discussion 12

12.2 - Organizational Control

L E A R N I N G O B J E C T I V E S

1. Know what is meant by organizational control.

2. Recognize that controls have costs.

3. Understand the benefits of controls.

Up to this point you have probably become familiar with the planning, organizing, and

leading components of the P-O-L-C framework. This section addresses the controlling

component, often taking the form of internal systems and process, to complete your

understanding of P-O-L-C. As you know, planning comprises all the activities associated

with the formulation of your strategy, including the establishment of near- and long-

term goals and objectives. Organizing and leading are the choices made about the way

people work together and are motivated to achieve individual and group goals and

objectives.

What Is Organizational Control?

The fourth facet of P-O-L-C, organizational control, refers to the process by which an

organization influences its subunits and members to behave in ways that lead to the

attainment of organizational goals and objectives. When properly designed, such

controls should lead to better performance because an organization is able to execute its

strategy better. Kuratko, D. F., Ireland, R. D., & Hornsby. J. S. (2001). Improving firm performance through entrepreneurial

actions: Acordia’s corporate entrepreneurship strategy. Academy of Management Executive, 15(4), 60–71. As shown in the

the P-O-L-C framework figure, we typically think of or talk about control in a sequential

sense, where controls (systems and processes) are put in place to make sure everything

is on track and stays on track. Controls can be as simple as a checklist, such as that used

by pilots, flight crews, and some doctors. Retrieved December 9, 2008,

from http://www.thehealthcareblog.com/the_health_care_blog/2007/12/pilots-use-chec.html Increasingly, however,

organizations manage the various levels, types, and forms of control through systems

called Balanced Scorecards. We will discuss these in detail later in the chapter.

Organizational control typically involves four steps: (1) establish standards, (2) measure

performance, (3) compare performance to standards, and then (4) take corrective action

as needed. Corrective action can include changes made to the performance standards—

setting them higher or lower or identifying new or additional standards. Sometimes we

think of organizational controls only when they seem to be absent, as in the 2008

meltdown of U.S. financial markets, the crisis in the U.S. auto industry, or the much

earlier demise of Enron and MCI/Worldcom due to fraud and inadequate controls.

However, as shown in the figure, good controls are relevant to a large spectrum of firms

beyond Wall Street and big industry.

The Need for Control in Not-for-Profit Organizations

We tend to think about controls only in the for-profit organization context. However,

controls are relevant to a broad spectrum of organizations, including governments,

schools, and charities. Jack Siegel, author of A Desktop Guide for Nonprofit Directors,

Officers, and Advisors: Avoiding Trouble While Doing Good, outlines this top 10 list of

financial controls that every charity should put in place:

Control 1—Require two signatures for checks written on bank and investment accounts.

This prevents unapproved withdrawals and payments.

Control 2—The organization’s bank statements should be reconciled on a monthly basis

by someone who does not have signature authority over the accounts. This is a further

check against unapproved withdrawals and payments.

Control 3—Since cash is particularly susceptible to theft, organizations should eliminate

the use of cash to the extent possible.

Control 4—Organizations should only purchase goods from an approved list of vendors.

This provides protection from phony invoices submitted by insiders.

Control 5—Many charities have discovered “ghost employees” on their payrolls. To

minimize this risk, organizations should tightly control the payroll list by developing a

system of reports between payroll/accounting and the human resources department.

Control 6—Organizations should require all otherwise reimbursable expenses to be

preauthorized. Travel and entertainment expenses should be governed by a clearly

articulated written policy that is provided to all employees.

Control 7—Physical inventories should be taken on a regular and periodic basis and then

be reconciled against the inventories carried on the books. Besides the possible

detection of theft, this control also provides a basis for an insurance claim in the case of

a fire, flood, or other disaster.

Control 8—Every organization should develop an annual budgeting process. The

nonprofit’s employees should prepare the budget, but the board should review and

approve it.

Control 9—Organizations should use a competitive bidding process for purchases above

a certain threshold. In reviewing bids, organizations should look for evidence of

collusion.

Control 10—Organizations that regularly received grants with specific requirements

should have someone who is thoroughly versed in grant administration.

