Module 2

Designing management control systems

Learning objectives
After reading this module, you should be able to:
1. Explain the relationships between control, management control and management
control systems.
2. Name examples of systems with increasing complexity.
3. Give examples of the three fundamental ways in which managerial behaviour can
be controlled.
4. Explain differences between strategy, management control and task control.
5. Explain the type of managerial activities that contribute to management control.

Real world vignette: Enron

One of the most striking examples of the role of management control in good and bad times is
found in the Enron case. When this case unfolded, it shocked the world of accounting, control
and governance. How could things have gone so wrong? Perhaps the most striking aspect of
the Enron case is the speed with which things can go wrong after the systems have proved to
be failing, as the following extract shows.
Enron formed after merger
Enron was formed in 1985 following a merger between Houston Natural Gas and Omaha-
based InterNorth. Kenneth Lay, who had been the chief executive officer (CEO) of Houston
Natural Gas, became Enron’s CEO and chairman, and quickly rebranded Enron into an energy
trader and supplier. Deregulation of the energy markets allowed companies to place bets on
future prices, and Enron was poised to take advantage.
Enron named America’s most innovative company
By 1993, Enron had set up a number of limited liability special purpose entities that allowed
Enron to hide its liabilities, growing its stock price. Analysts were already criticizing Enron for
‘swimming in debt’, but the company continued to grow developing a large network of natural
gas pipelines, and eventually moving into the pulp and paper and water sectors. Enron was
named ‘America’s Most Innovative Company’ by Fortune for six consecutive years between
1996 and 2001.
Misleading financial accounts
Creative accounting allowed Enron to appear more powerful on paper than it really was.
Special purpose entities – subsidiaries that have a single purpose and that did not need to be
included in Enron’s balance sheet – were used to hide risky investment activities and financial
losses. Forensic accounting later determined that many of Enron’s recorded assets and profits
were inflated, and in some cases, completely fraudulent and nonexistent. Some of the
company’s debts and losses were recorded in offshore entities, remaining absent from Enron’s
financial statements.
During the late 1990s and into the early 2000s, more and more special purpose vehicles were
created that allowed the company to keep debts off the books and inflate assets. These entities,
along with other accounting loopholes and poor financial reporting, let Enron ultimately hide
 billions in debt from special deals and projects. (For more on corporate disclosure, read The
Importance of Corporate Transparency.)
Sell-off
In August of 2001, shortly after the company achieved $100 billion in revenues, then-CEO Jeff
Skilling unexpectedly resigned, prompting Wall Street to question the health of the company.
Kenneth Lay once again took the helm, and both Lay and Skilling, in addition to other Enron
executives, began selling large amounts of Enron stock as prices continued to drop – from a
high of about $90.00 per share earlier in the year, to less than a dollar. The U.S. Securities and
Exchange Commission (SEC) opened an investigation. (For more on the structure of the
commission, check out Policing The Securities Market: An Overview Of The SEC.)
Dec. 2, 2001
Less than a week after a white knight takeover bid from Dynegy was called off, Enron filed for
bankruptcy protection. The company had more than $38 billion in outstanding debts. In the
following months, the U.S. Justice Department initiated a criminal investigation into Enron’s
bankruptcy. Several Enron executives and Enron’s auditor firm, Arthur Andersen, have since
been indicted for a variety of charges including obstruction of justice for shredding documents
and conspiracy to commit wire and securities fraud, and some have been sentenced to prison.1

Introduction

I n the previous module, we presented management control both as a function of management

and a perspective to view the management of organizations. In particular, we paid attention
to the role and organizational function of management control, as well as to the question of
what it means to say that management control is directed at influencing managerial behaviour.
In this module we extend our discussion of the significance of management control to the
design and functioning of management control systems. We define a system as a collection of
separate components that operate as a whole. The management control system, therefore,
comprises all the arrangements, tools and techniques that enable top-down and bottom-up
control. The emphasis on the management control system in this module means that we focus
on the systematic way in which organizations do and should exercise management control. The
components that form such a management control system are introduced consecutively in this
module. We then discuss the systematic nature of management control and show how a
mechanistic view of control in organizations helps us in the design and use of management
control systems. For this aim, the module starts with an example of a management control
system that is required to control the simplest mechanical processes. Management control is,
however, not about simple mechanical processes, but is about controlling human behaviour,
and doing so in organizations that consist of large numbers of humans. We show how the
mechanistic view of management control is applied as the managerial and other processes that
should be controlled become more complex. The increased complexity is not only caused by
organizations having to rely on human behaviour, which is complex by definition, but also
because individual processes are often intertwined, or part of larger-scale processes. This
means that when we talk about management control of a process, we should take into account
that the term ‘process’ could mean many different things. Presented in a stepwise fashion, this
means that we should identify various objects of control.
• Control of the individual manager,
• Control of the management team the manager is part of,
• Control of the unit that the management team supervises,
• Control of all units with management teams,
• Control of the whole organization.
We view organizations as forming a cascade of control objects. The control objects increase in
complexity from the level of the individual manager up until the level of the whole
organization. The cascading of managerial levels partly follows the complexity of systems as
documented in general systems theory. As indicated before, we start by illustrating the notion
of control for a simple mechanical process. We then move forward to understand how the
notion of control for a simple process can be applied to larger and more complex processes
that involve human beings. We define what we mean with a process of being in control or
being out of control. Finally, we look for elements in the controlled process that provide us
with levers for control. We distinguish between controls that affect managerial inputs,
managerial decisions and managerial results.

