A limited time offer!

urgent 3h delivery guaranteed

Integrated Performance Management Through Effective Management Control

Essay Topic: ,

9 Integrated Performance Management through Effective Management Control WERNER BRUGGEMAN Performance measurement and performance management are vivid themes in the literature on management control. So, it is only natural that we investigate how this literature has contributed to the field of Integrated Performance Management. The purpose of this chapter is to describe how management control systems can be used to effectively manage company and business performance.

We will write a custom essay sample on Integrated Performance Management Through Effective Management Control

or any similar topic only for you

Order Now

First, we define the scope of management control and describe the link with organizational strategy. Then, we focus on the three elements of the management control system: (1) the management control structure; (2) the control process; and (3) the management control culture (beliefs systems). We will describe these three elements in greater detail and give an overview of the findings in mainstream contingency research studying the effectiveness of control systems in various environmental and organizational contexts.

Management control defined Management control and the link with strategy Following Anthony and Govindarajan (1995), management control can be defined as a process of motivating managers to perform actions and activities in line with the goals and strategies of the organization. According to this definition, an organization is ‘under control’ when its members do what the management wants them to do. Management control comprises various tasks, among which are:

Planning the future activities of the organization; Coordinating the activities of the various members of the organization; Communicating information; Evaluating this information; Deciding on the actions to be taken; and Influencing people to adapt their behaviour according to the company goals (Anthony and Govindarajan, 1995). Integrated Performance Management through Effective Management Control ? 153 From the definition above, it follows that management control plays a central role in managing the company’s performance and the implementation of its strategies.

Therefore, it is of vital importance that management behaviour, which is stimulated by the management control system, is consistent with the strategy to be implemented (the so-called ‘intended strategy’ – see also Chapter 6). The starting points of the management control process are the mission, the vision and the strategies of the organization. We refer to Chapter 6 for a more thorough discussion of each of these concepts, but recapitulate them very briefly here. The mission of an organization is a description in general terms of the role of the company towards its stakeholders.

It describes the reasons for the company’s existence, its strategic focus and values, as well as how the long-term goals should be realized. The goals are descriptions of the long-term desired future of the company. The mission and goals translate into strategies, which specify the way in which the vision aspired to should be reached. The strategy in turn is translated into concrete performance objectives or targets. This is usually done through formalized action plans.

Management control and goal congruence The purpose of management control is to maximize congruence among the goals of the organization, its various entities and its individual managers. This is called goal congruence. The way in which managers react to management control information depends to a large extent on their personal goals. For effective management control, it is important to be able to measure the impact of these motivators, because they largely determine the behaviour of people in an organization, as well as the desirability of the consequences of their behaviour.

Business Management Study Guide

The management control system should be designed in such a way that, whenever managers take decisions that fit into their personal goals, these decisions should also be in the interests of the company as a whole. In other words, the management control system must create the conditions to foster a feeling within the members of the organization that they can best realize their personal goals by contributing as much as possible to the realization of the general company goals.

It is clear that the way in which managers are evaluated and financially rewarded for their performance plays a significant role in reaching ‘goal congruence’ (see also Chapter 13). Goal congruence is an important condition for effective performance management. The problem of goal congruence can be described in more detail in the following way. Corporate goals are translated into departmental goals, and in these departments people are working who also have their personal goals. A first problem that can arise is a lack of congruence between the corporate and departmental goals.

For example, a department or division of a company can have a long-term vision that says it is desirable to stay small and be profitable (in other words ‘small is 154 ? The Integrated Performance Management Framework beautiful’). On the other hand, top management might be striving for a company goal of strong growth and therefore wants the division to grow. In this case, there is a lack of congruence between the different visions, and a number of meetings will have to be organized to align the goals and strategies.

However, there is also the possibility that the division manager is opposed to the growth of his division because he is personally reluctant to make the required efforts. In this case, there is a conflict between the personal goals of the manager and the goals of the company. Role of management control in performance management Verifying whether the company (or the business unit or department) is on track is an important management function. Management control is an important instrument for motivating personnel to act in accordance with the goals and strategies of the organization.

This motivation is one of the major driving forces of the performance and the value of the company. The management control system must be adjusted to the goals and the strategies of the company and it must be optimally aligned. The contribution of control to strategy implementation Robert Simons (1995) has outlined how management control can contribute to effective strategy implementation. In his book, Levers of Control, he introduced four key constructs that must be analysed and understood in order to implement strategy successfully: core values, risks to be avoided, critical performance variables and strategic uncertainties.

Each construct is controlled by a different system, or lever, the use of which has different implications. These levers are: • Beliefs systems, used to inspire and direct the search for new opportunities. • Boundary systems, used to set limits on opportunity-seeking behaviour. There are three broad categories of boundary systems: business conduct boundaries, internal controls and strategic boundaries. 1 • Diagnostic control systems, used to motivate, monitor and reward achievement of specified goals.

