a. Concept of profit centre in non-profit organization
b. Management control in matrix structures
c. Implications of differentiated strategies on controls.
Ans. a) Concept of profit centre in NPO
By law NPO are allowed to make profit but are restrained from distributing it to owners and management This way they are non profit making organizations (from the owner's point of view). Such organizations include religious, charitable and educational trusts. Prime goal of management control systems in such organization is enhancing the service spread first and if possible then cost control rather and than operating efficiency. On the financial front, they enjoy many concessions from the government such as taxes, subsidies, grants etc so also they attract special control from these assisting institutes.
Characteristics:
1. Absent of profit performance measure leads to problems in assessing the efficiency of the organization. If the organization shows large net income it may be because that NPO may not be providing the services to the extent possible/ expected. If the organization shows net losses it may show the NPO facing risk of bankruptcy. Hence non availability of clear-cut performance yardstick makes the problem of control worst.
2. NPO's have contributed capital Plant: NPOs do not have shareholder as its stakeholder. The capital contribution to the business comes by way of contributions to assets such as building and equipments. Second kind of contribution could be in the form of monetary assistance, which entitles the organization to reap the interest on it keeping the principal amount intact.
3. Operating Assets represents the resources used for running day to day activities. And the contributed assets are not allowed to mix up with the operating assets.
4. Fund accounting: NPO need to keep two types of financial statements one set for contributed capital and another for operating capital. The nature of the contributed capital is beyond control of the management and therefore management concentrates on controlling the operating assets/investments.
5. Governance: Usually NPO are managed by trusts, who exercise less control on operational matters. Hence performance control is less demanding from owners' point of view and difficult from the point of view of management.
These characteristics pose difficulty in pricing of the product/services - what could be appropriate price? Usually it is set at total/full cost. The more stress expected on allocation of scare resources. Though not stricter control, but a sense of control can be built among the managers by way of using budgets for various activities and expenses. Non profit basis makes performance evaluation quite impossible. But one can make the things easier by concentrating on adherence to costs budgets, and enhancing the service base.
b) Management control in matrix structures
Matrix organizational structure assigns multiple responsibilities to the functional heads. Evaluation of performance of such organizational entities is very difficult. Though they offer economies of using scares functional staff, it poses problems of casting the individual responsibility. This form of organization is very complex, from the point of view of management control system.
At the end we must not forget that the management control system is for the organization and not the organization exists for management control system. One has to mold and remold the management control system to suit the given organization structure
A citation by Anthony is worth noting in this regard.
Usually in an advertisement agency, account supervisors are shifted from one
account to another on periodic basis, this practice allows the agency to look at the account from the perspectives of different executives. However taking in to consideration the time lag of result realization in such services is quite large. And this may pose problem of performance assessment of a particular executive. This does not mean a control system designer should insist on abandoning the rotation system of the executives.
Matrix structure offers advantages such as faster decision making process, efficiency and effectiveness but simultaneously it may pose problems such as added complexity in control function, assignment of responsibility and authority etc.
c) Implications of differentiated strategies on controls
Different corporate strategies imply the following differences in the context in which control systems need to be designed: As firms become more diversified, corporate-level managers may not have significant knowledge of, or experience in, the activities of the company's various business units. If so, corporate-level managers for highly diversified firms cannot expect to control the different businesses on the basis of intimate knowledge of their activities, and performance evaluation tends to be carried out at arm's length. Single-industry and related diversified firms possess corporatewide core competencies (on which the strategies of most of the business units are based. Communication channels and transfer of competencies across business units, therefore, are critical in such firms. In contrast, there are low levels of interdependence among the business units of unrelated diversified firms. This implies that as firms become more diversified, it may be desirable to change the balance in control systems from an emphasis on fostering cooperation to an emphasis on encouraging entrepreneurial spirit.
Ø Strategic planning: given the low level of interdependencies, conglomerates tend to use vertical strategic planning systems-that is, business units prepare strategic plans & submit to senior management to review & approve. The horizontal dimension might be incorporated into the strategic planning process in a number of different ways. First, a group executive might be given the responsibility to develop a strategic plan for the group as a whole that explicitly identifies synergies across individual business units within the group. Second, strategic plans of individual business units could have an interdependence section, in which the general manager of the business unit identifies the focal linkages with other business units and how those linkages will be exploited. Third, the corporate office could require joint strategic plans for interdependent business units. Finally, strategic plans of individual business units could be circulated to managers of similar business units to critique and review. These methods are not mutually exclusive. In fact, several of them could be pursued fruit. fully at the same time.
Ø Budgeting: The chief executives of single-industry firms may be able to control the operations of subordinates through informal and personally oriented mechanisms, such as frequent personal interactions. This lessens the need to rely as heavily on the budgeting system as the tool of control. On the other hand, in a conglomerate it is nearly impossible for the chief executive to rely on informal interpersonal interactions as a control tool; much of the communication and control has to be achieved through the formal budgeting stem. This implies the following budgeting system characteristics in a conglomerate. Business unit managers have somewhat greater influence in developing their budgets since they, not the corporate office, possess most of the information about their respective product/market environments. Greater emphasis is often placed on meeting the budget since the chief executive has no other informal controls available.
