2. • 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.
3. • 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.
4. • What is MCS?
• The term management control systems
consists of three words, namely:
1. Management
2. Control and
3. Systems
5. • Management:
• It is broadly defined as
planning, organizing, staffing, directing, evaluatin
g 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 organization’s
goals.
6. • Control:
• In today’s 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.
7. • 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.
8. • 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 firm’s senior
executives design and implement the
management systems to plan and control the
firm’s performance.
9. • 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.
10. • Elements of MCS include:
- Strategic planning
- Responsibility center allocation
- Transfer pricing
- Budgeting
- Resource allocation
- Performance measurement
- Evaluation and reward
11. • Management control is a must in any
organization that practices “decentralization”.
• One view argues that management control
systems must fit the firm’s strategy.
• This implies that strategy is first developed
through a rational and formal process and this
strategy then dictates the design of the firm’s
management systems.
12. • Another view is that strategies emerge
through experimentation, which are
influenced by the firm’s management systems.
• In this view, management control systems can
affect the development of strategies.
13. • 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.
14. • 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.
15. 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.
16. • 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.
17. • 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.
18. • 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)
19. • Formal control system (FCS):
• The controls are laid down by the management in
writing to influence the behaviour of employees
in achieving organization’s goals.
• Examples:
- Rules and regulations
- Procedures
- Work plan / work instructions.
20. • 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.
21. • 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
22. • 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 fed-
forward, and the level of the finished goods
inventory is controlled by reducing production.
23. • 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.
24. • 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.
25. • There are three types of informal controls:
1. Self- control
2. Social controls and
3. Cultural controls.
26. • 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 organization’s goals are in
congruence with the individuals goals.
27. • 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.
28. • Cultural controls:
• These are exercised through work-culture and
tradition of the organization.
29. • 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.
30. • Levels of controls in an organization:
Top Strategic control /
Mgt. planning
Management control
Middle Mgt.
Lower level Mgt.
Operational control
31. • 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.
32. • Management control:
• It deals with the effective utilization of
resources made available by the top-
management for the accomplishment of
organization’s objectives.
• It is exercised by the middle management
through interaction with the top management
and lower level management.
• It is medium term in nature.
33. • 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.
34. • 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
35. • 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.
36. • 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.
37. • 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.
38. 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.
39. • Elements of a control system:
Control Device Assessor
Detector
Effector
Entry being
controlled
Communication Network
40. • 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.
41. • 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.
42. • Organizational culture:
• It refers to the set of common
beliefs, attitudes and norms that explicitly or
implicitly guide managerial actions.
44. • MCS and behavioural considerations:
• People are important assets for an
organization.
• Without the cooperation of the
employees, managers can’t 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
45. • 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.
46. • Motivational problems:
• Motivation is important to help employees to
perform to their full potential.
• Most of the organization’s 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.
47. • 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.
48. • 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.
49. • 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
50. • 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.
51. • 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.
52. • 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.
53. • 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.
54. • 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.
55. • 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.
56. • 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.
57. • 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
58. • Internet cannot substitute the human element
involved in the management control.
• Implementing strategies through MCS
involves human interaction, social and
behavioural processes which can’t be
automated.
• MCS requires human judgement and
intervention, which an internet cannot do.
59. • 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.
60. 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.
62. • Management control systems are tools to
implement strategies.
• Strategies differ from organization to
organization and the controls should be
designed to meet the requirements of specific
strategy.
• Strategies are plans to achieve organization’s
goals.
63. • Corporate goals are determined by the CEO or
the top most person of an organization in
consultation with other members of senior
management.
• There can be different types of goals
depending on the strategy of the
company, like:
1. Profitability
2. Maximizing shareholder value
3. Risk and
4. Multiple-Stakeholder approach.
64. • Profitability:
• Also called as return on investment.
• Profitability here refers to the long term
profitability.
• Maximizing shareholders value:
• It refers to the market price of the
organization’s stock.
65. • Risk:
• Profitability of an organization is affected by
the management’s ability to take risk.
• The risk taking degree varies from managers
to managers.
• Some firm may explicitly state that the
management’s primary responsibility is to
preserve the company’s assets, with
profitability considered as a secondary goal.
66. • Multiple Stakeholder approach:
• A firm has the following multiple stakeholders:
1. Shareholders
2. Customers
3. Employees
4. Suppliers and
5. Society / Community
- The has a responsibility towards all these
stakeholders.
- The MCS should identify the goals for each of
these groups and track the performance.
67. Concept of strategy
• Strategy is defined as,” The general direction
in which an organization plans to move to
attain its goals”.
• Every organization has two or more strategies
depending on the SWOT analysis.
