When is it Worth it? Chapter 5 Kent Thorén INDEK / KTH. Builds on Merchant and Van der Stede

2 Recall that Controls benefit is a higher probability that people will both work hard and direct their energies to serve the organization’s interests. Controls benefit is a higher probability that people will both work hard and direct their energies to serve the organization’s interests. However, there are also costs of controls: However, there are also costs of controls: Direct out-of-pocket costs Direct out-of-pocket costs Harmful side-effects Harmful side-effects

3 Effectiveness of Control Control system effectiveness depends on whether the direct and indirect costs of control are reasonable considering: Control system effectiveness depends on whether the direct and indirect costs of control are reasonable considering:  The (behavioral) benefits of the controls  The cost of not having control

4 Direct Costs The direct monetary costs related to operating control systems. The direct monetary costs related to operating control systems. For example: For example: Investments in information systems. Investments in information systems. Managerial time spent on reporting and monitoring. Managerial time spent on reporting and monitoring. Other administrative costs. Other administrative costs. Costs of rewards to make results controls and action accountability effective. Costs of rewards to make results controls and action accountability effective.

5 Direct Costs (cont.) Quantification of direct costs can be more or less straightforward: Quantification of direct costs can be more or less straightforward: Easy to quantify: Easy to quantify: cost of cash bonuses, internal audit staffs, etc.; cost of cash bonuses, internal audit staffs, etc.; Difficult to quantify: Difficult to quantify: time spend on planning and budgeting activities, on pre-action reviews, etc. time spend on planning and budgeting activities, on pre-action reviews, etc.

6 Indirect Costs Dysfunctional effects linked to different control systems Dysfunctional effects linked to different control systems Behavioral displacement Behavioral displacement Gamesmanship Gamesmanship Operating delays Operating delays Negative attitudes Negative attitudes

7 Negative Attitudes Job tension, conflict, frustration, resistance, etc. Job tension, conflict, frustration, resistance, etc. Are often coincident with many harmful behaviors, such as, gaming, lack of effort, absenteeism, turnover, etc. Are often coincident with many harmful behaviors, such as, gaming, lack of effort, absenteeism, turnover, etc. Action controls often “annoy” professionals, but also lower-level personnel … Action controls often “annoy” professionals, but also lower-level personnel … Sometimes difficult to avoid: e.g., it is difficult for people to enjoy following a strict set of procedures for a long period of time... Sometimes difficult to avoid: e.g., it is difficult for people to enjoy following a strict set of procedures for a long period of time... Results controls... Results controls... Lack of employee commitment to the performance targets; Lack of employee commitment to the performance targets; targets are too difficult, not meaningful, not controllable. targets are too difficult, not meaningful, not controllable. Performance evaluations are perceived as being unfair; Performance evaluations are perceived as being unfair; The controls are implemented in a people-insensitive, non- supportive way. The controls are implemented in a people-insensitive, non- supportive way.

Design & Evaluation Chapter 6

9 A Framework for Making Control Systems Trade-offs

10 Control System Trade-offs II What is desired!? What is desired!? Key actions - i.e., actions that must be performed to provide the greatest probability of success. Key actions - i.e., actions that must be performed to provide the greatest probability of success. Key results – i.e. the few key areas where things must go right for the business to flourish. Key results – i.e. the few key areas where things must go right for the business to flourish. depend on strategy etc. depend on strategy etc. What is likely!? What is likely!?  Investigate potential for each control problem: Lack of direction, Lack of direction, Motivational problems, Motivational problems, Personal limitations. Personal limitations.

11 Control System Trade-offs III Whenever “what is likely” differs form “what is desired”, two sets of design questions should be addressed: Whenever “what is likely” differs form “what is desired”, two sets of design questions should be addressed: 1. Select types of controls 2. Choose how tightly to apply each type of control

A Simple Strategy Formulation Process 1. Identify KSFs of the industry 2. Review the firm in terms of how it meets the KSF 3. Compare with e.g. the largest rival (or several rivals) to make a more objective scoring 4. Project the future-state scoring to illustrate gaps 5. Use either the likely or the desired future state 6. Prioritize each KSF and draft high-level actions to maintain strong points, close critical gaps etc. This provides a starting point for strategy formulation 12

A Simple Strategy Formulation Process cont Equal+1+2 Industry KSF Raw material access Time-to-market R&D effectiveness Sales network Manufactring yield Current position vs. main rival Desired future position vs. main rival WeaknessStrength Secure raw material partnership Strategy Implications Improve R&D Review and enhance sales network Gap Define Desired Behaviors

What is Desired? 14 AwarenessAppealPreferPurchase MentionAdvocateCompareBook Direct influence Customer buying process Desired salesperson behavior

Start Outlining Control System Needs What is desired?MentionAdvocateCompareBook What is likely? -Motivation -Direction -Limitations Mention of our products Poor promotion Not likely today On customer request Control system candidates? -(Tools and) Training (Tools and) Training Performance measurements (Tools and) Training Rewards Control system typesPCPC + RC 15

Then Set Performance Areas, Target Levels etc. 16 Increase Activity Levles Target next FY Current 10-12% % of sales situations MentionAdvocateCompareBook 35-40%

17 Pros and Cons of Control Mechanisms Action controls Direct link between action and control Documentation and learning Efficient coordination (if technology is simple and stable) Proactive Stifling creativity and fast adaptation Foster sloppiness Negative attitudes Behavioral displacement risk Often costly (indirect costs) Results controls Feasibility due to monetary focus Can be used to enhance autonomy Relatively inexpensive Imperfect link to actions Shift risk to employees Risk of gamesmanship Motivation vs communication Costly (direct & indirect costs) Reactive Difficult to change quickly (particularly cultural controls) Requires significant trust Relatively inexpensive (except selection and training) Proactive Personnel or cultural controls

18 The different types of controls (action, results and people controls) are not equally effective at addressing each of the control problems. The different types of controls (action, results and people controls) are not equally effective at addressing each of the control problems. Lack of direction Personal limitations Lack of motivation Results accountability Action controls - Behavioral constraints - Preaction reviews - Action accountability People controls - Selection / placement - Training - Provision of resources - Strong culture - Group-based rewards Pros and Cons of Control Mechanisms II

19 Conclusions III Can people be avoided? (e.g., automation, centralization) Control-problem avoidance Can you rely on people involved? Can you make people reliable? Have knowledge about what specific actions are desirable? Able to assess whether specific action was taken? Have knowledge about what results are desirable? Able to measure results? Yes No Yes No Action controls People controls Results controls Yes No Yes No ? Yes

20 Questions chapter 4 & 5 Consider how controls of gaming operations at Bellagio, if technology could be applied to monitor dealers work as proposed in the case; what control systems could be removed and why? Consider how controls of gaming operations at Bellagio, if technology could be applied to monitor dealers work as proposed in the case; what control systems could be removed and why? What could the potential indirect costs be? What could the potential indirect costs be?

21 Questions chapter 6 Questions chapter 6 AirTex does not really have a strategy. What if it was given a growth mission. What would the desired behavior be at each department? What potential control problems would be candidates for addressing with new control systems? AirTex does not really have a strategy. What if it was given a growth mission. What would the desired behavior be at each department? What potential control problems would be candidates for addressing with new control systems?

Strategic Missions 22 The Four Missions: The Four Missions: BuildHoldHarvestDivest Invest in MS even at the expense of ST-earnings / CFs Maximize ST-earnings / CFs even at the expense of MS Outright sale - Slow liquidation Protect MS and competitive position