Management control systems

I flittle
you operate a machine, such as your computer, your PDA or the game computer of your
nephew, your aim is to control it. You want it to do what you want. Think about driving
a car. You press the accelerator, and the car goes faster. You rotate the steering wheel, and it
changes direction. You know how to change gear by shifting the stick if the car does not do so
automatically. You press the brake pedal, and the car slows or stops. With these devices, you
control the speed and direction of your car. These devices are your controls that you need to
ensure that you reach your destination. If any of these controls is inoperative, the car does not
do what you want it to do. In that situation, the car is out of control. The consequence is that
you will not reach your objective of arriving at your destination on time.
It is useful to try to apply the analogy of a car to the organization. Organizations must also
be controlled. Without control, organizations will not reach their objectives of creating value
for their stakeholders, and doing so on time. Devices must, therefore, be in place to ensure that
their strategic intentions are achieved. For obvious reasons, controlling an organization is
much more complicated than controlling a mechanical system such as a car. Still, we believe
that the example of controlling a mechanical system helps us to understand the essence of
management control too. We begin by describing the control process in simpler systems.

Elements of a controlled system

Every controlled system has at least five elements:
1. A detector or sensor – a device that measures what is actually happening in the
process being controlled.
2. An assessor – a device that determines the significance of what is actually happening
by comparing it with some standard or expectation of what should happen.
3. An effector – a device (often called ‘feedback’) that alters behaviour if the assessor
indicates the need to do so.
4. A communications network – devices that transmit information between the
detector and the assessor and between the assessor and the effector.
5. A predictive model – knowledge about the effect of the behavioural changes made by
the effector.
These five basic elements of any control system are diagrammed in Exhibit 2.1. We describe
their functioning in three examples of increasing complexity: the thermostat, which regulates
room temperature; the biological process that regulates body temperature; and the driver of a
car, who regulates the direction and speed of the vehicle.

EXHIBIT 2.1 Elements of a controlled process

Thermostat
The components of the thermostat are: (1) a thermometer (the detector), which measures the
current temperature of a room; (2) an assessor, which compares the current temperature with
the accepted standard for what the temperature should be; (3) an effector, which prompts a
furnace to emit heat (if the actual temperature is lower than the standard) or activates an air
conditioner (if the actual temperature is higher than the standard) and which also shuts off
these appliances when the temperature reaches the standard level; and (4) a communications
network, which transmits information from the thermometer to the assessor and from the
assessor to the heating or cooling element.
Body temperature
Most mammals are born with a built-in standard of desirable body temperature; in humans
that standard is 37 °C (100 °F). The elements of the control mechanism by which the body
strives to maintain that standard are: (1) the sensory nerves (detectors) scattered throughout
the body; (2) the hypothalamus centre in the brain (assessor), which compares information
received from detectors with the 37 °C (100 °F) standard; (3) the muscles and organs
(effectors) that reduce the temperature when it exceeds the standard (via panting and
sweating, and opening the skin pores) and raises the temperature when it falls below the
standard (via shivering and closing the skin pores); and (4) the overall communications system
of nerves.
This biological control system is homeostatic; that is, self-regulating. If the system is
functioning properly, it automatically corrects for deviations from the standard without
requiring conscious effort.
The body temperature control system is more complex than the thermostat, with body
sensors scattered throughout the body and the hypothalamus directing actions that involve a
variety of muscles and organs. It is also more mysterious; scientists know what the
hypothalamus does but not how it does it.
Car driver
Assume you are driving on a motorway where the legal (i.e. standard) speed is 130 km/h (81
mph). Your control system acts as follows: (1) your eyes (sensors) measure actual speed by
observing the speedometer; (2) your brain (assessor) compares actual speed with desired
speed, and, upon detecting a deviation from the standard, (3) directs your foot (effector) to
ease up or press down on the accelerator; and (4) as in body temperature regulation, your
nerves form the communication system that transmits information from eyes to brain and
brain to foot.
But just as body temperature regulation is more complicated than the thermostat, so the
regulation of a car is more complicated than the regulation of body temperature. This is
because there can be no certainty as to what action the brain will direct after receiving and
evaluating information from the detector. For example, once they determine that the car’s
actual speed exceeds 130 km/h, some drivers, wanting to stay within the legal limit, will ease
up on the accelerator, while others, for any number of reasons, will not. In this system, control
is not automatic; one would have to know something about the personality and circumstances
of the driver to predict what the actual speed of the car would be at the end point of the
process.

