Management Control

Systems
Prof. C . K . Sreedharan
Unit No: 01

 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.

 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.

 What is MCS?
The term management control
systems consists of three words,
namely:
1. Management
2. Control and
3. Systems

 Management:
It is broadly defined as planning, organizing,
staffing, directing, evaluating 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
organizations goals.

 Control:
In todays 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.

 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.

 The main focus of this subjectManagement Control Systems

(MCS)- is strategy implementation.
This subject provides knowledge,
insight and analylitical skills related
to how a firms senior executives
design and implement the
management systems to plan and
control the firms performance.

 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.

 Elements of MCS include:

- Strategic planning
- Responsibility center allocation
- Transfer pricing
- Budgeting
- Resource allocation
- Performance measurement
- Evaluation and reward

 Management control is a must in any

organization that practices
decentralization.
One view argues that management
control systems must fit the firms
strategy.
This implies that strategy is first
developed through a rational and
formal process and this strategy then
dictates the design of the firms

 Another view is that strategies

emerge through experimentation,
which are influenced by the firms
management systems.
In this view, management control
systems can affect the development
of strategies.

 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.

 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.

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

 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.

 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.

 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)

 Formal control system (FCS):

The controls are laid down by the
management in writing to influence the
behaviour of employees in achieving
organizations goals.
Examples:
- Rules and regulations
- Procedures
- Work plan / work instructions.

 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.

 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

 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 fedforward, and the level of the finished goods
inventory is controlled by reducing production.

 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.

 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.

 There are three types of informal

controls:
1. Self- control
2. Social controls and
3. Cultural controls.

 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 organizations
goals are in congruence with the
individuals goals.

 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.

 Cultural controls:
These are exercised through workculture and tradition of the
organization.

 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.

 Levels of controls in an organization:

Top
Mgt.

Middle Mgt.

Lower level Mgt.

Strategic
control /
planning
Management control

Operational control

 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.

 Management control:
It deals with the effective utilization
of resources made available by the
top-management for the
accomplishment of organizations
objectives.
It is exercised by the middle
management through interaction
with the top management and lower
level management.
It is medium term in nature.

 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.

 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

 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.

 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.

 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.

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.

 Elements of a control system:

Control Device

Assessor

Detector
Effector

Entry being
controlled
Communication
Network

 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.

 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.

 Organizational culture:
It refers to the set of common beliefs,
attitudes and norms that explicitly or
implicitly guide managerial actions.

 Strategy implementation
mechanism:
Management
Controls

Strateg
y

Organization
Structure

Human
Resource
Management

Organization
Culture

Performan
ce

 MCS and behavioural considerations:

People are important assets for an
organization.
Without the cooperation of the employees,
managers cant 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

 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.

 Motivational problems:
Motivation is important to help employees to
perform to their full potential.
Most of the organizations 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.

 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.

 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.

 Boundaries of management control/

Relationship between various
functions:
Activity
End result
Strategy Formulation

Management
Control

Task Control

Goals, strategies and

policies

Implementation of
strategies

Efficient and effective

performance of individual
tasks

 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.

 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.

 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.

 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. Examplethe components used in a product,
number of man hours etc.

 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.

 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

 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

 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

 Internet cannot substitute the human

element involved in the management
control.
Implementing strategies through
MCS involves human interaction,
social and behavioural processes
which cant be automated.
MCS requires human judgement and
intervention, which an internet
cannot do.

 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.

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.

Management Control
Systems
Unit No:02
Strategies
Prof. C.K.Sreedharan

 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
organizations goals.

 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.

 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
organizations stock.

 Risk:
Profitability of an organization is affected
by the managements ability to take risk.
The risk taking degree varies from
managers to managers.
Some firm may explicitly state that the
managements primary responsibility is to
preserve the companys assets, with
profitability considered as a secondary
goal.

 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.

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.