• A firm develops its strategies by matching its
core competencies with the industry
opportunity.
69. • Classification of strategy: Can be classified as
below:
Strategy
Corporate Level Business unit level
70. • Corporate Level Strategy:
• Key strategic issues:
1. Whether the present operation is in the right
mix of industries?
2. What industries or sub-industries the
company should operate?
• Generic strategic options:
1. Single industry related diversification
2. Unrelated diversification
* Corporate level strategy is formulated at
Corporate Office.
71. • Business Unit Level Strategy:
• Key strategic issues:
1. What should be the mission of business unit?
2. How should the business unit compete to realize
its mission?
• Generic strategic options:
1. Build, hold, harvest, divest
2. Low cost differentiation.
* Business unit level strategy are formulated by
business units in consultation with Corporate
Office.
72. • Corporate level strategy:
• Based on the corporate level strategy firms
can be classified as below:
1. A single industry firm
2. A related diversified firm and
3. An unrelated business firm
73. • A single industry firm:
• This type of firm operates in one line of
business.
• Example: Castrol- Lubricant industry.
• A related diversified firm:
• This type of firm operates in several
industries, and the business units benefit from
a common set of core competencies.
74. • Example:
• Procter & Gamble is an example.
• It has business units in detergent
soap, toothpaste, shampoo and other
branded FMCG products.
• It has two core competencies:
1. Core skill in chemical technology and
2. Marketing and distribution expertise in FMCG
branded products.
75. • An unrelated business:
• This type of firm operates in businesses that
are not related to one another.
• Example:
• ITC India Ltd-
tobacco, paper, biscuits, hospitality, agricultur
al products etc.
76. • Corporate level strategies- Graphical
Representation
High *Single Industry
Degree of
Relatedness * Related Diversification
*Unrelated Diversification
Low
Extent of Diversification High
77. • The management control systems for different
diversification strategies are quite different.
• The structure and form of controls
differ, which are explained subsequently.
78. • Business Unit / Strategic Business Unit /
Divisional Structure:
Chief Executive Officer
Staff
Manager Manager Manager
Business Unit-1 Business Unit-2 Business Unit- 3
Staff Staff Staff
Plant Marketing Plant Marketing Plant Marketing
Manager Manager Manager Manager Manager Manager
79. • A business units or SBUs act almost as if the units
are separate companies, though they are part of
the same parent company.
• A SBU is responsible for all functions involved in
producing and marketing a separate product line.
• The performance of a SBU is measured by the
profitability of the SBU.
• Though SBU managers exercise broad authority
over the SBUs, the headquarters holds certain key
powers like allocating funds , approval of budgets
and setting of the performance measures.
80. • Business Unit Strategies:
• Business Unit Strategies deal with how to
create and maintain competitive advantage in
each of the industries in which the company
has chosen to operate.
• The strategy of a business unit depends on
two factors:
1. Its mission- its overall objectives and
2. Its competitive advantage- how to compete
in its industry to accomplish its mission.
81. • Business Unit mission:
• In a diversified firm one of the important tasks
of senior management is resource
deployment- that is to make decisions
regarding the use of the cash generated from
some business units into other business units.
• Several models have been developed to help
diversified firms to effectively allocate
resources.
82. • There are two planning models, which are
widely used to develop the most appropriate
missions for the various business units.
• Both the models have the same set of
missions to choose namely-
Build, Hold, Harvest and Divest.
• The models are:
1. Boston Consulting Group’s two-by-two
growth-share matrix and
2. General Electrical Company / Mckinsey &
Company’s three-by-three industry
attractiveness-business strength matrix.
83. • BCG Model:
High
“Star” “Question Mark
Hold Build
Market
Growth
Rate “Cash Cow “Dog”
Harvest Divest
Low
Relative Market Share Low
High
84. • In the BCG model, every business unit is
placed in one of the four categories- Question
mark, star, cash cow and dog.
• BCG views industry growth rate as an indicator
of relative industry attractiveness and relative
market share as an indicator of the relative
competitive position of a business.
85. • BCG considers market share as one of the
important strategy parameters because of the
impact of experience curve.
• AS per BCG, cost per unit decreases with the
number of units produced over time.
• Since the market share leader will have the
greatest accumulated production
experience, such a firm should have the
lowest costs and highest profits in the
industry.
86. • Interpretation of BCG model:
• Question mark:
• Business units fall in this quadrant are
assigned the mission: “Build Market Share”.
• By building market share early in the growth
phase of an industry, the unit will enjoy low-
cost position.
• These units consume significant cash.
87. • Star:
• Business units falling under this quadrant are
assigned the mission: “ Hold” market share.
