Management

Control Systems
Twelfth Edition

Robert N. Anthony
Ross Graham Walker
Profes sor oflvlanagemenLCo ntrol. Emeritus
Graduate S chool of' Business A.dm inistration
Harvard Uniuersity

Vijay Govindarajan
Earl C. DaUln
Professor of International Business
Director; William F. Achtme-:ver
Center f'or Global L eadership
The Tuck Schoo! of Basiness
DartmoLi tIL CoLleg e

ra McGraw-Hili
ti1JlIi Irwin
Bos ton Burr Ridge , IL Dubuque , IA Madison . WI New yr rk San Francisco St. LOuis

Bangkok Bogota Caracas Kuala Lumpur lisbon London rvladna Mexico City

Milan Montreal New Deih l Santiago Seoul Singapore Sydney Taloei Toronto

Management
Control Systems
Twelfth Edition

Robert N. Anthony
R oss Graham Walk er
Professor of Management Control. Emeritus
Graduate S chool of Business .4.dministratio n
Harvard Uni versity

Vijay Govindarajan
Ea rl C. Daum
Professor nf In ternational Business
Director; Will iam F A:htmeyer
Center far Global Leadership
The Tuck School of Business
Dartmouth College

fa McGraw-Hili
tnftIiIij Irwin
80ston 8urr Ridge . IL DUbUque IA Madison. WI New York San Frane sec St. LOUIs
Bangkok Bogota Caracas Kuala L.Jmpur Lisbon London Maorid Mex,co City
I'an :Vlontreal f'Jew Delhi Santiaao Seoul Singapore Sydr.ey Taloel ~oront
Chapter

The Nature
of Management
Control Systems
The central focus of tIlls book is strategy implementation. In particular. the
book provides knowledg~, insight, and analytical skill.:; related to how a corpc'­
ratiou·s senior executives design and implement the ongoing management sys­
tems that are used to plan and control the firm's performance . Elements of
managem ent control systems include strategic planning; budgeting: resource
allocation; performance measurement, evaluation, and reward; responsibili t
center aJlocation; and lransfer pricing. The book builds on concepts from strat­
egy, organizationa.l behavior, human resources, and managerial accounting .
Management control is a must in any organization t hat practices decentral­
izati on . One 'view argues that management control systems must fit th e firm ·s
strategy. This implies the strategy is first developed through a formal and
rational process, and tlllS strategy then dictates the design of the firm 's man­
agement systems. An alternative perspective is that strategies emerge through
xperimentation , which are in.fluenced by th e firm 's management systems . In
this vi ew, management control systems can affect the development of strate­
gies. We wi ll consider both points of view, as well as their implications in terms
of the design and operation of management con trol systems.
When firms operate in industry contexts where environmental changes are
predictable, th ey can use a formal and rational process to develop the strategy
fir.<;t and then design management control systems to execute that strategy
However, in a rapidly changing environment, it is difficult for a firm to formu­
late the strategy first and then design managemen t syst ems to execute th
chosen strategy. Perhaps in such cnn texts. strategies emerge through experi­
mentation and ad hoc processes that are significantly influenced by the firm's
management control systems .
The importance of the subject matter covered in this book is captm-ed in th e
widely accepted truism that more than 90 percent of businesses (as well as
nonprofit organizations) founder on the rocks of implemen tati on: either the

1
2 Chapter One Th•.\lll/un.' u( JJam;gt'lIIe I11 COlltm/ '::;YS/i> /IIS

strategies never come intu b~ing UI' get Liistorted. or the implementation is
much more costly and time-comiUming than anticipated. However laudable
strategic intentions may be. if they do not become reality. they usually are nol
worth the paper on which they aTe \NritLen. Conversely, high-perfoml i11g com­
panies excel at execution. This book provides concepts. frameworks, and tool­
to help the reader gain that "execution advantage."
Consider the collapse of companies such as T.vco, Global Crossing, WorldCom,
and Enron. Part of the reason for their demise was the lapse ill controls. CEO
und top management compensation in these companies was so heavily tied to
stock options that executives were motivated to manipulate financials to buoy
the short-term stock price
Consider world-cl ass companies such as Emerson Electric. Lincoln Electric,
New York Times. Worthington Industries , 3M Corporation, N ucor Corpora­
tion , Dell Computer, Wal-Mart, Southwest Airlines, Cisco Systems, Corning,
Hasbro, and Analog Devi ces. Their long-term success lS not just because they
have developed good strategies: more importantly, t.hey have designed sys­
tems and processes that energize their employees tu execu te those s l rategies
effectively. This book includes case studies on these (;ompanies to dr ive home
the power of these companies' impl ementation capabilities
We begin this chapter by defining the thl-ee terms i.n t he book's title : control,
management, and systems . In the second section of the chapter, we distin ­
guish the management control funcbon, whjch is ow.' focus, from two other func­
ti ons that also involve planning and control: strategy formulation and task
control. The thiTd section of this chapter contains a r uad map pruviding an
overview of the wh ole book and a brief description ofthe contents of each ch apter.

Basic Concepts
Control
Press the accelerator, and your car goes faster. Rotate the steering wheel, an d
it changes direction. Press t he brake pedaL and the car sl ows or stops. With
these devices, you control speed and direction; if any of them is ino perative, the
car does not do what you want it to . In other words. it is out of control.
An organization must also be con trolled: that is. devices must be in place to
ensure that its strategic intentions are achieved. But controlling an organiza­
bon is mu ch more compli caLedthan controlling a car. We will begin by describ­
ing the control process in simpler systems.
Elements of a Control System
Every control system has at least foUl' elements :
1. A detector or sensor- a device that measures what is actually happen ­
ing in the process being controlled.
2. An assessor-a device that detennines the significance of what is actu­
ally h appening by comparing i t with some standard or expectation of
what should happen.
3. An effector- a device (often called "feedback") that alters behavior if the
assessor indicates the need to do so .
4 . Acomm unications netw ork-devices that transmit information be tween
the detector and the assessor a nd between the assessor and the effector.
 C h ~pte r I Tire.:' .,Yut111'1' )" Jfana,~ , 'nlL' n [ COl/lt 'u! ." Y:j t,:lI U:l 3

EXHIBIT 1.1
Elements of the
Control Process
C.mtJ"nl LI •
2 . Assessor. rllmparl~nn
I
~

1. Detector. InformatIOn 3. Effector. Behavior

about what.is happening alteratlon. if needed

Entitv
heing
controlled

These four basic elements of any control system are diagrammed in

Exhibit 1.1. We shall describe their functioning ill three examples of increasing
complexity: the thermostat, which regulates room temperatme; the biological
process that regulates body temperature; and the driver of an automobile, who
regulates the direction and speed of the vehicle.

