Question

Evaluating Management Control Systems

SPG Company manufactures and sells metal products that are used in many manufacturing operations. The management at SPG believes strongly in decentralized decision making and using performance evaluation and compensation to encourage high-performing managers. Marilyn Conners is the manager of the manufacturing operations, which produces and transfers the product to the marketing division. Jack Schwartz is the manager of marketing. Marilyn is evaluated on manufacturing cost relative to a budget for good output. Marilyn makes all production decisions. Jack is evaluated on company profit relative to a target. If a manager meets his or her target, they receive a bonus equal to 100 percent of salary.

Information on performance last year follows:

Required

What recommendations would you suggest for changes to the SPG management control system, if any? Discuss the delegation of decision authority, performance evaluation and measurement, and compensation design in your response.

Answer 1

Management control system

Management control system is needed to manage the complications arising out of decentralization like dysfunctional decision making. Owners of the organization use structure and procedures of management control system to influence the actions of its managers and other employees to ensure smooth implementation of organizational strategies. Management controls system comprises of three elements such as delegation fo decision making authorities, evaluation of performance and measurement systems and finally awarding compensation and rewards for performance.

Compensation system

Compensation system are made effective and attractive for managers in order to motivate for them for the best performance and achieve organizational objectives. Contingent compensation is part of compensation system where part of remuneration is based on performance. Paying commission to sales person based on sales revenue is part of compensation system that motivates sales teams to deliver their best, which eventually helps to achieve organizational objectives.

Contingent compensation may result in dysfunctional results also. Sales managers may take some decisions to meet their individual goals, that are not in the interest of organization. For example, sale managers may make false commitments or mislead customers about the benefits of sales schemes so that they can meet their sales targets.

Suggestion the SPG management control system

Delegation of decision authority

Delegation of decision authority is appropriately delegated in SPG management control system, which remains with M for manufacturing operations and J for marking operations.

Performance evaluation and measurement

SPG has set the target to measure and evaluate the performance is clearly defined and there are no doubts about that.

The targets for manufacturing manager M is set as $2.37 per unit and target for marketing manager J is set as $10 million.

Compensation design

SPG management makes bonus payment i.e. 100% of salary amount, to their managers after meeting the targets.

In the given case M will get his bonus because he has achieved his target i.e. cost per unit is $2.5 which is lower than $2.37 per unit.

J shall not be paid any bonus because is not able to achieve his target of $10 million.

Such a compensation system has many disadvantages like managers who are not able to achieve their targets feel demotivated and do not try to achieve them next time because chances of failure remains same. In the given case, J has reached actual profit up to $9.232 million against the target of $10 million. He missed the target by small margin and missed huge bonus amount.

J may adopt some unfair means to achieve his targets next time. It might have happened that M had used some unfair means to achieve the targets.

Hence, compensation system designed by SPG is unfavorable for organization because large portion of bonus is contingent compensation.

SPG should make changes in their compensation design like: -

• by reducing the percentage amount of bonus and adding the part as fixed salary amount

• Pay the bonus in the proportion of targets achieved. For example, 25% is paid when 50% of the target is achieved, 50% is paid when 75% of the target is achieved and 75% is paid when 90% of the target is achieved and 100% is paid on 100% achievement etc.