• These units already have a high market share in
their industry, and the objective is to invest cash
to maintain that position.
• These units generate significant amount of
cash, but they also need significant cash to
maintain their competitive strength in the
market.
88. • Cash cow:
• These units are the primary source of cash for the
organization.
• Because these units have high relative market
share, they have the lowest unit costs and hence
high profits.
• Since these units operate in low growth or
declining industries, they do not need to reinvest
all the cash generated.
• Hence these units generate a significant amount
of cash flows.
• Such units have “harvest” mission for cash flows.
89. • Dog: Units in this quadrant have a weak
competitive position in unattractive
industries.
• They should be divested unless there is a good
possibility of turning them around.
*** The firm should identify cash cows with
positive cash flows and redeploy these
resources to build market share in question
marks.
90. • Business Unit Competitive Advantage:
• Michael Porter has described two analytical
aids for developing a superior and sustainable
competitive advantage. They are:
1. Industry Analysis or Porter’s Five Forces
Model and
2. Value Chain Analysis
91. • Porter’s Five Force Model:
• Industry conditions play an important role in
the performance of individual firms.
• According to Porter, the structure of an
industry should be analyzed in terms of the
collective strength of five competitive forces.
92. Threat of new entrants
Bargaining Intensity of
Power of Competition Bargaining power
Suppliers & Of Customers
Rivalry
Threat from
substitutes
93. 1. The more powerful the five forces are, the
less profitable an industry is likely to be. In
industries where the average profitability is
high (Example- Pharmaceuticals), the five
forces are weak. In industries where average
profitability is low ( Example- Steel), the five
forces are strong.(in steel industries, threats
from substitutes is very high).
94. 2. Depending upon the relative strength of the
five forces, the key strategic issues facing the
business unit will differ from one industry to
another.
3.Understanding the nature of each force helps
the firm to formulate effective strategies.
95. • Generic competitive advantage:
• The five- forces analysis is useful in developing a
competitive advantage since it helps to identify
the opportunities and threats in the external
environment.
• With the understanding of the five forces, Porter
says that a business unit can respond to the
external opportunities in two generic ways and
develop a sustainable competitive advantage:
1. Low cost and
2. Differentiation
96. • Low cost:
• Cost leadership can be achieved through
economies of scale, tight cost control and cost
minimization.
• Differentiation:
• The focus of this strategy is to differentiate the
product offered by the business unit, creating
a perception as something unique.
97. • Value Chain Analysis:
• As explained earlier business units can
develop competitive advantage based on low
cost, differentiation or both.
• The best choice to attain competitive position
is to achieve cost-cum-differentiation.
• Ultimately competitive advantage is derived
from providing better customer value at a
lower cost.
98. • Value Chain is a complete set of activities starting
from raw material sourcing to post delivery
support to customers.
• Value Chain analysis tries to identify the activities
of the firm- from design to distribution- customer
value can be enhanced or costs lowered.
• By systematically analyzing costs, revenues and
customer value in each activity, the business unit
can achieve cost –cum- differentiation advantage.
99. • Typical value chain of a business:
Primary Activities
Product development / Manufacturing / Marketing / Logistics
Support Activities: Finance / HRD / IT
100. Management Control Systems
Organization Hierarchies
and
Behaviour in Organizations
Prof. C. K. Sreedharan
Unit No: 03
101. • The management control systems should ensure
that individual goals of the employees align with
the organizational goals.
• The process of alignment of individual goals with
the organizational goal is called as “ Goal
Congruence”.
• A good management control system influences
the behaviour of the organizational members in
a goal congruent manner.
• Hence MCS should ensure that individual actions
taken to achieve personal goals also help to
achieve the organizational goals.
102. • Both formal and informal systems influence
human behaviour in an organization.
• They also affect the degree to which goal
congruence can be achieved.
• The MCS designers should consider the impact
of informal processes ( work
culture, management style etc)along with the
formal processes.
103. • Influence of informal factors on goal
congruence
• Informal factors can be classified as:
1. External factors and
2. Internal factors.
104. • External factors: These are norms of desirable
behaviour that exist in the society.
• These norms affect an organization since it is
also part a society.
• These norms include a set of attitudes, often
selectively called as “ Work Ethic”.
• Work Ethic is manifested in employee’s loyalty
to the organization, their spirit , pride in doing
the job etc.
105. • Internal factors:
• The various internal factors are:
1. Culture
2. Management style
3. The informal organization and
4. Perception and communication
106. • Culture:
• It is the most important internal factor which
may impact the goal congruence.
• It is a set of common beliefs, norms of
behaviour and assumptions which are
prevalent throughout the organization.
• A company’s culture exists unchanged for
many years.