Diagnostic control systems attempt to measure output variables that represent important performance dimensions of a given strategy: critical performance variables. These factors must be achieved or implemented successfully for the intended strategy of the business to succeed. Diagnostic variables should be measured, monitored and controlled, but reporting on them to higher management is on an exception basis only, when a value falls outside a normal control limit and corrective actions must be taken. Interactive control systems, used to stimulate search and learning, allowing new strategies to emerge as participants throughout the Integrated Performance Management through Effective Management Control ? 155 organization respond to perceived opportunities and threats. As a fourth lever of control, these systems focus attention on strategic uncertainties and enable strategic renewal (i. e. , emergent strategies). Figure 9. 1 Levers of control Source: Simons (1995: 159) Control of business strategy is achieved by integrating these four levers of control.

The power of these levers in implementing strategy does not lie in how each is used alone, but rather in how they complement each other when used together. Two of the control systems – beliefs systems and interactive control systems – motivate organizational participants to search creatively and expand the opportunity space. These systems create intrinsic motivation by creating a positive informational environment that encourages information sharing and learning. The other two levers of control – boundary systems and diagnostic control systems – are used to constrain search behaviour and allocate scarce attention.

These systems rely on extrinsic motivation by providing explicit goals, formula-based rewards and clear limits to opportunity-seeking. These four levers create tension between creative innovation and predictable goal movement. This tension requires managers of effective organizations to know how to achieve both high degrees of learning (innovation) and high degrees of control (efficiency) (Simons, 2000: 304). Levers of control and the organizational lifecycle Developing an integrated control system does not happen overnight. Managers of small entrepreneurial firms perform their strategic control 56 ? The Integrated Performance Management Framework rather informally. As the business grows larger, however, informal processes become inadequate. Simons (1995, 2000) illustrates how the levers of control can be successfully implemented as a business grows and matures (see Figure 9. 2). Figure 9. 2 Introduction of control systems over the lifecycle of a business Source: Simons (1995: 128) In their most recent book, Kaplan and Norton (2001) point out the importance of using the Balanced Scorecard (see Chapter 3) as an interactive control system.

It is clear from Figure 9. 2 that an organization must have some experience with other control systems before it can exploit the Balanced Scorecard in this way. Diagnostic systems, boundary systems, and internal control systems are all necessary, but they do not create a learning organization aligned to a focused strategy. Some Balanced Scorecard implementation failures occurred because organizations used their scorecard only diagnostically, and failed to get the learning and innovation benefits from an interactive system.

The CEOs of successful Balanced Scorecard adopters succeeded because they use the scorecard interactively, for communication and to drive learning and improvement. They set overall strategy and then encouraged people within their organization to identify the local actions and initiatives that would have the highest impact for accomplishing the scorecard objectives. (Kaplan and Norton, 2001: 350) Management control versus task control Anthony and Govindarajan (1995) distinguish management control, which ultimately is about implementing strategies, from strategic planning and control and task control:

Integrated Performance Management through Effective Management Control ? 157 • Strategic planning and control is the process of determining and evaluating the goals of the organization, and formulating or reformulating the broad strategies to be used in attaining these goals. Strategic control refers to the maintenance of the environmental conditions of strategies. Strategic control is used to evaluate the background of existing strategies and the environmental assumptions on which the strategies were formulated.

It can also involve the reformulation of strategies. • Task control is the process of ensuring that specific tasks are carried out effectively and efficiently. For example, internal audit and internal control are often associated with task control. Elements of a management control system In the previous paragraphs, we have described the importance of management control for strategy implementation and for performance management. In the remainder of this chapter, we go deeper into the details of the management control system and focus on its compounding elements.

A management control system consists of three basic elements: (1) the management control structure; (2) the management control process; and (3) the management control culture. The first element, the management control structure, deals with the division of the organization into ‘responsibility centres’. A distinction needs to be made among the various types of responsibility centre, such as ‘revenue centres’, ‘expense centres’, ‘profit centres’, and ‘investment centres’. Determining the optimal structure is part of the task of management control.

The second element in a management control system, the management control process, comprises the cycle of: planning for the expected input and output; measuring the results; comparing plan to reality; and, finally, adjusting if necessary. The third element is the management control culture or the beliefs systems. This is the combination of communal values and behavioural norms, which determine the behaviour of managers and staff. Choosing an effective management control structure To manage an organization according to certain objectives, you must first choose an appropriate management control structure.