Thermostat The components of the thermostat are (1) a thermometer (the

detector), whi ch measures the current temperature of a room; (2) an assessor
which compares the current temperatme with the accepted standard for
what the temper atme should be; (3) an effector, which prompts a furnace to
emit heat (if the actual temperatme is lower than "he standard) or activates
an ai r conditioner (if the actual temperature is higher than th e standard ) and
which also shuts off these appliances when the temperature reaches the stan­
dard leveL and (4) a communications network, which transm it s informa tion
from the therm ometer to the assessor and from the assessor to the heating or
cooli ng element.
Body Te mperature Most mammals are born wi th a built-in standard of desir­
able body temperature; in human~ that standard is 98.6°F. The elements of the
control mechanism by wlUch the body strives to maintain that standard are
(1 ) the sensory nerves (detectors) scattered throughout the body; (2) the hypo­
. thalamus cen ter in the brain rassessor ), wbich compares i.nformation received
fromdetectors with the 98 .6°F standard: (3 ) the muscles and organs (effectors )
that reduce the temperature when it exceeds the standard (via panting and
weating, and opening the skin pores) and raise the temperatme wh en it falls
below the standard (via shivering and closing the skin pores ); and (4 ) tbe over­
all communications system of nerves.
This biological con trol system is homeostatic-that is, self-reguJating. If the
system is functi oning properly. it automatically corrects fo r deviations from the
standard without r equiring conscious effort.
The body temperature control system is more complex than the thermostat,
with body sensors scattered throughout the body and hypothalam us directing
actions t.hat involve a variety of muscles and organs. It is also more mysteri­
ous; scientists know wha t the hypothalamus does but not hou.· it does it.

A utom obile Driuer Assume you are driving on a highway where the legal (i.e.,
standard ) speed is 65 mph. Your control system acts as follows: (1) Your eyes
4 Cha pter One TIl(' .\"lItlil"o.' "{.1!i, ,ltl f',,-,,'l/cnl l 'ulI l' ·"i 8y"/o'lils

I;';cnsors ' me:15UrC actual speed by ubsen ing the ;:--pcedIJDlt'ter: 12 1 your brain
1assessor) compares actual speed with desired speed. and upon detecting a de­
viation from the staDdard, 13) directs your fuot (effector ) to ease up 01' pres,,;
down on the accelerator: and 14 ) as in body temperature regulation, your
nerves tOl'm the communit:atiun system Lhat transmits infol'mabon from eyes
to brain and brain to foot.
But just as body temperature regula Lion is more comphcated than the ther­
mostat, so Lhe regulation of a car is more complicated than the regulation of
body temperature . This is because there can be no certainty as to what acbon
the brain will direct after receiving and evaluaLing information ['rom the
detector For example. once they determine that Lhe car'5 actual speed exceeds
65 mph, some drivers, wan ting to stay within the legal limit, will ease up on
the acceleraLor, while others. for any number of l'easom. will not. In this sys­
tem. conLrol is not automatic; one would bave to know something about the
personality and circumstances of the driver to predict. \-vhat the actual speed of
the automobile would be at the end point of the process.

Management
An organization consists of a group of people who vy·ork together to achieve cer­
tain common goals (in a business organization a major goal is to earn a satis­
fact ory profit) . Orgaruzations are led by a hierarchy of managers, with the
chief executive officer (CEO) at th e top, and the managers of business units,
departments, functions, and other subunits ranked be low him or her in the or­
ganizational chart. The complexity of the organization determines the number
oflayers in the hierarchy All managers other than the CEO are both superiors
and suborclinaLes; they ::;upen'ise the people in their own units, ancl they are
supervised by the man<1gers to whom they report.
The CEO (or, in some organizations. a team of senior managers ) de cides on
the overalJ strategies that will enable the organization to llleet ils goals. Subject
to the approval of the CEO , the various business unit man agers formulate
additional strategies that will enable their respective units Lo further these
goal s. The management control process is the pmcel5s by which managers at all
levels ensure that the people they supervise implement their intended strategies.

Contrast with S impler Control Proct:sst's

The control process used by managers contains the same elements as those in
the simpler control systems desclibed earlier: detectors, assessors, effectors . and
a conununit:ations system. Detectors report what is happening throughout the
organization; assessors compare this information with the desired state; effec­
tors take corrective adion once a significant difference between the actual state
and the desired 5tate has been perceived; and the communications system tell
managers what is h appening and how that compares to the desired state .
There are, h owever, significan t dillerences between the management control
process and the simpler processes described eariler:
1. Unlike in the thermostat or body temperature systems, the standard is
not preset. Ratller, i t is a result of a wnscious planning process. III this
process , management decides what the organization should be doing,
and part of the control process is a comparison of actual ac complish­
ments with these plans. Thus, the control process in an organization
-

