Accounting, Organizations andSociety, Vol. 15, No. 112, pp. 127-143, 1990. 0361-36B2/90 t3.00+.00 Printed in Great Britain Pergamon Press plc

THE ROLE OF MANAGEMENT CONTROL SYSTEMS IN CREATING COMPETITIVE ADVANTAGE: NEW PERSPECTIVES*

ROBERT SIMONS Harvard University Graduate School of Business Administration

Abstract

For the last two decades, management control systems have been conccputaIized in terms of implementing a firm’s strategy. This view falls to recognize, however, the power of management control systems in the strategy formulation process. Based on a 2 year field study, a new model is presented to show how interactive management control systems focus 0rganizatIonaI attention on strategic uncertainties. This process is examined in two competing Erms to illustrate how top managers use formal systems to guide the

emergence of new strategies and ensure continuing competitive advantage.

We know surprisingly little about the effects of strategy on management control systems or, alternatively, about how these systems affect strategy. How do top managers actually use plan- ning and control systems to assist in the achieve- ment of organizational goals? What formal pro- cesses are emphasized at top management levels where responsibility rests for strategy formula- tion and implementation? Does the strategy of the firm affect the administrative systems used to set competitive policies?

Most writing on this subject has been norma- tive and not based on analysis of organizational practices; as a result, the function of manage- ment control described in accounting literature has changed little since Anthony ( 1965) defined management control in terms of assuring that or- ganizational objectives are achieved. During the 1960s and 1970s researchers built on Anthony’s work and that of others by attempting to develop the best way to design and use formal systems to help organizations implement their strategies and objectives.

Meanwhile, new directions were emerging in the strategy field. While early normative

research had focused on the processes used by managers to develop successful strategies, descriptive research in the 1970s and early 1980s began to identify patterns and com- monalities in the ways that firms compete in dif- ferent industries (e.g. Mint&erg, 1973a; Utter- back & Abernathy, 1975; Miles & Snow, 1978; Porter, 1980). The identification of patterns in strategic activity posed a new question for man- agement control researchers: what is the rela- tionship, if any, between the way a firm com- petes and the way that it organizes and uses its management control systems?

The few recent studies that have addressed this question indicate that there are systematic differences in management control systems among firms that compete in different ways (e.g. Miller & Friesen, 1982; Govindarajan & Gupta, 1985; Simons, 1987a). But these large sample, cross-sectional studies reveal little about the process of management control in these firms. The studies begin to provide answers to “how” management control systems differ among firms, but not to “why” they differ.

As part of a broader research program

*For comments on an earlier draft of this paper, I wish to thank my colleagues Robert Anthony, Chris Argyris, Joseph Bower, C. Roland Christensen, Evelyn Christiansen, Robert Eccles and Howard Stevenson. I also thank the participants of the Harvard Business School Control Workshop, especially Charles Christenson, Rajib Doogar, Julie Hertenstein, Robert Kaplan, Jean- Francois Manzoni, Kenneth Merchant and Richard Vancil. Last, but not least, I thank Anthony Hopwood for encouragement and suggestions.

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128 ROBERT SIMONS

(Simons, 1987b,c), the present study seeks to address this question directly by focusing on managementprocess as it relates to management control and strategy. The familiar normative approach to management control describes a feedback process of planning, objective setting, monitoring, feedback and corrective action to ensure that outcomes are in accordance with plans. Two attempts have been made in the past to link this framework with strategy. The first is Anthony’s ( 1965, 1988) - strategies are taken as given and management control systems moti- vate, monitor and report on their implementa- tion. Another attempt to couple strategy and management control can be seen in the concept of strategic control. Strategic control has been described as a system to assess the relevance of the organization’s strategy to its goals, and when discrepancies exist, to highlight areas needing attention (Lorange & Scott Morton, 1986, p. 10). Although strategic control has been identified as an important topic of strategic management (Schendel & Hofer, 1979, p. IS), the area has yet to generate a vigorous research program (Shrivastava, 1987). This failure is due in part to a lack of understanding of the relationship between management control systems and strategy.

The view of management control presented in this paper differs from the traditional tiame- work. My research indicates that management control systems are not only important for strategy implementation, but also for strategy formation. I define management control sys- tems, therefore, to recognize that these systems are more than devices of constraint and moni- toring: management control systems are the formalized procedures and systems that use in- formation to maintain or alter patterns in organi- zational activity. Using this definition, these sys- tems broadly include formalized procedures for such things as planning, budgeting, environmen- tal scanning, competitor analyses, performance reporting and evaluation, resource allocation and employee rewards (Simons, 1987a).

Although most strategy theorists correctly recognize that strategy formulation and strategy implementation are interrelated ( Andrews,

1980, p. 24) researchers still tend to conceptu- ally separate strategy implementation from strategy formation. This split has contributed to a lack of understanding of the nature of manage- ment control. Separating strategy formulation and implementation results in an artificial dichotomy that equates strategic planning with formulation and management control with im- plementation. The findings from the current study underscore the shortcomings of this ap- proach by demonstrating the power of manage- ment control systems in empowering organizational learning and interactively inllu- encing strategy.

I have three objectives in the discussion to follow. The first is to review the limited cross- sectional studies that have uncovered systema- tic relationships between management control systems and a firm’s strategy. This literature suggests that the identification of these patterns remains an important agenda for management control research. Second, based on extensive field research, a dynamic process model is intro- duced to describe the use of management con- trol systems at the top level of the firm. In this model, systems are used by top managers to set agendas for the discussion of uncertainties that arise as the firm attempts to create competitive advantage. Management control systems are used not only to monitor that outcomes are in accordance with plans, but also to motivate the organization to be fully informed concerning the current and expected state of strategic uncer- tainties. This general model may provide insight in explaining the fragmented relationships noted in previous empirical studies. Finally, a research agenda is outlined that may provide further knowledge about the relationship between management control systems and strategy. This leads to a discussion of some of the methodological issues that have to be addressed in future research.

