CH 16 Control Systems & Quality Management

Managing for Productivity
You will need to deal with seven challenges—managing for (1) competitive advantage, (2) diversity, (3) globalization, (4) information technology, (5) ethical standards, (6) sustainability, and (7) your own happiness and life goals.

Within this dynamic world, you will draw on the practical and theoretical knowledge described in this book to make decisions about the four management functions of planning, organizing, leading, and controlling.

The purpose is to get the people reporting to you to achieve productivity and realize results.

What Is Productivity?
Productivity can be applied at any level, whether for you as an individual, for the work unit you’re managing, or for the organization you work for. Productivity is defined by the formula of outputs divided by inputs for a specified period of time. Outputs are all the goods and services produced. Inputs are not only labor but also capital, materials, and energy.

What does this mean to you as a manager? It means that you can increase overall productivity by making substitutions or increasing the efficiency of any one element: labor, capital, materials, energy. For instance, you can increase the efficiency of labor by substituting capital in the form of equipment or machinery, as in employing a backhoe instead of laborers with shovels to dig a hole. Or you can increase the efficiency of materials inputs by expanding their uses, as when lumber mills discovered they could sell not only boards but also sawdust and wood chips for use in gardens. Or you can increase the efficiency of energy by putting solar panels on a factory roof so the organization won’t have to buy so much electrical power from utility companies.

Why Increasing Productivity Is Important
“Productivity growth is the elixir that makes an economy flourish,” says one business article. “Our society is wealthy,” says another, “precisely because it can churn out products like automobiles, flush toilets, and Google search algorithms at relatively low cost.” That is, the more goods and services that are produced and made easily available to us and for export, the higher our standard of living. Increasing the gross domestic product—the total dollar value of all the goods and services produced in the United States—depends on raising productivity, as well as on a growing workforce.
The U.S. Productivity Track Record
During the 1960s, productivity in the United States averaged a hefty 2.9% a year, then sank to a disappointing 1.5% right up until 1995. Because the decline in productivity no longer allowed the improvement in wages and living standards that had benefited so many Americans in the 1960s, millions of people took second jobs or worked longer hours to keep from falling behind. From 1995 to 2000, however, during the longest economic boom in American history, the productivity rate jumped to 2.5% annually, as the total output of goods and services rose faster than the total hours needed to produce them. From the business cycle peak in the first quarter of 2001 to the end of 2007, productivity grew at an annual rate of 2.7%. Then came the recession year 2008, when it fell to 2%. Then, from the fourth quarter of 2008 to the fourth quarter of 2009, productivity rose 5.4%—”a turnaround unprecedented in modern history,” says Newsweek—and it also rose an impressive 4.1% in 2010.7 From the first quarter of 2011 to the first quarter of 2012, however, the rate was only 0.5%, as companies began to approach the limit of how much they could squeeze from the workforce.
The Role of Information Technology
Most economists seem to think the recent productivity growth is the result of organizations’ huge investment in information technology—computers, the Internet, other telecommunications advances, and computer-guided production line improvements. From 1995 to 2001, for example, labor productivity in services grew at a 2.6% rate (outpacing the 2.3% for goods-producing sectors), the result, economists think, of information technology. (Since 2001, productivity has continued to advance in the service sectors in relation to the goods-producing sectors.) In particular, many companies have implemented enterprise resource planning (ERP) software systems, information systems for integrating virtually all aspects of a business, helping managers stay on top of the latest developments.
Enterprise Resource Planning (ERP)
In particular, many companies have implemented enterprise resource planning (ERP) software systems, information systems for integrating virtually all aspects of a business, helping managers stay on top of the latest developments.
Controlling
Control is making something happen the way it was planned to happen. Controlling is defined as monitoring performance, comparing it with goals, and taking corrective action as needed. Controlling is the fourth management function, along with planning, organizing, and leading, and its purpose is plain: to make sure that performance meets objectives.