C h~p t e r 1 T!;l! Sow"c <.It' .H ull <1.' 5"ment C"n tl"l/ ).I':' / I'I1lS 5

involves planning In many situations . planning and con tj"() I can be

vie\ved as two separate actlvitieti. Management control. howe\'er, in­
volves both planning and control .
2 . Like controlling an automobile I but unlike reguJaLing room or b ody
temperature I. managem ent contra! is not automatic. Some detectors in
an or ganization may be mechamc:al, hut th e manager often detects
imp ortan t information ',.vi.th her own eyes, ears, a n d other senses .
Althou gh she may have routine ways of comparing certain reports of
what is happemng with s t andards of what should be happenjng, the
manager must personally perform the assessor function, deciding for
hersel f wheth er the di fference between actual and standa r d perfor­
mance is significant enough to warrant action, and, if so, what action
to take . Then, because actions intended to alter an organization's be­
havior involve human beings, the manager must interact with at least
one other pe rson t o effect change.
enHke controlling an automobile, a function performed by a single
indi vidual, management control reqUIre,'; conrdination amo ng indiv id­
uals. An organization consists of m a ny separate parts , and m anage ­
ment con trol must en s u re that each part works in harmony with the
oth ers, a need that exists only minimally in t he case of the various
organs that <;on t r ol body temperature and not at all in the case of the
thermostat.
4. T h e connection fl'om percewzng the need (or action to determ ini ng the
act io n rel..ju ired to obtain the desired rel;ult m ay not be clea r. A man­
ager acting as assessor may decide that "costs are too high" but see no
asy or automatic action guaranteed to bring costs down t o wh at the
standard says they should be. The Lerm black box describes a n opera­
tion whose exact nature cannot be observed. Unlike t h e thermostat or
the aut omobile driver, a management. control system is a b lack box.
We can n ol' kn ow what action a given manager wi)] take when tl1ere i
a significa n t differencL' between actual and expected performance, nor
what (she assesses, if any) action others will take in rt:sponse to tl1e
manager's signal. By contrast, we know exactly when t h e therm ostat
wi.ll signal the need for acbon and what that action will be; and, in the
cas e of the autom obile. dr iver. the assessor phase may in volve judg­
me nt, but the action Itself is mechanical once the decisi.on t o ac t ha
been m ade .
5. ;I;Iuc h ma n agement control is selr control; that is, con trol is main­
tained not by an external regulating device like the thermostat, b u t
by m anagers who are using the ir own judgment rath er than following
i nstm ctions from a superior. Drivers who obey t h e 65 m ph speed limit
do so n ot because a sign commands it, but because they have consciously
decided t.ha t i L is in their best interest to obey the la w.

Systems
A system is a p rescnbed a nd usually repetitious way of"carrying out an acti L'ity
or a set of' actw ities. Systems are characterized by a more ur less rhythmiC,
coordinated, a n d recurring series of steps intended to accomplish a specifi ed
purpose. The thermostat. a n d t he body temperature control processes described
6 Chapter One Til" .\'U.lllr<c' o/Jla nllg';I?!t~/Ir (', ," i ," "/ S , ., tems

above are examples of :;ystems. ;';Ianagcment control systems . as we have seen,

are far more complex and judgmental.
:VIany management actions are unsystematIc. ylanagel's regularly encounter
situations for whic1l tlle rules are not well defined and thus must use their best
judgment i.n deciding what actions to take. The effectiveness of thei.r actions is
detenni..ned 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 l. If all systems ensu red th e correct a.ction (or a.Ll situations. there
wouLd be no need for h uman manager.<:.
In this book. we focus primarily on the systemati.c (i.e., formall aspects of the
management control fWl cti ()n. One can desclibe in considerable depth the var ­
ious steps in the formal system, t he iniormation that is collected and used in
each step, and th e principles that govern the system's operation as a whole.
But it is very difficult, except in general terms, to describe the appropriate
actions fo r managers encountering si tuations not contemplated in the forma l
system . These depend, among other factors , on the skills and personalities of
the people involved, their relation ships with one another, and the environmen
within which a particular problem arises . It is important to recognize, how­
ever, that these jnformal processes are strongly affected by the way the orga­
nization's formal control systems are designed and operated.

Boundaries of Management Control

In this section, we define management contr ol and distinguish it from two
other systems-or activities-that also require both planning and control:
strategy formulation and task control. Serious mistakes can be made if princi­
ples and generalizations specific to one system are applied in another.
As yOll will see, management control fits between strategy formulation
and task control in several respects. Strategy formulation is the least sys­
tematic 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 be­
tween. Strategy formulation uses rough approximations of the future. task
control l.lses current accurate data, and man'agement control is i.n between.
Each aCtivity involves both planlling and control , but the emphasis varies
with th e 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 of approximately equal importance i.n
management control.
The relationships uf these systems of activities to one an other are indicated
in Exhibit 1.2 In the foll ovving sections we define management control, strat­
egy fOI'Tl1ulation, an d task control in greater detail and further describe the dif­
ferences between them.

Management Control
iV/anagement control is the process by which managers influence other m em bers
of'the orga n iz ation to implem ent the organ ization's strategies. Several aspects
of this process ar e amplified here .
-- ChaPter! Th. ' VIlf/ln' ,)1 .\ / r1ll<1.(;"11/ ,·l1t ( '''/lIm! :::"'.'.<""W; 7

EXHIBIT 1.2 Activity :'Iratul·e of End Product

General
::;Lra tegy
Relationships l.----l.~ Gools , ~trategie", . and p(}IiCle~
(i>rmulntlon
among Planning
and Control
FunctiolL'i

~ Ianagem e nt i 1> 1m plenwnt.at 11m or strategie~

c()ntrol

Et'ficienl and effective

performance of individual tasks

JlIla nagemenl Cont1'Ol Actiuitie.c;

Management control involves a variety of activities, including
• Planning 'lv'hat the organization should dv.
• Coo rdi nating the activities of several parts ofthe organ ization .
• Commun icating information.
• Ewlua ting information.
• Decidi ng what, if any, adion should be taken .
• In fluencing people to change their behavior.
~Ianagement control does not necessarily require th at all actions corre­
spond to a preyi ously de lermined plan. such as a budget. Such plans are
based on circumstances ueli eved to exist at the time they were form ulated. If
hese circumstances ha ve changed at thl2 time of implementation, the actions
dictaLed by the plan may no longer be appropriate. While a thermostat re ­
sponds to the actual temperature in a room , management control involves
anticipating futm·e conditions to ensure that the organization·s objectives are
aUained . 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 obstruc t its implementation. In other words, con­
for m 'ing to a budget is not necpssarily good, and d ep arture from a budget is
not necessarz)y bad.

