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. Management 2. Control and 3. Systems

 Management: It is broadly defined as planning, organizing, staffing, directing, evaluating 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 organizations goals.

 Control: In todays 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 goals b) Identification of deviations from the goals c) Initiating corrective actions to rectify the deviations and d) 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 firms senior executives design and implement the management systems to plan and control the firms 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 firms strategy. This implies that strategy is first developed through a rational and formal process and this strategy then dictates the design of the firms management systems.

 Another view is that strategies emerge through experimentation, which are influenced by the firms 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) and 2. 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 organizations 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 controls 2. Process controls and 3. 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 fedforward, 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- control 2. Social controls and 3. 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 organizations 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 Mgt.

Strategic control / planning

Middle Mgt.

Management control

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 topmanagement for the accomplishment of organizations 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

Entity 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.

 Strategy implementation mechanism:

Management Controls

Strategy

Organization Structure

Human Resource Management

Performance

Organization Culture

 MCS and behavioural considerations: People are important assets for an organization. Without the cooperation of the employees, managers cant implement their decisions. To manage people effectively, control systems are required for the following reasons: 1. Lack of direction 2. Motivational problems and 3. 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 organizations 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 access 2. Multi-targeted approach 3. Cost economy and 4. 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 cant 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 goals 2. Aligning these individual goals with those of the organization 3. Setting performance measures for functional areas. 4. Communicating strategy and specific performance objectives throughout the organization.

5. Evaluating the performance against the set standards 6. Reviewing the performance and taking appropriate corrective actions 7. Influencing the individuals to change their behaviour. - The above need human intervention and judgment, which cannot be replaced by the internet.