• Certain practices become rituals, carried out
automatically because of the belief that" This
is the way things are done here”.
107. • Management style:
• Management styles like
charismatic, autocratic, democratic, participative etc
play major role in achieving goal congruence.
• Example:
• Reginald Jones was appointed CEO of General Electric
Company in 1970. During that time the company faced
many problems like price-fixing scandal that sent
several executives to jail and also the company had to
wind up its mainframe computer business.
• Jones was formal, dignified, refined bright and willing
to delegate enormous amount of authority.
• Jones management style was well suited for bringing
more decipline to the company.
108. • He instituted the formal strategy planning and
built up one of the first strategic planning units in
a major corporation.
• Jones retired in 1980, the GE Board deliberately
selected Jack Welch, a man with a very different
management style.
• Welch was outspoken, impatient, informal and an
entrepreneur. These qualities well suited for the
company for growth.
• During his tenure, mega acquisitions, rapid
expansion into Europe and Asia and
implementation of concepts like six sigma – put
GE in a growth trajectory.
109. • The informal organization:
• The organizational chart shows a formal
relationship- that is, the official authority and
responsibilities.
• An informal organization relationship exists
between various members of the
organization.
110. • Example: Production Manager Division A
reports to the General Manager of division A.
But in the course of fulfilling his
responsibilities, the production manager
actually communicates with many other
people in the organization, as well as with
other managers, support units and other
people who are simply friends.
• The MCS should give due importance to the
informal relationships that exist in an
organization.
111. • Perception and communication:
• In order to achieve goal congruence, operating
managers should know about organizational
goals and the actions that are supposed to be
taken for achieving them.
• Clear communication should be given to every
one in the organization so that there is
absolute clarity in the perception.
112. • Formal Control System:
• It is already seen that informal factors have a
major influence on the effectiveness of an
organization’s management control system.
• The other major influence on MCS is the
formal systems.
113. • The formal control systems can be classified
into two types:
1. The management control system itself and
2. Rules.
- Formal control systems we have already
studied (Input control, process
control, output control).
- Rules can be implemented through
manuals, work instructions, procedures etc.
114. • Rules:
• Rules indefinitely exist unless modified
• Rules can be modified depending upon the
circumstances and in the best interest of the
company.
• If there is a rule of giving 2 months credit to
customers, it can be changed by the Sales
Manager for a large value customer.
• Some rules can be positive requirements, like
using protective equipments while others can be
prohibition of undesirable actions like paying
bribes etc.
115. • Hence the factors that influence goal
congruence in an organization are:
1. Informal factors
- External factors
- Internal factors
2. Formal factors
116. Types of Organizations
• The organization structure influences the
design of the organization’s management
control systems.
• Organization structures can be generally
classified into three categories:
1. Functional organization
2. Business Unit structure organization or
Divisional structure and
3. Matrix structure.
117. • The structure of any organization depends on:
1. Nature of business, its size and complexity
2. Inter-functional relations and
3. Extent of control needed.
119. • The functional structure is based on the
principle that a manager has a specialized
knowledge on a specific function and can take
better decisions regarding his function.
• A skilled manufacturing manager or a skilled
marketing manager are likely to make better
decisions in their respective field than would a
manager responsible for both functions.
120. • Advantage:
• Since a specialist supervises his people, skilled
higher level managers supervise the lower
level managers, this type of structure ensures
efficiency.
121. • Disadvantages:
1. It is difficult to measure the effectiveness of
different functional managers(
marketing, production etc), since each
function contributes jointly to the
organization’s final output.
122. 2. The structure consists of managers in one
function who report to higher level managers
in the same function, who in turn report to
the still higher level manager in that function.
- When a dispute arises between managers of
different functions, it can be resolved only at
the top, even though it may have originated at
a much lower organizational level.
123. 3. Functional structures would not be effective
for a firm with diversified products and
markets.
4. This type of structure prevents cross-
functional coordination in certain areas like
new product development.
124. • Business Unit structure has already been
discussed in Unit No: 02.
• Advantages of SBU Structure:
1. It provides a training ground for managers
who can be considered for heading the entire
organization.
2. The SBU also reacts faster to the threats and
opportunities in the market more quickly.
125. • Disadvantages:
• There is a duplication of work, since some of
the staff may duplicate some work that is
being carried out in head quarters.
• There is a possibility of dispute between SBUs
where one SBU supplies some products to
another SBU.
126. • Matrix Structure:
Chief Executive officer
Staff
Function A Manager
( Production) Project X Manager
Function B manager
Project Y Manager
(Quality)
Function C Manager
Project Z Manager
(Finance)
127. • The matrix structure tries to integrate the desired
features of the functional structure and the SBU
structure.
