Organizational Controls
What are Organizational Controls?
Organizational controls are strategic processes by which management can (1) guide the use of strategy, (2) indicate how to compare actual results with expected results, (3) monitor the ongoing activities of an organization and its members, (4) evaluate whether activities are performed effectively and efficiently, and (5) suggest corrective action to improve performance if they are not.
It is difficult for a firm to successfully exploit its competitive advantages without effective organizational controls. Properly designed organizational controls provide clear insights regarding behaviors that enhance firm performance.
Organizational controls do not just mean reacting to events after they have occurred. Instead, it also means keeping an organization on track, anticipating events that might occur, and swiftly responding to new opportunities that present themselves.
Thus, controls are not just about monitoring how well an organization and its members are achieving current goals or how well the firm is utilizing its existing resources. It is also about keeping employees motivated, focused on the important problems confronting an organization now and for the future, and working together to find ways to change a company so that it will perform better over time.
Organizational Structure versus Organizational Controls
Organizational structure and organizational controls are two parts of the organizational design that affects the strategy performance of any firm.
In order to proceed with organizational design, strategic managers choose the strategy and proper organizational structure that can enable the organization to use its resource most effectively. Strategic managers then create organizational controls systems to evaluate whether their strategy and organizational structure are working as intended, how they could be improved, or how they should be changed if they are not working properly.
In general, performance declines when the firm’s strategy is not matched with the most appropriate structure and controls.
Components of Organizational Controls Systems
Companies develop organizational controls systems that establish ambitious goals and targets for all managers and employees, and then they develop performance measures that stretch and encourage managers and employees to excel in their quest to raise performance.
Four basic types of control systems are available to executives: (1) strategic (output) control, (2) financial control, (3) behavioral control, and (4) clan control. Different organizations emphasize different types of control, but most organizations use a mix of all types.
Strategic Controls versus Financial Controls
Both strategic and financial controls are important aspects of a firm’s structure and are used to support the implementation of strategies. Any structure’s effectiveness is determined using a balanced combination of strategic and financial controls.
Determining the most appropriate balance to have in place between strategic and financial controls at specific points in time is challenging, partly because the relative use of controls varies by type of strategy.
Firms determining how strategies are to be implemented must keep these relative degrees of balance between controls by type of strategy in mind when making implementation-related decisions.
At the business level, diversified firms using the cost leadership strategy emphasize financial controls (such as quantitative cost goals), while companies and business units using the differentiation strategy emphasize strategic controls (such as subjective measures of the effectiveness of product development teams).
A corporate-level wide company emphasizes sharing among business units (as called for by related diversification strategies) results in an emphasis on strategic controls, while financial controls are emphasized for strategies in which activities or capabilities are not shared (e.g., in an unrelated diversification strategy).
Strategic Controls (Output Controls)
What are Strategic Control Systems
Strategic controls are concerned with examining the fit between what the firm might do (as suggested by opportunities in its external environment) and what it can do (as indicated by its internal organization in the form of its resources, capabilities, and core competencies).
Thus, strategic controls are largely subjective criteria intended to verify that the firm is using appropriate strategies for the conditions in the external environment and the company’s competitive advantages.
It develops goals that tell managers how well their strategies are creating a competitive advantage and building distinctive competencies and capabilities that will lead to future success.
Strategic managers establish goals and measures to evaluate efficiency, quality, innovation, and responsiveness to customers. In strategic controls, strategic managers estimate or forecast appropriate performance goals for each division, department, and employee and then measure actual performance relative to these goals. Often a company’s reward system is linked to performance on these goals so that strategic control also provides an incentive structure for motivating employees at all levels in the organization.
Strategic controls demand rich communications between managers responsible for using them to judge the firm’s performance and those with primary responsibility for implementing the firm’s strategies (such as middle- and first-level managers). These frequent exchanges between managers are both formal and informal in nature.
Strategic controls are also used to evaluate the degree to which the firm focuses on the requirements to implement its strategies.
For a business-level strategy, the strategic controls are used to study value chain activities and support functions to verify that the critical activities and functions are being emphasized and properly executed.
For a corporate-level strategy, strategic controls are used to verify the sharing of activities (in the case of the related-constrained strategy) or the transferring of core competencies (in the case of the related-linked strategy) across businesses.
To use strategic controls when evaluating either of these related diversification strategies, headquarter executives must have a deep understanding of the business-level strategies being implemented within individual strategic business units.
Effective strategic controls help the firm understand what it takes to be successful, especially where significant strategic change is needed.
Implementation of Strategic Control Systems
Strategic control systems must be developed to measure performance at 4 levels in an organization: the corporate, divisional, functional, and individual levels.