Contrast with simpler control processes

An organization consists of a group of people who work together to achieve certain common
goals (in a business organization a major goal is to earn a satisfactory profit). Organizations are
led by a hierarchy of managers, with the CEO at the top, and the managers of business units,
departments, functions and other subunits ranked below him or her in the organizational
chart. The complexity of the organization determines the number of layers in the hierarchy. All
managers other than the CEO are both superiors and subordinates; they supervise the people
in their own units, and they are supervised by the managers they report to.
The CEO (or, in some organizations, a team of senior managers) decides on the overall
strategies that will enable the organization to meet its goals. Subject to the approval of the CEO,
the various business unit managers formulate additional strategies that will enable their
respective units to further these goals. The management control process is the process by
which managers at all levels ensure that the people they supervise implement their intended
strategies.
The control process used by managers contains the same elements as those in the simpler
control systems described earlier: detectors, assessors, effectors and a communications
system. Detectors report what is happening throughout the organization; assessors compare
this information with the desired state; effectors take corrective action once a significant
difference between the actual state and the desired state has been perceived; and the
communications system tells managers what is happening and how that compares to the
desired state. There are, however, significant differences between the management control
process and the simpler processes described earlier.
Unlike in the thermostat or body temperature systems, the standard is not pre-set. Rather, it
is a result of a conscious planning process. In this process, management decides what the
organization should be doing, and part of the control process is a comparison of actual
accomplishments with these plans. Thus, the control process in an organization involves
planning. In many situations, planning and control can be viewed as two separate activities.
Management control, however, involves both planning and control.
Like controlling a car (but unlike regulating room or body temperature), management
control is not automatic. Some detectors in an organization may be mechanical, but managers
often detect important information with their own eyes, ears and other senses. Although they
may have routine ways of comparing certain reports of what is happening with standards of
what should be happening, managers must personally perform the assessor function, deciding
for themselves whether the difference between actual and standard performance is significant
enough to warrant action, and, if so, what action to take. Then, because actions intended to
alter an organization’s behaviour involve human beings, managers must interact with at least
one other person to effect change.
Unlike controlling a car, which is a function performed by a single individual, management
control requires coordination among individuals. An organization consists of many separate
parts, and management control must ensure that each part works in harmony with the others,
a need that exists only minimally in the case of the various organs that control body
temperature and not at all in the case of the thermostat.
The connection from perceiving the need for action to determining the action required to
obtain the desired result may not be clear. A manager acting as assessor may decide that ‘costs
are too high’ but sees no easy or automatic action guaranteed to bring costs down to what the
standard says they should be. The term ‘black box’ describes an operation whose exact nature
cannot be observed. Unlike the thermostat or the car driver, a management control system is a
black box. We cannot know what action given managers will take when there is a significant
difference between actual and expected performance, or what action, if any, they assess others
will take in response to the manager’s signal. By contrast, we know exactly when the
thermostat will signal the need for action and what that action will be; and, in the case of the
car driver, the assessor phase may involve judgement, but the action itself is mechanical once
the decision to act has been made.
Finally, it needs to be emphasized that a lot of management control is self-control; that is,
control is maintained not by an external regulating device such as the thermostat, but by
managers using their own judgement rather than following instructions from a superior.
Drivers who obey the 130 km/h speed limit do so not because a sign commands it, but because
they have consciously decided that it is in their best interest to obey the law. This also means
that all organizations should be both conscious of, and explicitly cherish and stimulate, those
characteristics of their culture that stimulate such self-control. The stimulation of such cultural
characteristics is, therefore, one of the principal goals of designing management control
systems, which is the subject of the next section.

Management control system and processes, in and out of control

A activities.
system is a prescribed and usually repetitious way of carrying out an activity or a set of
Systems are characterized by a more or less rhythmic, coordinated and recurring
series of steps intended to accomplish a specified purpose. The thermostat and the body
temperature control processes described above are examples of systems. Management control
systems, as we have seen, are far more complex and judgemental.
Many management actions are unsystematic. Managers regularly encounter situations for
which the rules are not well defined and, therefore, must use their best judgement in deciding
what action to take. The effectiveness of their actions is determined by their skill in dealing
with people, not by a rule specific to the system (though the system may suggest the general
nature of the appropriate response). If all systems ensured the correct action for all situations,
there would be no need for human managers.
In this course, we focus primarily on the systematic (i.e. formal) aspects of the management
control function. One can describe in considerable depth the various steps in the formal
system, the information that is collected and used in each step, and the principles that govern
the system’s operation as a whole. But it is very difficult, except in general terms, to describe
the appropriate actions for managers encountering situations not contemplated in the formal
system. These depend, among other factors, on the skills and personalities of the people
involved, their relationships with one another, and the environment within which a particular
problem arises. It is important to recognize, however, that these informal processes are
strongly affected by the way the organization’s formal control systems are designed and
operated.
In the remainder of this section, we discuss the three forms of control that directly impact
the process under the managers’ supervision. We use a simplified scheme as a basis of our
analysis, which is shown in Exhibit 2.2.

