures are, “leading indicators”; they show the progress of key areas in implementing a strategy. Cycle time is an example of a driver. Whereas outcome measures indicate only the final result, driver in measures can be used at a lower level and indicate incremental changes that will ultimately affect the outcome. By focusing management attention on key aspects of the business, driver measures affect behavior in the organization. If a business unit’s desire is to improve time-to-market, focusing on cycle time allows management to track how well this goal is being achieved, which, in turn, encourages employees to improve this particular measure.

Outcome and driver measures are inextricably linked. If outcome measures indicate there is a problem but the driver measures indicate the strategy is being implemented well, there is a high chance that the strategy needs to be changed.

Financial and No financial Measures

Organizations have developed very sophisticated system to measure financial performance. Unfortunately, as many U.S. firms discovered, during the 1980s industries were being driven by changes in non-financial areas, such as quality and customer satisfaction, that eventually impacted company’s financial performance.

Even though they recognize the importance of non financial measures, many organizations have failed to incorporate them in to their executive-level performance reviews because these measures tend to be much less sophisticated than financial measures and senior management is less adept at using them.

Internal and External Measures

Companies must strike a balance between external measures, such as customer satisfaction, and measures of internal business processes, such as manufacturing yields. Too often companies sacrifice internal development for external results or ignore external results together, mistakenly believing that good internal measures are sufficient.

Measurements Drive Change

The most important aspect of the performance measurement system is its ability to measure outcomes and drivers in a way that causes the organization to act in accordance with its strategies. The organization achieves goal congruence by linking overall financial and strategic objectives with lower-level objectives that can be observed and affected at different organizational levels. With these measures, all employees can understand how their actions impact the company’s strategy.

Key Success Factors

Customer-Focused Key Variables

The following key variables focus on the customer:

Bookings: In most business units, some aspect of sales volume is akey variable. Ideally, this is sales orders booked, since unexpected changes in this variable can have future repercussions throughout the business. Because bookings precede sales revenue, this is a better indicator than sales revenue itself. A decrease in this variable signals that adjustments to marketing activities may be warranted-in the hope of increasing sales or production activities or both-to change operating levels.

Book orders: An indication of an imbalance between sales andproduction, back orders can suggest customer dissatisfaction.

Market share: Unless the market share is watched closely,deterioration in the unit’s competitive position can be obscured by reported increases in sales volume that result from overall industry growth.

Key account orders: In business units that sell to retailers, the ordersreceived from certain important accounts-large departmental stores, discount chains, supermarkets, mail-order houses-may indicate early the entire marketing strategy’s success.

Customer satisfaction: This can be measured by customer surveys,“mystery shopper” approaches, and number of complaint letters.

Customer retention: This can be measured by the length of customerrelationships.

Customer loyalty: This can be measured in terms of repeat purchases,customer referrals, and sales to the customer as a percentage of the customer’s total requirements for the same product or service.

Key Variables Related to Internal Business Processes

The following key variables to internal business processes:

Capacity utilization: Capacity utilization rates are especiallyimportant in businesses in which fixed costs are high (e.g., paper, steel, aluminum manufacture). Similarly, in a professional organization, the percentage of the total available professional hours that is billed to clients-sold-time is a measure of fixed-resource utilization. In a hotel, the [percentage of rooms occupied each day-occupancy rate-is the capacity utilization measure.

On-time delivery.

Inventory turnover.

Quality: Indicators of quality include the number of defective unitsdelivered by each supplier, number and frequency of late deliveries, number of parts in a product, percentage yields, scrap, rework, machine breakdowns, number of customer complaint, level of customer satisfaction, warranty claims, field service expenses, and so on.

Cycle time: This equation for cycle time is a tool used to analyzeinventory requirements.

Cycle time = processing time + storage time + movement time +Inspection time

Implementing a Performance Measurement System

Implementation of a performance measurement system involves four general steps:

Define strategy.

Define measured of strategy.

Integrate measures into the management system.

Review measures and results frequently.