Strategic control systems are the formal target-setting, measurement, and feedback systems that allow strategic managers to evaluate whether a company is achieving superior efficiency, quality, innovation, and customer responsiveness and is implementing its strategy successfully.
Managers at all levels must develop the most appropriate set of measures to evaluate corporate-, business-, and functional-level performance. These measures should be tied as closely as possible to the goals of achieving superior efficiency, quality, innovativeness, and responsiveness to customers.
Firms must ensure that the standards used at each level do not cause problems at the other levels. Rather, the controls at each level should provide a platform on which managers at the levels below can base their control systems.
Strategic Controls as Divisional Level Goals
Divisional goals state-corporate managers’ expectations for each division’s performance on such dimensions as efficiency, quality, innovation, and responsiveness to customers.
Generally, corporate managers set challenging divisional goals to encourage divisional managers to create more effective strategies and structures in the future.
Strategic Controls as Functional Level Goals
Strategic control at the functional and individual levels is a continuation of control at the divisional level.
Divisional managers set goals for functional managers that will allow the division to achieve its goals. As at the divisional level, functional goals are established to encourage the development of competencies that give the company a competitive advantage.
The same four building blocks of competitive advantage (efficiency, quality, innovation, and customer responsiveness) act as the standards against which functional performance is evaluated.
In the sales function, for example, goals related to efficiency (such as cost of sales), quality (such as a number of returns), and customer responsiveness (such as the time needed to respond to customer needs) can be established for the whole function.
Strategic Controls as Individual Level Goals
Functional managers establish goals that individual employees are expected to achieve to allow the function to achieve its goals.
Sales personnel, for example, can be given specific goals (related to functional goals) that they in turn are required to achieve. Individuals are then evaluated on the basis of whether they achieve their goals. The achievement of these goals is a sign that the company’s strategy is working and it is meeting organizational objectives.
Characteristics of Effective Strategic Control Systems
First, it should be flexible enough to allow managers to respond as necessary to unexpected events.
Second, it should provide accurate information, giving a true picture of organizational performance.
Third, it should supply managers with the information in a timely manner because making decisions on the basis of outdated information is a recipe for failure.
Steps to Design Strategic Control Systems
Step 1: Establishment of performance standards and targets
Establish the standards and targets against which performance is to be evaluated. The standards and targets that managers select are the ways in which a company chooses to evaluate its performance.
General performance standards often derive from the goal of achieving superior efficiency, quality, innovation, or responsiveness to customers. Specific performance targets are derived from the strategy pursued by the company.
Step 2: Actual measurement and monitoring of standards and targets
Create the measuring and monitoring systems that indicate whether the standards and targets are being reached. The company establishes procedures for assessing whether work goals at all levels in the organization are being achieved.
In some cases, measuring performance is fairly straightforward. Managers can measure quite easily how many customers their employees serve by counting the number of receipts from the cash register.
In many cases, however, measuring performance is difficult because the organization is engaged in many complex activities. How can managers judge how well their research and development department is doing when it may take 5 years for products to be developed? How can they measure the company’s performance when the company is entering new markets and serving new customers? How can they evaluate how well divisions are integrating their activities?
Step 3: Comparison between actual performance and established targets
Managers evaluate whether and to what extent performance deviates from the standards and targets developed in step one. If performance is higher, management may decide that it has set the standards too low and may raise them for the next time period.
Firms are constantly trying to raise performance, and they raise the standards to provide a goal for managers to work toward. On the other hand, if performance is too low, managers must decide whether to take remedial action. This decision is easy when the reasons for poor performance can be identified, for instance, high labor costs.
More often, however, the reasons for poor performance are hard to uncover. They may stem from external factors, such as a recession. Alternatively, the cause may be internal. For instance, the research and development laboratory may have underestimated the problems it would encounter or the extra costs of doing unforeseen research.
Step 4: Initiation of corrective actions
The final stage in the control process is to take the corrective action that will allow the organization to meet its goals.
The firm now initiates corrective action when it is determined that the standards and targets are not being achieved. Such corrective action may mean changing any aspect of strategy or structure.
Financial Controls
What is a Financial Control?
Financial controls are largely objective criteria used to measure the firm’s performance against previously established quantitative standards. When using financial controls, firms evaluate their current performance against previous outcomes as well as against competitors’ performance and industry averages.
Financial controls are the measures most commonly used by managers and other stakeholders to monitor and evaluate a company’s performance.
Typically, strategic managers select financial goals they wish their company to achieve (such as goals related to growth, profitability, and/or return to shareholders), and then they measure whether or not these goals have been achieved.
The main reason for the popularity of financial performance measures is that they are objective.
Financial controls are emphasized to evaluate the performance of the firm using the unrelated diversification strategy since strategic controls can hardly deal with this type of extensive diversification.