EXHIBIT 2.2 The fundamental managerial process

 This scheme presents the process of controlling the behaviour of an individual manager in
its most basic form. Despite its simplicity, it communicates that the management process, from
the point of view of control, exists of managers providing input, which is transformed via the
execution of effort into managerial performance. It is this process that we need to control to
ensure that these managerial inputs, efforts and performances are goal-congruent; that is, they
help the organization achieve its strategic objectives.

Management control by control of managerial input

A first element of the managerial process that may be subject to control are the managerial
inputs, which are symbolized with the term ‘manager’ in Exhibit 2.3. With managerial inputs,
we mean the combination of capabilities, characteristics, knowledge and intentions that
managers brings to their function. Specifically, control can be exercised by ensuring that these
capabilities, characteristics, knowledge and intentions increase the chance that the manager
will engage in such behaviours as can be deemed consistent with the organization’s objectives.
We address three applicable controls in detail below, which are normally seen as belonging to
the human resource management (HRM) activities of the organization.
• Staffing: this function involves designing jobs and roles in the organization and
ensuring that the right people are recruited, promoted or selected to take on these
jobs and roles. This function includes activities to ensure that the organization also
has sufficient managerial capacity and ability in the future.
• Development: this function involves ensuring basic conditions that enable managers
to be informed about organizational goals and to behave in line with those goals.
Activities include introduction programmes for new managers, organizing training
programmes to enhance competencies, and influencing collegiality, citizenship and
culture in line with the organization’s overall strategies. Human resource (HR) may
also be responsible for programmes that enhance the health and safety of the
organizational members.
• Culture building: this function involves leading, by example or by explicit
management, managers into showing the right kinds of behaviour. This can be done
both with and without forms of coercion. One label that has been used to describe
such controls is that of socio-ideological modes of control, which aim to influence
social relations, emotions, identity formation and ideology.2 These types of control
are the formal way in which cultural values and characteristics of the organization,
or its subunits, are influenced. If well implemented, they enhance cooperation,
effort and trust and, therefore, enhance control.

EXHIBIT 2.3 Management control by managerial inputs

Certain practices become rituals, carried on almost automatically because ‘this is the way
things are done here’. Others are taboo (‘we just don’t do that here’), although no one may
remember why. Organizational culture is also influenced strongly by the personality and
policies of the CEO, and by those of lower-level managers with respect to the areas they
control. If many organizational participants are members of a labour or trade union, the rules
and norms accepted by the union also have a major influence on the organization’s culture.
 The organizational cultural factor that probably has the strongest impact on management
control is management style. Usually, subordinate managers’ attitudes reflect what they
perceive their superiors’ attitudes to be, and their superiors’ attitudes ultimately stem from the
CEO and other members of the organizational highest ranks. Managers come in all shapes and
sizes. Some are charismatic and outgoing; others are less ebulient. Some spend a lot of time
looking and talking to people (‘management by walking around’); others rely more heavily on
written reports. When evaluating the effect of higher-level management style on lower-level
managerial behaviour we often discuss this in terms of ‘tone at the top’; that is, higher-level
managers set the example in the way they act, the opinions they proclaim and the norms they
seem to adhere to for lower-level managers. Audit professionals and advisory agencies on
corporate governance have traditionally stressed the importance of ‘tone at the top’ as a
powerful way to make lower-levels managers behave in line with organizational objectives.
‘Tone at the top’ affects behaviour because such lower-level managers, willingly and
consciously, as well as unwillingly and unconsciously, will reciprocate the behaviour they see
displayed. Human beings have a natural inclination to such reciprocity, which may lead to
imitation or even amplification of the behaviour they encounter from their superiors. ‘Tone at
the top’ may, therefore, be an instrument of management control, but may also lead
organizations into disaster. Notably, in some of the cases of organizational disaster that we
have mentioned, the tone at the top may have been a strong driver. Although social context
may be an important part of good management control, management control is more than
social context. In fact, management control systems may sometimes want to counter potential
negative effects that a social context may have on individual managerial behaviour. Thus, while
reciprocity and people’s desire to adhere to group norms and imitate each other’s behaviour
may enhance the overall goal orientation of an organization’s management, the adverse effects
need always to be considered and countered if possible.
Example: Some organizations are known, and even notorious, for their reliance on input controls. Firms and organizations
that rely heavily on the knowledge and expertise of their employees most notably apply input controls. Universities, hospitals
and research and development (R&D)-intensive firms belong to this group of organizations. They are all known for a large
amount of freedom for decentralized managers, often apparently at the cost of efficiency and overall performance. When such
organizations try to apply controls that limit individual ability and creativity, performance immediately suffers as well. Thus,
universities, hospitals and R&D-intensive firms face a trade-off between the costs and benefits of the large freedom that input
controls allow. We take a further look at this tension in Module 12.