STRATEGY, COMPETITIVE ADVANTAGE AND MANAGEMENT CONTROL

Before attempting to discuss the relationship

CREATING COMPETITIVE ADVANTAGE 129

between management control and strategy, we must Rrst differentiate among a number of inter- related concepts in the strategy literature: strategy as process, strategy as competitive posi- tion, strategy at the business level and corporate strategy.

Strategic process describes the managerial activity inherent in shaping expectations and goals and facilitating the work of the organiza- tion in achieving these goals. Many inlluential writers from Barnard (1938) through Andrews ( 1980) have considered how business leaders should manage organizational processes to gain competitive advantage.

A firm’s strategic position, by contrast, refers to how the firm competes in its markets, i.e. the product and market characteristics chosen by the firm to differentiate itself from its com- petitors and gain competitive advantage. Unlike the process analysis, the positional approach examines the strategic choices made by firms in- dependent of the management process by which those choices were made; patterns in business unit strategic action are the unit of analysis.

Patterns in strategic actions have been iden- tified at both the business level and the corpo- rate level of the firm. Business strategy refers to how a company competes in a given business and positions itself among its competitors (Andrews, 1980, p. IS). Defining strategy as pat- terns of action (Mintzberg, 1978; Mintzberg & Waters, 1985), this vein of research has de-em- phasized the link between observed strategies and prior, explicit managerial intentions. Re- search has concentrated instead on uncovering recurring patterns in the way that firms deliver value to customers.

These recurring patterns have been identified empirically and clustered into strategic archetypes (Table 1 provides a summary of four illustrative studies that identify and describe strategic archetypes).’ Strategic archetypes de- monstrate that Rrms can compete successfully in a variety ofways: for example, superior value can be offered to customers through new product

features, high service levels, outstanding quality or low cost (Porter, 1985).

Other research has investigated patterns in strategic activities at the corporate level of diversified firms. Corporate strategy is con- cerned with determining what business(es) the organization chooses to compete in and the most effective way of allocating scarce resources among business units (Schendel & Hofer, 1979, p. 12). Patterns have been identified using typologies that describe the operating and financial characteristics of the divisions in diver- sified firms. These typologies are exemplified by the portfolio approach to corporate strategy popularized by U.S. consulting firms in the 1970s and reviewed in Hamermesh ( 1986, pp. 9-l 7).

The research discussed in this paper focuses on the relationship between business strategy (i.e. how a firm achieves competitive advantage) and the Rrm’s use of management control systems. The analysis considers the importance of both strategic process and strategic position in understanding the role of formal systems. The relationship between control and corporate strategy, while not a focus of this research, is addressed briefly in the conclusion of the paper.

Previous studies of strategy and management control

If firms compete in identifiable but different ways, e.g. low cost or product uniqueness, what are the opportunities to design management control systems in accordance with the strategy of the firm? Three strategy researchers, Miles & Snow (1978) and Porter (1980), for example, agree that overall cost leadership and Defender strategies require sophisticated cost controls. Other than this simple observation, the strategy studies that have identified strategic archetypes offer little insight into how management control systems might be designed in different strategic situations.

Studies in other areas, however, are beginning to illustrate how these systems may difFer among Rrms following different strategies. Khandwalla

’ Other studies that have attempted to identify strategic archetypes include Miller & Friesen ( 1978), Wissema eta!. (1980). Galbraith & Schendel ( 1983) and Herbert & Deresky (1987).

130 ROBERT SIMONS

TABLE 1. Illustrative studies of strategic archetypes

Study IdentiEed archetypes Features

Mintzberg( 1973a)

Utterback & Abernathy

(1975)

Miles & Snow ( 1978)

Porter ( 1980) Overall cost leadership

Entrepreneurial

Adaptive

Planning mode

Performance-maximizing

Sales-maximizing

Cost-minimizing

Defender

Prospector

Analyzer

Reactor

DIIferentiation

Focus

(1972, 1973) in the first study of its kind, focused on the relationship between formal accounting-based control systems and the type of competition in an industry. He concluded that increased competition leads to increased use of management control procedures. This relation- ship was strongest for product competition, moderate for marketing competition and weakest for price competition. This study, like others focusing on the relationship between for- mal control systems and external environments of the firm (e.g. Gordon 81 Narayanan, 1984; Ewusi-Mensah, 1981; Hedberg 81 Jonsson, 1978), did not consider the strategies of the

Opportunity seeking founding CEO, bold decisions, growth- oriented, high uncertainty. I Reactive, incremental goal setting relative certainty in

decision-making. Analysis dominates decisions, integrated strategies, placid

environment.

Uncertain environment, offers unique products, searches for

new opportunities. Standardized products, more stable environment, high level of

competition, some product differentiation.

Standard product, extreme price competition, high efficiency, low innovation, sophisticated control techniques.

Stable environment, limited product range, competes through low cost or high quality, efficiency paramount, centralized structure. Always seeking new product and market opportunities, uncertain environment, flexible structure.

Hybrid. Core of traditional products, enters new market after viability established, matrix structure. Lacks coherent strategy, structure inappropriate to purpose, misses opportunities, unsuccessful.

Low price, high market share focus. Standardized product, economies ofscale, tight cost control. Product uniqueness brings brand loyalty, emphasis on marketing and research. Focus on defined buyer group, product line or geographic

market. Niche strategy.

firm, but did suggest that control system design was sensitive to the way that the firm competes.

