Kim Langfield-Smith (1997): Management Control Systems

and Strategy: A critical Review

Management Control Systems (MCS)
- Management Control was defined as “the process by which managers ensure that resources
are obtained and used effectively and efficiently in the accomplishment of the organizations
objectives.”
- MCS have also been described as processes for influencing behaviour
- MCS provide a means for gaining cooperation among collectives of individuals or
organizational units who may share only partially congruent objectives
- Controls have been categorized into:
1. Formal and informal controls (Anthony)
2. Output and behaviour controls (Ouchi)
3. Market, bureaucracy and clan controls (Ouchi)
4. Administrative and Social controls (Hopwood)
5. Results, action and personnel controls (Merchant)
- Formal Controls:
o Formal Controls include rules, standard operating procedures and budgeting systems
o They are more visible, objective components of the control systems, and the easiest
to research
o MCS & Strategy have primarily focused on Formal Controls
o These include Output and Result controls (Feedback nature)
o They involve monitoring, measuring and taking corrective actions with financial
orientation
o Controls that focus on Feedforward are
1. Administrative controls (standard operating procedures and rules)
2. Personnel controls (human resource management)
3. Behaviour controls (ongoing monitoring of activities and decisions)
- Informal Controls:
o Not consciously designed
o Include unwritten policies and often derive from the organizational culture
o Clan controls derive from the shared values and norms, or the company’s culture
o However, some formal controls also derive from the organizational culture
o The effectiveness of formal controls may be dependent on informal controls
- The role of MCS in the formation and implementation of strategy is becoming of greater
importance
- The emphasis on senior management is becoming less relevant with an increasing interest in
employee empowerment
- As employees become more involved in activities with strategic significance, the artificial
boundaries between operational, managerial and strategic control may no longer hold

Strategic Frameworks
Defining Strategy
- Strategy has been described as a pattern of decisions about the organizations future,
(Mintzberg) which take on meaning when it is implemented through the
organizations structure and processes (Miles & Snow)
- Johnson: strategic decisions occur at many levels of managerial activity
o They are concerned with the long-term directions of the organization
o The scope of an organization’s activities
 o The matching of organizational activities to its environment and resource
capabilities
o The allocation of major resources and considerations of the expectations and
values of the organization’s stakeholders
- Corporate Strategy  Concerned with decisions about the types of businesses to operate
(Structure & Finance the company)
- Business strategies  Relate to each business unit of the organization and focus on how
individual SBUs compete within their particular industries
- Operational Strategies  Address how the various functions of the organization contribute
to the particular business strategy and competitiveness of the organization
Strategy Formulation and Implementation
- Strategy Formulation is the managerial activity involved in forming strategies while
Strategy implementation is concerned with translating the chosen strategy into
actions
- These actions encompass allocation of resources and designing suitable
administrative systems, including MCS
- Not all strategies arise in the same way:
o Intended strategies are those that are formally planned, but may not always
be realized due to unrealistic expectations or misjudgement
o Realized strategies may develop from those intended, or may emerge
incrementally
Alternative research paradigms
- Strategy is a craft
- Positivist approach: assuming that strategy is an outcome of rational choice
- Mintzberg & Quinn stress the ambiguous and messy nature of strategic decisions,
and the need to design systems that allow for flexibility and encourage creativity in
strategic planners  formal controls are counterproductive
- Strategy only resides in the minds of key managers
Operationalizing strategy
- Hambrick proposes four approaches to operationalizing strategy:
o Textual descriptions  appropriate for case studies and theory building, too
weak for testing
o Partial measurement involves considering variables such as market share,
or a particular manufacturing strategy, but does not capture the full breadth
of an organization’s strategy
o Multivariate/Multidimensional measurement  Common to strategy and
marketing research and involves measuring a series of variables and
conducting large scale statistical analysis of associations, but very complex
o Typologies  comprehensive profiles of different strategic types and have
the advantage of emphasizing the integrative components of each strategy
Strategic Variables
- Miles and Snow described three organizational types:
o Defenders: have a narrow product range and undertake little product/markt
development (Critical functions: Finance, Production, Engineering)
o Prospectors: continually searching for market opportunities and creators of
change and uncertainty, to which their competitors must respond (Critical
functions: Marketing, R&D)
 o Analyzers: combine the strongest characteristics of defenders and
prospectors
- Porter described three generic strategies:
o Cost leadership: aims to become the lowest cost producer in its industry;
Source of Competitive advantage is economies of scale, access to favourable
raw material prices and superior technology
o Differentiation: focuses on providing products with attributes that are highly
valued by its customers (After sales service, high quality etc.)