Retrieved January 30, 2009, from http://www.charitygovernance.com/charity_governance/2007/10/ten-financial-c.html#more.

The Costs and Benefits of Organizational Controls

Organizational controls provide significant benefits, particularly when they help the

firm stay on track with respect to its strategy. External stakeholders, too, such as

government, investors, and public interest groups have an interest in seeing certain

types or levels of control are in place. However, controls also come at a cost. It is useful

to know that there are trade-offs between having and not having organizational controls,

and even among the different forms of control. Let’s look at some of the predominant

costs and benefits of organizational controls, which are summarized in the following

figure.

Costs

Controls can cost the organization in several areas, including (1) financial, (2) damage to

culture and reputation, (3) decreased responsiveness, and (4) botched implementation.

An example of financial cost is the fact that organizations are often required to perform

and report the results of a financial audit. These audits are typically undertaken by

external accounting firms, which charge a substantial fee for their services; the auditor

may be a large firm like Accenture or KPMG, or a smaller local accounting office. Such

audits are a way for banks, investors, and other key stakeholders to understand how

financially fit the organization is. Thus, if an organization needs to borrow money from

banks or has investors, it can only obtain these benefits if it incurs the monetary and

staffing costs of the financial audit.

Controls also can have costs in terms of organization culture and reputation. While you

can imagine that organizations might want to keep track of employee behavior, or

otherwise put forms of strict monitoring in place, these efforts can have undesirable

cultural consequences in the form of reduced employee loyalty, greater turnover, or

damage to the organization’s external reputation. Management researchers such as the

late London Business School professor Sumantra Ghoshal have criticized theory that

focuses on the economic aspects of man (i.e., assumes that individuals are always

opportunistic). According to Ghoshal, “A theory that assumes that managers cannot be

relied upon by shareholders can make managers less reliable.” Ghoshal S., & Moran, P. (1996). Bad

for practice: A critique of the transaction cost theory. Academy of Management Review. 21(1), 13–47. Such theory, he

warned, would become a self-fulfilling prophecy.

Less theoretical are practical examples such as Hewlett-Packard’s (HP) indictment on

charges of spying on its own board of directors. In a letter to HP’s board, director Tom

Perkins said his accounts were “hacked” and attached a letter from AT&T explaining

how the breach occurred. Records of calls made from Perkins’s home phone were

obtained simply with his home phone number and the last four digits of his Social

Security number. His long-distance account records were obtained when someone

called AT&T and pretended to be Perkins, according to the letter from AT&T. Retrieved

January 30, 2009, from http://i.n.com.com/pdf/ne/2006/perkins_letter.pdf HP Chairman Patricia Dunn

defended this rather extreme form of control as legal, but the amount of damage to the

firm’s reputation from these charges led the firm to discontinue the practice. It also

prompted the resignation of several directors and corporate officers. Retrieved January 30, 2009,

from http://news.zdnet.com/2100-9595_22-149452.html

The third potential cost of having controls is that they can afford less organizational

flexibility and responsiveness. Typically, controls are put in place to prevent problems,

but controls can also create problems. For instance, the Federal Emergency

Management Agency (FEMA) is responsible for helping people and business cope with

the consequences of natural disasters, such as hurricanes. After Hurricane Katrina

devastated communities along the U.S. Gulf Coast in 2005, FEMA found that it could

not provide prompt relief to the hurricane victims because of the many levels of

financial controls that it had in place. U.S. Government Printing Office. (2006, February 15). Executive

summary. Select Bipartisan Committee to Investigate the Preparation for and Response to Hurricane Katrina.

The fourth area of cost, botched implementation, may seem obvious, but it is more

common than you might think (or than managers might hope). Sometimes the controls

are just poorly understood, so that their launch creates significant unintended, negative

consequences. For example, when Hershey Foods put a new computer-based control

system in place in 1999, there were so many problems with its installation that it was

not able to fulfill a large percentage of its Halloween season chocolate sales that year. It

did finally get the controls in working order, but the downtime created huge costs for the

company in terms of inefficiencies and lost sales. Retrieved January 30, 2009, from Hershey profits for 4Q

1999 down 11% due to SAP implementation problem. http://www.greenspun.com/bboard/q-and-a-fetch-

msg.tcl?msg_id=002SUM Some added controls may also interfere with others. For instance, a

new quality control system may improve product performance but also delay product

deliveries to customers.