Goal Congruence
Alth ough systemabc, the management control process is by no means me­
chanical; rather, it involves interactions among individuals. which cannot be
described in mechanical ways . Managers have personal as well as organiza­
tional goals. The cen tral control problem is to induce them to act in pursuit
of their personal goals in ways that will belp attain the organizati oD·s goals
as well . Goal cong ruence means that, insofar as is feasible, the goals of an
organization's individual members should be consisten t with the go:.:thi of
the organization itself. The management control system should be desjgned
and operated wi th the principle of goal congruence in mind.
8 Chclpler Olle The Su/ur,' u/ Jlrtr1(1;.:t:ml' .'1f ('''"lmi S_, $te.'1rs

Tnul ti) r Implemen tinff Strategy

Management control systems help managers move an organization toward its
stratef:,ric obj ectives Thus. managemellt control f'oi.:u ses primarily UII strategy
ex ecutLOn.

Example. As of :2005 , Wal-Mart. with sales re \'enues of mono than $:288 billion.
was the largest retailer in the world, thanks Lv its winning strategy of selling
branded product.:; at low cost . The company's management control system was
directed toward the effici ent management of store operations, which in turn
conferred a cost advantage companywide . Data ir om more than 5,300 individual
stores on items :5uch as sales, expenses , and profit and loss wen~ collected. ana­
lvzed, and tr::m,,;mitted electronically nn a real-time basis, rapidly reveallng how
a particular region , district, store. de partment within a store . or ite m within a
department was performing. This inf'oTInation enabled the company to reduce
the likelihood of stock-outs and the need fi)l- mru'kdowns n ll slow moving stock,
and to maximize inventory turnover. The data from "outstanding" performer"
among 5,300 stores were used to improve operations in "problem" stores.
Further. the company was able to redu(;8 pil ferage-related losses , a major
oncem, by instituting a policy of sharing 50 percen t of the savi ngs from
decreased pilferage in a particular s tore , as compared LO the industry
standard, amo ng that store's employee~l
Management controls are only one oftbe tools managers use in implementing
desired strategies. As indicated in Exhibit 1.3, strategies are al..o implemented
through the organization's stnlcture, its management of human resources, and
its particulul' culture.
Organizational structure specifies the roles , reporting relationships, and di­
vision of responsibilities that shape decision-making v.'ithin an organization.
Hum an resource management is the selection, training, evaluation , promotion,
and termination of empl oyees so as to develop the knowledge and skills req llired
to execute organizational strategy. Culture refers to the set of common beliefs,
attitudes, and norms that explicitly or implicitly guide managerial acti ons .
Fina.ncial an d N onfinancial Emphasis
lVia nagement control systems encompass both financ ial and nonfinancial per­
/ormance measures. The financial dimension focu se::; on the monetary "bottom

EXHIBIT 1.3 Implementation Mechanisms

Framework for
Strategy
Implementation

Human
Strategy r e5 0urc~ Perfol"lDanCe
m::magemcnt

' wal-Ivlart, 2004 Annual Report.

 ':::hJPt~ r I The' S lIllI/'(' "r' '' fr/ll''I~r'm''lIl (ontrol Sysreill ., 9

EXHIBIT 1.4 line"-llei income. return on equity, and :=;0 forth But "il'tually all organiza­
Interactive tional su blmits ha\'e nonfinancwl obJcctives-pmduct quality. market share.
Control customcl' satisfaction. on-time deliven. and employee morale.

Today':3 Aid in Dec'eloping New Strategie;j

cuntrols
As discussed eadieI', the pl'imar:y role of management contr ol is to ensure the
execution of chosen strategies. In industries that are subject to rapid environ­
mental c:hanges. however. management control information. especially of a
nonfinancial na ture, can also provide the basis for considering new str ategies.
Tomorrow' ·
sO'ategy This function, illustrated in Exhibit 1A. is referred to as interact~Le control.:2
Interactive control calls management's attention to developments-both nega­
tive (e .g. , loss of market share. customer com pl aints) and positive (e.g .. the
opening u p of a new marke t as a result ofLhe elimination of certain govern ment
regulations)-that indicate the need fo1' ne\\>' strategic initiatives . Interactive
conlrols are an integral part ofthe management control system .

Strategy Formulation
S t rategy formula tlun is the. proreliS of'deciding 011 the goals o{ the organ ization
a nd t he strateg ies for attaining these goals. In this book. we use the word goals
to de:;cribe the broad overall aims of an organization, and the term objectives to
describe specific steps to accomplish the goals wi.thi n a ,gi ven time fr ame.
Goals are timeless. they exist until they are changed, and they are changed
only rarely. For many businesses. earning a satisfactory return on investment
is an impor tant goal; for others. attaining a large market sh are is equally
im portan L. Non profit organizatlons also have goals; in general, they seek to
pro\ride the m a..x imum services possible with available funding . In the strategy
form ulation process, th e goals of the urganization are usually taken as a given,
although on occasion strategic th.inking· can focus on the goals themselves .
Strategies are big plans, important plans . They state in a gener al way the
clirection in which senior management wants the organj zation to move . A deci ­
sion by an automobile manufacturer to produce and seU an electric automobile
would be a strategi c decision .
The need for formulating strategies usually arises in response to a percei.ved
th reat (e .g., market inroads by competitors. a shilt in t onsumer tastes, or new
government ref,rulati ons ) M opportunity (e.g., technological innovations, new
perceptions of cust omer behavior, or the developme nt of new ap plications for
existing products). A new CEO . especially one brought in from the outside ,
usually percei.ves both threats and opportunities differently from how his or
her predecessor did. Thus, changes in strategies often occur when a new CEO
takes over.
Examples, Loujs V. Gerstner became the CEO of IBM in 1993. In the course of
the next six years , h e transforme d the comparly from <:I mainframe com puter
manufactm'er to a leader in networking systems . computer sprvices. and
e-business solub ons.
W11en Edward Zander took ()Ver os th e CEO of Motorola in December 2003 ,
his f1rs t move was to focus the lege ndary company on the customers ratll cr than