o Focus Strategy: organization focuses on niche market (CA is delivered by
either cost leadership or differentiation)
- Miller and Friesen categorized firms in two:
o Conservative: engage in innovation with reluctance, usually as a response to
serious challenge
o Entrepreneurs: aggressively pursue innovation, and control systems were
used to warn against excessive innovation
- Gupta and Govindarajan developed four strategic missions:
o Build: Aims to improve market share and competitive position, even though
this might decrease short term earnings or cash flow
o Harvest: Strives to maximize short term profit and cash flow rather thn
increase market share
o Hold: Protect market share and competitive position (firms with high market
share in high growth industries)
o Divest: Business plans to cease operations
Integrating the strategy variables
- To assist in integrating the frameworks, the differences and similaries between the
strategy classifications can be considered:
- Differences:
o Typology of prospector vs defender has a broad scope, while competitive
positioning of cost leadership vs differentiation is much narrower
o The entrepreneur vs conservative classification is focused on the extent of
product innovation, while build vs harvest is based on the market share vs
short term profit trade-off
- As illustrated in Figure 1. The strategies
followed by particular business units can
be described along three dimensions:
Typology, Strategic Mission & Competitive
position
- When the detailed descriptions are
reviewed in relation to environmental
uncertainty, this leads to the Figure 2.
o A viable combination may be for
prospectors to compete via
differentiation and to pursue a
build mission
o A non-viable combination for a
prospector is to pursue
differentiation and a harvest
strategy
Analysis of Research Evidence
- This section contains an analysis of research that examines the relationship between
specific aspects of MCS and strategy
Contingency Research
- In contingency research that studies MCS and strategy, the strategy has been defined
and measured in many ways
- In the following discussion, the strategy variable is classified relating to either
prospector or defender strategies
The nature of control systems and strategy
- Two contrasting pictures emerge of the nature and role of control systems
Control System for Defender like Strategy Control System for Prospector like Strategy
- Very detailed, focusing on reducing - Miles and Snow point out that prospectors
uncertainty have difficulty implementing
- Emphasizing problem solving comprehensive planning systems due to
- But: Unable to assist in new product the changing demands of the environment
development or to locate market - Control Systems focus more on problem
opportunities finding than problem solving
- Finance & Production are focus  - Flexible structures and processes may
Technological efficiency is important assist the org. to respond rapidly to
- Control Systems are centralized and changes in the environment and to create
heavy reliance on feedforward that change
control - Coordination may be expensive and
- Also achieved through creating difficult due to overlapping project teams
highly specialized work roles, and shared information and resources
formalized job descriptions and - Use of broadly defined jobs and the lack of
standard operating procedures standard operating procedures may
- Porter: Highly structured encourage innovation
organizations also support a cost - Control may be decentralized and result
leadership focus oriented
- Miller & Freisen: Conservative firms - Porter: Differentiation strategy as also
(Similar to defenders) need a control relying on control through coordination
system that signals the need for rather than formal controls
innovation by indicating significant - Miller & Freisen: Firms following a
drops in market share, reduction in entrepreneurial strategy (similar to
the sales of old or obsolete products prospectors) require a control systems
and declining profitability that signals when productivity and
efficiency have fallen, to signal when
innovation needs to be curbed
Control Systems and the level of competition
- Three forms of competitions mentioned by Khandwalla (1972)
o Product
o Process
o Marketing
- The stronger the competition the greater the reliance on formal control systems
- Intense product competition requires complex organizational forms  sophisticated
control systems may plan an integrative role
 - Organizations that face intense product competition are likely to follow a prospector
or differentiator strategy
- The specific controls measures by Khandwalla include formal accounting controls,
such as flexible budgeting, internal auditing, use of ROI and inventory control
- However: Innovation was more suited to unstructured and organic organizations,
where there was less reliance on formal controls
- Limitation: The findings are ambivalent, as the focus of the study was only on the use
of controls, without considering their effectiveness
Controls and discretionary decision making
- Merchant studied controls systems and discretionary decision making
- Strategy was defined by managers within the company as:
o Rapid growth
o Selective growth
o Maintain or generate cash flow
o Harvest cash flow
- Controls go beyond the financials, as they include personnel and procedural controls
- Controls used in businesses that followed a growth strategy were not different from
the controls used under a maintain or selective growth strategy
- When a rapid growth strategy was followed discretionary decisions were more highly
affected by controls such as net income targets, headcount controls and use of
meetings where senior management gave directives
- Limitation: Findings are limited, research exploratory and no empirical research
Strategy and Cost Control
- Some agreement that cost control is more important in firms following a defender-
type strategy
- Porter: tight cost controls were appropriate when following a cost leadership
- Miles & Freisen: difficult to integrate as their view on strategy was defined in terms
of product innovation; However, their argument for the lack of sophisticated cost
controls in entrepreneurs is consistent with Miles & Snows view of prospectors and
inconsistent with Khandwalla!
