Simons, Chapter 1: Organizing Tensions

1
Simons, Chapter 1 Organizing Tensions
How can managers 1 Lever potential for
innovation and ensure adequate control? 2 Drive
growth that enhances profitability? 3
Communicate strategy and goals to employees? 4
Organize resources in support of strategy? 5
Measure and track performance toward achieving
strategy? 6 Ensure that they are not exposed to
undue risk? 7 Link information from employees
to strategy makers?
2
Systems for Performance Measurement
Control 1 Purpose is to convey
information (financial and non-financial). 2
Part of the FORMAL control system. (but the
informal control system should not be
ignored) 3 Designed to be used by managers. 4
Used to maintain behaviour or to change
behaviour. Performance measurement
systems Ensure that goals are being met, so that
strategy can be achieved.
3
Balancing Organizational Tensions 1 Profit,
vs growth, vs control 2Short-term vs
long-term 3Performance expectations of
different constituencies 4Opportunities vs
attention 5Motives of human behaviour People
in organizations want to contribute choose to
do right strive to achieve like to innovate
and want to do competent work BUT may be
prevented by organizational blocks.
growth
Business Strategy
profit
control
4
Simons, Chapter 2 Basics for a Successful
Strategy
How to Control Strategic Decisions? Business
Strategy How the company chooses to compete
(core competences) Corporate Level Strategy
array of businesses Business unit level strategy
defined product markets Use SWOT analysis to
support decisions Strengths (internal) Weaknes
ses (internal) Opportunities (external) Threat
s (external) Business Goals Specific
measurable objectives set for managers in pursuit
of strategy.
5
Competitive Firm-specific resources Market
Dynamics SWOT capabilities MIS
SION BUSINESS STRATEGY
PERFORMANCE GOALS MEASURES ACTIONS
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Porters Five Forces of Competitive
Markets
Potential New Entrants
Suppliers
Customers
Existing Rivalry
Market Substitutes
7
The 4 Ps of Strategy Perspective strategy
as a mission Position choosing how to
compete Plan setting performance
goals Patterns in action feedback
adjustment. Compare with bottom-up or emergent
strategy
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Simons, Chapter 3 Organizing for
PerformanceChapter 4 Using Information for
Performance Measurement Control
The organization chart shows the
inter-relationship of individuals and work
units. A work unit has authority and
responsibility to pursue some sub-set of the
organizational objectives. Work units may be
process oriented (functionally specialized benef
it of process specialization less diffusion of
attention. Work units may be market oriented
(product/customer/geographical focus) economies
of scale or scope benefits of product or
customer or market specialization Trade-off
between efficiency and responsiveness.
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Span of control how many people report to a
manager narrow span 1-3 people wide span 7 or
more people. Span of accountability the range
of performance measures used to asses a managers
achievements. narrow span cost centre wide
span profit centre. Span of attention The
domain of activities within a managers
view narrow span centralized org. wide span
decentralized org.
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Fig. 4-1 Information for Achieving Profit Goals
Strategies Board of Directors
Shareholders Information about strategies
payoffs Top management Lower
Organizational levels
Information about progress in achieving intended
strategies plans
Information about intended strategies plans
Information about strategic domain
Information about emerging threats opportunities
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Table 4-1 Input-Process-Output Model
Measures Input Measure Process Measure Output
Measure Non-Financial New engineering
product delivery new products products hours
milestones achieved introduced Order
telephone order completion orders processing
answering staff time processed Parts
components setup time output units manufacture
meeting specs meeting standard Financial New
labour cost of sales
from products materials prototyping new
products Order clerical labour cost of
backorder cost per order processing handling
processed Parts cost of setup cost
cost per unit manufacture components cost of
rework unit
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Figure 4-3 Cybernetic Feedback
Model Standard Inputs Process
Outputs Feedback
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Choosing What to Control 1 Technical
feasibility of monitoring measuring 2
Understanding cause effect 3 Cost 4
Desired level of innovation.
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Table 4-2 What to Control Control Inputs
When Control Processes When Control Outputs
When processes outputs processes can be
outputs can be observed re unobservable observed
measured measured cost of input is
high cost of measuring/ cost of
measuring/ relative to value of monitoring
process monitoring outputs output is low is
low quality and/or standardization is safety
is important critical for safety and/ or
quality cause effect cause
effect relationship is clear relationship is
unclear proprietary processes innovation is
desired give strategic advantage
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Uses of Information Decision making Planning
Co-ordination Control Ex-post
evaluation Motivation through extrinsic
rewards Motivation through intrinsic
rewards Signaling Education
learning External communication Investors,
lenders their advisors Suppliers business
partners Customers Employees.
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Table 4-3 Information Bias Purpose of
Information Bias Desired by Managers Decision
making none accuracy important for planning
control Motivation Inflate targets to
make stretch goals Early warning trade-off
reduced accuracy for increased timeliness Eva
luation eliminate factors beyond
control External communication reduce
expectations to ensure goals can be achieved
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Simons, Chapter 5 Building a Profit Plan
Purposes of budgets