2Robert Simons, " Control 10 (In Age of Empowerment," Harvard Bu,I'm ess Ren ew. March- April 1995,
pp . 80-8 8.
r 10 (I' dpter One the Sal/II''; fir .1funll;J.t!IJIt!rlt (',mrl"lJi System . .
-
on Lech.nu·ltl~y .
To un "u h,) actively 5et uut to ~hl"it feenhatk ["!"Om .,nnle of the
c()mpany".~largest clients. Following- thi"" the incenti\'e strUl.:tUTe was chang-ed
to provide bonuses to employees based on the entire company's performance a
opposed to the divisIOn's perI()rmance. elfectiyel) putting an end to the war
among the "six warring tribes," us ~Iotorola'3 six busine::;ses Were known undur
his predecess()J". Even though most of the groundwork was laid before his
arrival. his renewed focus resulted in a -!;: percent im:rease in sales. a tripling
of net profits. and a si..xfold increase in the operating "arnings in the 6.rst
quarter of 2004 as compared witb the first quarter u[' 2003 . Motorola's stock
price had gained 40 percent during the same time perind.1
Given pOOl" result:; in 2000, 3~I. for the first time in its history, chose an
outsider, Jim McNemcy~ as the CEO . Between 2000 and 2003 , McNerney had
turned things around . Both prOfits and stock prices durillg this pf'riod increased
bv :35 percent. Mw.~erney has made several bold moves
1. He emphasized fast-growi ng sect.ol's. such o.s health care and ctisplay and
graphics.
:2 . He instituted six-sigma programs on a large scale.

;3 . He establis hed metriclS for new products introductions .

4 . Inste3d of giving the same increase in research and develo pment (R&D )
fo r each divisi.on, he gave ctifferential R&D dollars across divisions based
on the potent.i.al growth opportunities in each division. I
Strategies to address a lhreat or op portuniLy can arise from anywhere in
an organizati on and at any time. New ideas do not ema nate solel y from the
research and development team or the headquarters starf. 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 form u·
lation should never be assigned to a particular person. or organizational unit.
Pro\iding a means of bringing worthwhile ideas directly 1..0 the attention of
eruoT' management without allowing them to be blocked at lo wer levels 15
important.
Distinctions between Strategy Form.alation and JI/ anagement Control
Strategy formulat ion is the process of deciding on new strategies : managemen t
control is the process of implementing those strategies. From the standpoint of
systeI;l1s design. the m ost -important distinction between strategy formulati on
and management control is that strategy formulation is essentially unsystem­
atic. !breats, opportunities. and new ideas do not occur at regular intervals ;
thus, strategic decisions may be made at any time .
FUl-thennore, the analysis of a proposed strategy varies wi th the na tUl'e of
the str ategy. Strategic ana lysis i.nvolves much judgment, and the numbers
u sed in the process are usually rough estimates . By con trast, the management
control process involves a series of steps that occur in a predi ctable 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 manageme nt control process involves managers and their staffs at all lev­
els in the organizati on.

3www.moloroiJ .com/content.
48usinessWeek, April 12, 2004.
-

Ch doter I Thc .\'UIlI ,..: ".(,I/"/1a,:!':1I7CI1' C',lIl ttoi S ;',,(,'/11" 11

Task Control
Dr
Tash mntrol is the pmcess eni3unng that "pecij7ed tushs (tTe carried r)llt eflec­
ti v ely and elfzciently.
Task con\'ro] is t ran saction-oriented- that is. it in volves the performance of
individual tasks according to rules established in the management control
process. Task control often consists of seeing that these rules are foll owed. a
function t hat in some cases does not even require the presence of human be­
ings. Numerically controlled machine tools, process control computers, and ro­
bots are mechanical task controL devices. Their function involves hum ans on ly
when the latter pro ve less expensive or more reliable; this is likely to happen
only if unusual events occur so frequently that programming a computer \v1th
1'1) les for dealing with these events is not worthwhile ,
Many task control activities are scientific: that is. the optimal decision or
the appro priate action for bringing an out-of-control condition back to the de­
sired state is predicta ble V'.rithin acceptable limits. For instance, the rules for
conomie order quantity determine the amount and timing of purchase orders ,
Task control is the focus of many management science and operations research
tech nique
Most of the information in an organ.ization is task control information: the
num ber of items ordered by customers , the pounds of materi al and units of
components used in the manufacture of products, the number of hou rs em­
ployees work , and the amowlt of cash di sbursed , Many of an organizatlon
entral activities-including procurement, scheduling, order entry, logistics,
quality control. and cash management-are task control systems. Some ufthem,
though mechanica l, can be extremely complicated.
Examples. An entire steel mill may be controlled by elect-ronic devices. with
each piece of equipment instructed by a computer to carry out prescribed tasks ,
The computer senses tbe environment (e.g" the temperature of a steel ingot) ,
If its findings indicate 3 departure from che desired state, it either injtiat e
(;orrective action or, ifit lacks the capacity to do so on its own. conveys the need
for correction to a computer that controls all the computers in one sedi on of the
mill. This compu ler in turn may refer the problem to a coordinating computer
tor the mill as a whole , The Manufacturing Resource Plannin g Il\IRP III system
used to control manufactw'ing operations in many companies requires millio ns
oflines of computer instructions , The switching mechanisms used to conn ect
t'Wo parties in a tele phone cOJ?versation cost billions of doUars. And systems for
progTaDl trading and other types of decisions made by traders in the financial
markets in vol ve complicated decision rules and minule-by-minute information
about the prices of hundreds of finanl:ial insLrumenta.
As the::;e examples s uggest, certain a ctivities that were once perfonned
by man agers ar e now a utomated and have thus become task con trol activi­
ties. This shift from managemen t control to ta sk control frees some of the
manager's time for other management actlvltles (unless it eliminates the
manager 's position).
D istinction:;; between Tash Control and Managentent Control
The most important distinction between task control and management control
is tha t many task contr ol systems are scientific, yvhel'eas management control
can never be reduced to a science. By definition, management contr ol in ­
volves the beh a vior of managers, and this cannot be expressed by equations ,
12 Chapter One ThL' S ul li l'l! "i .1,/(//1/114,'111 "111 C"l/Il m l S \'-'I"I1/ $