 Strategy formulation methodology:

Environmental Analysis
-PEST factors
- Customers
-Competition
- Suppliers etc

Internal
Analysis
-Technical
competency
-Manufacturing capability
-Marketing capability
- Distribution capability

Opportunities & Threats

Strengths & Weaknesses

-Identify Opportunities

- Identify core competencies

Match core competencies
With external opportunities

Formulate Strategies

 Classification of strategy: Can be

classified as below:
Strategy

Corporate Level
level

Business unit

 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.

 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.

 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

 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.

 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.

 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, agricultural
products etc.

 Corporate level strategies- Graphical

Representation
High

Degree of
Relatedness

*Single Industry

* Related Diversification

*Unrelated Diversification
Low
Extent of Diversification

High

 The management control systems for

different diversification strategies are
quite different.
The structure and form of controls
differ, which are explained
subsequently.

 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

Plant
Marketing
Plant
Plant Marketing
Manager
Manager
Manager
Manager Manager

Staff
Marketing
Manager

 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.

 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.

 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.

 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 Groups two-by-two
growth-share matrix and
2. General Electrical Company / Mckinsey &
Companys three-by-three industry
attractiveness-business strength matrix.

 BCG Model:
High
Star
Hold
Market
Growth
Rate

Question
Mark
Build

Cash
Cow

Dog
Divest

Low
High

Harvest
Relative Market
Share

Low

 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.

 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

 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.

 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.

 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.

 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.

 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 Porters Five
Forces Model and
2. Value Chain Analysis

 Porters 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.

Threat of new entrants

Bargaini
ng
Power of
Supplier
s

Intensity
of
Competiti
on
&
Rivalry

Threat from
substitutes

Bargaining power
Of Customers

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).

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.

 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

 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.

 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-cumdifferentiation.
Ultimately competitive advantage is
derived from providing better
customer value at a lower cost.

 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 cumdifferentiation advantage.

 Typical value chain of a business:

Primary Activities
Product development / Manufacturing

/ Marketing

Support Activities: Finance / HRD

/ Logistics

IT

Management Control
Systems
Organization Hierarchies
and
Behaviour in Organizations
Prof. C. K. Sreedharan
Unit No: 03

 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.

 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.

 Influence of informal factors on goal

congruence
Informal factors can be classified as:
1. External factors and
2. Internal factors.

 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
employees loyalty to the
organization, their spirit , pride in
doing the job etc.

 Internal factors:
The various internal factors are:
1. Culture
2. Management style
3. The informal organization and
4. Perception and communication

 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 companys culture exists
unchanged for many years.
Certain practices become rituals,
carried out automatically because of
the belief that" This is the way

 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.

 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.

 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.

 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.

 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.

 Formal Control System:

It is already seen that informal
factors have a major influence on the
effectiveness of an organizations
management control system.
The other major influence on MCS is
the formal systems.

 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.

 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.

 Hence the factors that influence goal

congruence in an organization are:
1. Informal factors
- External factors
- Internal factors
2. Formal factors

Types of Organizations
The organization structure influences
the design of the organizations
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.

 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.

 Functional Organization Structure:

CEO
Staff
Manufacturi
ng
Manager

Marketing
Manager
Staff

Manag
er
Plant-1

Manag
er
Plant-2

Manage
r
Plant-3

Staff
Manage
r
RegionA

Manage
r
RegionB

Manage
r
RegionC

 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

 Advantage:
Since a specialist supervises his
people, skilled higher level managers
supervise the lower level managers,
this type of structure ensures
efficiency.

 Disadvantages:
1. It is difficult to measure the
effectiveness of different functional
managers( marketing, production
etc), since each function contributes
jointly to the organizations final
output.

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.

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.

 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.

 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.

 Matrix Structure:
Chief Executive officer
Staff

Function A
Manager
( Production)
Function B
manager
(Quality)
Function C
Manager
(Finance)

Project X
Manager

Project Y
Manager

Project Z
Manager

 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 1970s
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.

 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.

 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.

 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.

 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.

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

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.

 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.

 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.

 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.

 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.

 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.