Each of these steps is iterative, requiring the participation of senior executives and employees throughout the organization. Though the controller may be responsible for overseeing its development; it is a task for the entire management team.

Define Strategy

The scorecard builds a link between strategy and operational action. Therefore, the process of defining a scorecard begins by defining the organization’s strategy. In this phase, it is important that the organization’s goals are explicit and that targets have been developed.

Define Measures of Strategy

The next step is to develop measures to support the articulated strategy. The organization must focus on a few critical measures at this point or management will be overloaded with measures. Also, it is important that the individual measures be linked with each other in a cause-effect manner.

Integrate Measures into the Management System

The scorecard must be integrated with the organization’s formal and informal structures, culture, and human resource practices. For instance, the effectiveness of scorecard will be compromised if managers’ compensation is based only on financial performance.

Review Measures and Results Frequently

Once the scorecard is up and running, it must be consistently and continually reviewed by senior management. The organization should look for the following:

How is the organization doing according to the outcome measures?

How is the organization doing according to the driver measures?

How has the organization’s strategy changed since the last review?

How have the scorecard measure changed?

The most important aspects of these reviews are as follows:

They tell management whether the strategy is being implemented correctly and how successfully it is working.

They show that management is serious about the importance of these measures.

They keep measures aligned to ever-changing strategies.

They improve measurement.

A performance measurement system provides a mechanism for linking strategy action. It operates in the assumption that financial measures alone are not sufficient to operate an organization and that special attention must be placed on developing sophisticated, non financial measures. The primary role of management controls is to help execute chosen strategies. In industries that are subject to very rapid environmental change, management control information can also provide managers with a tool for thinking about new strategies; this is called interactive control. Interactive controls are not a separate system but an integral part of the management control system.

Balanced Score Card

Concept of Balanced Score Card

Balanced Score Card is a comprehensive performance measurement framework that translates an organisation’s strategy into clear objectives, measures, targets and initiative. It represents management system that can motivate breakthrough improvement critical areas of product, process, customer and market development. It integrates the measures used across the organization and helps it to grapple with the intangible or intellectual assets.

The Balanced Score Card is a management system that enables organizations to clarify their vision and strategy and translates them in to action. Kaplan and Norton describe the innovation of the balance score card as follows:

“The balanced score card retains traditional financial measures. But financial measures tell the story of past events, an adequate storey of industrial age companies for which investments in long-term capabilities and customer relationship were not critical for success. These financial measures are inadequate, however, for guiding and evaluating the journey that information age companies must make to create future value through investment in customers, suppliers, employees, processes, technology, and innovation.”

It proves effective because the variables measures through this tool are grounded in the organization’s strategic objectives and competitive demands. By narrowing down the critical indicators within four parameters the scorecard helps organizations to have a strategic vision.

It helps in communicating the multiple, linked objectives that companies must achieve to compete on the basis of capabilities and innovation and not just tangible physical assets.

David Chaudron in his article, ‘Using the balanced scorecard to combine viewpoints of Company’s successes defines Balanced Scorecard as

A way of Measuring organizational, business unit of department success

A way of Balancing long-term and short-term actions

A way of Balancing different measures of success such as: Financial, Customer, Internal Operations and Human Resource Systems & Development

A way of trying strategy to measure to action

In short, Balanced Scorecard is a business management concept that transforms both financial and non-financial data into a detailed roadmap, that helps an enterprise measure performance and meet both short and long-term objectives. It provides feedback about both the internal business process and external outcomes in order to continuously improve strategic performance and results. When full deployed, the balance scorecard transforms strategic planning from an academic exercise into the nerve centre of an enterprise.

Need For Balanced Scorecard

The need for balanced scorecard arises from the fact that there is a gap that exists between the mission, vision, strategy and the actions initiated by employees on a daily basis. This can be depicted with the help of the following figure:

Gap between Mission- Vision- Strategies- Employees’ Everyday Actions

Structure of Balanced score card

Traditional performance measurement, focusing on external accounting data, has become obsolete and something more was needed to provide modern enterprises with efficient planning tools. With this need in mind BSC was developed as a conceptual framework for translating an organization’s vision into a set of performance indicators, distributed among four perspectives viz. Financial, Customer, International Business Processes, and Learning and Growth.