Miller & Friesen ( 1982) studied the relation- ship between two strategic archetypes, which they labelled “entrepreneurial” and “conserva- tive”, and the use of control systems.’ The firms in their sample were split into two strategic groups based on ratings of innovation and risk taking. The conservative subsample possessed many of the attributes of Miles & Snow’s ( 1978) “Defenders” and Mintzberg’s (1973a) “Adap- ters”: low differentiation, homogeneous markets and stable environments. The second subsample was the entrepreneurial firm, similar to Miles &

’ In the Miller & Friesen ( 1982) study, “controls” was a single variable among a set of 13 variables. The 13 variables measured organizational attributes such as environment, information processing, structure, and decision making. The “controls” variable was calculated by averaging the scores of sbt Likert-type scales that related to the comprehensiveness of controls, and the use of cost and profit centers, statistical quality control practices, variance analysis and formal personnel appraisals.

CREATING COMPETITIVE ADVANTAGE 131

Snow’s “Prospector” and Mintzberg’s “Entrep- reneurial” firms. These Brms experienced more hostile environments and competed through product diReren&tion.

Miller & Friesen’s analysis indicates that the strategy of the firm a@ects the way that manage- ment controls are used to either encourage or discourage innovation. Control was positively correlated with innovation for conservative firms and negatively correlated with innovation for entrepreneurial firms. The authors specu- lated that conservative firms use formal control systems to signal market opportunities an&or declining results; as a result, innovation in- creases. For entrepreneurial firms, however, control systems flag innovative excess and result in less innovation.

Govindarajan 81 Gupta ( 1985) studied the re- lationship between corporate strategy and one aspect of management control - bonus remun- eration. The research focused on corporate- level, portfolio strategies in diversified firms (e.g. build market share, maximize cash flow, prepare to liquidate business). Govindarajan & Gupta concluded that long run evaluation criteria and subjective, non-formula bonus calculations are effective for businesses follow- ing a “build” strategy, but detrimental to busi- ness units pursuing a “harvest” strategy.

Building on the Miles & Snow (1978) typol- ogy, Simons ( 1987a) studied firms classified as either Prospectors or Defenders to determine whether management control systems differ between the two groups. Using concepts de- rived firorn the management control literature, factor analysis was used to reduce questionnaire scales to ten dimensions of management con- troL3

Statistical analysis and interview data indi- cated that control systems differ systematically between Prospector and Defender firms. Successful Prospectors use a high degree of fore- cast data in control reports, set tight budget

goals and monitor outputs carefully. Cost con- trol is reduced. Moreover, large Prospectors em- phasize frequent reporting and use uniform con- trol systems that are modified frequently. These results led to speculation that Prospectors use their mangement control systems intensively to monitor uncertain and changing environments. Defenders, by contrast, use management control systems less actively. Negative correlations were calculated between profit performance and attributes such as tight budget goals and the monitoring of outputs. Defenders, operating in stable environments, emphasize bonus remun- eration based on achieving budget targets and report little change in their control systems over time.

A CLOSER LOOK AT STRATEGY AND MANAGEMENT CONTROL SYSTEMS

The studies cited in the preceding section suggest that there is a link between the way that Erms achieve competitive advantage and the design and use of their management control sys- tems. Little is known, however, about how this association should be conceptualized to in- crease our knowledge and improve our predic- tive ability.

The research which provides the basis for the present analysis, conducted over a 2 year period, focuses on the use of management control sys- tems by top management - those responsible for ensuring that strategies are formulated and implemented. (In some organizations, top man- agement refers to one individual; in large com- plex organizations, top management commonly refers to an operating committee, comprising heads of businesses or sectors, chaired by a CEO.) The concepts and model presented in the paper were developed during a series of field studies in a single U.S. industry. The first stage of the project involved in-depth interviewing and

S The ten factors developed and used in the Simons ( 1987a) study were tightness ofbudget goals, extent of external scanning, monitoring of results, use of cost control, use of forecast data, extent to which goals relate to output measures, reporting frequency, use- of formula-based remuneration, extent to which controt systems are tailored and the degree of changeabiky of control systems.

132 ROBERT SIMONS

document review in three competing com- panies in this industry. The concepts reported in this paper were developed from this work and were then tested by expanding the sample to in- clude an additional 13 firms in the industry. In all, over 70 interviews (augmented by reviews of relevant documentation and, in some cases, observations of company meetings) with top managers, each of approximately 2 hours dura- tion, were conducted in the sixteen firms that agreed to participate in the study.

The subsequent analysis focuses on how two competing firms in this industry organize their management control systems at top manage- ment levels. The strategy of each firm is described followed by a brief overview of selected aspects of their management control systems. The control system aspects described are those identified by top managers of these firms as important to the way they manage their business. If a particular aspect of management control was identified as important by the mana- gers in one firm, then a description is also pro- vided of how the competing firm uses this aspect of management control. After this brief descrip- tion, a conceptual model is presented to explain the differences in control system configuration between the two firms.

Company A and company B compete in the same industry; each company employes over 30,000 people and both companies are success- ful. Over the last 10 years, both companies have recorded compound growth rates of approxi- mately 10% in sales and earnings and each has outperformed industry averages in terms of growth in sales, earnings, and cash flow. The shares of both company A and company B are rated by market analysts as high quality invest- ments. Each company, however, follows a distinctly different strategy.

Company A competes in its various markets through cost leadership and customer service. Its products are a diverse group of well-known, mature products concentrated in high volume, low price categories. The company specializes in offering products that heighten efficiency and cut costs for the customer. Some of its inter- mediate products are licensed from com-

petitors. Compared to competitors, the com- pany has done historically little R&D (approxi- mately 4% of sales in 1986) and is ranked as the lowest R&D spender in the industry.

“We are now definitely the low-cost producer in the markets we serve,” observes the CEO of company A. “However, once in a while, by seren- dipity, we come across something promising. We have a habit of seizing on products the pack has scored”. Company A rarely introduces revo- lutionary new products, although existing pro- duct features evolve over time to take advantage of new technology and perceived customer needs. In terms of the strategic archetypes described in Table 1, company A might be described as a “Defender” (Miles & Snow, 1978) an “Adaptive firm” (Mintzberg, 1973) an “Over- all Cost Leader” (Porter, 1980) or as a “Cost- Minimizing” firm (Utterback & Abernathy, 1975).