A management control structure is the system of basic principles for the functioning of the organization or the organizational structure in which the management control will take place. Hellriegel, Slocum and Woodman (1992: 5) define the organizational structure as ‘the structure and formal system of communication, division of labor, coordination, control, authority and responsibility necessary to achieve the organization’s goals’. 158 ? The Integrated Performance Management Framework Elements of a management control structure When defining the management control structure, the following questions must be answered: What are the various departments in the organization? • What are the responsibilities of the various department managers? • How are the activities of the various departments coordinated, and what are the coordination mechanisms? Defining the departmental structure In organizing for effective performance management, the company may choose a functional organization structure, a multidivisional structure, a matrix organization or a network organization structure. When choosing the functional organization structure, the tasks are grouped based on the functional specialty to which they belong.

Traditionally, the following departments are presented in the organizational chart: ‘Sales and Marketing’, ‘Engineering’, ‘Production’, ‘Distribution’, ‘Purchasing’ and ‘Finance’. An organization can also be controlled within a multidivisional structure, which is a structure based on products or markets instead of functions. If based on products, we have a product-oriented department structure. The sales, development, production and purchasing activities with regard to a certain product are concentrated in one, individual department. On the other hand, the organization could also be structured around markets.

In this case, all tasks that deal with a certain geographical market are grouped. The multidivisional structure groups management tasks in divisions, each of which focuses on a certain product or geographical area where the products are sold. Division managers are responsible for the daily operational decisions within their division. Top management no longer wants to engage itself in daily problems, but instead focuses on the important strategic decisions (e. g. , investment decisions, acquisitions and divestments). When designing a multidivisional structure, the business unit concept can be taken as a starting point.

In this concept, the organization is structured around strategic business units or SBUs. An SBU is an operating unit of a planning focus that groups a distinct set of products or services sold to a uniform set of customers, facing a well-defined set of competitors. Many companies have a combination of functional and product- or market-oriented structures in their organizational structure. They prefer to work in a matrix organization. On the horizontal line, we find an R&D manager, a production manager, a financial manager and a purchasing manager.

On the vertical line, we see the various business or product line managers. They are responsible, first of all, for the marketing and sales of their product line, but they must also take care of the coordination between the various functional departments. Staff members in the various functional departments are thus led by two managers. Integrated Performance Management through Effective Management Control ? 159 Defining the responsibility of managers After determining the department structure by which the organization will be controlled, it is important to define the responsibilities of each department.

A department or an organizational unit, led by a manager with clearly specified responsibilities, is called a responsibility centre. An organizational structure is therefore a hierarchy of responsibility centres. Delegated responsibility demands appropriate authority. When assigning the responsibility for a specific output to a certain department, this department should also have control over its output. So, responsibility requires the existence of ‘controllability’. Delegated responsibility also requires an appropriate ‘accountability’.

A manager is considered to be ‘accountable’ when he or she is assessed according to the realization of his or her objectives. In other words, performance is monitored, and if his or her performance turns out to be bad, management will take the necessary actions. A responsibility centre is not only assessed on its output (which result has been achieved? ), but also on its input (how many inputs were used? ). In general, a responsibility centre should be assessed on two basic criteria: efficiency and effectiveness. Efficiency is the relation between output and input.

The more cars that are made in a car manufacturing company with the same production costs, the more efficient the operation is. The cost per unit (i. e. , the total production cost divided by the number of units produced) is therefore an efficiency norm. Effectiveness expresses the extent to which the realized output is aligned with the goals and strategies to be realized. It could be that the sales department has become more efficient by selling more with the same people, but that the sales efforts were focused on markets in which the company has chosen not to be active for strategic reasons.

In this case, the sales efforts were not effective, i. e. , they did not contribute to the realization of the corporate strategy. When designing a management control system, one must determine what efficiency and effectiveness mean concretely for each department and how these can be measured. Assigning responsibilities to the departments means determining the right performance measures. The responsibilities of the manager can be divided into financial, strategic and operational responsibilities. Performance measures must be defined for each of these responsibility areas.

We call them financial, strategic and operational performance measures. With regard to the financial responsibilities, we can distinguish among the following types of responsibility centres: expense centres, revenue centres, profit centres and investment centres. • Expense centres are departments that are responsible for the costs they have made (input), but whose output is not measured in financial terms. In a functional organization structure, typical expense centres are the production department, the R&D department, the purchasing department and the financial department.

Staff functions are also usually controlled as expense centres. 160 ? The Integrated Performance Management Framework • Revenue centres are departments in which the output, but not the input, is measured in financial terms. Typical revenue centres are the sales departments. Their management task is not concerned with the costs incurred; instead, they strive to reach a turnover objective. • In a profit centre, the manager is responsible for the costs and also for the revenues of the department. Thus, the ‘profit centre’ manager receives a profit report for his or her department. In investment centres, the profit as well as the investments (‘assets employed’) are measured. The department manager has the authority to take investment decisions and is also responsible for the profitability of the investments made. A typical performance measure for investment centres is the return on investment (ROI). Regarding strategic responsibilities, a manager’s task not only involves realizing financial goals; the manager and his or her team may also be charged with contributing towards realizing the competitive strategy of their division and the general strategy of the company.