Management control by control of managerial decisions

Managerial effort is a generic term that applies to all the observable actions and choices
managers make as part of their managerial responsibilities. We refer to it in terms of
‘decisions’ in Exhibit 2.4, to emphasize that discretion in decision making is an essential feature
of managers, rather than employees. The actions and choices are made by managers in the
context of their managerial role, and because we assume that managers do not automatically
act and choose in line with organizational objectives, for the reasons mentioned in the first
module, we can implement controls that directly help managers to take the right actions.
Controlling decisions, therefore, means that managerial discretion is limited to those decisions’
categories or decision choices that are considered in line with organizational objectives. There
are various ways to control decisions taken by managers. While they normally come in the
form of rules, they typically also involve bureaucratic ways to seek ex-ante or ex-post approval
of decisions. An important set of decisions that are subject to such controls are those related to
new investments. Investment appraisal is an important issue in most companies. These types
of control are an important part of the organization’s formal control system, which we discuss
in more detail in Module 5. Some examples include the following:
• The formal delegation of decision-making authority to lower-level managers By
formal delegation, we mean that managers lower in the hierarchy obtain the
 relative freedom to take actions and make decisions for their respective subunits.
This is a formal way of control, as the delegation is never a carte blanche, and
should specify the kinds of decision that decentralized managers can take.
• The formal delegation of decision-making responsibility to lower-level managers
Complementary to delegation of decision-making authority is the specification of
the responsibilities that managers carry. For example, managers can be given the
freedom to make investments that adhere to certain criteria such as earning a
budgeted amount of return of more than 10 per cent or not exceeding a certain
amount of investment cash flows.
• The prescription of certain behaviours of managers in some specific situations
Organizations normally use formal procedures that describe crucial ‘do’s and
don’ts’ of managers concerning, for example, the way they report their accounting
performance, the way they do business in foreign countries and the way they deal
with HR-related, ethical or environmental issues. These codes of conduct are
sometimes explicitly communicated to the outside world, to signal their importance
to the organization.

EXHIBIT 2.4 Management control by controlling decisions

Example: Some organizations seem destined to apply controls that limit managerial discretionary freedom. Indeed,
governmental organizations are sometimes portrayed as bureaucratic, which means that somehow the system seems to have
taken over the power from the people. But there is a good reason why many governmental agencies, such as the police, the
army and social security organizations, rely on decision control. In these organizations, values of equality, fairness and
legitimacy are often seen as far more important goals in the long run than achieving short-term performance through
managerial freedom creativity. As the pressure on such organizations to become more efficient is mounting in many countries,
however, the trade-off between the values mentioned and the cost efficiency of these organizations is under increased
scrutiny. We take a further look at this challenge in Module 12.

Management control by control of managerial output (performance)

A third way to control managerial behaviour is by making managers accountable for certain
‘results’ as depicted in Exhibit 2.5. Accountability for results can take the form of target setting,
such that managers are instructed to achieve certain goals. The use of management by
objectives (MBO) and balanced scorecard philosophies relies heavily on this way of controlling
managerial behaviour. Another form of making managers accountable for results is through
linking managerial compensation to the achievement of certain results. While such a practice is
common for most board managers, the practice of tying relatively large monetary payments to
performance at lower levels in the organization has become more general only in the last few
decades outside the USA. Module 11 deals with the ways in which such systems can be
designed to motivate managers towards goal congruence. Some examples include:
• the clear formulation and communication of performance targets to be reached by
managers, or teams of managers;
• the explicit tying of rewards to the attainment of such performance targets in the
form of bonuses, stock options or just praise;
• establishing a link between performance targets and formal promotion policies.

EXHIBIT 2.5 Management control by controlling managerial outputs (performance)

Example: The focus on the results of managerial decisions has traditionally been strong in sales-driven firms. In such
organizations, it was typically considered that sales efficiency would be enhanced by allowing managers large amounts of
creative and behavioural freedom, but combining this freedom in input and decisions with a strict definition of results.
Currently, there are still large differences between countries in adoption of this logic in other than sales functions. The
financial sector in particular has recently been scrutinized for its strict reliance on targets and associated bonuses, to the
detriment of controls on inputs and decisions. This, according to some, would induce speculative and even immoral behaviour,
leading to pleas to reinstall controls that focus on cultural values (inputs), and ethical norms (decisions).