The unrelated diversification strategy’s focus on financial outcomes requires using standardized financial controls to compare performances between business units and those responsible for leading them.
The performance of one company can be compared with that of another in terms of its stock market price, return on investment, market share, or even cash flow so that strategic managers and other stakeholders, particularly shareholders, have some way of judging their company’s performance relative to that of other companies.
Important Financial Control Measures
Financial controls consist of many different measures, notably (1) accounting-based measures, such as return on investment (ROI) and return on assets (ROA), and (2) market-based measures, such as economic value-added, are examples of financial controls.
The stock price is a useful measure of a company’s performance.
This is primarily because the price of the stock is determined competitively by the number of buyers and sellers in the market. The stock’s value is an indication of the market’s expectations for the firm’s future performance.
Thus, movements in the price of stock provide shareholders with feedback on a company’s and its manager’s performance.
Stock market price acts as an important measure of performance because top managers watch it closely and are sensitive to its rise and fall. Because stock price reflects the long-term future return from the stock, it can be regarded as an indicator of the company’s long-run potential.
Return on investment (ROI), a measure of profitability determined by dividing net income by invested capital, is another popular kind of financial control.
At the corporate level, the performance of the whole company can be evaluated against that of other companies to assess its relative performance. Top managers can assess how well their strategies have worked by comparing their company’s performance against that of similar companies.
At the divisional level, ROI can also be used to judge the performance of an operating division by comparing it to that of a similar freestanding business or other internal division. Indeed, one reason for selecting a multidivisional structure is that each division can be evaluated as a self-contained profit center. Consequently, management can directly measure the performance of one division against that of another. ROI is a powerful form of control at the divisional level. The most successful divisional managers are promoted to become the next generation of corporate executives.
Failure to meet the stock price or ROI targets also indicates that corrective action is necessary.
It signals the need for corporate reorganization in order to meet corporate objectives, and such reorganization can involve a change in structure or the liquidation and divestiture of businesses. It can also indicate the need for new strategic leadership.
Behavioral Controls
What is a Behavioral Control?
To make the organizational structure work, employees must learn the kinds of behaviors they are expected to perform. Using managers to tell employees what to do lengthens the organizational hierarchy, is expensive and raises costs. Consequently, strategic managers rely on behavior controls.
Behavior control is control through the establishment of a comprehensive system of rules and procedures to direct the actions or behavior of divisions, functions, and individuals. While strategic control focuses on results, behavioral control focuses on controlling the actions that ultimately lead to results.
The objective of using behavior controls is not to specify the goals but to standardize the way of reaching them. Rules standardize behavior and make outcomes predictable. If employees follow the rules, then actions are performed and decisions handled the same way, time and time again. The result is predictability and accuracy.
In order to have an effective behavioral control system, firms should create an effective reward structure, because people tend to focus their efforts on the behaviors that are rewarded.
Problems can arise when people are rewarded for behaviors that seem positive on the surface but that can actually undermine organizational goals under some circumstances. Managers need to be aware of such trade-offs and strive to align rewards with behaviors.
The main kinds of behavior controls are operating budgets, standardization, rules and procedures, and organizational culture.
Operating Budgets
An operating budget is a blueprint that states how managers intend to use organizational resources to achieve organizational goals most efficiently. Operating budgets regulate how managers and workers are to attain goals that have been established.
Most often, managers at one level allocate to managers at a lower level a specific amount of resources to use to produce goods and services.
Once they have been given a budget, managers must decide how they will allocate certain amounts of money for different organizational activities. These lower-level managers are then evaluated on the basis of their ability to stay within the budget and make the best use of it.
Most commonly, large organizations treat each division as a stand-alone profit center, and corporate managers evaluate each division’s performance by its relative contribution to corporate profitability.
Standardization
Standardization is the degree to which a company specifies how decisions are to be made so that employees’ behavior becomes predictable.
In practice, there are 3 things an organization can standardize: inputs, conversion activities, and outputs.
First, an organization can control the behavior of both people and resources by standardizing inputs into the organization.
This means that managers screen inputs according to pre-established criteria or standards and then decide which inputs to allow into the organization.
If employees are the input in question, one way of standardizing them is to specify which qualities and skills they must possess and then to select only those applicants who possess them.
If the inputs in question are raw materials or component parts, the same considerations apply. High quality and precise tolerances from component parts can minimize problems with the product at the manufacturing stage. Just-in-time (JIT) inventory systems also help standardize the flow of inputs.
Second, the aim of standardizing conversion activities is to program work activities such that they are done the same way time and time again.
The goal is predictability. Behavior controls, such as rules and procedures, are among the chief means by which companies can standardize throughputs.
Third, the goal of standardizing outputs is to specify what the performance characteristics of the final product or service should be.