 Dotted Line Relationship Solid Line

Relationship
Corporate
Controller

Corporate
Controller

Business
Unit
Manager
Business
Unit
Controller

Business
Unit
Manager
Business
Unit
Controller

 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.

 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.

 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 units 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.

 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.

Management Control
Systems
Responsibility Centers
Unit No: 04
Prof. C K Sreedharan

 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 organizations operations.

 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

 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.

 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 companys various
responsibility centers are to help implement
the strategies of the organization.

 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.

 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.

 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.

 Based on these factors,

organizations have different
structures.
Some of the popular structures are:
1. Functional organization
2. Business Unit structure organization
or Divisional structure and
3. Matrix structure.

 Core operation of responsibility

center
Inputs

Resources used
Measured by cost

Transformation
Processes
(Work)

Outputs

Goods or Services
Revenue Generation

 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.

 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.

 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.
Managements decision to increase
advertisement expenditure is based on
judgment rather than data.

 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.

 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

 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.

 Effectiveness:
It is determined by the relationship
between a responsibility centers
output and its objectives.
The more the output contributes to
the objectives, the more effective is
the unit.

 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.

 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.

 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.

 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.

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.

 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.

 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.

 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

President

Investme
nt Center

Profit Center
VicePresident
(Other
Divisions)

Vice-President
(Apparel Div.)

Productio
n
Manager
(Apparels)
Expense Center

Marketing
Manager
(Apparels)
Revenue
Center

 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

 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.

 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.

 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.

 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.

 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.

Management Control
Systems
Expense Centers
Unit No: 05
Prof. C K Sreedharan

 Expense center:
These are responsibility centers
whose inputs are measured in
monetary terms, but outputs are
measured in terms of number of
Inputs
Outputs
units.
Work
Cost in rupees

Number of
units

Manufacturing Cost Center- is an example of expense center.

 Expense centers can be classified as

below:
Engineered Expense Center

Discretionary Expense Center

Proper estimation of input costs

Output of these centers cant be
Can be done with reasonable degreeMeasured in monetary terms.
of accuracy.
Example- HRD, legal department,
Output can be measured.
PR depat. etc
Example- Material, labour etc

 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.

 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.

 Discretionary Expense Centers:

These are administrative and support
unit like- HRD, PR department, legal
department etc.
The output of these centers cant be
measured in monetary terms.
Discretionary means that it is the
managements decision to decide
how much to spend

 In these units expenses (inputs) are

expressed in monetary terms but
outputs cant be measured in
monetary terms.
Discretionary expenses are those
expenses which are incurred as per
organizations policies, which are
derived from strategic planning, its
goals and objectives.

 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

 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

 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

 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 centers 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.

 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.

 Incremental Budgeting:
The discretionary expense centers
current level of expenses is taken as
a starting point.
This amount is adjusted upwards for
inflation and other cost increases.

 Incremental budgeting has two drawbacks:

1. The discretionary expense centers
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.

 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.

 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 zerobase review by stating some reason or
the other( Example: Have some other
important work to do, very busy etc).

 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.

 Measurement of performance of
discretionary expense center:
The primary job of a discretionary
expense centers 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.

 Control over spending can be

exercised by requiring superiors
approval before the budget is
overrun.
Sometimes, a certain percentage of
overrun (say, 5%) is permitted
without any special approval.

 Other types of discretionary expense

centers:
1. Administrative and support centers
2. Research and development centers

 Administrative centers include senior

corporate managers with support
staffs.
Support centers are units that
provide services to other
responsibility centers.

 Administrative and support centers

have the following control problems:
1. Difficulty in measuring the output
2. Lack of goal congruence

 Difficulty in measuring output:

Activity such as payroll preparationit is difficult to quantify output.
Also other activities involve- advice
and service functions that are
impossible to quantify.
Since output cant e measured it is
difficult to set cost standards.

 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.

 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 years actual
expenses.

 Research and development centers:

They have the following control
problems:
1. Difficulty in relating results to inputs
and
2. Lack of goal congruence

 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.

 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.

 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.

 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.