The company is organized into approximately 100 divisions which are grouped into four major sectors. Business Week magazine reports that company A is “considered to be one of the best- managed firms in the industry.”

In contrast, company B competes through product inovation and marketing. Its products are premium priced and have advanced features. Products are developed internally and the features of most products are updated and improved on a regular basis. Marketing is inten- sive, using both media and sales representatives. The company has been successful in developing new markets through research-based product development. The company is widely regarded within the industry as an innovation leader. Most of the company’s R&D effort is concentrated on product development; in 1986 company B spent approximately 10% of sales on R&D, making it the largest spender on R&D in its industry.

Company B differentiates its products on quality and innovativeness. The company at- tempts to achieve market leadership by aggres- sively marketing new products and enhancing its leadership image. Since it is often developing new markets, it competes in rapidly changing environments. Its Statement of Strategic Direc- tion states, in part, “We are dedicated to profita-

CREATING COMPETITlVE ADVANTAGE 133

ble high growth. To achieve this, we must be well positioned in growth markets. Each management must be aggressively innovative, willing to take risks, and strive to grow faster than the markets in which it competes”. This company could be described as a “Prospector” (Miles & Snow, 1978) a “Differentiation firm” (Porter, 1980) “Performance-maximizing” (Ut- terback & Abernathy, 1975), or “Entrepreneu- rial” (Mintzberg, 1973).

The company is decentralized. It is structured into three sectors with over 100 operating com- panies worldwide that manufacture and seiI over 20 basic product categories. Fortune magazine’s annual survey recently rated this company as

one of the most admired companies in America.

Management control systems in the two companies

Given that these two highly-regarded com- petitors follow different strategies, what are the differences in the way they organize their man- agement control systems? Companies of this size and complexity are bound to have many differ- ences; the analysis is limited, therefore, to the use of management control systems at top man- agement levels, since it is this group of individu- aIs that has ultimate responsibility for strategy making and implementation. At this level, the differences in management control systems

TABLE 2. Comparison of competitive characteristics and top-level management control systems used at two companies

Company A

Competitiw characteristics

Miles&Snow ( 1978) Defender Mintzberg( 1973a) Adaptive

Porter ( 1980) Overall cost leader

Management control systems at top management levels

1. Strategic planning review

2. Financial goals

3. Budget preparation and Review

4. Budget revisions and updates

5. Program reviews

6. Evaluation and reward

Sporadic. last update 2 years ago. Does Intensive annual process. Business mangers not motivate a lot of discussion in the prepare strategic plans for debate by top company. management committee.

Set by top management and communicated down through organiization.

Established by each business unit and rolled up after a series of review and challenge meetings.

Budgets prepared to meet financial goals. Budgets coordinated by Finance Dept and presented to top management when assured that goals will be met.

Not revised during budget year

Intensive monitoringofproduct- and process-related programs. Programs cut across organizational boundaries and affect aii layers of company.

% of bonus based on contribution to generatingprofit inexcessofplan. % based on personal goals (usuaily quantified).

Company B

Prospector

Entrepreneurial Differentiation

Market segment prepares budgets with focus on strategy and tactics. Intensive debate at presentations to top mangement committee.

Business units rebudget from lowest expense levels three times during year with action plans to deal with changes.

Programs limited to R&D which is delegated to local operating companies.

Bonus based on subjective evaluation of effort. MB0 system used throughout organization.

134 ROBERT SIMONS

between the two fhms (highlighted in Table 2) are striking.

Company A Company A has a S-year strategic plan that has not been revised for over 2 years. The plan is prepared by operating managers with the assistance and coordination of head office staff groups and presented to the top managers who comprise the Office of the Chief Executive (OCE). These managers report that the plan is for informational purposes and is not used actively in running the business.

Based on prior operating performance and market expectations, profit goals are established each year by the CEO and President of company A and communicated to division heads. Each division then prepares an annual budget to meet these goals. After the finance department verifies that the consolidated budget will meet corpo- rate profit goals, the completed budgets are sub- mitted to top management for approval. Annual budget presentations to top management are characterized by the CEO as “show and tell”; problems and issues have been identified and worked out in person with the CEO and Presi- dent prior to the meetings. Once approved, budgets are never changed.

Budget reviews by top management during the year are limited to monthly reports to the OCE of sales, gross margin percentages, total operating expenses, tax rates and earnings per share.

Top management pays extremely close atten- tion to a series of ongoing programs: these programs are established for the review of new product technologies, changes in existing pro- duct features and a variety of “value improve- ment” efforts. Since programs are designed to explore new ways of doing things, they often cut across organizational boundaries and involve many people at different levels of .the company.

Each program is reviewed regularly (at least once every 6 weeks and often more frequently) using formal reports and presentations to the highest level of management. Coals are estab- lished for all individuals working with each pro- gram and achievement against goals is measured on a regular basis. The ongoing review process

generates product and process ideas throughout the organization that are tested and ultimately implemented. New programs are often estab- lished from ideas generated during existing program review.

Bonuses at company A are received by a relatively small group of middle and senior man- agers (the management group eligible for bonuses is 2.5% of total employees). Bonuses range from 15% to 50% of salary and are allo- cated to employees based on corporate perform- ance against budget (‘A), operating unit per- formance against budget ($4) and individual ob- jectives that are negotiated with superiors (1/3).

Company B. Company B invests heavily in long range planning. All planning, however, is done by operating managers; there are no plan- ning staff groups. Long range plans are based on 5 and 10 year forecasts and are updated each year by comparison with the plan prepared the year before. All changes in estimates require proposed tactics to deal with the changed environments. Included in the plans for each operating company are forecasts of competitive environments, pro formu income statements by product category for each major competitor, as well as an analysis of each competitor’s per- ceived strategy.