Ø Transfer Pricing: Transfers of goods and services between business units are more frequent in single-industry and related diversified firms than in conglomerates. The usual transfer pricing policy in a conglomerate is to give sourcing flexibility to business units and use arm's-length market prices. However, in a single-industry or a related diversified firm, synergies may be important, and business units may not be given the freedom to make sourcing decisions.
Ø Incentive Compensation: The incentive compensation policy tends to differ across corporate strategies in the following ways-
Ø Use of formulas: Conglomerates, in general, are more likely to use formulas to determine business unit managers' bonuses; that is, they may base a larger portion of the bonus on quantitative, financial measures, such as X percent bonus on actual economic value added (EVA) in excess of budgeted EVA. These formula-based bonus plans are employed because senior management typically is not familiar with what goes on in a variety of disparate businesses. Senior managers of single-industry and related diversified firms tend to base a larger fraction of the business unit managers’ bonus on subjective factors. In many related diversified firms, greater degrees of interrelationships imply that one unit's performance can be affected by the decisions and actions of other units. Therefore, for companies with highly interdependent business units, formula-based plans that are tied strictly to financial performance criteria could be counterproductive.
Ø Profitability measures: In the case of unrelated diversified firms, the incentive bonus of the 'business unit managers tend to be determined primarily by the profitabi1ity of that unit, rather than the profitability of the firm~ Its purpose is to motivate managers to act as though the business unit were their own company. In contrast, single-industry and related diversified firms tend to base the incentive bonus of a business unit manager on both the performance of that unit and the performance of a larger organizational unit (such as the product group to which the business unit belongs or perhaps even .the overall corporation). When business units are interdependent, the more the incentive bonus of general managers emphasizes the separate performance of each unit, the greater the possibility of interunit conflict. On the other hand, basing the bonus of general managers more on the overall corporate performance is likely to encourage greater interunit cooperation, thereby increasing managers' motivation to exploit interdependencies rather than their individual results.
Ø Business Unit Strategy: Diversified corporations segment themselves into business units and typically assign different strategies to the individual business units. Many chief executive officers of multi business organizations do not adopt a standardized, uniform approach to controlling their business units; instead, they tailor the approach to each business unit's strategy.The strategy of a business unit depends on two interrelated aspects: (1) Its mission ("What are its overall objectives?") and (2) its competitive advantage. ("How should the business unit compete in its industry to accomplish its mission?"). Typically business units choose from four missions: build, hold, harvest, and divest. The business unit has two generic ways to compete and develop a sustainable competitive advantage: low cost and differentiation.
Ø Mission The mission for existing business units could be either build, hold, or harvest. These missions constitute a continuum, with "pure build" at one end and "pure harvest" at the other end. To implement the strategy effectively, there should be congruence between the mission chosen and the types of controls used. The mission of the business unit influences the uncertainties that general managers face and the short-term versus long-term trade-offs they make. Management control systems can be systematically varied to help motivate the man ager to cope effectively with uncertainty and make appropriate short-term versus long term trade-offs. Thus, different missions often require systematically different management control systems.
Ø Mission and Uncertainty "Build" units tend to face greater environmental uncertainty than "harvest" units for several reasons: Build strategies typically are undertaken in the growth stage of the product life cycle, whereas harvest strategies typically are undertaken in the mature decline stage of the product life cycle. Such factors as manufacturing process; product technology; market demand; relations with suppliers, buyers, and distribution channels; number of competitors; and competitive structure change more rapidly and are more unpredictable in the growth stage than in the mature/decline stage. An objective of a build business unit is to increase market share. Because the total market share of all firms in an industry is 100 percent, the .battle for market share is a zero-sum game; thus, a build strategy puts a business unit in greater conflict with its competitors than does a harvest strategy. Competitors' actions are likely to be unpredictable, and this contributes to the uncertainty that build business units face. On both the input side and the output side, build managers tend to experience greater dependencies on external individuals and organizations than do harvest managers. For instance, a build mission signifies additional capital investment (greater dependence on capital markets), expansion of capacity (greater dependence on the technological environment), increase in market share (greater dependence on customers and competitors), increase in production volume (greater dependence on raw material suppliers and labor markets), and so on. The greater the external dependencies a business unit faces, the greater the uncertainty it confronts.Build business units are often in new and evolving industries; thus, build managers are likely to have less experience in their industries. This also contributes to the greater uncertainty that managers of build units face in dealing with external constituencies.
Ø Mission and Time Span The choice of build versus harvest strategies has implications for short-term versus long-term profit trade-offs. The share-building strategy includes (a) price 'cutting, (b) major R&D expenditures (to introduce new products), and (c) major market development expenditures. These actions are aimed at establishing market leadership, but they depress short-term profits. Thus, many decisions that a build unit manager makes, today may not result in profits until some future period. A harvest strategy, on the other hand, concentrates on maximizing short-term profits.
