JoHo

CHAPTER 1

1.1 Introduction

Management control is important for organizations because failures in management control can lead to large financial losses, reputation damage, and possibly even to organizational failure.

Despite the importance of having good management control systems (MCSs), management critics have argued that adding controls does not always lead to better control and that the MCSs in common use cause managers to be excessively short-term oriented or are prone to stifle creativity and initiative.

An old narrow view of a MCS is that of a simple cybernetic (regulating) system, involving a single feedback loop (thermostat). This book takes a broader view and recognizes that some management controls are proactive rather than reactive. Proactive means that the controls are designed to prevent problems before the organization suffers any adverse effects on performance. The benefit of management control is that the probability that the firm’s goals will be achieved increases.

1.2 Management and control

Management literature includes many definitions of management. All relate to the processes of organizing resources and directing activities for the purpose of achieving organizational objectives. There are different functions, resources and processes of management:

To focus on management control we must distinguish the concept objective setting and strategy formulation:

1. Objective setting: objectives do not have to be quantified and do not have to be financial. Employees must have some understanding of what the organization is trying to accomplish.

2. Strategy formulation: defines how organizations should use their resources to meet their objectives. It can be specified formally or left largely unspecified. Interaction between management and employees is important. Strategy can be intended or emergent.

Control systems have two basic functions:

1. Strategic control: the process of monitoring as to whether to various strategies adopted by the organization are helping its internal environment to be matched with the external environment. It allows managers to evaluate a company's program from a critical long-term perspective. (external focus)

2. Management control: include processes for planning, organizing, directing, and controlling program operations. (internal focus)

Management controls are necessary to guard against possibilities that people will do something the organization does not want them to do or fail to do something they should do (behavioral orientation).

1.3 Causes of management control problems

The causes can be classified into three main categories:

1. Lack of direction

Employees do not know what the organization wants from them.

2. Motivational problems

Individual and organizational objectives do not naturally coincide: individuals are self-interested. Employee fraud and theft are the most extreme examples of motivational problems.

3. Personal limitations

They may be caused by a lack of requisite intelligence, training, experience, stamina, or knowledge for the task at hand. Some jobs are not designed properly.

1.4 Characteristics of good management control

Good control means that management can be reasonably confident that no major unpleasant surprises will occur. It must be future driven and objectives driven.

Out of control describes the situation where there is a high probability of poor performance.

Perfect control would require complete assurance that all physical control systems are foolproof and all individuals on whom the organization must rely always act in the best way possible. Control loss is the cost of not having a perfect control system. Optimal control can be said to have been achieved if the control losses are expected to be smaller than the cost of implementing more controls. Assessing whether good control has been achieved must be future oriented (no unpleasant surprises in the future)and objectives driven (because the goals represent what the organization wants). But still it is difficult and subjective to determine control as ‘good’.

1.5 Control problem avoidance

There are four avoidance strategies (to eliminate the possibility of control problems):

1. Activity elimination

Managers can sometimes avoid the control problems associated with a particular entity or activity by turning over the potential risks, and the associated profits to a third party. Transaction Cost Economics: whether specific activities (transactions) can be controlled more effectively through markets or internally.

2. Automation

The use of computers, robots, expert systems, and other means of automation to reduce their organization’s exposure to some control problems. Automation can provide only a partial control solution at best. Limitations are: feasibility, cost and the replacement of control problems with others.

3. Centralization

Centralize decision-making in some areas of their companies at specific points in the histories to improve control.

4. Risk sharing

Sharing risks with outside entities can limit the losses that could be incurred by inappropriate employee behaviors. Risk sharing can involve buying insurance to protect against certain types of large, potential losses the organization might not be able to afford. Or share risks with an outside party is to enter into joint venture agreement.

1.6 Control alternatives

If control problems cannot be avoided, management controls must be implemented. These are what is addressed in this book.