Management Control Systems Chapter 16: The Influence of Situational Factors on MCSs Merchant and Van der Stede: Management Control Systems © Pearson Education Limited 2003

Contingency / situational factors … There are no universally best control systems that apply to every situation in all organizations ... Contingency factors - Organizational factors; - Technological factors; - Strategic factors; etc. MCS variables - Type + tightness of controls used; - Design of the budgeting system; - Performance measures emphasized; - Objectivity of performance evaluations; - Design of reward systems; etc. Outcome variables - Degree of control; - Dysfunctional side-effects; - Control costs.

Strategy typologies ... Corporate diversification strategy Refers to what businesses the firm should invest in and how these businesses should be coordinated. Defines where to compete; Single business – related / unrelated diversified. Business unit competitive mission Defines the mission for each of the businesses; Build – hold – harvest – divest. Business unit competitive position Determines how to compete in each of the businesses; Low cost – differentiation

Corporate diversification strategy ... Number of Businesses Degree of Relatedness High low Related Diversifiers Unrelated Single Business Firms One line of business. Operational synergies based on a common set of core competencies. Connection between businesses is purely financial (holdings).

Implications on MCS design ... Control of SBU-manager over budget formulation Importance attached to meeting the budget Bonus criteria Bonus determination Bonus basis Single / Related Business Low (?) high financial and non-financial criteria primarily financial criteria primarily subjective or discretionary (?) primarily formula-based SBU + corporate performance primarily SBU-performance Unrelated Diversified Budgets Incentives

Business unit competitive mission ... Has to do with the resource allocation decisions from the corporate office ... cf., internal capital markets; Cash generated in one business can be used to finance growth in another business. Depends also on the industry attractiveness, market opportunities and SBU-competitive ability ... HQ S B U

Portfolio models ... ? Cash source Build Hold Market growth rate Relative market share Cash source Cash use Market growth rate L H Hold Dog Divest $$$ Harvest ? Build

The four missions ... Build Hold Harvest Divest Maximize Invest in MS even at the expense of ST-earnings / CFs Maximize even at the expense of MS Outright sale - Slow liquidation Protect MS and competitive position

Implications on MCS design … (1) BUDGETS Control of SBU-manager over budget formulation Importance attached to meeting the budget Build …. Harvest relatively high relatively low Budget revisions during the year relatively easy relatively difficult Budget reporting rather interactive rather diagnostic Tolerance towards budget deviations Objective Administrative Financial Subjective Interpersonal Strategic

Implications on MCS design … (2) INCENTIVES Build …. Harvest Bonus criteria Bonus determination more emphasis on non-financial criteria primarily financial criteria primarily subjective or discretionary (?) formula-based CAPITAL BUDGETING Evaluation of capital investments more subjective and qualitative more objective and quantitative

Business unit competitive strategy ... Industry’s competitive structure Firm’s competitive advantage Threat of new entry; Threat of substitutes; Power of suppliers; Power of buyers; Direct rivalry. Cost leadership ... Achieve low cost relative to competitors Differentiation … Create something which is perceived unique by the customer

Low cost – differentiation … economies of scale tight cost control standard products cost minimization standardized tasks and production processes brand loyalty superior customer service product features product design technology Cost leadership Differentiation … different business unit strategies require different MCS ...

Implications on MCS design … (1) BUDGETS Control of SBU-manager over budget formulation Importance attached to meeting the budget Low Cost … Differentiation relatively high relatively low Budget revisions during the year relatively easy relatively difficult Tolerance towards budget deviations

non-financial criteria Implications on MCS design … (2) INCENTIVES Bonus criteria Bonus determination more emphasis on non-financial criteria primarily financial criteria more subjective or discretionary (?) formula-based Low Cost … Differentiation

Differences across countries ... Behavioral similarities Self-interest is probably a universal behavioral trait. Factors that affect MCSs across countries National culture People’s tastes, norms, values, social attitudes, religions, personal priorities, and responses to interpersonal stimuli. Local Institutions Government agencies, banking systems, labor unions, financial markets, accounting rules, regulations, etc.. Local business environments Stage of economic development, political risk, inflation, labor availability, labor quality, labor mobility, etc.

Cultural differences ... National culture has a direct effect on MCS because control problems are behavioral problems. Individualism Incentives based on individual vs. group performance; Degree of engaging in myopic, self-centered behavior. Power distance Degree of centralization of decision-making; Degree of participation in setting performance targets. Uncertainty avoidance Degree of subjectivity in performance evaluations; Degree of formality of planning / budgeting processes. Masculinity Degree of performance-based rewards.

Local institutions ... Labor unions Use of performance-based rewards (>< seniority-based). Financial markets and stock market valuations Frequency of profit measurement; Use of short-term incentives; Likelihood of myopic behavior. Threat of hostile takeovers Use of reward schemes to get common stock in managers’ and employees’ hands. Accounting regulations

Local business environments ... Risk and uncertainty-related factors Business risk Military conflicts, bombings, corporate espionage, etc. Political risk Negative: forced production, prohibition of layoffs, price controls; Positive: tariff barriers, subsidies, research support, etc. Stage of economic development Age and size of corporations, degree of computerization, degree of development of accounting, information, and control systems. Inflation Financial risk (e.g., use of flexible budgeting). Labor Availability, Quality, and Mobility Use of action controls, personnel controls, and long-term incentives.

Foreign currency translation ... Local managers bear foreign currency translation risk if their performance in measured in home-country currency. Can subsidiary managers control this risk? Authority to make cross-border investment, product sourcing, or marketing decisions; Authority to write purchase or sales contracts in one currency or another; Authority to make foreign exchange transactions (hedging, swaps, or arbitrage). If not, Evaluate manager in local currency; Treat foreign exchange losses and gains “below” the line; Calculate foreign exchange variance and treat is as uncontrollable; Flex the budget to end-of-year currency rates.