For example, the general company strategy may be concerned with growth in all business units and with global operations. Choosing and formulating this strategy may be the work of general management, but translating it into the business unit may be the responsibility of the division manager. The division manager may also be responsible for defining and developing a competitive advantage (in the areas of quality, flexibility and customer service, for example) for his or her business unit. The manager may be responsible for constantly tracking the evolution of customer satisfaction and adapting the competitive strategy in time to this evolution.

When strategic responsibilities are also delegated to a lower level in the organization, the manager responsible should be evaluated with regard to the level of success of the chosen strategies. Performance measures must be determined for this as well. The method of the Balanced Scorecard (see Chapter 3) may be of help here. Finally, regarding operational responsibilities, it is obvious that managers of responsibility centres are also responsible for managing daily operations. A number of ‘key performance measures’ can be defined for this, which are followed up closely by top management.

The division manager may be asked to realize objectives with regard to inventory levels, processing times, products out of specification, revision times, etc. Restriction of responsibilities and freedom of action Each responsibility centre is restricted in its activity by a number of rules and procedures. Rules are formal expressions of the behaviours that are permitted and not permitted to the members of a department. Procedures are descriptions of steps to be followed in executing a task or in making decisions.

Rules and procedures provide a detailed specification of the kinds of responsibility and freedom of action the responsibility centre has or does not have. They indicate how the responsibilities and freedom of action are restricted. The Integrated Performance Management through Effective Management Control ? 161 indicated restrictions can be expressed in a positive or negative way. Positive responsibility restrictions describe what the responsibility centre manager may do. Negative restrictions describe what the manager is not allowed to do.

Some restrictions relate to responsibilities, others are involved with the manager’s freedom of decision. The freedom of an individual in an organization can also be restricted by general codes of behaviour, which result from existing laws, statutory provisions and ethical values. These are meant to prevent the potential mix of personal and company interests (e. g. , they indicate in what way confidential information should be treated). Restriction of responsibilities and freedom of action are all part of the boundary systems of a company.

These are ‘explicit statements embedded in formal information systems that define and communicate specific risks to be avoided’ (Simons, 1995: 112). Coordination mechanisms When the department structure and the responsibilities of the various departments are defined, rules must be set up with regard to the actions between departments as well. The responsibility for realizing the global company goals and strategies cannot be split up into independent partial responsibilities. Departments and divisions must cooperate in various areas.

Therefore, it is important that rules with respect to this cooperation be defined that motivate the managers maximally to target their efforts towards realizing the global company goals. There are two important kinds of rules that coordinate actions between departments: (1) formal coordination mechanisms (task forces, standing committees, integrating managers); and (2) transfer price systems. Choosing the optimal management control structure Designing the management control structure involves a number of choices. The decision can be made to manage in a functional structure or in a divisional tructure. Within a divisional structure, the divisions can be structured around products, markets, business units, or a combination of these. One can also choose to work in a matrix organization. Then, a choice must be made regarding the degree of delegation of responsibilities. A department can be led as an expense centre, a revenue centre, a profit centre or an investment centre. The responsibilities of these centres can be restricted in various ways, and cooperation between departments can be coordinated by several coordination mechanisms and rules regarding transfer prices.

In some companies, management control is characterized by a detailed set of formal rules, centralized decision power, limited delegated responsibilities and a strict hierarchy of authority. Such a structure is called mechanistic. At the other end of the spectrum, we have the organic organizations. They are characterized by few rules, decentralized power of 162 ? The Integrated Performance Management Framework decision, group decision-making, broadly defined functional responsibilities and a flexible application of the hierarchic relations.

We can now ask the question: Do optimal choices exist? In order to answer this question, we must first define what makes a management control structure optimal. The answer to this question can be found in the description of the task of management control: the objective of management control is to motivate managers maximally to realize the corporate goals and to implement the strategies. So, a management control structure is optimal when it maximally stimulates the desired goal-oriented behaviour and minimally leads to undesired (or dysfunctional) behaviour.

To be able to choose a management control structure, one must predict what the effect of the choice will be on the management behaviour and whether the expected effect is desired or not. For example: • A company that wants to realize a competitive strategy of flexibility (custom-made work) in its business units wonders if it is optimal to manage the departments in a functional organization structure, in which the sales department is responsible for the turnover and the production departments (as expense centres) are responsible for the price of the products made.

To be able to answer this question, we need to know to what extent the production managers are inclined to handle specific customer demands in a flexible way when the price of the products is the most important performance measure. • Universities lead their faculties and departments as discretionary expense centres with respect to educational activities. In the short term, the deans and department heads are responsible for the costs of their faculties and departments, and not directly for the number of students and the revenues.

