Managerial Control Chapter Fourteen © 2013 by McGraw-Hill Education.  This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.  This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 

Learning Objectives LO 1 Explain why companies develop control systems for employees. LO 2 Summarize how to design a basic bureaucratic control system. LO 3 Describe the purposes for using budgets as a control device. LO 4 Define basic types of financial statements and financial ratios used as controls. LO 5 List procedures for implementing effective control systems. LO 6 Discuss ways in which market and clan control influence performance

Managerial Control Control Any process that directs the activities of individuals toward the achievement of organizational goals The Siamese twins of management Planning

Signs that a Company Lacks Controls

Broad Categories of Control Bureaucratic control The use of rules, regulations, and authority to guide performance Market control Control based on the use of pricing mechanisms and economic information to regulate activities within organizations

Broad Categories of Control Clan control Control based on the norms, values, shared goals, and trust among group members.

The Control Process Figure 14.1

Control Systems have Four Steps Setting performance standards. Measuring performance. Comparing performance against the standards and determining deviations. Taking action to correct problems and reinforce successes.

Step1-Setting Performance Standards Expected performance for a given goal: a target that establishes a desired performance level, motivates performance, and serves as a benchmark against which actual performance is assessed. Performance standards can be set with respect to: quantity quality time used Cost Ex. Pizza delivery time-40 minutes, 95% customer satisfaction, increasing sales by 5%, decreasing accidents by 10%, decreasing employee absences by 30%, increasing productivity by 5%, increasing quality to 98%, etc.

Setting Standards A good standard must enable goal achievement. Companies determine standards by listening to customers or observing competitors. Standards can be determined by benchmarking other companies. Determine what to benchmark. Identify the companies against which to benchmark. Collect data to determine other companies’ performance standards. The first criterion for a good standard is that it must enable goal achievement. Companies determine standards by listening to customers, observing competitors, or benchmarking other companies. When setting standards by benchmarking, the first step is to determine what to benchmark. Companies can benchmark anything, from cycle time (how fast) to quality (how well) to price (how much). The next step is to identify the companies against which to benchmark your standards. Since this can require a significant commitment on the part of the benchmarked company, it can take time to identify and get agreement from them to be benchmarked. The last step is to collect data to determine other companies’ performance standards.

Step2-Measuring Performance Written reports Oral reports Personal observation

Step3-Comparing Performance with the Standard Principle of exception A managerial principle stating that control is enhanced by concentrating on the exceptions to or significant deviations from the expected result or standard.

Step4-Corrective Action Identify performance deviations Analyze those deviations Develop and implement programs to correct them Control Process Correct Identify Analyze The next step in the control process is corrective action.

Dynamic, Cybernetic Process Develop & Implement Program for Corrective Action Set Standards Measure Performance Compare with Standards Identify Deviations Analyze Deviations Source: H. Koontz & R.W. Bradspies, “Managing Through Feedforward Control: A Future Directed View,” Business Horizons, June 1972, 25-36. As shown in Figure 16.1, control is a continuous, dynamic process. It begins by setting standards, measuring performance, and then comparing performance to the standards. If the performance deviates from the standards, then managers and employees analyze the deviations and develop and implement corrective action programs that achieve the desired performance by meeting the standards. Managers must repeat the entire process again and again in an endless feedback loop. The control process is cybernetic because of the feedback loop in which actual performance is compared to standards so that deviations can be minimized or corrected. An example is controlling business expenses. Managers then compare performance to the pre-established standards. If they identify deviations from standard performance, they analyze the deviations and develop corrective programs. Then implementing the programs (hopefully) achieves the desired performance. To maintain performance levels at standard, managers must repeat the entire process again and again in an endless feedback loop. So control is not a one-time achievement or result. It continues over time (a dynamic process) and requires daily, weekly, and monthly attention from managers. Cybernetic takes its meaning from the Greek word kubernetes, meaning “steersman,” one who steers or keeps on course. 1.4