- In contrast: Simons (1987):
o High performing prospectors place importance on controls such as forecasting
data, tight budget goals and the careful monitoring of outputs, but little
attention to cost control
o Large high performing prospectors emphasized frequent reporting and the
use of uniform control systems
o Control systems are used less intensively by defenders (especially large
defenders) compared to prospectors
o In large defenders, high financial performance was negative correlated with
tight budget goals and use of output monitoring
o Findings are not consisting with Porter and Miles and Snow
- Dent (1990) found several explanations for Simon’s findings:
o Prospectors control system may restrict risk taking, where authority for
product development and market innovation is delegated
o Thus, balancing the innovative excess encouraged by prospectors’
organizational arrangements
o Prospectors may rely on performance monitoring to encourage organizational
learning in the face of high task or environmental uncertainty
 o Financial Controls are the only way that the wide scope of a prospectors
activities can be captured
o Defenders being more stable organizations, may not require intense cost
controls
- A major limitation for Simons: He did not consider non-financial controls
Performance evaluation and reward systems
- Defender, Cost leadership and harvest strategies
o High performing defenders awarded bonuses for the achievement of budget
targets (objective measure)
o Same was found for firms following a low cost strategy, harvest and low cost
strategies and cost leaders
o Reliance on long run criteria and subjective bonuses hampered effectiveness
in firms following a harvest mission
o Defender-like strategies usually operate within a low level of environmental
uncertainty & their product range is stable, as well as their internal efficiency
may allow performance levels to be specified with precision
Objective performance evaluation and reward systems have been found to
support defender like strategies
- Firms that follow prospector, differentiator and build strategies:
o Porter: subjective performance evaluation was appropriate for differentiators
o Gov & Gupta: supported the same for build mission firms and build an
differentiation strategy
o Gov & Gupta: also build strategies demand a long term orientation, incentive
bonuses should also be based on long-run criteria
o Gov & Fisher: Reliance on behaviour controls by differentiators implies
subjective bases are used for performance evaluation, as may the low
emphasis on meeting budget targets
o In Contrast: Gupta & Gov: while subjective rather than objective approaches
to determining bonuses were more beneficial when there is a high degree of
resource sharing between business units, resource sharing itself makes a
greater contribution to effectiveness in cost leaders than in differentiators
o The findings are not surprising, as usually high environmental uncertainty is
associated with those strategies, as well as, R&D and Innovation are hard to
quantify objectively
- Range of questions is still unanswered: Mix of salary and non salary components,
potential for linking rewards to both business unit performance and corporate
performance etc.
Resource Sharing and Control Systems
- Resource sharing refers to the sharing of functional resources between two or more
SBUs within a single firm, and may include using common sales forces and common
R&D facilities
- In high performing cost leaders:
o Gov & Fisher: output controls (and not behaviour controls) were combined
with high resource sharing
- In Contrast:
o Miles & Snow found: standard operating procedures by defenders
o Porter: Cost leaders may rely on frequent cost reports
- In high Differentiator firms:
 o Gov & Fisher: firms with high resource sharing relied on behaviour controls
(the continual monitoring of decisions and actions), which is odd with the
entrepreneurial mode of prospectors and their reliance on subjective
performance assessment
o It was found that where there was low resource sharing, output controls were
used by effective differentiators
- A conflict: Ouchi & Eisenhardt:
o Behaviour controls are more suitable where there is high task
programmability and where outcomes can be readily measured  defender
& cost leader situation
o As task programmability decreases and outcomes can be clearly specified,
greater reliance may be placed on output controls  No situation typically
faced by prospectors
- Gov& Fisher: rely on agency theory to argue that output controls are effective in
SBUs following a low cost strategy and behaviour controls for Differentiation
Operational Control Systems and strategy
- Daniel & Reitsperger (1991): studied the nature of control systems that support
particular quality strategies using two different approaches to managing quality
o Under the Economic conformance level, a cost minimizing quality level is
achieved by balancing prevention and appraisal costs against internal and
external failure costs
o Control may be achieved through continuous improvement of quality goals,
the reduction in defective units and frequent feedback on quality
performance to employees
o Cost Quantification may not be considered important, as achieving a high
quality is assumed to lead to lower costs
o Their second paper emphasized the need for MCS at the operations level to
specifically support manufacturing strategies, using performance targets and
feedback information
Case Study Research
- Offers the potential for a deeper examination of the processes involved in the
relationship between MCS and strategy formulation and implementation
- In this section, the cases reviewed address a series of interrelated issues:
o Managers’ perceptions as mediating the link between MCS and strategy
o the role of MCS in effecting or impeding strategic change
o Choice of interactive and diagnostic controls to manage strategy
Managers perceptions as mediating MCS and Strategy
- Archer & Otley (1991) present a case about an agricultural manufacturing company,
which participates in both cost leadership and product differentiation within a
specialized niche market AND relies on formal, as well as informal controls
o Here the MCS was unable to assist in developing new strategies, as it told the