These indicators facilitate measurement of an organization’s progress toward achieving its vision and identifying the long-term drivers of success. Through the BSC, an organization can monitor both its current performance and it efforts to improve processes, motivate and educate employees, and enhance the information system that determines the ability to learn and improve.

Each of the above mentions perspective aims at establishing a balance with other perspectives. These perspectives include:

Financial Perspective (How Do We Perceive Our Share Holders?)

Customer Perspective (How Do We Perceive Our Customers?)

Process Perspective (In What Process Should We Excel To Succeed?)

Learning And Innovation Perspective (How Will We Sustain Our Ability To Change And Improve?)

Benefits of Balanced Scorecard

Alignment of strategy with key performance objectives at all levels of the organization:

Most of the organizations fail to align their strategy at different levels of the organization. The result is an organization that is not operating at maximum efficiency, typically leading to less than optimal performance as well as missed opportunities. With a Balanced Scorecard, the corporation, down to each organizational unit and even to the individual level, can understand the key performance indicators that they have control of and responsibility for and understand the relationship to the overall success of their organization.

Measuring and managing business performance effectively

The balanced scorecard provides management with visibility into operations and issues of all business units and enables them to easily monitor and understand how organizations are progressing against plan. However, a truly effective scorecard also goes a step further and enables organizations to implement and track key initiatives for addressing problems areas or pursuing business opportunities. By having visibility across organizations, a senior management can also provide more visibility across organizations, and when appropriate, more effectively cross-utilize resources.

Strategic feedback

Balanced Scorecard that has been deployed across the enterprise offers the divisional units an unsurpassed communication platform for feedback and information sharing. Often looked upon as “the strategic knowledge management system” within an organization, a scorecard focuses on proactive communication for addressing problems early and pursuing business opportunities faster and more effectively than traditional management models.

Maximising the overall IT investment

Most organizations have significant investments in data warehouses, data marts as well as OLTP and ERP systems, such as SAP, people soft and Baan. These back-office systems are the primary sources of data collected within an enterpriser. A balance scorecard, as the strategic analytical application within an organization, should work in harmony with existing sources of data, extracting and packaging this information and sharing it as part of the scorecard.

Double-Loop Feedback

In traditional industrial activity, “quality control” and “zero defects” were the watchwords. In order to shield the customer from receiving poor quality products, aggressive efforts were focused on inspection and testing at the end of the production line./ The problem with this approach is that the true causes of defects could never be identified, and there would always be inefficiencies due to the rejection of defects. Deming had concluded that variation is created at every step in a production process, and the causes of variation need to be identified and fixed. In this can be done, then there is a way to reduce the defects and improve product quality indefinitely. To establish such a process, Deming emphasized that all business process should be part of a system with feedback loops. The feedback data should be examined by managers to determine the cause of variation, what are the processes with significant problems, and then they can focus attention on fixing that subset of processes.

The balanced scorecard incorporates feedback around internal business process outputs’ as in TQM, but also adds a feedback loop around the outcomes of business strategies. This creates a “double-loop feedback” process in the balanced scorecard.

Outcome Metrics

It is rightly said, “You can’t improve what you can’t measure”. So organizations need to develop basis for measuring the strategic plan. The measurement tool should provide information on the key business drivers and variables that managers need to watch. Managers have to then evolve processes to collect information relevant to these metrics and reduce it to numerical form for storage, display, and analysis. Decision makers examine the outcomes of various measured processes and strategies and track the results to guide the company and provide feedback.

Thus the value of tools measurement lies in their ability to provide a factual basis for defining:

Strategic feedback to show the present status of the organization

Diagnostic feedback into various processes to guide improvements on a continuous basis.

Trends in performance over time

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