• This structure was first implemented successfully in
NASA, USA in 1970’s
• This structure is commonly used in Project based
organizations and for new product development.
• In this structure an employee reports to two different
managers- one reporting manager is functional
manager and the another one is the project manager.
• Examples: P & G, L & T, Bharati Airtel – some of the
organizations which have adopted Matrix Structure.
128. • The functional aspect in the matrix structure
helps in the utilization of skilled knowledge of
the functional experts and the SBU / divisional
aspect helps in customer focus.
• This structure is commonly used in project
based organizations and for new product
development.
129. • Advantages:
• Functional aspects of the structure brings in
specialization and SBU aspects brings in more
focus and hence helps in improving
profitability and customer oriented approach.
• This is useful in organizations which have a
limited product range.
• Very useful where the products require close
coordination among many specialists.
• Useful when the markets are too small to
justify separate divisions for each product.
130. • Disadvantages:
• It calls for a high degree of cooperation and
coordination among managers.
• Due to the presence of dual authority, there is a
possibility of conflicts arising between managers.
• Individuals involved require strong interpersonal
skills.
• This structure will not be successful if the
members of the organization are not mutually
respectful.
• Establishing MCS is more difficult than other two
structures.
131. • Criteria for design of MCS:
• We have seen that every structure has
inherent advantages and disadvantages.
• The senior management should carefully
evaluate the suitability of each structure
against its nature of business and other
considerations before selecting a particular
type.
• System designer must always fit the system to
the organization rather than the other way
around.
132. Functions of the Controller
• A controller is the person who is responsible
for designing and operating the management
control system.
• In many organizations the Chief Financial
Officer performs the role of a Controller.
• Presently many companies have Chief
Information Officer (CIO) who carries out the
activities of a Controller.
133. Functions of Controller
• Designing and operating MCS.
• Preparation of financial statements, financial
reports (including tax returns) for
shareholders and external parties.
• Preparation and analysis of performance
reports, interpretation of these
reports, analysis of budget proposals from
various departments and consolidating them
into overall annual budget.
134. • Supervision of internal audit and accounting
control procedures and establishing adequate
control over fraud.
• Identification and imparting appropriate
training to personnel in the organization
regarding MCS.
135. • Relation of Controller in functional / line
organization:
• The controllership function is a staff
function(advisory in nature).
• The use of the information is the responsibility
of the line management.
• Controller is responsible for developing and
analyzing the reports and to recommend
necessary actions to the management.
136. • Controllers also play an important role in the
preparation of strategic plans and budgets.
• They may also asked to scrutinize
performance reports and draw the attention
of line managers.
• Hence controllers also act as line managers.
137. • Business Unit Controller:
• Business Unit Controllers inevitably have
divided loyalty.
• On the one hand, they report to Corporate
Controller, who is responsible for the overall
operation of the MCS.
• On the other hand, they also report to the
manager of the SBU, for whom they provide
staff assistance.
138. • Based on the relationship of the Controller
with the SBU manager and Corporate
Controller , there are two possible types of
relationships:
1. Dotted Line Relationship and
2. Solid Line Relationship.
139. • Dotted Line Relationship Solid Line Relationship
Corporate
Corporate
Controller
Controller
Business Unit
Manager Business Unit
Manager
Business Unit
Business Unit
Controller
Controller
140. • Dotted Line Relationship:
• Business Unit Controller reports to the
business unit manager, who is his immediate
boss.
• He has also a dotted line relationship ( indirect
reporting) with the Corporate Controller.
141. • Solid Line Relationship:
• In this type, business unit controllers report
directly to the corporate controller. This type
of relationship is shown by the solid line.
• They also indirectly report to the business unit
head.
142. • There are problems with each type of
relationship.
• If the business unit controller reports to the
business unit head, he may not provide correct
reports regarding unit’s performance to senior
management.
• On the other hand, if business unit controller
directly reports to the Corporate Controller, the
business unit manager may treat him as a spy
from the Corporate Office.
143. • Regardless of the reporting relationships, it is
expected that the controller will not report
misleading information or conceal
unfavourable information.
• He is expected to ethically perform his duties
in the overall interest of the organization.
145. • An organization is meant for achieving certain
predefined objectives.
• In a small organization all decisions required
for achieving the objectives can be made by
one person.
• However, when the organization grows and
becomes complex, it may become impossible
for one person to make all decisions.
• In this scenario decision making is delegated
to managers by giving them authority over a
part of the organization’s operations.
146. • One important implications of this delegation of
authority is that managers to whom the
authority is delegated are held responsible for
the consequences of their decisions.