• To translate the strategy of the business into a
  detailed plan to create value, (planning)
• To evaluate whether sufficient resources are
  available to implement the intended strategy,
  (co-ordination)
• To create a foundation to link economic goals
  with leading indicators of strategy
  implementation, (control)
• To motivate employees managers to achieve
  strategies.

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The Three Wheels of Profit Planning 1 The
Profit Wheel Objective to summarize expected
revenues and expense outflows for a specified
future accounting period. Process 1 Forecast
sales Sales drive expenses Sales are
predictable, but not controllable Base
forecasts on macroeconomic factors regulation,
competitors customers. 2 Forecast
expenses Variable expenses (mostly engineered
costs) Fixed expenses Committed/engineered
costs Discretionary costs Activity driven
costs. 3 Calculate profit 4 Price the
investment in new assets 5 Test key assumptions
(sensitivity analysis).
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The Three Wheels of Profit Planning 2 The Cash
Wheel Objective Estimating whether the company
will have enough cash to operate. Process 1
Estimate net cash flow from operations Direct
method estimated receipts less estimated
payments Indirect method net income plus
depreciation 2 Estimate cash needed to fund
growth in operating assets 3 Price the
acquisition divestiture of long-term assets 4
Estimate financing needs interest payments.
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The Three Wheels of Profit Planning 3 The ROE
Wheel Objective To see whether the ratio of
profit to investment is enough. Process 1
Calculate estimated overall return on
equity Net income (IAIT)/Shareholders
equity Financial leverage (assets/shareholders
equity) 2 Estimate asset utilization Sales/as
sets (in detail in total) 3 Compare projected
ROE with industry benchmarks with investor
expectations. The Final Question Do the three
wheels (cycles) achieve the intended strategy?
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Simons, Chapter 6 Evaluating Strategic Profit
Performance
Efficiency (input/output ratio) Effectiveness
(extent of achieving strategy) Analysis
depends on ability to measure outputs (also
inputs processes) existence of a
predetermined standard of performance ability
to use variances as feedback cause
change. Variances profit plan
variances market share variances revenue
variances production efficiency cost
variances variances for non-variable costs.
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Activity Based Variance Analysis Budget Act
ual Number of batches 500 490 Supplies used per
batch 1.50 litres 1.40 litres Cost of supplies
/litre 80 80.50 Total supplies
cost 60,000 55,223 Volume variance effect
of ? in of batches (500 490) 1.50 80
1,200 (F) Efficiency variance effect of
efficient use of inputs 490 (1.50 - 1.40
litres) 80 3,920 (F) Spending
variance effect of ? in input prices 490 1.40
(80 80.50) 343 (U)
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Strategic Profitability Analysis competitive
effectiveness component (this is a key factor
for companies pursuing a differentiation
strategy). operating efficiency
component (this is a key factor for companies
pursuing a low-cost/high-volume
strategy). market size and market share
variances are key factors for any strategy.
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Simons, Chapter 7 Designing asset Allocation
Systems
Table 7-1 Sources Types of Information for
Asset Allocation About Discrepancy
Evidence Source Costs too high
input costs accounting prices
prices marketing may be lowered
study prod/eng. Quality inadequate
competitors marketing customers
marketing prices marketing
study engineering Capacity
insufficient salesgtcapacity marketing
forecastgtcapacity new product
introduction all roles
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Assets Allocation Procedures 1 the analyses
needed to support a request. 2 the process for
review spending limits, by manager/area catego
rization of assets health safety
regulations (choose the most cost-effective
method) increasing operating efficiency or
revenue (payback / ROI / NPV /
IRR) enhancing competitive effectiveness (ali
gnment with existing strategy risks of
acquisition risks of non-acquisition quali
ty of support information track record of
people involved). feasibility and
reversibility. 3 the time frame for review
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Simons, Chapter 8 Linking Performance to Markets
External market transactions include customer
markets financial markets supplier
markets. The discipline of the market price is
very effective, but the transactions still need
to be actively managed. Internal market
transactions occur whenever a product or service
is traded not at arms length within a company
or group of companies. The absence of an
unambiguous market price means that we have to
use substitutes and approximations in determining
transfer prices.
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Transfer prices have two potential
roles Firstly they allocate profit between
divisions (this is a zero-sum game). A well
chosen transfer price is fair to all the
parties that have contributed to making the
profit. This role is essential fro profit
performance evaluation. Secondly they may cause
managers to make decisions that are, or are not,
in the best interests of the company as a
whole (they may be locally optimal, but globally
sub-optimal) (this is NOT a zero-sum game). A
well chosen transfer price sends signals that
cause managers to react in goal congruent ways.
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Transfer Pricing Alternatives 1 Market
prices Where these are available they will
result in a fair allocation of profit between
units correct signals for optimal decisions a
feeling of managerial autonomy a sense of
objective measurement. Market prices may need to
be adjusted elimination of costs avoided on
internal transactions (delivery, packing,
advertising, selling costs etc) inclusion of
costs unique to internal transactions.
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Transfer Pricing Alternatives 2 Cost Based
Transfer Prices In the absence of an
unambiguous outside market price the transfer
price will normally be set by reference to
cost variable cost or full cost or activity
based cost actual cost or standard cost with a
profit margin or without a profit margin 3 2
2 12 basic choices In reality cost based
transfer prices display so wide a range that they
would be better described as special cases of a
negotiated transfer price.
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Transfer Prices Desiderata Corporate managers
want optimal decisions in both the long and
short run clear rules to curtail argument and
dissent. Division managers want fair
assessment of their financial performance fair
assessment of their good business
decisions downstream units to understand the
full costs of the resources they have
acquired. Financial staff want simple,
credible, explainable, justifiable rules fair
allocation of costs and margins optimal
decisions in both the long and the short run.
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Table 8-2 Major Trade-Offs in Transfer Pricing
Methods Objective VC FC FC Profit
ABC Market Rational decisions by
selling units poor moderate better
better best Rational decisions by
buying units poor better better
better moderate Accurate
product contribution poor moderate
better better best Easy to
understand best better moderate
worst best Easy to apply
easy moderate difficult difficult
varies (from Eccles, 1985)
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• External Markets 1 Customer Markets
• A unique value proposition
• a mix of products and service attributes that a
  firm offers to its customers in terms of price,
  product features, quality, availability, image,
  buying experience and after-sales warranty and
  service.
• products and services should meet customers
  needs and expectations
• the value proposition should be differentiated
  from that of competitors
• revenues should exceed the cost of delivering the
  value proposition.