To ensure that their products are standardized, companies apply quality control and use various criteria to measure this standardization.
One criterion might be the number of goods returned from customers or the number of customers’ complaints. On production lines, periodic sampling of products can indicate whether they are meeting performance standards.
Rules and Procedures
Rules constrain people and lead to standardized, predictable behavior.
However, rules are always easier to establish than to get rid of, and over time the number of rules an organization uses tends to increase.
As new developments lead to additional rules, often the old rules are not discarded, and the company becomes overly bureaucratized.
Consequently, the organization and the people in it become inflexible and are slow to react to changing or unusual circumstances. Such inflexibility can reduce a company’s competitive advantage by lowering the pace of innovation and reducing responsiveness to customers.
Integration and coordination inside the organization may fall apart as rules impede communication between functions.
Managers must therefore be constantly on the alert for opportunities to reduce the number of rules and procedures necessary to manage the business, and they should always prefer to discard a rule rather than add a new one.
Hence, reducing the number of rules and procedures to the essential minimum is important.
Strategic managers frequently neglect this task, however, and often only a change in strategic leadership brings the company back on course.
Organizational Culture
Organizational culture is an important behavioral control that serves the dual function of keeping organizational members goal-directed yet open to new opportunities to use their skills to create value.
Organizational culture is the specific collection of values and norms that are shared by people and groups in an organization and that control the way they interact with each other and with stakeholders outside the organization.
Organizational culture functions as a form of control in that strategic managers can influence the values and norms that develop in an organization—values and norms that specify appropriate and inappropriate behaviors and that shape the way its members behave.
Organizational values are beliefs and ideas about what kinds of goals members of an organization should pursue and what kinds of standards of behavior employees should use to achieve these goals. From organizational values develop organizational norms, the guidelines or expectations that prescribe appropriate kinds of behavior by employees in particular situations and control the behavior of organizational members toward one another.
Managers of different kinds of organizations will deliberately try to cultivate and develop the organizational values and norms that are best suited to their strategy and structure.
Managers might cultivate values that encourage employees always to be conservative and cautious in their dealings with others, to consult their superiors before they make important decisions, and to record their actions in writing so they can be held accountable for what happens.
Strategic Leadership
Organizational culture is the product of strategic leadership provided by an organization’s founder and top managers.
The organization’s founder is particularly important in determining culture because the founder imprints his or her values and management style on the organization.
The leadership style established by the founder is transmitted to the company’s managers, and as the company grows, it typically attracts new managers and employees who share the same values. Moreover, members of the organization typically recruit and select only those who share their values. Thus, a company’s culture becomes more and more distinct as its members become more similar.
Strategic managers need to use strategic leadership to establish organizational values and norms that will help them bring their organizations into the future.
The virtue of these shared values and common culture is that it increases integration and improves coordination among organizational members. Rules and procedures and direct supervision are less important when shared norms and values regulate behavior and motivate employees.
When organizational members subscribe to the organization’s cultural norms and values, this bonds them to the organization and increases their commitment to finding new ways to help it succeed. That is, such employees are more likely to commit themselves to organizational goals and work actively to develop new skills and competencies to help achieve those goals.
Clan Controls
Instead of measuring results (as in strategic control) or dictating behavior (as in behavioral control), clan control is an informal type of control.
Clan control relies on shared traditions, expectations, values, and norms to lead people to work toward the good of their organization. Clan control is often used heavily in settings where creativity is vital, such as many high-tech businesses. In these companies, the output is tough to dictate, and many rules are not appropriate.
Executives can look to clan control as a tool to improve the performance of struggling organizations.
Resources
Further Reading
- Nature and Scope of Control (legalpaathshala.com)
- Organizational Control Objectives (cliffsnotes.com)
- Controlling: Nature and Scope of Control (theintactone.com)
- Nature Of Control (strategic-control.24xls.com)
- Controlling: Meaning, Nature and Principles (businessmanagementideas.com)
- Organizational Control Systems (tutorialspoint.com)
- Management Control System – Definition, Characteristics and More (cleverism.com)
Related Concepts
References
- Hitt, M. A., Ireland, D. R., & Hoskisson, R. E. (2016). Strategic Management: Concepts: Competitiveness and Globalization (12th ed.). Cengage Learning.
- Hitt, M. A., Ireland, D. R., & Hoskisson, R. E. (2019). Strategic Management: Concepts and Cases: Competitiveness and Globalization (MindTap Course List) (13th ed.). Cengage Learning.
- Hill, C. W. L., & Jones, G. R. (2011). Essentials of Strategic Management (Available Titles CourseMate) (3rd ed.). Cengage Learning.
- Mastering Strategic Management. (2016, January 18). Open Textbooks for Hong Kong.