• Delegation of authority and responsibility brings
in a degree of accountability.
• Hence organizations assign specific authority and
responsibility to different levels of the
organization and evaluates the person in charge
of each level on the basis of achievement of
results.
• Any such level is called as “Responsibility Center”
147. • Each unit or sub-unit thus becomes a
responsibility center.
• A firm is a collection of responsibility
centers, each of which is represented by a box
on the organization chart.
• These responsibility centers form a hierarchy.
• MCS is required to assess the performance of
each of these responsibility center.
148. • A responsibility center exists to accomplish
one or more purposes- termed as its
objectives.
• The firm as whole has goals, and senior
management decides on the action plan to
achieve these goals.
• The objectives of the company’s various
responsibility centers are to help implement
the strategies of the organization.
149. • Every organization is the sum total of its
responsibility centers.
• If each responsibility center meets its
objectives, the ultimate goal of the
organization will have been achieved.
150. • Types of delegation:
• One of the first steps required in implementing
the concept of responsibility center is to have a
clear understanding of the strategy to be
followed by the company.
• It is not possible for all the organizations to
follow a particular pattern.
• Authority and responsibility can be delegated
in a number of ways.
151. • It is determined by the following:
a) Nature and complexity of the organization
b) Environmental factors
c) Nature of business
d) Philosophy of the management.
152. • Based on these factors, organization’s have
different structures.
• Some of the popular structures are:
1. Functional organization
2. Business Unit structure organization or
Divisional structure and
3. Matrix structure.
153. • Core operation of responsibility center
Inputs Transformation Outputs
Processes
(Work)
Resources used Goods or Services
Measured by cost
Revenue Generation
154. • Responsibility centers receive inputs in the
form of raw materials, labour and using
working capital, equipment and other
assets, the responsibility centers transform
the inputs into outputs, which are either
tangible (goods) or intangible( services).
• Revenues are earned by these outputs.
155. • Relation between inputs and outputs:
• Management is responsible for ensuring
optimum relationship between inputs and
outputs.
• In some centers , like in a production
department, the relationship is direct. Here the
inputs of raw material become a part of the
finished goods.
• Here control focuses on using the minimum input
necessary to produce the required output, as per
correct quality requirements and in right
quantity.
156. • However, in many situations, inputs are not
directly related to outputs.
• Advertising expense is an input that is
intended to increase sales revenue.
• But revenue is affected by many factors other
than advertising, the relationship between
increased advertising and any subsequent
increase in revenue is rarely measurable.
• Management’s decision to increase
advertisement expenditure is based on
judgment rather than data.
157. • Measuring inputs and outputs:
• Responsibility centers input is generally
expressed in terms of Cost.
• It is the monitory measure of resources used by a
responsibility center.
• Annual revenue earned by the responsibility
center is often used as a measure of output of a
responsible center.
• However it is always not possible to measure the
outputs of a responsibility center.
• Examples: Quality control department, PR
department.
158. • Efficiency and Effectiveness:
• These are the two criteria by which the
performance of a responsibility center is
judged.
• Efficiency: It is the ratio of outputs to inputs.
• Efficiency = Output / Input
159. • Responsibility center “A” is more efficient than
responsibility center “B” if:
1. It uses fewer resources than “B” but
produces the same output.
2. If “A” uses the same amount of resources but
produces a greater output.
160. • Effectiveness:
• It is determined by the relationship between a
responsibility center’s output and its
objectives.
• The more the output contributes to the
objectives, the more effective is the unit.
161. • Efficiency and effectiveness are not mutually
exclusive. Every responsibility center ought to
be both efficient and effective.
• Hence each responsibility center should meet
its goals in an optimum manner.
162. • The role of profit:
• A major objective of any profit oriented
organization is to earn a satisfactory profit.
• Thus profit is an important measure of
effectiveness.
• Further, since profit is the difference between
revenue ( a measure of output) and expense
( a measure of input), it is also a measure of
efficiency.
• Hence profit measures both effectiveness and
efficiency.
163. • Types of responsibility centers:
• Any business organization is concerned with
four major elements and they are:
1. Expenses
2. Revenue
3. Profit (Revenue minus expenses) and
4. Investment.
164. • Thus, conceptually there are four subsets of
responsibility center:
1. If the manager in charge of a responsibility
center has control over expenses, his sphere
of control can be termed as “Expense
Center”.
2. If a manager has control over revenue, that
area can be termed as “Revenue Center”.
165. 3. If a manager is responsible for profits by
controlling both revenue and expenses, that
responsibility area may be referred as a
“Profit Center”.
4. If a manager controls investments, that
responsibility area may be referred as an
“Investment Center”.