Planning is setting goals and deciding how to achieve them.

Organizing is arranging tasks, people, and other resources to accomplish the work.

Leading is motivating people to work hard to achieve the organization’s goals.

Controlling is concerned with seeing that the right things happen at the right time in the right way.

All these functions affect one another and in turn affect an organization’s productivity.

Why Is Control Needed?
Lack of control mechanisms can lead to problems for both managers and companies. For example, the CEO of Yahoo, Scott Thompson, is discovered to have falsified his résumé by claiming to have a computer science degree—and 11 days later he is out, bringing turmoil to an already troubled company.

The senior banker of J. P. Morgan Chase, Ina Drew, contracts Lyme disease and is frequently out of the office when traders begin taking more and more risky bets, culminating in a loss of at least $3 billion and public demands for greater bank regulation. California-based Pacific Gas & Electric Co. accidentally overpressurizes pipelines on its gas system more than 120 times since its 2010 San Bruno explosion that killed eight people, raising risks of another disaster. Could greater control have helped avoid or reduce the consequences of these situations? Of course.

There are six reasons why control is needed.

1. To Adapt to Change & Uncertainty
Markets shift. Consumer tastes change. New competitors appear. Technologies are reborn. New materials are invented. Government regulations are altered. All organizations must deal with these kinds of environmental changes and uncertainties. Control systems can help managers anticipate, monitor, and react to these changes.

Example: As is certainly apparent by now, the issue of climate change or global warming has created a lot of change and uncertainty for many industries. The restaurant industry in particular is feeling the pressure to become “greener,” since restaurants are the retail world’s largest energy user, with a restaurant using five times more energy per square foot than any other type of commercial building, according to Pacific Gas & Electric’s Food Service Technology Center. Nearly 80% that commercial food service spends annually for energy use is lost in inefficient food cooking, holding, and storage. In addition, a typical restaurant generates 100,000 pounds of garbage per location per year. Thus, restaurants are being asked to reduce their “carbon footprints” by instituting tighter controls on energy use.

2. To Discover Irregularities & Errors
Small problems can mushroom into big ones. Cost overruns, manufacturing defects, employee turnover, bookkeeping errors, and customer dissatisfaction are all matters that may be tolerable in the short run. But in the long run, they can bring about even the downfall of an organization.

Example: You might not even miss a dollar a month looted from your credit card account. But an Internet hacker who does this with thousands of customers can undermine the confidence of consumers using their credit cards to charge online purchases at Amazon.com, Priceline.com, and other web retailers. Thus, a computer program that monitors Internet charge accounts for small, unexplained deductions can be a valuable control strategy.

3. To Reduce Costs, Increase Productivity, or Add Value
Control systems can reduce labor costs, eliminate waste, increase output, and increase product delivery cycles. In addition, controls can help add value to a product so that customers will be more inclined to choose it over rival products.

Example: As we have discussed early in the book (and will again in this chapter), the use of quality controls among Japanese car manufacturers resulted in cars being produced that were perceived as being better built than American cars. Another example: 3M Co.’s system for creating plastic picture-hanging hooks used to be split among four states and take 100 days; after reworking the system to get rid of “hairballs,” as the former CEO called them, now all production takes place at one hub and takes a third as much time.

4. To Detect Opportunities
Hot-selling products. Competitive prices on materials. Changing population trends. New overseas markets. Controls can help alert managers to opportunities that might have otherwise gone unnoticed.

Example: A markdown on certain grocery-store items may result in a rush of customer demand for those products, signaling store management that similar items might also sell faster if they were reduced in price.

5. To Deal with Complexity
Does the right hand know what the left hand is doing? When a company becomes larger or when it merges with another company, it may find it has several product lines, materials-purchasing policies, customer bases, even workers from different cultures. Controls help managers coordinate these various elements.