As a consequence, the professors are not motivated to have many students, and they organize very few (if any) activities to influence and increase the number of students in the short term. Faculties and departments could also be managed as profit centres. The question is: What would be the effect on the management behaviour of deans, chairmen and professors? Would they act in a more commercial way? Would they lose their interest in research? Would this lead to overly aggressive competition among universities and, if so, is aggressive competition a corporate strategic choice within educational policy?

To be able to make an optimal choice of management control structure, good insight into the strategy that is to be realized is crucial. The choice of the management control structure must be aligned with the strategic choices of the company. Knowledge of how managers will be influenced by certain structural choices is also important. One can learn from one’s own experience or from the experiences of other companies. In most cases, companies learn from their own experience. Setting up a management control structure is a dynamic process. The key is to look for

Integrated Performance Management through Effective Management Control ? 163 both well-motivated and dysfunctional management behaviours in the existing structure. Ultimately, the process should yield new ideas for improving the structure to promote the desired behaviour and eliminate the dysfunctional behaviour. Experiences from other companies can also be helpful. A significant part of the literature on management control focuses on research of the general tendencies and patterns in management behaviour in various types of management control structure.

A general conclusion is that there is no management control structure that is optimal for all control situations. The optimal management control structure depends on the situation. The research that studies which management control structure best suits which type of environment is called ‘contingency research’. This contingency research has focused on two major contingency variables: (1) the environment; and (2) a firm’s strategy.

Study of the first contingency variable has helped identify the appropriate structures to fit the levels of uncertainty in the environment (Burns and Stalker, 1961; Lawrence and Lorsch, 1967; Galbraith, 1973; Drazin and Van de Ven, 1985). Structure is generally discussed in terms of mechanistic versus organic approaches to organizing, and it is believed that more organic structures are best suited to uncertain environments. These are structures that focus on ‘clan control’, i. e. , social control coordinated by integrative mechanisms such as task forces and meetings.

Contingency research also shows that management control structures should be well suited to the company’s chosen strategy. Different strategies may require different control structures. A popular typology deals with the strategic mission of business units, which may vary from a ‘build’ strategy, to a ‘hold’ strategy, a ‘harvest’ strategy and, finally, a ‘divest’ strategy. The objective of a build strategy is to increase market share and production volumes, while a hold strategy tries to protect the existing market share and maintain the current competitive position.

A harvest strategy focuses on maximizing cash flow and profit in the short run, even if this is at the expense of market share. Last, the divest strategy concerns the decision to withdraw from a certain business. Other strategy typologies that are often used in the management control literature come from Porter (1985) and Miles and Snow (1978) (see Chapter 6 for more information). Evidence from the strategy/organizational design research suggests that for strategies characterized by a conservative orientation (defenders), harvest and cost leadership are best served by entralized control systems, specialized and formalized work, simple coordination mechanisms, and directing attention to problem areas (Miles and Snow, 1978; Porter, 1985; Miller and Friesen, 1982). For strategies characterized by an entrepreneurial orientation (prospectors), build and product differentiation are linked to a lack of standardized procedures, decentralized and results-oriented evaluation, flexible structures and processes, complex coordination of overlapping project teams, and directing attention at curbing excess innovation. 164 ?

The Integrated Performance Management Framework Designing an effective management control process Phases in the management control process The management control process can best be represented by a closed loop control cycle (see Figure 9. 3). The process starts from the strategy of the company, from which the action programmes are derived. Once the programmes are set up and approved, their financial implications for the coming year can be expressed in a budget. At the end of the budget period, the actual performance is measured and compared to the budget.

The results of this analysis are then reported to top management and used in the evaluation of the efficiency and effectiveness of the responsibility centres concerned and their managers. The management control process thus starts from strategic planning and target setting and consists of the following five phases: Figure 9. 3 The management control process Integrated Performance Management through Effective Management Control ? 165 • • • • • Planning action programmes (programming); Preparing the budget; Executing the plan; Measuring performance, following up the budget and reporting; and Evaluating and rewarding.

Important design parameters of the control process When used in an appropriate way, the budgeting process may motivate managers to improve performance. The motivating impact of the budget is influenced by the following parameters. The level of management commitment to budget targets First of all, companies may use the budget to assess the financial impact of their strategic action plans. In this case, budgeting is primarily used as a feed forward control mechanism and its primary function is to support the planning process (‘budgeting for planning’).

Budget targets are an indication and show the direction in which the company wants to go, but managers do not feel a strong pressure to realize the targets. Budget targets can also be seen as commitments for the managers. In this case, the budget is used for control. Top-down versus bottom-up budgeting Budget targets may be imposed topdown by executive management (in consultation with the division managers, or not). Besides this, there is also a bottom-up process, in which each division sets up its own budget, yet within the general goals and directions of the company.