166. • Hence there are four types of responsibility
centers classified according to the nature of the
monetary inputs and / or outputs that are
measured for control purpose.
• Classification is also based on the scope of
responsibility and decision making authority
given to managers.
• They are:
1. Revenue centers
2. Expense centers
3. Profit centers and
4. Investment centers.
167. • Characteristics of a Responsibility Center:
• An effective responsibility center shall have the
following characteristics:
1. It is a clearly defined segment of an organization
2. A designated individual is responsible for its
performance, namely, the output produced by
the segment as well as inputs consumed by the
segment.
3. The designated individual has the necessary
authority to discharge the assigned
responsibilities.
168. • Example:
• Raj Apparels is organized with clear delegation of
responsibilities.
• The Production Manager is responsible for all the
activities related to production.
• Marketing Manager is responsible for all activities
related to the marketing of products.
• Vice-President, Apparel Division is responsible for
the profits of the division.
• Only the President is responsible for the
investment decisions for the different divisions
169. Investment
President Center
Profit Center
Vice-President Vice-President
(Apparel Div.) (Other Divisions)
Production Marketing
Manager Manager
(Apparels) (Apparels)
Expense Center Revenue Center
170. • In this organization the various responsibility
centers are:
• Production manager: Expense Center
• Marketing manager: Revenue Center
• Vice President (Apparel Division): Profit Center
• President: Investment Center
171. • Expense centers or cost centers:
• A cost or expense center is a segment of an
organization in which the managers are held
responsible for the cost or expense incurred
but not for revenues.
• Example: Manufacturing function
• For planning purpose cost estimates are given
by budget estimates.
• Performance evaluation is done by cost
variance, that is the difference between the
actual and budgeted costs for a given period.
172. • Revenue center:
• A revenue center is a part of the organization
which is primarily responsible for generating
sales revenue.
• Example: Marketing function.
• The performance of a revenue center is
evaluated by comparing the actual revenue
with the budgeted revenue and actual
marketing expenses.
• Hence the primary measurement of
performance is revenue generated.
173. • Profit center:
• It is the segment of an organization whose
manager is responsible for both revenue and
cost.
• Managers have control over both costs and
revenues.
• Managers have authority and responsibility to
make decisions regarding both costs and
revenues.
• Example: SBU / division of a company.
174. • The main objective of a profit center is to earn
profit.
• The performance of a profit center is
evaluated in terms whether the center has
achieved its budgeted profit.
• Profit center manager determines selling
price, marketing programmes and production
policies.
175. • Investment Center:
• An investment center is a part of the
organization which is primarily responsible for
investment decisions and hence to be
evaluated on the basis of performance of
Return on Investment(ROI).
• Hence an investment center is responsible for
both profits and investments.
• The manager of an investment center has
more authority and responsibility than the
manager of an expense center or a manager
of a profit center.
177. • Expense center:
• These are responsibility centers whose inputs
are measured in monetary terms, but outputs
are measured in terms of number of units.
Inputs Outputs
Work
Cost in rupees Number of units
Manufacturing Cost Center- is an example of expense center.
178. • Expense centers can be classified as below:
Engineered Expense Center Discretionary Expense Center
Proper estimation of input costs Output of these centers can’t be
Can be done with reasonable degree Measured in monetary terms.
of accuracy.
Example- HRD, legal department,
Output can be measured. PR depat. etc
Example- Material, labour etc
179. • Engineered Expense Center:
• They have following characteristics:
1. Their input can be measured in monetary
terms
2. Their output can be measured in physical
terms and
3. The rupee equivalent of input required to
produce one unit of output can be
determined.
4. Standard cost estimations can be made.
180. • In an engineered expense center, output
multiplied by the standard cost of each unit
produced measures what the finished product
should have cost.
• The difference between the theoretical and
actual cost represents the efficiency of the
expense center being measured.
181. • Discretionary Expense Centers:
• These are administrative and support unit like-
HRD, PR department, legal department etc.
• The output of these centers can’t be
measured in monetary terms.
• Discretionary means that it is the
management’s decision to decide how much
to spend
182. • In these units expenses (inputs) are expressed
in monetary terms but outputs can’t be
measured in monetary terms.
• Discretionary expenses are those expenses
which are incurred as per organization’s
policies, which are derived from strategic
planning, its goals and objectives.
183. • In a discretionary expense center, the
difference between budget and actual
expense is not a measure of efficiency.
• If actual expenses do not exceed the budget
amount, it can be said that the manager has
"Lived within the budget”.
• Living within the budget does not necessarily
indicate efficient performance.