managers only to “do what is currently being done more effectively”
o Three Issues that arise from the case
1. A mix of formal & informal controls can be used to support the
strategic direction
2. Committee meetings may plan an integrative role in linking MCS and
the execution of strategy
 3. Potential for MCS to support existing strategy may be mediated by
managers perception
Accounting Controls and Strategic Change
- Robert (1990): emphasized how accounting controls can create a climate that can act
against successful strategy formation and implementation processes
- The accounting controls emphasized:
o Autonomy
o Instrumentality
o Individuality
o Dependence
- Conformity & distorted communications were encouraged, which conflicted with
successful strategy formation/implementation
- However, the management meetings mentioned above also supported the mediation
between accounting controls and strategy
The Choice of interactive and diagnostic controls to manage strategy
- Simons Levers of Control:
- MCS are not viewed merely as devices that constrain and monitor activities to ensure
that organizational goals are achieved, but play a role in maintaining or altering
patterns of organizational activity
- “Interactive Controls”: those that senior management choose to monitor personally
(Directs attention towards strategic uncertainties and allows mgmt. to monitor
external threats/opportunities)
- “Diagnostic Controls”: are used to implement intended strategies (Measure critical
performance variables and their management is delegated to staff specialists)
- Prospector companies, following differentiation strategy & entrepreneurial,
operating in an uncertain environment used budgeting systems and plannings
systems interactively to set agendas and action plans and rewards subjectively
- Defender companies, following cost leadership & conservative, in a stable
environment focused on diagnostic controls. Interactive controls were also in place
to scan the environment for threats undermining low cost position
- Later onwards he added:
- “Belief System”: core values, creating positive and inspirational forces
- “Boundary System”: Control for critical performance variables and sets constraints
and ensures compliance
Conclusion of Case Research
- All cases emphasized the importance of managers’ perceptions effecting the nature
of strategic change
- All cases have a lack of generalizability and their inability to provide a body of
accumulated knowledge
- Managers perceptions can be considered a mediating variable in the relationship
between MCS and strategy
- Interdependence of formal and informal controls and strategic processes and the
role of MCS in either supporting, or impeding strategic change was common to all
cases
Contemporary approaches to performance measurement systems
- Balance scorecard provides a balance between short term and long term measures
and across the strategic dimensions of business
 - The assumption is that performance measures direct attention and motivate
employees to actin in strategically desirable ways, and help management to assess
progress towards strategic goals
- Performance measures are assumed to be necessary in all situations, no matter what
strategy is pursued

Methodological limitations of Contingency Research Studies

Operationalizing management Control Systems
- A key difference in each study is the breadth of controls measured  The variation in
the number and type of controls makes it difficult to develop a coherent body of
knowledge
- The important distinction between existence and use of controls was not
acknowledged
- Measuring the use of informal and clan controls is difficult
Measuring Effectiveness
- Effectiveness has been presented as a necessary dependent variable in CR as it
provides the means for determining the appropriate fit between MCS and
organizational variables
- Effectiveness however, is defined differently in each research
- If the measure of effectiveness is not appropriate for all firms, then the results of
analyses must be carefully interpreted
Weaknesses in operationalizing strategy
- Several weaknesses in the way that researchers operationalized strategy
o Strategy can be measured using several variables, but the multidimensional
nature of strategy is not acknowledged
o Using certain strategic typologies can potentially result in a circular research
design
o Distinction between intended and realized strategy was not explicitly
recognized in all studies, or in the measurement instruments
o Some survey instruments did not recognize the relevant nature of strategy,
which may have led to inaccurate classifications of strategic types
o The assumption has been made that all managers view their organizations
strategy using the same orientation adopted by the typology
o The assumption has been made that managers who are surveyed are fully
aware of the strategy of their organization, especially the one intended
o Perceptions of intended strategy can vary among managers within one
organization
o Failure to recognize that strategy can be an ongoing developmental process
o MCS needed to support a particular strategy may only be partially developed
at the time of the study as the change process may be continuous

Conclusion
- Purpose of the paper was to review and critique research that examines the
relationship between MCS and strategy
- The contingency research focused on identifying the characteristics of MCS
associated with effectiveness under different strategies
o But is fragmented and sometimes conflicting
- The case research addressed the relationship between MCS and strategy in much
greater depth and in a dynamic way to provide interesting propositions and theories
o Also included management perceptions
- Focus has usually been on senior management and on business strategy
o For further research the operational levels should be reviewed
o Especially the nature of controls suitable at the operational level is interesting
- In studying MCS and strategy the interactions are complex and perhaps only in depth
research can help us understand the complex nature of these relationships
- It is not clear what role MCS can play to bring intended strategies to
realization, or whether MCS can minimize the disruption caused by strategic
change