EXHIBIT 1,5 Strategy Formulation Management Control Task Control

Examples of
Decisions in Acquire an unrelated In troduce new product or Coordinate order entry
Planning and busmess brand within product hne
Control Enter a new business Expand a plant Schedule production
Functions Add direct mail selling Determine advertislIlg Book TV commercial s
budget
Change debt/equity ICltio Issue new debt Manage cash flows
Adopt affirmative action Implement mino ri ty Maintain personnel reco rd s
policy recruitment program
Devise inventory Decide inventory levels Reorder an item
speculation policy
DeCide magn it ude and Control research Run individual research
direction of research organization project

Seriuus errors may be made when principles developed by management

cientists for task contro l situations are applied to management control situ­
abons. In managemenL control , managers interact with other ma,nagers; in
task control, either human beings are not involved at all (as in some auto­
mated production processes), or the interaction is between a man ager and a
nonruanager.
In management con trol the focus is on organizational units; in task control
the focus i.s on specific tasks performed by these organizationaJ units (e .g.,
manufacturing J ob N o. 59268 , or ordeti.ng 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 strate­
gies, Task control relat es to specified tasks, most of which require little or no
j udgment to perfonll.
Exllibit 1.5 identifies differences among management control, task control,
and strategy formulation by giving examp les of each.

Impact of the Internet on Management Control

The information revolution started with the invention of the telephone by
Alexarrder Graham Bell in the'late 19th century. For con"umers, th e tele­
phone provided a significant benefit-convenience . People no longer had to
visit a store to get informaLion about a product, determine its availab ility, or
piace an order. The pace of the information re volution accelerated with the in­
vention of com pu ters, gaining tremendous momenLum in the 1990s wit h the
advent of the Internet.
The Internet provide;; major benefits that th e telephone docs not:
• Instant access, On the Web . huge amounts of data can be sent to anyone ,
anywhere in the woddin a matter of seconds .
• ivlulti-targeted comnwnication.The Internet has a vastly expanded one-to­
many reach; one Web entry can reach million::; of people .
• Cnstless communication , Abusiness that uses telephone operators Lo interface
with customers mu st pay [or telephone personnel salaries, toll-Cree ("800")
cali::;, and the bricks and mortar to support the customer service function.
Communication with cusLomers via Lhe Interne t avoids aJ t these cost
 Chdpter 1 rh ~ S ri/urI' o(.IIu l/(IifP IIl I 'll I COl/l ml ",-"stems 13

G Anility to d isplay images . Unlike the telephone, the vVeb enables consumers
lo see the product~ being offered for sale.
~ Shifting pllU'er and ('ontrol to the indicidllal. Perhaps the most dramatic
benefit of the Web is that Lhe iudi vidual is "'Virtually king." Consumers are
in control and can use the Web 2-1 hours a day at their own convenience
""'ithout bei:ng interrupted or unduly influenced by sales representatives or
telemarketers .
With these advantages Ule Internet ha::; changed the rules of the game jn the
business-to-i ndi vidual consumer sector.
Example. Prior to 199.5, most hooks were purchased from bnokstores or from
printed catalogs . In 1995 , Amazon .l.:lllll began offering book s on sale on itt; We b
site . By 2005, Amazon .com had deVE'loped an active customer base of 49 mjljion
from seven countries, expanded its product offerings to 31 categOlies from books
to garden t ools, anc! had more than S6 .92 billion in revenues for fisca l 2004 . The
virtual store format of Amazon .com provided better convenience. a better selec­
tio n, and be tter prices than traditional "brick and mortar" stores. From 2000
onward. major offli ne retailers established partnerships with Amazon .com to set
up and manage their online retail presence. Amaz on. com's alliances 'with Toys
"R" U~ , Nordstrom Inc., :vIacy's Target, and even offline (' umpetitor Border
Groups had positioned it to define the rules in the online retail sect.or. Even
companies such as Of1lce Depot Inc. and Wine.com , who had a strong online
retai l presence, entered into partnerships with Amazon .com . To attr:lct small
busin esses, Amazon .com set up a hugely successful program to enlist third- party
sellers (nearly a million by end of 2003 ), whom they caU "Associates," to hawk
thei.r products on its Web site. For many of these asso(;iates, A.mazon .com
became their source ofhvelihood.5

The Internet h as also ch anged business-tv-business commerce.