Benefits

Although organizational controls come at some cost, most controls are valid and

valuable management tools. When they are well designed and implemented, they

provide at least five possible areas of benefits, including (1) improved cost and

productivity control, (2) improved quality control, (3) opportunity recognition, (4)

better ability to manage uncertainty and complexity, and (5) better ability to

decentralize decision making. Let’s look at each one of these benefits in turn.

Summary of Control Costs and Benefits

• Key Costs

o Financial costs—direct (i.e., paying for an accountant for an audit) and indirect

(i.e., people such as internal quality control the organization employs whose

primary function is related to control).

o Culture and reputation costs—the intangible costs associated with any form of

control. Examples include damaged relationships with employees, or tarnished

reputation with investors or government.

o Responsiveness costs—downtime between a decision and the actions required to

implement it due to compliance with controls.

o Poorly implemented controls—implementation is botched or the implementation

of a new control conflicts with other controls.

• Key Benefits

o Cost and productivity control—ensures that the firm functions effectively and

efficiently.

o Quality control—contributes to cost control (i.e., fewer defects, less waste),

customer satisfaction (i.e., fewer returns), and greater sales (i.e., repeat

customers and new customers).

o Opportunity recognition—helps managers identify and isolate the source of

positive surprises, such as a new growth market. Though opportunities can also

be found in internal comparisons of cost control and productivity across units.

o Manage uncertainty and complexity—keeps the organization focused on its

strategy, and helps managers anticipate and detect negative surprises and

respond opportunistically to positive surprises.

o Decentralized decision making—allows the organization to be more responsive by

moving decision making to those closest to customers and areas of uncertainty.

First, good controls help the organization to be efficient and effective by helping

managers to control costs and productivity levels. Cost can be controlled using budgets,

where managers compare actual expenses to forecasted ones. Similarly, productivity can

be controlled by comparing how much each person can produce, in terms of service or

products. For instance, you can imagine that the productivity of a fast-food restaurant

like McDonald’s depends on the speed of its order takers and meal preparers.

McDonald’s can look across all its restaurants to identify the target speed for taking an

order or wrapping a burger, then measure each store’s performance on these

dimensions.

Quality control is a second benefit of controls. Increasingly, quality can be quantified in

terms of response time (i.e., How long did it take you to get that burger?) or accuracy

(Did the burger weigh one-quarter pound?). Similarly, Toyota tracks the quality of its

cars according to hundreds of quantified dimensions, including the number of defects

per car. Some measures of quality are qualitative, however. For instance, Toyota also

tries to gauge how “delighted” each customer is with its vehicles and dealer service. You

also may be familiar with quality control through the Malcolm Baldrige National Quality

Program Award. The Baldrige award is given by the president of the United States to

businesses—manufacturing and service, small and large—and to education, health care,

and nonprofit organizations that apply and are judged to be outstanding in seven areas:

leadership; strategic planning; customer and market focus; measurement, analysis, and

knowledge management; human resource focus; process management; and results.

Retrieved January 30, 2009, from http://www.nist.gov/public_affairs/factsheet/baldfaqs.htm Controlling—how well

the organization measures and analyzes its processes—is a key criterion for winning the

award. The Baldrige award is given to organizations in a wide range of categories and

industries, from education to ethics to manufacturing.

The third area by which organizations can benefit from controls is opportunity

recognition. Opportunities can come from outside of the organization and typically are

the result of a surprise. For instance, when Nestlé purchased the Carnation Company for

its ice cream business, it had also planned to sell off Carnation’s pet food line of

products. However, through its financial controls, Nestlé found that the pet food

business was even more profitable than the ice cream, and kept both. Opportunities can

come from inside the organization too, as would be the case if McDonald’s finds that one

of its restaurants is exceptionally good at managing costs or productivity. It can then

take this learned ability and transfer it to other restaurants through training and other

means.