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Measures of Attainment of the Value
Proposition Financial Measures Revenue/revenue
growth Gross Profit Margin Warranty expense
customer returns. Non-Financial
Measures Market share/ growth in market
share Customer satisfaction Referrals
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External Markets 2 Factor Markets Financial
Reliability of payment Promptness of
payment Price adequacy. Non-Financial Complex
ity of bidding/contract process Difficulty of
meeting quality criteria Difficulty of meeting
delivery criteria Penalties for
non-performance.
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External Markets 3 Financial Markets Financial
performance measures Profit Revenues -
costs Return on investment Profit/investment Re
sidual income Profit fair return on
investment Market value outstanding shares
market price Market value added market value
capital from owners and lenders Economic
value added. A version of residual income.
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Economic Value Added Objectives Move way from
accrual accounting towards cash flows Replace
historic cost asset values with market asset
values. Adjustments Replace with LIFO
inventory value Current inventory value Tax
liability on earnings Tax currently
payable Goodwill amortization Eliminated R D
expense Eliminated Required return Weighted
average cost of capital
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Simons, Chapter 9 Building a Balanced Scorecard
9-1 Translating Vision Strategy 4
Perspectives Financial Perspective
Goals Measures How do we look to
shareholders? Customer Perspective
VISION Internal Business
Perspective Goals Measures STRATEGY
Goals Measures How do our customers see
us? At what must we excel? Innovati
on Learning Perspective
Goals Measures Can we continue to improve
create value?
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Financial performance measures Profit Revenu
es - costs Return on investment Profit/investmen
t Residual income Profit fair return on
investment Market value outstanding shares
market price Market value added market value
capital from owners and lenders Economic
value added. A version of residual income.
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9-2 Customer Perspective Core Outcome
Measures Financial objectives Customer outcome
s Market share Customer profitability
Account share Customer Customer acqu
isition retention Customer
satisfaction Core outcome drivers
internal business process measures
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9-3 Customer Perspective Linking Unique Value
Proposition to Core outcome Measures Customer
Customer Customer acquisition satisfaction ret
ention Value Product/service
Image Relationship attributes Uniqueness
Brand equity Convenience Functionality Trust
Quality Responsiveness Price Time
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9-4 Develop Goals Measures for Critical
Internal Business Performance Variables.
Identify customer need Identify
market Innovation cycle Product design
development products 1st to market
sales from new products Build product/service O
perations cycle Deliver product/service quality
(defect rates, yields) cycle
time cost Service the customer Post-sales
cycle cycle time Customer need
satisfied Satisfactory Corporate
profitability outcomes
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Develop Goals Measures for Critical Learning
Growth Performance Variables. People training
empowerment satisfaction levels. Systems inf
ormation availability. Procedures alignment of
incentives with objectives.
43
Balanced Scorecard Balance between Financial
Non-financial Short-term Long-term Internal
External Objective Subjective Objective arti
culation of strategy on measurable
dimensions measurement of progress towards
strategy.
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Simons, Chapter 10 Using Diagnostic
Interactive Controls Systems