To conclude this section, two points warrant some emphasis. The first point is that the
description of these elements of management control is broadly meant to provide a way in
which we can systematically discuss, design and change elements of management control and
the relative emphasis put on inputs, process and outputs. In any specific situation, however,
the way in which a manager’s behaviour is controlled is always a combination of these types of
controls. Designing a management control system therefore results in choosing the relative
emphasis that is put on controlling inputs, controlling decisions and effort, and controlling
managerial outputs. In Module 5 we discuss how this can be referred to as the choice between
making certain controls ‘tighter’ or instead making them ‘looser’. A second remark relates to
the question of what we mean by the system being ‘in control’ or being ‘out of control’. While
these statements are increasingly used and have received an enormous emphasis in the
business press and beyond, at the most fundamental level, they mean nothing more than the
chance that the organization, through its cybernetic control processes, is able to reach its goals.
Thus, the thermostatic process is ‘in control’ if deviations from the desired room temperature
lead to extra warmth being produced. The process is ‘out of control’ if, for example, the heater
continues burning gas after the desired temperature has been reached. This fundamental
meaning of these concepts should be kept in mind, as the difference between the simple
thermostatic control problem and that of controlling organizations is paramount. In fact, it is
highly unlikely that organizations are either fully ‘in’ or fully ‘out of’ control, as the example
below may illustrate for Schiphol, one of Europe’s largest airports, which is located close to
Amsterdam. Thus, while ‘in control’ and ‘out of control’ are fashionable statements, they are of
little help for the immediate design of management control systems.
Example: This is the statement in the Schiphol Annual Report of 2012 on risk management and internal control:3
‘We aim to reduce the possibility of errors, wrong decisions and surprises due to unforeseen circumstances as much as
possible. Comprehensiveness in this respect cannot be guaranteed. It can never be ruled out that we may be exposed to risks of
which we are currently unaware, or which may not, or not yet, be considered important at this time. Furthermore, no risk
management or internal control system can provide an absolute safeguard against failure to achieve corporate objectives, or
against full prevention of any possible loss, fraud or breach of rules and regulations. To name one example, Schiphol is
particularly susceptible to adverse weather conditions and other natural phenomena. Although we cannot prevent or influence
such phenomena, we can ensure that their effects are kept to a minimum.’

Delineating management control, strategic control and task control

I ndistinguish
this section, we define management control, strategic control and task control. We
management control from two other systems – or activities – which also require
both planning and control: strategy formulation and task control. Serious mistakes can be
made if principles and generalizations specific to one system are applied in another. As you will
see, management control fits between strategy formulation and task control in several
respects. Strategy formulation is the least systematic of the three, task control is the most
systematic, and management control lies in between. Strategy formulation focuses on the long
run, task control focuses on short-run activities, and management control is in between.
Strategy formulation uses rough approximations of the future, task control uses current
accurate data, and management control is in between. Each activity involves both planning and
control, but the emphasis varies with the type of activity. The planning process is much more
important in strategy formulation, the control process is much more important in task control,
and planning and control are approximately equal in importance in management control. The
relationships of these systems of activities to one another are indicated in Exhibit 2.6.

EXHIBIT 2.6 General relationships among planning and control functions

In the following sections we define management control, strategy formulation and task
control in greater detail and further describe the differences between them.

Management control
Management control is the process by which managers influence other members of the
organization to implement the organization’s strategies. Several aspects of this process are
amplified here.
Management control activities
For the most simplistic way of presentation, the actual activities that managers perform in the
execution of their management control roles are various, and include at least the following
activities:
• planning what the organization should do;
• coordinating the activities of several parts of the organization;
• communicating information;
• evaluating information;
• deciding what, if any, action should be taken;
• influencing people to change their behaviour.
Management control does not necessarily require that all actions correspond to a previously
determined plan such as a budget. Such plans are based on circumstances believed to exist at
the time they were formulated. If these circumstances have changed at the time of
implementation, the actions dictated by the plan may no longer be appropriate. While a
thermostat responds to the actual temperature in a room, management control involves
anticipating future conditions to ensure that the organization’s objectives are attained. If a
manager discovers a better approach – one more likely than the predetermined plan to achieve
the organization’s goals – the management control system should not obstruct its
implementation. In other words, conforming to a budget is not necessarily good, and departure
from a budget is not necessarily bad.
Goal congruence
Although systematic, the management control process is by no means mechanical; rather, it
involves interactions among individuals, which cannot be described in mechanical ways.
Managers have personal as well as organizational goals. The central control problem is to
induce them to act in pursuit of their personal goals in ways that will help them attain the
organization’s goals as well. Goal congruence means that, insofar as is feasible, the goals of an
organization’s individual members should be consistent with the goals of the organization
itself. The management control system should be designed and operated with the principle of
goal congruence in mind.
Tool for implementing strategy
Management control systems help managers move an organization towards its strategic
objectives. Thus, management control focuses primarily on strategy execution.
Example: As of 2013, Wal-Mart, with sales revenues of more than $466 billion, was the largest retailer in the world, with
10,800 stores in 27 countries. Its growth is believed to follow from its strategy of selling branded products at low cost. The
company’s management control system was directed towards the efficient management of store operations, which, in turn,
conferred a cost advantage companywide. Data from more than 5,300 individual stores on items such as sales, expenses, and
profit and loss were collected, analysed, and transmitted electronically on a real-time basis, rapidly revealing how a particular
region, district, store, department within a store or item within a department was performing. This information enabled the
company to reduce the likelihood of stock-outs and the need for markdowns on slow-moving stock, and to maximize inventory
turnover. The data from ‘outstanding’ performers among 5,300 stores were used to improve operations in ‘problem’ stores.
Further, the company was able to reduce pilferage-related losses, a major concern, by instituting a policy of sharing 50 per cent
of the savings from decreased pilferage in a particular store, as compared with the industry standard, among that store’s
employees.4

Management controls are only one of the tools managers use in implementing desired
strategies. As indicated in Exhibit 2.7, strategies are also implemented through the
organization’s structure, its management of human resources and its particular culture.