The global company budget is then formed by combining the various sub-budgets. The level of participation during the budgeting process When setting up a budgeting process, an important parameter is the level of participation managers may have in the target-setting process. We can talk about participative budgeting when subordinate managers participate in the budgeting process and in defining the budget objectives. Participative budgeting involves back-and-forth communication between superiors and subordinates – they share information and converge on a mutually acceptable budget.

It is generally agreed that involvement in setting up the budget leads to higher acceptance than when the budget is imposed fully from the top. Moreover, it is assumed that participative budgeting has a positive effect on the commitment of the division managers who have to realize the budget later on. The difficulty of budget targets It is necessary to think about guidelines regarding the degree of difficulty in realizing the budgets (‘goal difficulty’). Certain companies have a policy of realistic budgets, where the budget objective will be accepted if it most probably can be reached.

Other 166 ? The Integrated Performance Management Framework companies prefer challenging budgets, where top management expects the division managers to work very hard. The basic assumption behind challenging budgets is that managers can always achieve more with their team than they think they can. The task of top management is to stimulate managers to try to excel themselves over and over again. In this situation, managers who submit realistic budgets are evaluated poorly beforehand and a more challenging budget is imposed on them from the top.

Whatever the budget philosophy, a budget can be accepted if it holds sufficient task content, i. e. , if the team in the department will have to exert a lot of effort to realize the budget. As a general rule, the set targets ought to be realistic but challenging. This means that they may not be set unattainably high, which results in frustration and manipulation of data, but they may also not be too easily achievable, because then most of the performance stimulus disappears. Tolerance for budget slack It should also be verified whether or not the budget is too pessimistic.

Some managers may be inclined to build a certain ‘slack’ into their budget. The phenomenon of budget slack occurs when a manager submits a budget in which a certain ‘buffer’ is built in so that the budget objectives are relatively easy to reach. Indeed, in a participative budgeting process the tendency might exist to ask more than one strictly needs to cover oneself against unforeseen circumstances or out of fear that top management will reduce the budget by a certain amount.

For example, if the purchasing department fears that it will no longer be able to buy raw materials at the prices that were budgeted in the past, it can ask for extra means for this part of the budget. It can also be that managers prefer not to set the budget standards too high in companies where their bonuses are calculated on the degree to which they have reached their budget objectives. In all these cases, the general interests of the company are not respected because, by building in budget slack, the company funds are not optimally allocated.

Fairness in budget target setting When assessing the budget, one should verify whether the task content of the budgets of the various departments are of equal value. The budget negotiation process is not only a vertical negotiation process in the organization, it is also a process of comparing the planned efforts of the various departments. Dynamic managers, who always work with challenging budget objectives, may become demotivated when they discover that other departments are tolerated when they exert less effort (i. e. , make less profit or be less productive).

However, equally balancing the task content of the budgets of the various departments presents difficulties because the management problems may differ widely per department (e. g. , different management functions, product groups, markets, etc. ) and the concept ‘task content’ is difficult to measure objectively. The task content of a budget depends on the experience of the manager and his or her team. There is also a certain Integrated Performance Management through Effective Management Control ? 167 psychological insight involved here.

Some managers, along with their teams, feel more quickly swamped with work than others. In any case, clear imbalances in the performances of the various departments need to be eliminated as quickly as possible. For instance, in a profit centre structure, where all divisions are making profits and a certain division is constantly in the red, a thorough restructuring plan must be set up in the short run to make the department profit-making as fast as possible. Tightness of budget control With regard to following up the budget, a choice can be made between tight and loose control.

The tightness of the control is determined by the degree to which restrictions are imposed on the freedom of subordinates and emphasis is placed on reaching the predefined objectives. In most cases, it is assumed that tight control provides more certainty that the people in the organization will act as is expected of them. This can be done by determining the activities in detail, by following up very accurately the results of the departments, and by exerting pressure on the responsible managers to adjust quickly potentially unfavourable anomalies. With tight budget control, it is frequently (e. g. monthly) verified whether the real costs and revenues are in accordance with the planned short-term objectives. Undesired anomalies in the budget are not tolerated and must be eliminated quickly. The advantage of tight control is that managers become more aware of the importance of costs and profitability, and they actively seek ways to eliminate inefficiencies. However, tight control may also have undesired dysfunctional effects. Focusing on short-term results too intently may encourage managers to organize actions that optimize profitability in the short term, but that are disadvantageous in the long term.

For example, in order to reach its budget figures, the purchasing department may decide to buy cheaper, but qualitatively inferior, raw materials. However, this may lead to significant quality problems in production and possibly to lower quality end products, which result in losing the goodwill of the customers. When the emphasis is primarily on reaching budget objectives in the short term, managers may also not be motivated to make the strategic investments that are necessary for the long-term survival of the company.