Long range plans are debatetl heavily in the organization and must ultimately be sent, in summary form, to the CEO. The final debate and approval of long range plans takes place annually in an Executive Committee meeting which com- prises the CEO, President and key sector heads and company group chairmen.

In company B, budgets, as well as a second- year forecast, are prepared annually by operat- ing managers throughout the organization. Budgets are formally revised three times during the year; each revision requires a full re-estima- tion of all budget items and programs. Budgets are the focus of a great deal of debate among operating managers and are used, not as purely financial documents, but rather as agendas to discuss tactics, new marketing ideas, and pro- duct development plans throughout the organi- zation and ultimately at the top management

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level. To focus the debate on strategies rather than Bnancials, the plans and budgets are re- duced at the top management level to four num- bers only (estimated unit sales, revenues, net income and ROI) and to the tactics that will be used to achieve these numbers.

Profit goals are established on a bottom-up basis as managers throughout the organization set personal and business unit goals based on perceived corporate needs. These goals are challenged rigorously at all levels in the organi- zation during a series ofprofit planning meetings held at various times during the year. Once the review process at lower levels is complete, top management rarely makes a formal request to operating managers to reconsider their budget to deliver more profit.

Unlike company A, the use of programs is gen- erally limited to the R&D area, which is decentralized to operating companies. Programs are therefore managed at the local level and are not typically an agenda for top corporate man- agement.

Bonuses at company B are entirely subjective and are based on effort and innovation rather than performance against predetermined targets. Managers throughout the organization spend a great deal of time each year discussing and reviewing suggestions concerning approp- riate bonus levels for subordinates. Bonus recommendations for all managers with salaries in excess of $95,000 are reviewed by the Execu- tive Committee. Below the executive commit- tee level, all managers are eligible for annual bonuses, the amount of which is determined subjectively by operating company presidents. After bonuses have been awarded, the Executive Committee also uses a “post audit” to review the reasons for unusually high or low bonus awards throughout the organization. Through a special bonus plan for entrepreneurial accomplishment, the company distributes additional bonuses in excess of s 1 million annually; recommendations for these special bonuses, which typically repre- sents l&50% of an individuals salary, are re- viewed and acted upon by the Executive Com- mittee.

A PROCESS MODEL

Casual observation suggests that all large, complex organizations have similar types of management control systems. Short and long range plans, Bnancial budgets, capital budgets, variance analyses and project reporting systems are commonplace tools in virtually every large, professionally managed corporation. But the il- lustrative example presented above shows that there are distinct differences in the way that management control systems are used at top management levels in different firms. How can we explain the differences in management con- trol systems between company A and company B? How do these differences relate to their strategies?

The answer lies in how and why top managers choose to personally monitor certain manage- ment control systems and to delegate other aspects to subordinates. Four concepts are used to develop the model: limited attention of mana- gers; strategic uncertainties; interactive manage- ment control; and organizational learning.

Limited attention Interviews conducted during this research

reveal that managers have neither the time nor the capacity to process all the information avail- able to them. ‘Iwo concepts, well established in the literature, support this observation. First, managers are rational only within cognitive boundaries (Simon, 1957). Mind is a scarce re- source (Williamson, 1986, p. 5) and must be viewed as a constraint on the information pro- cessing capabilities of managers. Second, top managers must engage in many concurrent ac- tivities. Mint&erg ( 1973b) argues that top man- agers have ten working roles including that of figurehead, leader, liaison, monitor, dis- seminator, spokesman, entrepreneur, distur- bance handler, resource allocator and negotiator. Decision-related activities represent only a subset of the activities of top managers; interpersonal and informational roles are equally important.

The concept of limited attention has import- ant implications for management control. A

136 ROBERT SIMONS

multitude of activities demand attention - ap- pearing at outside functions, speeches to employees, reading reports, making and ratify- ing decisions, evaluating employees, planning for succession - and daily choices must be made. Thus, only limited subsets of the organiza- tion’s formal management control process can have the attention of top management; most areas of management control are delegated, by necessity, to subordinates.

Strategic uncertainties Because of these attention constraints, top

managers report that they implicitly rank the set of activities they monitor from most critical to least critical: this ranking allows top managers to attend to strategic uncertainties-uncertainties that top managers believe they must monitor personally to ensure that the goals of the firm are achieved.4

Although firms competing in the same indus- try face the same set of potential uncertainties (changes in government regulation, intensity of competition, advance of new technologies, nature of customers and suppliers, product life cycles and diversity in product lines), the strategy of the firm strongly influences which uncertainties are critical to the achievement of chosen objectives.5 For example, managers in company A believe that they can only sustain their low cost position if their products evolve to offer superior efficiency to users. The strategic uncertainties that top managers in company A monitor personally, therefore, relate to potential changes in product technology that yield superior cost-in-use benefits to customers.

Although company B faces the same set of po- tential uncertainties as company A, its strategy has resulted in diiferent strategic uncertainties. Top managers in this firm monitor the choice of appropriate competitive responses for its vari- ous operating companies that compete through

aggressive marketing tactics and new product introductions.

Interactive management control Top managers must decide which aspects of

management control systems to use inter- actively and which aspects to program (Simons, 1987b). Management controls become inter- active when business managers use planning and control procedures to actively monitor and intervene in ongoing decision activities of sub- ordinates. Since this intervention provides an opportunity for top management to debate and challenge underlying data, assumptions and action plans, interactive management controls demand regular attention from operating sub- ordinates at all levels of the company. Program- med controls, by contrast, rely heavily on stti specialists in preparing and interpreting infor- mation. Data are transmitted through formal reporting procedures and operating managers are involved infrequently and on an exception basis.