Three Basic Control Methods Feedback Control Concurrent Control Feedforward Control control that focuses on the use of information about previous results to correct deviations from the acceptable standard. is the control process used while plans are being carried out, including directing, monitoring, and fine-tuning activities as they are performed. Feedback control is a mechanism for gathering information about performance deficiencies after they occur. This information is then used to correct or prevent performance deficiencies. Study after study has clearly shown that feedback improves both individual and organizational performance. In most instances, any feedback is better than no feedback. However, if there is a downside to feedback, it is that it sometimes occurs too late. Sometimes it comes after big mistakes have been made. Concurrent control is a mechanism for gathering information about performance deficiencies as they occur. Thus, it is an improvement over feedback, because it attempts to eliminate or shorten the delay between performance and feedback about the performance. Feedforward control is a mechanism for gathering information about performance deficiencies before they occur. In contrast to feedback and concurrent control, which provide feedback on the basis of outcomes and results, feedforward control provides information about performance deficiencies by monitoring inputs, not outputs. Thus, feedforward seeks to prevent or minimize performance deficiencies before they occur. the control process used before operations begin, including policies, procedures, and rules designed to ensure that planned activities are carried out properly 1.5

Control Isn’t Always Worthwhile or Possible Control is achieved when behavior and work procedures conform to standards and goals are accomplished. Control loss occurs when behavior and work procedures do not conform to standards. Implementing controls isn’t always worthwhile or possible because: Regulation costs Whether the costs and both intended and unintended consequences of control exceed its benefits. Cybernetic feasibility The extent to which it is possible to implement each step in the control process. If one or more steps cannot be implemented, then maintaining effective control may be difficult or impossible.

The Role of Six Sigma At a six-sigma level, a process is producing fewer than 3.4 defects per million, which means it is operating at a 99.99966 percent level of accuracy Six Sigma companies have not only close to zero product or service defects but also substantially lower production costs and cycle times and much higher levels of customer satisfaction

Management Audits Control Various Systems An evaluation of the effectiveness and efficiency of various systems within an organization

Management Audits Control Various Systems External audit An evaluation conducted by one organization, such as a CPA firm, on another. Internal audit A periodic assessment of a company’s own planning, organizing, leading, and controlling processes.

External Audit Investigates other organizations for possible merger or acquisition Determines the soundness of a company that will be used as a major supplier Discovers the strengths and weaknesses of a competitor to maintain or better exploit the competitive advantage of the investigating organization

Internal Audit Assesses what the company has done for itself What it has done for its customers or other recipients of its goods or services.

Budgetary Controls Budgeting The process of investigating what is being done and comparing the results with the corresponding budget data to verify accomplishments or remedy differences also called budgetary controlling.

Budgetary Controls Fundamental budgetary considerations proceed through three stages: Establishing expectancies starts with the broad plan for the company and the estimate of sales, and it ends with budget approval and publications. Budgetary operations stage deals with finding out what is being accomplished and comparing the results with expectancies. The last stage involves taking corrective action when necessary.

A Sales-Expense Budget Exhibit 14.3

Types of Budgets Sales Production Cost Cash Capital Master

Types of Budgets Sales budget usually prepared by month, sales area, and product. Production budget is expressed in physical units. Cost budget is used for areas of the organization that incur expenses, but bring in no revenue, such as accounting, HR, Legal, etc. Cash budget is prepared after all other budget estimates are completed. Capital budget is used for the cost of fixed assets such as plant and equipment. Master budget includes all major activities of the business.

Checking the Checkers Accounting audits Procedures used to verify accounting reports and statements. Performed by outside CPA firm.

Activity-Based Costing Activity-based costing (ABC) A method of cost accounting designed to identify streams of activity and then to allocate costs across particular business processes according to the amount of time employees devote to particular activities

How Dana Discovers What Its True Costs Are Exhibit 14.5

Balance Sheet Balance sheet A report that shows the financial picture of a company at a given time and itemizes assets, liabilities, and stockholders’ equity.