EXHIBIT 2.7 Framework for strategy implementation

Organizational structure specifies the roles, reporting relationships and division of

responsibilities that shape decision making within an organization. HRM is the selection,
training, evaluation, promotion and termination of employees so as to develop the knowledge
and skills required to execute organizational strategy. Culture refers to the set of common
beliefs, attitudes and norms that explicitly or implicitly guide managerial actions.
Financial and non-financial emphasis
Management control systems encompass both financial and non-financial performance
measures. The financial dimension focuses on the monetary ‘bottom line’ – net income, return
on equity, and so on. But virtually all organizational subunits have non-financial objectives –
product quality, market share, customer satisfaction, on-time delivery and employee morale.
Aid in developing new strategies
As discussed earlier, the primary role of management control is to ensure the execution of
chosen strategies. In industries that are subject to rapid environmental changes, however,
management control information, especially of a non-financial nature, can also provide the
basis for considering new strategies. This function, illustrated in Exhibit 2.8, is referred to as
interactive control. Interactive control calls management’s attention to developments – both
negative (e.g. loss of market share, customer complaints) and positive (e.g. the opening up of a
new market as a result of the elimination of certain government regulations) – that indicate the
need for new strategic initiatives. Interactive controls are an integral part of the management
control system.

EXHIBIT 2.8 Interactive control

Strategy formulation
Strategy formulation is the process of deciding on the goals of the organization and the
strategies for attaining these goals. In this book, we use the word ‘goals’ to describe the broad
overall aims of an organization, and the term ‘objectives’ to describe specific steps to
accomplish the goals within a given time frame.
Goals are timeless; they exist until they are changed, and they are changed very rarely. For
many businesses, earning a satisfactory return on investment is an important goal; for others,
attaining a large market share is equally important. Non-profit organizations also have goals; in
general, they seek to provide the maximum services possible with available funding. In the
strategy formulation process, the goals of the organization are usually taken as a given,
although on occasions strategic thinking can focus on the goals themselves.
Strategies are big plans, important plans. They state in a general way the direction in which
senior management wants the organization to move. A decision by a car manufacturer to
produce and sell an electric car would be a strategic decision.
The need for formulating strategies usually arises in response to a perceived threat (e.g.
market inroads by competitors, a shift in consumer tastes or new government regulations) or
opportunity (e.g. technological innovations, new perceptions of customer behaviour, or the
development of new applications for existing products). A new CEO, especially one brought in
from the outside, usually perceives both threats and opportunities differently from how his or
her predecessor did. Thus, changes in strategies often occur when a new CEO takes over. The
impact of CEO changes can be illustrated by the sad example of Ahold.
Example: An interesting case of CEO behaviour is found in the history of Ahold, a global company with Dutch origins, active in
the retailing business, which owns Giant and Stop & Shop in the USA and 7,000 stores in Europe, including Supersol and
Hipersol in Spain and ICA throughout Scandinavia:5
‘In Amsterdam, they’re calling it “Enron on the Zaan,” referring to the river that flows near the headquarters of Royal Ahold, the
world’s largest food retailer. And while that might be an exaggeration, Ahold has certainly scandalized the Netherlands’ normally
placid business life. The company’s CEO, Cees van der Hoeven, and its finance chief, Michael Meurs, abruptly resigned last week
following the discovery that a food-service subsidiary in the U.S. had overstated its operating earnings by at least $500 million.
Ahold’s stock immediately plunged by two-thirds, erasing €5 billion in value, although it picked up again slightly at the end of the
week. Meanwhile, Dutch regulators, the Securities and Exchange Commission in Washington and the U.S. attorney’s office in
Manhattan started official investigations, and shareholder class-action suits have already been filed in the U.S.’
The question is how this could happen to such a successful business that during the course of its history had managed to grow
worldwide. In the analysis of this case, the personality of the CEO played an important role.
‘Van der Hoeven, 55, is a tall, heavy-smoking former Shell executive with a commanding manner. When he took over as CEO in
1993, he promptly launched an international acquisition binge that turned the once family-owned firm into a colossus with 35
companies spread over four continents and sales in 2002 the company puts at more than €70 billion. But he also loaded Ahold
with more than €12 billion of debt.’
Signs of things being wrong reached investors and stock-market analysts when Ahold published its annual results in 2001, and
the company was seen as engaging in ‘muddy accounting’.
‘The European version showed profits of over €1 billion. But the U.S. version, under American accounting rules, showed net income
was just €120 million – almost 90% less. However tempting the Enron comparison may be, no allegations have so far emerged of
massive and systemic fraud by top management; instead, the two men may have resigned to take responsibility for their lack of
oversight. [ … ].’
The new CEO, Anders Moberg, who replaced Cees Van der Hoeven at Ahold in 2003, has managed to get Ahold back on a
positive strategic track since. Dick Boer, CEO of Ahold since 2011, stated that ‘With 20 consecutive quarters of identical sales
growth, steady market share growth in our main markets over the past five years, and consistently strong cash generation, we
have a robust and successful business. This is thanks to the people at all of Ahold’s companies, whose hard work, innovative
thinking and dedication to customers helps drive our ability to keep getting better every day.’6