Example. Comp anies have used the Internet to reconfigure their relation­
ships with corporate customers, Take the case of Cisco Systems, the Silicon
Valley com pa ny, which supplied Lhe hardware-rou ters , serv ers, swiLches,
etc .-that was at the heart of communication networks . In 2005, virtually
aU of sales re venues of Ci.:icO came from nl1assisted tran sact ions from its Web
si te . To quote Bruce Judson : "Cisco's Web site aUows customers La configure
proQ.ucts "vi th complex features , with its 'intelligent configurator ' softwar e
r ejecting orders where specific 'compon ents would be inco mpatible with other
parts Inaccuracies on orders 'processed through the Internet have actually
droppe d ITom more than 25 percent before this autom ated system existed to
less than one-tenth of a percent n ow. Annua l savings fTo m CiS<.:O·i; site, which
reflect the other administrative efficiencies in addition to th e elimination of
oT'd\;r error s , are estimated at over $250 million a year, and the absence of
errors has also allowed Cisco to improve delivery time by three days . For
Cisco, th e Intern e\. has meant faster service, quicker production cycles, and
savings."6

The impact of the Internet on Lhe world of business has been signi ficant.
What, th en , has been the Internet's impact on management controls within
an organization ? Management control systems inv olve information, and orga­
nizations require an infra structure to process th at jnformation. The Internet

5Amalon.com, An nual Reports and Web site.

6B ruce Judson, Hyper WafS (New York: Scribner, 1999). p. 93.

14 Chapter One TIll' Sa !u n: 'i(:li(lllag.!melll Cuntml ;)vslem.,

provide:; that infrastrudure. making the pro(;(>::;"ing of inf'onnation eo.sier and

faster. with fewer error s. On the \-Veb. a mauager can collect huge amounts
of data, store that data, analyze it in different forms , and send it to anyone in
the organization. Managers can also use this information to customize and
personali ze their reports .
The Internet fa cilitates coordination and control through the efficient and
effective processing of information . but the Internet cannot substitute for the
fundamental p rocesses that Qrp involved In management control. This is be­
caUSe implementi ng stTategies tbrough management controls is essentially a
social and beha~' ioral process and thus cannot be fully automated. The avail­
ability of electronic access to databases can tributes little to the judgment calls
required to design and operate un optimal control system. Such judgments
involve
l. Understanding the relative importance of the various, and sometimes
competing, goals that dlive indi \iduals to act (e.g., personal achieve ­
ment versus collective achievement, value creation for customers and
shareholders rather than for one:;elf).
2. Aligning various individual goals with those oftbe organization .
3. Developing specific 0bjectives by which busines:; units. functional al 'ea~,
and individual departments ,'Vill be judged.
4 , Communi cating strategy and specific performance objectives through ­
out the organization.
5 . Det ermining the key variables to be measured in assessing an individ­
ual's contribution to strategic goal::;,
6. E valuating actual performance relative Lo the standard and making in­
ferences as to ho,\' well the manager has performed.
7. Conducting productive performance revi.ew meetings .
8. Designing t he right reward structure.
9. Influencing individuals to change their behavior.
In sum, although the Internet has vastly improved infonnation processing,
the fundame n tal elements of management control-what information to col­
lect 'a nd h ow to use it-are essentially behavioral in nature and thus n ut
menab Je to a formula approach .

Road Map for the Reader

This book is organized into three parts, each of which is described bliefiy h ere.

The Management Control Environment (Part 1)

Managemen t control primarily invol ves the implementation of strategies. A.o
backgrolmd, there fore , we describe generic types of organization strategies in
Chapter 2.
In Chapter 3, we descri.be some of Lhe characteristics of organizations that
affect the man agem ent control process. fOCUSing primarily on th e behavior of
individuals withill an organization .
 Chapter 1 T'lk Satu l'i' tJf Jlllnug~I/l"nt COllt l'l;1 ..... vst'·m ~ 15

In Chapters -i, 5, 6, and 7 we define and de"cribe different types ofresponsi­

bility centers , and discuss the considerations involyed in assigning financial
responsibility to Vi:lrious on;anizational subunitd , (The incorporation of non­
financial meaSlU'es into management control systems is discussed in Part 2 of
the book, primarily in Chapter 11. )
Chapter 4 introduces the basic concept of responsibility centers. A responsi·
bility center is an organiza tion unit headed by a manager l1:ho is responsible jar
its activities. Each responsibility cenier has inputs and outputs. Inputs are the
resources that the r esponsibility center uses ill doing whatever it does. Out­
puts are the results of the center's work. Technically, these outputs are prod­
ucts, but they are not necessarily product:; sold to outside customers . Services
rendered by one responsibility center to anot her are also products. Responsi­
bility center s can be classified according to the degree to which their inputs
and output s can be measured in monetary tenns .
Chapter 4 describes expense centers and revenue centers . I n an expense cen­
ter, inputs are m eas ured as monetary costs, but outputs either are not measured
at all or are measu red in qua.ntitative, nonmonetary terms. In an expense center
the manager is r esponsible primarily for expense controL There are two types
of expense center s. In an engineered expense center, actual costs are compared
with standard costs to determine how efficiently the center has operated. In a
discretionary expense center, there is no way to determlne reliable standard
costs, and expenses vary at the discretion of the manager and his or her superi­
ors. Th e efficien cy of a discretionary expense center cannot be measured.
In a reven ue cen ter, reL'enues are m.easured in monf:!ta rv terms , but expenses
are not matched with these revenue·'S . Branch sale~ offices are often revenue
centers . A comparison of budgeted and actual revenu es indicates the effecti\'e­
ness of the r even ue center.
Chapter 5 deals with profit centers, in which both reven ues and the expenses
associated ~u ith g enerati ng these revenues are measured; the difference between
them is p rofit. Actual profit compared with budgeled profit is a measure of the
manager's efficien cy.
If a profi t center provi des outputs to other responsibility centers, or if it
receive:; inputs from other responsibility cenlers, prices must be established
for these out puts and in puts: These prices are call ed transl'er p rices, as distin ­
guished from market prices, tha t is, those ch arged to outside customers.
Developing transfer prices in a way that fa6litates management control is
discussed in Chapter 6.
In Ch apter 7, we discuss in vesl ll1 ent centers, in w hich both profit a.n d th e in·
uestment (i .e., the assets) used in. carrying out that center's I'esponsibility are
m ea~ ured . The return on investme nt is the broadest meaSUl'e of the manager's
efficiency an d effectiveness .