Moreover, excessively tight budget control may lead to building in ‘slack’ when setting up the budget objectives or to playing accounting tricks to artificially boost the short-term results. On the contrary, with loose budget control deviations from the budget that arise in between are overlooked by top management, and there is a trust that potentially unfavourable anomalies will be eliminated by the divisional managers at the end of the budget period. The budget is used more for communication and planning, and there is less pressure to undertake immediate short-term actions to adjust the results.

The use of budget performance in rewarding managers When setting up the budget, for managers of responsibility centres it is required that the 168 ? The Integrated Performance Management Framework proposed objectives be realized (although we know some companies that start paying bonuses when only 80 per cent – and even 60 per cent – of the budget target is realized). At the end of the year, the actual results are compared to the planned objectives and are further analysed by means of variance analysis.

In this way, the budget is an ideal basis for evaluating the performances of the responsible managers. Managers who succeed in realizing the proposed objectives must be rewarded for their good performance. This reward may be of a financial nature (e. g. , bonus, salary increase or other financial advantages), but the reward may also be more focused on non-financial motivators, such as promotion, extension of responsibilities and recognition. A bonus for performance relative to the budget can be determined subjectively or by formula.

To be effective, the reward system must be designed in such a way that it optimally motivates the managers to act in accordance with the corporate goals and strategies. Optimizing management control process policies A management control process (and more specifically, the budgeting process) is effective when it motivates managers on the various levels of the organization to perform actions in line with the organizational goals and strategies. From contingency research on management control, evidence suggests links between strategy and the characteristics of the management control process.

Defenders, and companies with conservative, cost leadership strategies, find cost control and specific operating goals and budgets more appropriate than entrepreneurs, prospectors and companies with product differentiation strategies (Simons, 1987; Dent, 1990; Chenhall and Morris, 1995). Chenhall and Morris (1995) have found that tight control is suitable for conservative strategies; they also found tight control in entrepreneurial situations but, importantly, operating together with organic decision styles and communications.

Some research has been focused on the relationship between the chosen competitive strategy and the management control process. Differentiation strategies are associated with a de-emphasis on budgetary goals for performance evaluation (Govindarajan, 1988). Govindarajan and Fisher (1990) found that product differentiation with high sharing of resources (between functional departments) and a reliance on behavioural control was associated with enhanced effectiveness.

Bruggeman and Van der Stede (1993) found that business units implementing differentiation strategies based on a make-to-order strategy preferred loose control in budgeting, while business units with a cost leader strategy or a differentiation strategy based on standard products found tight budget control more suitable. They also found that bottom-up budgeting and a commitment to budget targets was considered optimal for all competitive strategies. Overall, Van der Stede Integrated Performance Management through Effective Management Control ? 169 2000) has shown that product differentiation strategies are associated with less rigid budgetary control, but this is also associated with increased budgetary slack. It has also been suggested that bonus systems must be suited to the strategy. Anthony and Govindarajan (1995) suggest that formula-based bonus determination approaches should be used with a harvest strategy and that subjective bonus determination is optimal for build strategies. Contingency research has also found relationships between characteristics of the management control process and the level of uncertainty in the environment.

Companies operating in an environment of unpredictable change require an appropriate set of control process characteristics. Uncertainty has been related to performance evaluation characterized by a more subjective evaluation style (Govindarajan, 1984; Moores and Sharma, 1998), less reliance on incentive-based pay (Bloom, 1998), non-accounting style of performance evaluation (Ross, 1995), and participative budgeting (Govindarajan, 1986). As environmental uncertainty increases, using more participative budgeting increases performance. In contrast, when environmental uncertainty is low, participative budgeting ecreases performance. In situations where environments are stable and predictable, there is little informational benefit from participation because superiors have sufficient information to develop budgets. Companies may also operate in a hostile, difficult environment. This is an environment that is stressful, dominating and restrictive. Environmental hostility has been associated with a strong emphasis on meeting budgets (Otley, 1978). Hostility from intense competition has been related to a reliance on formal control and sophisticated accounting, production and statistical control (Khandwalla, 1972; Imoisili, 1985).

The optimization of target-setting approaches seems to be related to task complexity. Locke and Latham (1990) found that difficult goals lead to higher performance, but this effect is moderated by task complexity. The result leads us to expect that performance will be higher when managers are invited to work towards challenging targets, except when the performance task is too complex. The appropriateness of bottom-up budgeting has been associated with information asymmetry between superiors and subordinate managers (Shields and Young, 1993).

When subordinates have much better information about their business than their superiors do, bottom-up budgeting leads to more accurate budgets, arising from the use of the subordinates’ better information. When top-down budgeting is used in the case of high information asymmetry, subordinates may reject the budget because it is not consistent with their information. Top-down budgeting is beneficial in situations where superiors have sufficient knowledge about the subordinate’s activities being budgeted. 170 ? The Integrated Performance Management Framework

The role of beliefs systems The management control culture is the third and final part of the management control system. Managers’ behaviours and actions are not only influenced by structural and procedural elements, but also by the formal beliefs systems in the organization. Simons defines beliefs systems as ‘the explicit set of organizational definitions that senior managers communicate formally and reinforce systematically to provide basic values, purpose, and direction for the organization’ (Simons, 1995: 34).