Balance Sheet Assets Liabilities Stockholders’ equity The values of the various items the corporation owns. Liabilities The amounts a corporation owes to various creditors Stockholders’ equity The amount accruing to the corporation’s owners. Assets = Liabilities + Stockholders’ equity

Profit and Loss Statement An itemized financial statement of the income and expenses of a company’s operations Exhibit 14.7

Financial Ratios Current ratio A liquidity ratio that indicates the extent to which short term assets can decline and still be adequate to pay short-term liabilities

Financial Ratios Debt-equity ratio Return on investment (ROI) A leverage ratio that indicates the company’s ability to meet its long-term financial obligations Return on investment (ROI) A ratio of profit to capital used, or a rate of return from capital

Using Financial Ratios Management myopia Focusing on short-term earnings and profits at the expense of longer-term strategic obligations.

Bureaucratic Control has a Downside Rigid bureaucratic behavior occurs when control systems prompt employees to stay out of trouble by following the rules. a. Tactical behavior – the most common type of tactical behavior is to manipulate information or report false performance data. Resistance occurs for several reasons: a. Comprehensive control systems increase the accuracy of performance data and make employees more accountable for their actions. b. Control systems can change expertise and power structures. c. Control systems can change the social structure of the organization.

Bureaucratic Control has a Downside Rigid bureaucratic behavior Tactical behavior Resistance to control

More Effective Control Systems The systems are based on valid performance standards. They communicate adequate information to employees. They are acceptable to employees. They use multiple approaches. They recognize the relationship between empowerment and control.

Balanced Scorecard Balanced scorecard Control system combining four sets of performance measures: financial, customer, business process, and learning and growth

The Balanced Scorecard Encourages managers to look at four different perspectives on company performance. Customer Perspective How do customers see us? Internal Perspective At what must we excel? Innovation and Learning Perspective Can we continue to create value? Financial Perspective How do we look to shareholders? The balanced scorecard encourages managers to look beyond traditional financial measures to four different perspectives on company performance. How do customers see us (the customer perspective)? What must we excel at (the internal perspective)? Can we continue to improve and create value (the innovation and learning perspective)? How do we look to shareholders (the financial perspective)?

Advantages of the Balanced Scorecard Forces managers to set goals and measure performance in each of the four areas Minimizes the chances of suboptimization performance improves in one area, but at the expense of others The balanced scorecard has several advantages over traditional control processes that rely solely on financial measures. First, it forces managers at each level of the company to set specific goals and measure performance in each of the four areas. The second major advantage of the balanced scorecard approach to control is that it minimizes the chances of suboptimization, where, performance improves in one area, but only at the expense of decreased performance in others.

The Balanced Scorecard: Southwest Airlines

Market Control Market control involves the use of economic forces and the pricing mechanisms that accompany them to regulate performance. Market controls let supply and demand determine prices and profits Market controls at the corporate level are used to regulate independent business units. Market controls at the business unit level regulate exchanges among departments and functions. Market controls at the individual level provide a natural incentive for employees to enhance their skills and offer them to potential firms.

Examples of Market Control Exhibit 14.9

Clan Control Clan control - creating relationships built on mutual respect and encouraging the employee to take responsibility for his or her actions Clan control relies on empowerment and culture 1.Bureaucratic controls don’t work well today because: a. Employees’ jobs have changed – nature of work is evolving. b. The nature of management has changed. c. The employment relationship has changed.

Clan Control Managers must empower employees by: a. putting control where the operation is b. using ‘real time’ rather than after-the-fact controls c. rebuilding the assumptions underlying management control to build on trust rather than distrust d. moving to control based on peer norms e. rebuilding the incentive systems to reinforce responsiveness and teamwork

Management Control in an Empowered Setting Put control where the operation is. Use real-time rather than after-the-fact controls. Rebuild the assumptions underlying management control to build on trust rather than distrust. Move to control based on peer norms. Rebuild the incentive systems to reinforce responsiveness and teamwork.

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