The Management Control Process ( Part 2)

Much of the management control process involves informal interactions
between one manager and anolhe r or between a man ager and his or her sub­
ordinates . Informal communications occur by means of memoranda, meetings ,
conversations, and even by facial expres:;ions . Recently the term manage m ent
by walk ing aro und has come to signify the im portance of thi. s information .
 ..

16 Chapter One Th, _Va/ure n,r"JlaJ/(lI<emL'1I1 ("JI7trol SVstl'lI1S

The informal in Leractions take place within a formal planning and control sys­
tem . Such a system includes the following activities : ill strate2ic planning,
( :2) budge t preparation. 1:31 exet:ution. an d I-!) evaluation of performance. Each

activity leads to the next, in a regular cycle. Collectively, they consti tute a
closed loop
In Chapter 8, we discuss strategic planning, which is the proce~s of'decid ­
ing on the m aj()r programs that the organizatinn will undertak~ to implement
its strategies a nd the approximate amount of reSou r(;e~ that u.;ill be deI.'oted
to eac;h . The output of the process results in a document called the strategic
plan (or. in some companies, the long-range planl. Stl'ategic plans t:over a
period that extends over several years (typically three or fiv e ) In a profit­
oriented company each principal product or product line is a program . In a
nonprofit organization the principal services that the organization provides
are its programs .
Strategic planning is the first step in the management control cycle . In a
company that uses a calendar year, the planning usually takes place in the
spring or summer of the year that precedes the budget year At that time deci­
sions ar e made that take account of any changes in strategies that h ave
occurred since the last strategic plan was developed.
Budget preparation is di~cussed in Chapter 9 An operating budget is the
organization's plan for a specified time period, u,<;ually a year. The budget repre­
sent::; a fine-tuning of Lhe strategic plan, incorporating the most current infor­
mation, In the budge t, revenues and expenses are rearranged from programs to
responsibility centers : thus, the budget shows th e expenses that each manager
is expected tn i_n cur. The process of preparing the budget is essentiaHy one of
negotiation between the managers of each responsi bility center and their supe­
riors. The end product of these negotiations is an agreed-upon statement of
the anticipated eX'j)enses for the coming year (if the responsibility center is an
expense center). or the planned profit or expected return on investmen t (if the
responsibility center is a profit center or an investment center).
In Chapters 10, 11, and 12 we discuss performance measw'ement, perfor­
mance evaluation , and management compensation,
During the year , managers execute the program or part of a program for
wll ich they are responsible and also report on what has h appened in the cow'se
offul£lJing that responsibihty, Ideally, reports are structured so that they pr o­
.de information about both programs an d responsibility centers . Reports on
responsibilit y centers may show budgeted and actuaJ information , Jill anci al
and nonfinancial performance measures, and internal and external informa­
tion . These reports keep managers at higher levels informed about the status
of the various programs in their charge and also help to ensme that the work
of th e various responsibility centers is coordinated.
Tbe managers' reports also are used as a basis for control. T he process of
evaluation i~ a comparison of actual expenses and those that sho uld have been
incurred under the circu msta nces, If the circumstances assumed in the bu dget
process are unchanged. the comparison is between budgeted and actual
amounts. If circumstances have changed, these changes are taken into ac­
count. Ultimately. the analysis leads to praise or constructive criticism of the
responsibility cen ter managers .
Chapter 10 deals \vith the analysis and evaluation of financial performance
measures.
 Chapte r 1 Till.' SnlW',> IJ/J i unCliJ.t'm ... nl ('Pllt,.,." ~\·stt'II/S 17

Chapter 11 eXpaIll\'; the fucus uf~elfo]'mancc evaluation to discu::,s the incur­

poration of nonfinancial measures and to consider the design ofa balanced score­
(·ani . incorporating both financial and nonfinanci ~11 meaSUTes . This chapter also
contains a discussion of interactive col1trols-th~ use of' management control
information (especially the nonfinancial variety) in developing new stTategies .
Chapter 12 describes the considerations involved ill designing management
incentive compensatio n pJans to induce goal congruence.

Variations in Management Control (Part 3)

The chapters in Part 2 describe the typical managemen t control process. In
Part 3 we describe severa) variations from this pattern : dilferentiated controls
for differentiated strategies (Chapter 1:3). service organizations (Chapler 14),
and multinational or garrizabons I Chapter 15 ).
The final chapter (Chapter 16) describes the m3l1ugement co ntrol of pro.i ­
ects. Tills differs somewhat from t he management cuntroJ of ongoi ng opera­
tions. wh ich has been uur focus up to this point.

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 . Managemen t control is the process b
which managers influence other members of the organization to implement th
organization's strategies. Management control is facilitated by a formal system
that includes a recurring cycle of activities.
;'vlanagement control is one of three planning and control function s 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 ensur­
ing that specified tasks are carried out effectively and efficien tly
The book is divided into three parts. Part 1 discusses the control environ­
ment in an organization. Control is exercised by managers who supervise
responsibility cen ters. Part 2 describes the management control process, which
consists of a set of regularly recurring activities : strategic planning, budget
'preparation, execution, and performance evaluation. Part 3 describes control
systems that depart from the typical pattern.

Suggested Additional Readings

Besanko, David, David Dl'anove, Mark Shanley, and Scott Schaefer. Econo ­
mics of Strategy, 3rd ed. New York: J ohn Wiley & Sons, 2004.
Bossidy, Larry, and Ram Charan. Execu tion : The Discipline of Getting Th ings
Done. New York: Crown Books , 2002 .
Collins, Jim. Good to Great. New York: HarperCollins, 2001.
Dell, Michael, and Kevin Rollins. "Execution Without Excuses ." Harvard
Business Review, March 2005 , pp. 1-9.
Dent, Jeremy F. "Global Competition: Challenges for lVlanagement
Accounting and Control." Management Accounting Research 7. n o. 2
(June 1996), pp . 247-69 .