184. • MCS for discretionary expense centers:
• Features of budget process for discretionary
expense centers:
• Budget preparation:
• Budgetary preparation for discretionary
expense center is different from engineered
expense center.
• In an engineered expense center, budget is
based on unit cost of performing the task
efficiently.
185. • By contrast, management formulates the
budget for the discretionary expense center
by determining the magnitude of the job that
needs to be done.
• The work done by discretionary expense
center falls under two general categories:
1. Continuing work and
2. Special work
186. • Continuing work: This is done consistently from
year to year.
• Special work: This is only one time work.
• A technique often used in preparing a
discretionary expense center’s budget is
“Management by Objectives”- a formal process in
which a budgetee proposes to accomplish
specific tasks and suggests the measurements to
be used in performance evaluation.
187. • The planning of discretionary expense center
is usually carried out in one of the following
two ways:
1. Incremental budgeting or
2. Zero- Base Review.
188. • Incremental Budgeting:
• The discretionary expense center’s current
level of expenses is taken as a starting point.
• This amount is adjusted upwards for inflation
and other cost increases.
189. • Incremental budgeting has two drawbacks:
1. The discretionary expense center’s current
level of expenses is accepted and not
examined whether this cost is really justified.
2. Managers of these centers typically tend to
request additional resources, which are
generally provided.
- Despite these limitations, most budgeting in
discretionary expense center is incremental
budgeting.
190. • Zero-base review:
• This is an intensive review, ascertains from the
scratch, the resources actually required to
carry out each activity within the expense
center. This expense level is fixed as the base
level. This level remains as the base level.
• The expense center attempts to keep the
costs reasonably within this base level.
• Again a thorough review is carried out after a
fixed interval of time, say after five years. This
level is set as a new base year.
191. • Zero base budgeting is time consuming and
are traumatic for the managers whose
operations are being reviewed.
• Also the managers will always try to justify
their current level of spending and will try to
stop the process of zero-base review by
stating some reason or the other( Example:
Have some other important work to do, very
busy etc).
192. • Companies generally carry out this zero- base
review, whenever there is a significant erosion
in profitability.
• These efforts are called as:
a) Downsizing or
b) Rightsizing or
c) Restructuring or
d) Process Reengineering.
193. • Measurement of performance of discretionary
expense center:
• The primary job of a discretionary expense
center’s manager is to ensure that the desired
outputs are achieved within the allocated
budget.
• Spending more than the budget may be cause
of concern; spending less may indicate that
the planned work is not being done.
194. • Control over spending can be exercised by
requiring superior’s approval before the
budget is overrun.
• Sometimes, a certain percentage of overrun
(say, 5%) is permitted without any special
approval.
195. • Other types of discretionary expense centers:
1. Administrative and support centers
2. Research and development centers
196. • Administrative centers include senior
corporate managers with support staffs.
• Support centers are units that provide services
to other responsibility centers.
197. • Administrative and support centers have the
following control problems:
1. Difficulty in measuring the output
2. Lack of goal congruence
198. • Difficulty in measuring output:
• Activity such as payroll preparation- it is
difficult to quantify output.
• Also other activities involve- advice and
service functions that are impossible to
quantify.
• Since output can’t e measured it is difficult to
set cost standards.
199. • Lack of goal congruence:
• The staff may want to develop an ideal
system, but an ideal system will be too costly.
• The organization may accept minor flaws in its
system rather than having a perfect system
which may be too costly.
200. • Budget preparation:
• The proposed budget for an administrative or
support center usually consists of a list giving
the details of expenses that would be
incurred, which would be compared with the
current year’s actual expenses.
201. • Research and development centers:
• They have the following control problems:
1. Difficulty in relating results to inputs and
2. Lack of goal congruence
202. • Difficulty in relating results to inputs:
• The results of R&D activities are difficult to
measure quantitatively.
• Compared to administrative activities, some of
the activities of R&D have a semi tangible
outputs in the form of patents, new products
or new processes.
• But it is difficult to correlate output to input
on an annual basis because the completed
product or process may involve several years
of effort.
203. • Lack of goal congruence:
• The goal congruence problem in R&D centers
is similar to that in administrative centers.
• The research manager may like to build the
best research facility money can buy, even
though that may be too expensive than the
company can afford.
204. • R&D Programme:
• There is no scientific way of determining the
optimum size of an R&D budget.
• Many companies allocate a certain percentage
of revenue towards R&D.
• The R&D programme consists of a list of
programmes plus a small allowance for
unplanned work.
205. • Measurement of performance:
• At regular intervals, usually on a quarterly
basis, companies compare actual expenses
with the budgeted expenses.
• The R&D center also submits regular progress
reports which helps the management to
assess the effectiveness of a R&D project.