Beliefs systems are an important element of an organization’s corporate culture. The corporate culture is the set of values, beliefs and norms of behaviour shared by members of a firm that influences individual employee preferences and behaviours (Besanko et al. , 2000). Ouchi (1980, 1981; Ouchi and Johnson, 1978) considers culture as an alternative control system in the organization. He introduces the idea of clan control, by which he means control through an internal system of organizational norms and values. Culture influences the behaviour of individuals.

Individuals who value belonging to the culture will align their individual goals and behaviours to those of the firm and pay more attention to selfcontrol. A culture that is intensively held by most employees is called a strong culture. Culture can support a company’s competitive advantage (Barney, 1986). It is supportive when the values espoused by the culture are very much in line with the chosen direction and the performance objectives of the firm (e. g. , a company with a product leadership strategy where all employees love to change things and learn from new experiences).

In this case, we talk about a ‘high performance culture’. In other words, the culture is clearly aligned with the strategy of the firm. Of course, the opposite also holds. If there is a cultural misfit, culture can also be a source of persistently poor performance. This occurs when the values underlying the firm’s culture are in conflict with the chosen strategic direction. For example, a culture stressing efficiency, stability and routine behaviour will not support the implementation of a flexibility strategy. In this case, culture may be a barrier to change and managers will experience a ‘low performance culture’.

So, it is important that the majority of the employees believe what top management believes. It is the task of management control to define a set of common beliefs. It frequently happens that top managers have explicitly expressed the vision, the mission, the goals, the key values and the strategies of the firm, but lower-level managers and employees do not share the underlying beliefs. Goal statements about creating shareholder value are experienced as ‘grand terminology’ when employees do not feel the passion of working on value-creating projects.

A strategy of highquality products will not succeed if all employees are not convinced that they should work to ‘zero defect’ and do their work ‘right the first time’. Many flexibility strategies fail because people do not like ‘to change their Integrated Performance Management through Effective Management Control ? 171 Figure 9. 4 The origins of unhealthy corporate cultures Source: Kotter and Heskett (1992: 145) 172 ? The Integrated Performance Management Framework plans. ’ In general, successful strategy implementation needs beliefs systems supporting the chosen strategy.

The beliefs of employees and managers may be hard to change, but they can be influenced by training sessions, by inspiring leadership, and by demonstrating the success of the new strategy and successful strategic projects. John Kotter and James Heskett (1992) have written a book about corporate culture and performance in which they propose a stepwise approach to the creation of a high-performance culture and focus on the origins of healthy and unhealthy corporate cultures. Their ideas are presented in Figure 9. 4 and Figure 9. 5. Figure 9. 5 The creation of a performance-enhancing culture Source: Kotter and Heskett (1992: 147)

Integrated Performance Management through Effective Management Control ? 173 Conclusion Control and evaluation is the fourth component of our Integrated Performance Management Framework. In this chapter, we have shown the important role of management control for strategy implementation and for performance management. Developing an appropriate management control system is a prerequisite for effectively managing an organization. On a broader level, Simons (1995) has shown that control of business strategy is achieved by integrating four levers of control.

These levers create tension between creative innovation (emergent strategies) and predictable goal movement (intended strategies). This proves the crucial role of control in the strategy implementation and performance management process. We then focused our attention on the three basic elements of the management control system: (1) the management control structure; (2) the management control process; and (3) the beliefs systems. We have analysed optimal management control structures and processes from a goal congruence perspective.

That is, we have investigated how to design a management control structure and process that maximally stimulates goal-oriented behaviour and leads to minimal dysfunctional behaviour. Attention is also paid to how strategy affects the choice for a particular management control system. It is clear that management control also interacts with the organizational behaviour component. From Chapter 10 on, we investigate this fifth component in greater detail. Note 1 Business conduct boundaries are those that define and communicate standards of business conduct for all employees.

Like the Ten Commandments, they specify actions that are forbidden. Internal controls are the policies and procedures designed to ensure reliable accounting information and safeguard company assets. Strategic boundaries define what types of business opportunity should be avoided, thereby drawing a box around the opportunities that individuals are encouraged to exploit. Strategic boundaries are installed to ensure that individuals throughout the organization are engaged in activities that support the basic strategy of the business (Simons, 2000: 289).

How to cite Integrated Performance Management Through Effective Management Control, Papers

Choose cite format:
Integrated Performance Management Through Effective Management Control. (2017, Jul 13). Retrieved October 15, 2019, from https://phdessay.com/integrated-performance-management-through-effective-management-control/.