Controls also help organizations manage uncertainty and complexity. This is a fourth

area of benefit from well-designed and implemented controls. Perhaps the most easily

understood example of this type of benefit is how financial controls help an organization

navigate economic downturns. Without budgets and productivity controls in place, the

organization might not know it has lost sales or expenses are out of control until it is too

late.

Control Criteria for the Baldrige National Quality Award

Measurement, Analysis, and Improvement of Organizational Performance: How Do You

Measure, Analyze, and then Improve Organizational Performance? (45 points)

Describe how your organization measures, analyzes, aligns, reviews, and improves its

performance using data and information at all levels and in all parts of your

organization. Describe how you systematically use the results of reviews to evaluate and

improve processes.

Within your response, include answers to the following questions:

1. Performance Measurement

1. How do you select, collect, align, and integrate data and information for tracking

daily operations and for tracking overall organizational performance, including

progress relative to strategic objectives and action plans? What are your key

organizational performance measures, including key short-term and longer-term

financial measures? How do you use these data and information to support

organizational decision making and innovation?

2. How do you select and ensure the effective use of key comparative data and

information to support operational and strategic decision making and

innovation?

3. How do you keep your performance measurement system current with business

needs and directions? How do you ensure that your performance measurement

system is sensitive to rapid or unexpected organizational or external changes?

2. Performance Analysis, Review, and Improvement

1. How do you review organizational performance and capabilities? What analyses

do you perform to support these reviews and to ensure that the conclusions are

valid? How do you use these reviews to assess organizational success, competitive

performance, and progress relative to strategic objectives and action plans? How

do you use these reviews to assess your organization’s ability to respond rapidly

to changing organizational needs and challenges in your operating environment?

2. How do you translate organizational performance review findings into priorities

for continuous and breakthrough improvement and into opportunities for

innovation? How are these priorities and opportunities deployed to work group

and functional-level operations throughout your organization to enable effective

support for their decision making? When appropriate, how are the priorities and

opportunities deployed to your suppliers, partners, and collaborators to ensure

organizational alignment?

3. How do you incorporate the results of organizational performance reviews into

the systematic evaluation and improvement of key processes?

Retrieved January 30, 2009, from http://www.quality.nist.gov.

The fifth area of benefit in organizational control is related to decentralized decision

making. Organization researchers have long argued that performance is best when those

people and areas of the organization that are closest to customers and pockets of

uncertainty also have the ability (i.e., the information and authority) to respond to them.

Galbraith, J. R. (1974). Organization design: An information processing view. Interfaces, 4, 28–36. Galbraith believes

that “the greater the uncertainty of the task, the greater the amount of information that

must be processed between decision makers during the execution of the task to get a

given level of performance.” Firms can reduce uncertainty through better planning and

coordination, often by rules, hierarchy, or goals. Galbraith states that “the critical

limiting factor of an organizational form is the ability to handle the non-routine events

that cannot be anticipated or planned for.” Going back to our McDonald’s example, you

can imagine that it would be hard to give a store manager information about her store’s

performance and possible choices if information about performance were only compiled

at the city, region, or corporate level. With store-level performance tracking (or, even

better, tracking of performance by the hour within a store), McDonald’s gives store

managers the information they need to respond to changes in local demand. Similarly, it

equips McDonald’s to give those managers the authority to make local decisions, track

that decision-making performance, and feed it back into the control and reward

systems.

K E Y T A K E A W A Y

This chapter introduced the basics of controls, the process by which an organization

influences its subunits and members to behave in ways that lead to attaining

organizational goals and objectives. When properly designed, controls lead to better

performance by enabling the organization to execute its strategy better. Managers must

weigh the costs and benefits of control, but some minimum level of control is essential

for organizational survival and success.

R E F L E C T I O N S

1. What do properly conceived and implemented controls allow an organization to do?

2. What are three common steps in organizational control?

3. What are some of the costs of organizational controls?

4. What are some of the benefits of organizational controls?

5. How do managers determine when benefits outweigh costs?

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