Strategies to address a threat or opportunity can arise from anywhere in an organization

and at any time. New ideas do not emanate solely from the R&D team or the headquarters staff.
Virtually anyone might come up with a ‘bright idea’, which, after analysis and discussion, can
form the basis for a new strategy. Complete responsibility for strategy formulation should
never be assigned to a particular person or organizational unit. Providing a means of bringing
worthwhile ideas directly to the attention of senior management without allowing them to be
blocked at lower levels is important.
Distinctions between strategy formulation and management control
Strategy formulation is the process of deciding on new strategies; management control is the
process of implementing those strategies. From the standpoint of systems design, the most
important distinction between strategy formulation and management control is that strategy
formulation is essentially unsystematic. Threats, opportunities and new ideas do not occur at
regular intervals; thus, strategic decisions may be made at any time.
Furthermore, the analysis of a proposed strategy varies with the nature of the strategy.
Strategic analysis involves a great deal of judgement, and the numbers used in the process are
usually rough estimates. By contrast, the management control process involves a series of
steps that occur in a predictable sequence according to a more or less fixed timetable, and with
reliable estimates.
Analysis of a proposed strategy usually involves relatively few people – the sponsor of the
idea, headquarters staff and senior management. By contrast, the management control process
involves managers and their staff at all levels in the organization.

Task control
Task control is the process of ensuring that specified tasks are carried out effectively and
efficiently.
Task control is transaction-oriented – that is, it involves the performance of individual tasks
according to the rules established in the management control process. Task control often
consists of seeing that these rules are followed, a function that in some cases does not even
require the presence of human beings. Numerically controlled machine tools, process control
computers and robots are mechanical task control devices. Their function involves humans
only when the latter prove less expensive or more reliable; this is likely to happen only if
unusual events occur so frequently that programming a computer with rules for dealing with
these events is not worth while.
Many task control activities are scientific; that is, the optimal decision or the appropriate
action for bringing an out-of-control condition back to the desired state is predictable within
acceptable limits. For instance, the rules for economic order quantity determine the amount
and timing of purchase orders. Task control is the focus of many management science and
operations research techniques.
Most of the information in an organization is task control information: the number of items
ordered by customers, the pounds of material and units of components used in the
manufacture of products, the number of hours employees work and the amount of cash
disbursed. Many of an organization’s central activities – including procurement, scheduling,
order entry, logistics, quality control and cash management – are task control systems. Some of
them, though mechanical, can be extremely complicated.
Distinctions between task control and management control
The most important distinction between task control and management control is that many
task control systems are scientific, whereas management control can never be reduced to a
science. By definition, management control involves the behaviour of managers, and this
cannot be expressed by equations. Serious errors may be made when principles developed by
management scientists for task control situations are applied to management control
situations. In management control, managers interact with other managers; in task control,
either human beings are not involved at all (as in some automated production processes), or
the interaction is between a manager and a non-manager.
In management control the focus is on organizational units; in task control the focus is on
specific tasks performed by these organizational units (e.g. manufacturing Job No. 59268, or
ordering 100 units of Part No. 3642).
Management control is concerned with the broadly defined activities of managers deciding
what is to be done within the general constraints of strategies. Task control relates to specified
tasks, most of which require little or no judgement to perform.
Exhibit 2.9 identifies differences among management control, task control and strategy
formulation by giving examples of each.

EXHIBIT 2.9 Examples of decisions in planning and control functions

Strategy formulation Management control Task control
Introduce new product or brand within product
Acquire an unrelated business Coordinate order entry
line
Enter a new business Expand a plant Schedule production
Add direct mail selling Determine advertising budget Book TV commercials
Change debt/equity ratio Issue new debt Manage cash flows
Adopt affirmative action policy Implement minority recruitment programme Maintain personnel records
Devise inventory speculation policy Decide inventory levels Reorder an item
Decide magnitude and direction of Run individual research
Control research organization
research project

Summary
A system is a prescribed way of carrying out any activity or set of activities. The system used by
management to control the activities of an organization is called the management control
system. Management control is the process by which managers influence other members of the
organization to implement the organization’s strategies. Management control is facilitated by a
formal system that includes a recurring cycle of activities. Management control is one of three
planning and control functions that are present in almost every organization. The other two
are strategy formulation, the largely unsystematic process of identifying threats and
opportunities and deciding on new strategies in response; and task control, the process of
ensuring that specified tasks are carried out effectively and efficiently. Most importantly, we
identified several factors that are always part of the management process that require control.
After an introduction into the basic form of the control process, we have showed how such a
control process may apply to managerial inputs, managerial effort or to managerial outputs.