Modern companies have many different types of management control systems. How do top managers decide which systems to make inter- active and which to program? Top managers will choose to make a management control system interactive if the system collects information about strategic uncertainties. The selected inter- active system can then be used by top managers for three functions: signalling, surveillance and decision ratification.

Signalling is the use of information to reveal preferences (Spence, 1974; Meyer, 1979). Signalling is necessary since top managers can- not always know when or where the impetus for important policy decisions will originate, how or why a decision will be made, or by whom. The decision process is diffuse with inputs from multiple actors over a protracted time period (Pinfield, 1986; Leifer & White, 1986; Burgel-

4 Strategic uncertainties are different than the concept of critical success factors that was popularized by business consultants in the 1960s and is taught in business schools today (Daniel, 1966). Critical success factors are the distinctive competencies that the firm must possess to sustain current competitive advantage (e.g. manufacturing efficiency for a strategy ofoverall cost leadership; research and development productivity for a strategy of new product introduction).

’ A critical uncertainty for all firms is the ability to internally generate profit to provide resources to fund business strategies (Donaldson, 1984, p. 12). Thus, top managers always monitor personally the profit-generating ability of the firm.

man, 1983; Mintzberg et al, 1976; Cohen et al., centives to produce and share information. 1972). For this reason, top managers do not Moreover, this focusing of organizational atten- know ex ante, and often not even expost, who in tion and the interactive exchange of information the organization initiates and fosters important stimulates learning throughout the organization policy decisions. By using interactive manage- about the strategic uncertainties that are per- ment controls to monitor stratagic uncertain- ceived by top management. By focusing atten- ties, top managers reveal their values and prefer- tion throughout the organization, top managers ences to the many individuals in the organiza- use interactive management control to intlu- tion who have input in decision processes. ence and guide the learning process - under-

Surveillance is the search for surprises; inter- standing that individual ideas and initiatives will active management controls provide guidance emerge over time in unsystematic ways. By em- to organizational members as to where to look phasizing select management controls and mak- for surprises and what types of intelligence infor- ing them interactive (and programming and de- mation to gather. Feldman & March ( 1981) legating others) top managers ensure that the or- describe this function: ganization is responsive to the opportunities and

threats that the firm’s strategic uncertainties pre- Organizations, as well as individuals, . . . gather informa- sent. tion that has no apparent immediate decision conse- quences. As a result, the information seems substantially

The four concepts presented above can now

worthless within a decision-theory perspective. The per- be summarized and integrated: the intended

spective is misleading. Instead of seeing an organization business strategy of a firm creates strategic un-

as seeking information in order to choose among given al- certainties that top managers monitor. While all ternatives in terms ofprior preferences, we can see an or- large companies have similar management con- ganization as monitoring its environment for surprises (or for reassurances that there are none). The surprises’

trol systems, top managers make selected con-

may be new alternatives, new possible preferences, or trol systems interactive to personally monitor

new signilicant changes in the world (p. 176). the strategic uncertainties that they believe to be critical to achieving the organization’s goals.

Finally, decision ratification by top managers The choice by top managers to make certain

(as distinct from decision making) is necessary control systems interactive (and program

when any strategic policy decision commits the others) provides signals to organizational par-

organization and its resources (Mintzberg, ticipants about what should be monitored and

1973b, p. 87; Bower, 1986, pp. 64). Interactive where new ideas should be proposed and tested.

management controls allow top managers to be This signal activates organizational learning and,

fully informed about such decisions throughout through the debate and dialogue that surrounds

the organization. the interactive management control process, new strategies and tactics emerge over time.

Organization learning The recursive nature of the model (Fig. 1)

The final concept needed to complete the illustrates why management control systems

analysis is organizational learning. Organiza- should be considered as an important input to

tional learning describes the ways that organiza- strategy formation. We know that strategies can

tions adjust defensively to reality and use know- be both intended and emergent (Mintzberg,

ledge to improve the fit between the organiza- 1978). This model illustrates, moreover, that

tion and its environment (Hedberg, 198 1, p. 3). emergent strategies can be intluenced and man-

Comprehensive reviews of the concept of or- aged - serendipity can be guided by top mana-

ganizational learning are found in Argyris & gers who use formal process to focus organiza-

Schon ( 1978) and Fiol & Lyles ( 1985 ). tional attention and thereby generate new ideas,

I have argued that the personal involvement of tactics and strategies. Management control pro-

top managers, the defining characteristic of cesses, which have been characterized solely as

interactive control, influences strongly the in- tools for implementing goals, can be instrumen-

CREATING COMPETITIVE ADVANTAGE 137

138 ROBERT SIMONS

Business

strategy *-

Strategic

Uncertainties

4

low end-use cost: new, more efficient product technologies of competitors and changes in buyer needs are potential threats.

I

Organizational

Learning

l

Choice of Interactive

Management Control Systems

bv Top Management

Fig. 1. Process model of relationship between business strategy and management control systems.

tal in allowing the organization to learn and adapt over time.

Applying the model Since company A and company B compete in

the same industry, each firm faces the same set of potential uncertainties (Fig. 2). From this set of potential uncertainties, top managers of each firm have identified strategic uncertainties that relate to their company’s individual strategy. From interviews at company A, it is clear that top managers believe that the major strategic un- certainty facing the firm is new product technologies or attributes that could shift exist- ing low cost advantage. They recognize that company A’s success derives from continually providing customers with products that offer

To manage these strategic uncertainties, top management has made a limited subset of man- agement controls interactive and programmed other controls. The program review system, which operates from the lowest organizational level to the CEO’s office, is an example of an interactive management control system that is a major information source for both top manage- ment and all operating managers in the com- pany. Programs focus on ways to improve value for customers (“cost improvement with equal or better quality”), new technologies that build on existing product lines and product enhance- ments to help customers be more efficient. Pro- grams typically have the potential of affecting a wide range of the company’s products and there- fore cut across formal organizational bound- aries.