• Diagnostic Control Systems
• .the formal information systems that managers
  use to monitor organizational outcomes and
  correct deviations from preset standards of
  performance (cybernetic control).
• Set a goal in advance
• Measure outputs
• Calculate performance variances
• Use the variance as feedback to bring
  performance back into line with standards.

Objectives Increasing the Return on
Management Strategy implementation through
critical performance variables Conservation of
attention.
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Effective Use of Diagnostic Control
Systems 1. Setting negotiating goals areas
to be controlled levels of achievement 2. Ali
gning performance measures performance measures
should reflect goals priorities 3. Designing
incentives link rewards with results to
implement strategy 4. Reviewing exception
reports concentrate on exceptions as
deviations from standards 5. Following up
significant exceptions initiate action to put
things back on track.
46
Risks in Using Diagnostic Control
Systems Measuring the wrong variables Building
slack into targets Gaming the
system (smoothing biasing illegal acts).
47
Interactive Control Systems are the formal
information systems that managers use to
personally involve themselves in the decision
activities of subordinates. These deal with
Strategic Uncertainties the emerging threats
and opportunities that could invalidate the
assumptions upon which the current business
strategy is based changes in competitive
dynamics changes in internal competencies unknow
able in advance emerge unexpectedly over time.
48
Examples of Strategic Uncertainties New
technology eroding the business ability to
create value or providing new opportunities to
create value. Changes in population demographics
changing the needs for products or
services. Predatory pricing by competitors
putting the existing value proposition at risk,
or exit of a competitor from a market may create
new opportunities. Product defects causing
customer dissatisfaction. Changing tariffs or
regulations may change the basis of competition.
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Differentiate
Critical Performance Variables Strategic
Uncertainties Recurring What must we do well
to What changes in Questions achieve our
existing strategy? assumptions
change future strategies? Focus
on Implementing intended Testing
identifying strategy . new strategies. Driven
by Goal achievement, Top management search
for efficiency, effectiveness unease
Disruptive change
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Senior management vision
Business strategies
Strategic uncertainties
Learning
Choice
Debate dialogue
Interactive control system
Signalling
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Criteria for Use as an Interactive Control
System Information should be simple to
understand Information should be about
strategic uncertainties Must be used by
managers at multiple levels in the
organization Must generate new action plans.
52
Design Choice of Interactive Control
Systems Strategic If S.U. High If S.U.
Low Uncertainty then I.C.S. Then
I.C.S. Technological Focus on emerging Focus on
changing dependence new technologies customer
needs Regulation Focus on socio- Focus on
competitive market protection political threat
threats opportunities opportunities Valu
e chain Accounting based Input/output complexity
measures measures Ease of tactical Short
planning Long planning response
horizon horizon
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Reasons for Limiting Interactive Control to One
System Economic management attention is a
scarce costly resource Cognitive Ability to
process disparate information is
limited Strategic Multiple interactive control
systems would diffuse the signal about what is
important.
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• Interactive Control Systems and Incentives
• Do not used formula approach to frustrate
  gaming.
• Subjective basis for rewards
• requires subordinates to make their efforts
  visible
• reduces information biasing
• makes superiors develop a sound understanding of
  the business its environment.
• Contingencies may be used to link a diagnostic
  control system to an interactive control system.