Ø Strategic Planning When the environment is uncertain, the strategic planning process is especially important management needs to think about how to cope with the uncertainties, and this usually requll1 longer-range view of planning than is possible in the annual budget. If the environment is stable, there may be no strategic planning process at all or only a broad-brush strategic plan. Thus, the strategic planning process is more critical and more important for build, as compared with harvest, business units. Nevertheless, some strategic planning of the harvest business units may be necessary because the company's overall strategic plan must encompass all of its businesses to effectively balance cash flows. In screening capital investments and allocating resources, the system may be more quantitative and financial for harvest units. A harvest business unit operates in a mature industry and does not offer tremendous new investment possibilities. Hence, the required earnings rate for such a business unit may be relatively high to motivate the manager to search for project with truly exceptional returns. Because harvest units tend to experience stable environments with predictable products, technologies, competitors, and customers), discounted cash flow PCF) analysis often can be used more confidently. The required information used to evaluate investments from harvest units is primarily financial. A build unit, however, is positioned on the growth stage of the product life cycle. Since the corporate office wants to take advantage of the opportunities in a growing market, senior management may set a relatively low discount rate, thereby motivating build managers to forward more investment ideas to corporate office. Given the product/market uncertainties, financial analysis of some projects from build units may be unreliable. For such projects, nonfinancial data are more important.
Ø Budgeting The calculational aspects of variance analysis comparing actual results with the budget identify variances as either favorable or unfavorable. However, a favorable variance does not necessarily imply favorable performance, nor does an unfavorable variance imply unfavorable performance. The link between a favorable or unfavorable variance, on the one hand, and favorable or unfavorable performance, on the other hand, depends on the strategic context of the business unit under evaluation.
Ø Incentive Compensation Syste In designing an incentive compensation package for business unit managers, the following questions need to be resolved:
1. 1. What should the size of incentive bonus payments be relative to the general manager's base salary? Should the incentive bonus payments have upper limits?
2. What measures of performance (e.g., profit, EVA, sales volume, market share, product
development) should be used when deciding the general manager's incentive bonus awards? If multiple performance measures are employed, how should they be weighted?
3. How much reliance should be placed on subjective judgments in deciding on the bonus amount?
4. How frequently (semiannual, annual, biennial, etc.) should incentive awards be made?
With respect to the first question, many firms use the principle that the riskier the strategy, the greater the proportion of the general manager's compensation in bonus compared to salary (the "risk/return" principle). They maintain that because managers in charge of more uncertain task situations should be willing.to take greater risks, they should have a higher percentage of their remuneration in the form of an incentive bonus. Thus, "build" managers are more likely than "harvest" managers to rely on bonuses.
As to the second question, when rewards are tied to certain performance criteria, behaviour ls influenced by the desire to optimize performance with respect to those criteria. Some performance criteria (cost control, operating profits, and cash flow from operations) focus more on short-term results, whereas other performance criteria (market share, new product development, market development, and people development) focus on long-term profitability. Thus,
linking incentive bonus to short-term criteria tends to promote a short-term focus on the part of the general manager and, similarly, linking incentive bonus to long-term criteria is likely to promote long-term focus. Considering the relative differences in time horizons of build and harvest managers, it may not be appropriate to use a single, uniform financial criterion, such as operating profits, to evaluate the performance of every business unit. A better idea would be louse multiple performance criteria, with differential weights for each criterion depending on the business unit's mission.
The third question asks how much subjective judgment should affect bonus amounts. At one extreme, a manager's bonus might be a strict formula-based plan, with the bonus tied to performance on quantifiable criteria (e.g., X percent bonus on actual profits in excess of budgeted profits). At the other extreme, a manager's incentive bonus amounts might be based solely on the superior's subjective judgment or discretion. Alternatively, incentive bonus amounts might also be based on a combination of formula-based and subjective approaches. Performance on most long-term criteria (market development, new-product development, and people development) is harder to measure objectively than is performance along most short-run criteria (operating profits, cash flow from operations, and return on investment).As already noted, build managers- in contrast with harvest managers, should concentrate more on the long run, so they typically are evaluated more subjectively than are harvest managers.
As to the final question, the frequency of bonus awards does influence the time horizon of managers. More frequent bonus awards encourage managers to concentrate on short-term performance since they have the effect of motivating managers to focus on those facets of the business they can affect in the short run.
Ø Competitive Advantage A business unit can choose to compete. Either as a differentiated player or as a low-cost player, Choosing a differentiation 'approach, rather than a low-cost approach, increases uncertainty of a business unit's task environment for three reasons.
1. Product innovation is more critical for differentiation business units than for low cost business units. This is partly because a low-cost business unit, with primary emphasis on cost reduction, typically prefers to keep its product offerings stable over time; a differentiation business unit, with its primary focus on uniqueness & exclusivity, is likely to engage in greater product innovation.
2. A low cost business unit typically tend to have narrow product lines to minimize the inventory carry costs as well as to benefit from scale economies. Differentiation business units on the other hand tend to have a broader set of products to create uniqueness.
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