Managers in company A know, by the em- phasis that top management puts on the review of selected programs, which aspects of the busi- ness are considered critical to long term organi- zational success. For each program, information is continually gathered throughout the organiza- tion, agendas are set to review progress and new information, and changes and surprises are rapidly communicated. The organizational

Comp*nv

Intwactiv. strategic Managwnent

UllCWtWti~ Controls

A Customer Service

‘Diffusion of proprietary knowledge Internal product innovation Newtechnology

Mark&g innovations Buyer learning

‘Productintroductionsin adjacent industries lndustrv volume Scale effects Input costs

.Process innovation New industry entrants

~Government/regulatory action

Timing of new product Tactical planning

introductions. and budgeting

I Market tactics of - Subjective rewards

Employee actions I 1

L-w-_-- ____ -__a I 1 competitors. I

I

New competitor products ‘Chanaesinbuvertastes

Fig. 2. Summary of interactive process model in two firms.

CREATING COMPETITIVE ADVANTAGE 139

learning engendered through the interactive management control system is a powerful intIu-

ence on strategy making. The CEO of company A described how new

strategies emerge from the process, “I really work those programs. Everyone understands how important they are. New initiatives are not decided as part of the planning process, but as part of the program review process. The Capital Expenditure Committee is not doing strategic thinking about programs - they just say “yes” when a proposal is developed out of a program review and someone comes to them asking for money. In fact, many of our new programs arise out of the review process. As we sit and discuss these things, someone will have a bright idea for product enhancement or a new way of doing something. This often leads to new programs which can eventually take us into new technologies or open up a whole new group of products.”

Top management at company A pays little day- to-day attention to aspects of the firm’s manage- ment control systems that do not relate to strategic uncertainties. Long range planning is programmed and is not an agenda item for top management: strategies throughout the Iirm are clear and consistent. Profit planning and budget- ing, an annual event orchestrated by staffdepart- ments, are not interactive because the environ- ment is relatively stable and well understood; top managers do not need to rely on these systems to motivate the organization to con- stantly scan changes in the market. The rewards system is also programmed since bonuses are de- termined largely by reference to quantitative targets and require minimal attention from top management. Even aspects of management con- trol systems that are associated with the success of current strategies, i.e. so-called “critical suc- cess factors”, are programmed and delegated to staff specialists.

The programming of critical success factors is apparent in the way that top management at company A deal with manufacturing and logisti- cal operations - clearly critical success factors for this low cost producer. Every Wednesday at 10:00 a.m., a 20 minute meeting is held with 15

key managers, chaired by a member of the top management group. Conversation focuses on one sheet of paper that reviews twelve product categories in terms of unit sales, inventory levels, backorders, service levels and quality control release times - all against target. The chairman described the meetings, “we run the day-to-day operations by focusing on things off track If there is a problem, the individual had better have the answer before he walks in. In this way, we can review the entire business in twenty minutes each week. We have become very good at understanding what we were looking at so we can just do it.”

Because company B follows a diRerent strategy, its top managers focus on digerent strategic uncertainties. By competing through

product innovation rather than price and effi- ciency, top managers want their organization to focus on marketing tactics that can exploit new product development and thereby build market share or open new markets. Top managers per- ceive strategic uncertainties that relate to the timing of new product introductions and the defensive actions of competitors. Accordingly, the top management of company B has chosen to make planning and budgeting highly interactive and tactical

The development and discussion of 5 and 10 year plans, for example, is an important agenda for top management and, by Implication, for all operating managers in company B. Each year, plans for each operating unit are revised with reference to the previous year’s plan; product life cycles are carefully monitored. All antici- pated changes are coupled with action plans that focus on marketing tactics and the timing of new product introductions - both strategic uncer- tainties for company B. These plans, which are based on environment, competitor and technol- ogy assessments, are prepared, challenged and debated over a period of several months each year by successive levels of operating managers until they are debated at the Executive Commit- tee level. Staff units play no role in this process. The highly interactive nature of long range plan- ning results in intense organizational learning about changes in the competitive product mar-

140 ROBERT SIMONS

kets and ideas on how to react offensively to these threats and opportunities. From these dis- cussions, new strategies emerge.

Top management has also made profit plan- ning and budgeting interactive at company B by focusing attention, almost continuously during the year, on budget changes and action plans to deal with changed conditions. Managers use this bottom-up process not as a financial exercise, but rather to set agendas to debate current and future product/market strategies in the com- pany’s changing markets. Budget discussions throughout the year revolve around unantici- pated changes in the competitive environment, marketing tactics to preempt competitor actions, and the type and timing of new product developments. Managers point out that they are planning and budgeting so frequently and with so much discussion about appropriate tactics and targets that it is unnecessary to formally issue corporate goals. One top manager elabo- rated, “the feeling that we are forever planning is due to the fact that you never have the luxury of putting the plan on a shelf- it forces you to con- tinually look at your mistakes and learn how to do better next time.”

The reward system at company B has been made interactive and thus also demands a great deal of attention from managers throughout the organization. Managers cannot rely on a formula, but must rather attempt to subjectively assess each individuals contribution in rapidly chang- ing market environments. Rewarding effort rather than results requires evaluators to under- stand competive business environments, poten- tial opportunities and constraints, and the range of action alternatives available to subordinate managers. This information gathering process generates learning about strategic uncertainties and about possible new tactics and strategies.

Like company A, the top managers at company B are not normally involved in controls that do not focus on strategic uncertainties. The review of detailed cost information is programmed and is not an agenda for top management. Efficiency programs are typically overseen by staff groups. As a top manager stated, “I leave the analysis of variances, etc., to the financial people. I let them

bring any problems to me. I don’t check it or get involved in it myself.” Even programs for new product development, a critical success factor, are managed at the local operating company without regular attention Ram top mangement; given limited attention, top management chooses to focus instead on the strategic uncer- tainties that arise from the actions of com- petitors.