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Control System Tasks Managers Staff Diagnost
ic Set/negotiate targets Design
maintain Control Receive review systems Systems
exception reports Prepare exception Follow up
exceptions reports Interactive Choose which
system Gather compile Control use
interactively data Systems Schedule frequent
face- Facilitate interactive to-face meetings
with sub- process ordinates to discuss
data Demand response from operating managers
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Simons, Chapter 11 Aligning Performance Goals
and Incentives

• Go from goals to targets
• Goals are guides to implement strategy
• Goals provide clarity of purpose
• Goals communicate priorities
• Goals are selected because they are
• critical variables
• performance drivers

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Measurement of Performance Goals and Incentives

• Strategic alignment
• Priorities, goals and strategy
• Communicate to employees
• What gets measure is what is get done
• Objective independently measured and verified
• Complete captures all the relevant attributes of
  achievement
• Responsive reflects actions that a manager can
  directly influence
• Linked to value
• Input process output model
• Leading and lagging

58
Setting Standards for Performance Goals and
Incentives

• By comparison
• Pre set standards
• Internal or external benchmarking
• To motivate
• Effort
• Level of difficulty
• Participate in goal setting
• Align incentives
• Intrinsic and extrinsic

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Calculating Incentives

• Incentive individuals are paid more when
  performance exceeds some base or threshold.
• Bonus pool a pot of money reserved for the
  payment of incentive and recognition awards, and
  is determined by reference to business or
  corporate-level performance.
• Allocation formula allocation of the bonus pool
  to individuals based on individual performance,
  business performance and corporate performance.
• Types of incentives
• Cash
• Gifts and prizes
• Deferred cash payments
• Awards of company stock
• Grants of options for the future purchase of
  company stock

60
Simons, Chapters 12 13 Identifying and
Managing Strategic Risk
Sources of Strategic Risk
Operations breakdown in a core operating,
manufacturing or processing capability. Use the
input-process-output to measure it. Asset
impairment loose a significant portion of the
assets current value because of a reduction in
the likelihood of receiving future cash flows.
Types of impairment financial, physical or
intellectual property rights. Use the balance
sheet to measure it. Competitive changes in the
competitive environment that impair the business
ability to successfully create value and
differentiate its products or services. Use the 5
forces model to measure it. Franchise the value
of the entire erodes due to a loss in confidence
by critical constituents. It is a consequence.
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• Pressures for Fraud
• Growth
• Pressure for performance in high-growth
  companies
• Rapidly expanding scale of operations
• Many new employees decreasing experience and
  lack of consistent values
• Culture
• Entrepreneurial risk taking
• Fear in bearing the bad news
• Internal competition
• Incomplete management information
• Information management
• High transaction volume and increasing
  processing speed
• Transaction complexity
• Decentralized decision making

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• Conditions for Misrepresentation and
  Fraud
• Pressure
• Pressure for performance and incentives
• Personal problems
• Opportunity
• Access to manipulations to their advantage
• Actions remain undetected
• Rationalization

Pressure Temptation for Fraud
Opportunity rationalization
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How to Manage Strategic Risk

• Deploying Beliefs
• Core values are the beliefs that define basic
  principles, purpose and direction.
• Inspirational leaders
• Communicate formally and reinforce
  systematically the belief system
• Control human behavior

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How to Manage Strategic Risk

• Setting Boundaries
• Communicate specific risks to be avoided
• Define standards of business conduct for all
  employees
• Punish noncompliance with business conduct codes
• Implement Internal Controls
• Structural safeguards ensure clear definition
  of authority for individuals handling assets and
  recording accounting transactions.
• Systems safeguards ensure adequate procedures
  for transaction processing.
• Staff safeguards ensure that accounting and
  transaction-processing staff have the right level
  of expertise, training and resources.

65
Simons, Chapter 14 Levers of Control for
Implementing Strategy
Lever Strategy Communicate Assets
Function Of control Belief
Perspective Vision Core values
Grand purpose Boundary Position
Strategic Risks to avoid Limit freedom

domain Diagnostic Plan Plan
and Critical perfor- Implement
goals
mance variables strategy Interactiv
e Pattern Strategic
Strategic Emergent of
action uncertainties uncertainties
strategy