Managers in each of these firms have made certain management controls interactive and programmed others. This phenomenon is not limited to these two companies, but was ob- served also in the other 14 companies in the sample. One CEO captured the spirit of the phenomenon, “we can have all the formal pro- cesses in the world and some of these, frankly, I don’t give a damn about and others I do. And everyone understands the difference.”

DISCUSSION AND CONCLUSION

The model presented in this paper departs from the traditional analysis of “fit” between formal systems and critical success factors. In- stead, new concepts are introduced to link man- agement control systems with competitive ad- vantage. The research underscores the impor- tance of the dynamic relationship between for- mal process and strategy: competitive strategic positioning, management control and the pro- cess of strategy-making play one upon the other as the firm evolves and adapts over time. The analysis shows that interactive management control processes can be used to manage emer- gent strategy: rather than focusing on what the organization already understands and does well, these systems direct organizational attention to emerging threats and opportunities.

Theories of information provide additional perspective to the ideas presented in this paper. Language theorists differentiate between rules that constrain and those that open up new realms of activity (Campbell, 1982, p. 128). The latter type of rule is capable of generating vari- ety, novelty, and surprise. This distinction is analogous to that between programmed and

CREATING COMPETITIVE ADVANTAGE 141

interactive controls. Campbell (1982) illus- trates the power of fixed rules in producing un- predictable amounts of complexity as informa- tion and meaning is generated. The necessity of structure to produce meaning a concept funda- mental to theories of information and language, is echoed in the way that managers use struc- tured, formal process interactively to motivate organizational learning. “Structure and free- dom,” summarizes Campbell, “like entropy and redundancy, are not warring opposites, but com- plementary forces” (p. 264).

Top managers use formal process to gain maximum advantage from these forces. These managers know that decisions and actions affect- ing current strategies will emerge from all corners of the organization; their primary job is to provide guidance, resources and incentives to motivate the organization to gather and inter- pret new information so that the organization can respond and adapt. Energy is channelled and directed by the interactive process; formal man- agement control systems provide a common language. The organization is energized: momentum is created to exploit existing strate- gies and to anticipate strategic uncertainties. In- formation is shared and interpreted. Action plans are tested. New strategies emerge.

Our analysis suggests that caution is necessary in interpreting previous studies that have focused on strategy and control. Cross-sectional studies such as Khandwalla ( 1972, 1973) and Miller & Friesen ( 1982) were conducted using a single measure for control that was computed as the simple average of the importance of various aspects of a firm’s administrative controls system. Thus, scores to represent the use of cost control and variance analysis, formal appraisal of personnel, capital budgeting techniques and flexible budgeting were averaged to produce one summary index. The process model developed here, however, suggests that it is not the mean value that is of importance, but rather the distribution of management attention among the various control subsystems.

Studies that have decomposed control sys- tems into constituent elements support the process model presented in this paper. Govin-

darajan & Gupta (1985) noted that subjective bonus systems were beneficial for emerging businesses following “build” strategies, but de- trimental to businesses in a “harvest” mode. Interactive reward systems based on subjective evaluation of effort are appropriate for firms that need to motivate organizational learning in rapidly changing environments and where re- warding team effort is important - typical con- ditions of firms in a growth phase. This approach is costly, however, and generally uneconomic for businesses in slow decline.

Simons ( 1987a) found that Prospectors gen- erally use a lot of forecast data, set tight budget goals, monitor outputs carefully and emphasize frequent reporting with uniform control sys- tems. Like company B, the prototypical Prospec- tor faces strategic uncertainties owing to rapidly changing product or market conditions; inter- active management control systems such as planning and budgeting are used to set agendas to debate strategy and action plans in these rapidly changing conditions. Defenders, by con- trast, use planning and budgeting less inten- sively. Like company A, which operates in a rela- tively stable environment, many aspects of the business that are important in terms of current competitive advantage are highly controllable and managers need only focus on strategic un- certainties - often related to product or technological changes that could undermine current low cost positions.

Further research must also be sensitive to the unit of analysis. This study has focused on busi- ness strategy. But what are the process relation- ships between management control systems and corporate strategy? Recently, the portfolio man- agement approach that has been the corner- stone of corporate strategy has been strongly criticized (Porter, 1987). The ability of diver- sified firms to add value through portfolio tech- niques is argued to be increasingly limited in today’s efficient capital markets. In terms of the process model presented here, a strategic uncer- tainty for the diversified firm is the appropriate allocation of resources among diverse business units. Given the scarce attention of top mange- ment, focusing attention on portfolio allocations

142 ROBERT SIMONS

may limit the attention that can be accorded to business-related aspects of management control to the detriment of organizational learning and effective strategy making.

This research offers a new perspective for un- derstanding how and why firms make the design choices that we observe in practice. But there are many other questions to be answered. How do managers identify strategic uncertainties? What types of interactive management controls’ are used by managers in different organizations? Do patterns exist among firms following similar strategies? Are strategic uncertainties unique to each tkn or do patterns exist across firms? Research to answer these questions is ongoing and some further results are reported in Simons (1987c).

Management theoriests must strive to under- stand better the dynamic relationship between strategy and management control processes.

This means not only recognizing that strategy formation and implementation are intertwined, but also opening up the meaning of management control to a broader notion that builds upon guidance rather than coercion, and on learning as well as constraint. We need, in fact, a better language to describe management control pro- cesses. Control systems are used for multiple purposes: monitoring, learning, signalling, constraint, surveillance, motivation and others. Yet, we use a single descriptor - mangement control systems - to describe these distinctly different processes. Eskimos use precise words to describe diflFei:nt types of snow and sailors have specialized words for ropes that perform different functions. Management control theorists also need a precise vocabulary to de- velop and communicate the concepts necessary to describe complex organizational phenomena.

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