Example: In recent years, Macy’s Inc. has twice had to deal with complexity. In 2006, it pulled together several chains with different names—Marshall Field’s, Robinsons-May, Kaufmann’s, and other local stores—into one chain with one name, Macy’s, and a much-promoted national strategy. But after losing money in 2007, CEO Terry Lundgren began altering course from a one-size-fits-all nationwide approach to a strategy that tailors the merchandise in local stores to cater to local tastes.

6. To Decentralize Decision Making & Facilitate Teamwork
Controls allow top management to decentralize decision making at lower levels within the organization and to encourage employees to work together in teams.

Example: At General Motors, former chairman Alfred Sloan set the level of return on investment he expected his divisions to achieve, enabling him to push decision-making authority down to lower levels while still maintaining authority over the sprawling GM organization. Later GM used controls to facilitate the team approach in its joint venture with Toyota at its California plant.

Steps in the Control Process
Control systems may be altered to fit specific situations, but generally they follow the same steps. The four control process steps are (1) establish standards; (2) measure performance; (3) compare performance to standards; and (4) take corrective action, if necessary.
1. Establish Standards: “What Is the Outcome We Want?”
A control standard, or performance standard or simply standard, is the desired performance level for a given goal. Standards may be narrow or broad, and they can be set for almost anything, although they are best measured when they can be made quantifiable.

Nonprofit institutions might have standards for level of charitable contributions, number of students retained, or degree of legal compliance. For-profit organizations might have standards of financial performance, employee hiring, manufacturing defects, percentage increase in market share, percentage reduction in costs, number of customer complaints, and return on investment. More subjective standards, such as level of employee morale, can also be set, although they may have to be expressed more quantifiably as reduced absenteeism and sick days and increased job applications.
One technique for establishing standards is to use the balanced scorecard, as we explain later in this chapter.

2. Measure Performance: “What Is the Actual Outcome We Got?”
The second step in the control process is to measure performance, such as by number of products sold, units produced, or cost per item sold. For example, Hyundai has a quality goal signified by GQ 3-3-5-5. The goal represents the company’s desire, expressed in 2010, to finish in the top three in quality ratings provided by J. D. Power’s dependability survey within three years, and to be among the top five quality automakers within five years.21 (In 2012, the Hyundai Genesis was named the most dependable midsize premium car by J. D. Power.)

Performance measures are usually obtained from three sources: (1) written reports, including computerized printouts; (2) oral reports, as in a salesperson’s weekly recitation of accomplishments to the sales manager; and (3) personal observation, as when a manager takes a stroll of the factory floor to see what employees are doing.

As we’ve hinted, measurement techniques can vary for different industries, as for manufacturing industries versus service industries. We discuss this further later in the chapter.

3. Compare Performance to Standards: “How Do the Desired & Actual Outcomes Differ?”
The third step in the control process is to compare measured performance against the standards established. Most managers are delighted with performance that exceeds standards, which becomes an occasion for handing out bonuses, promotions, and perhaps offices with a view. For performance that is below standards, they need to ask: Is the deviation from performance significant? The greater the difference between desired and actual performance, the greater the need for action.

How much deviation is acceptable? That depends on the range of variation built in to the standards in step 1. In voting for political candidates, for instance, there is supposed to be no range of variation; as the expression goes, “every vote counts” (although the 2000 U.S. presidential election was an eye-opener for many people in this regard). In political polling, however, a range of 3%-4% error is considered an acceptable range of variation. In machining parts for the spacecraft Orion (NASA’s scheduled 2015 successor to the space shuttle), the range of variation may be a good deal less tolerant than when machining parts for a power lawnmower.

The range of variation is often incorporated in computer systems into a principle called management by exception. Management by exception is a control principle that states that managers should be informed of a situation only if data show a significant deviation from standards.

Management by Exception
The range of variation is often incorporated in computer systems into a principle called management by exception. Management by exception is a control principle that states that managers should be informed of a situation only if data show a significant deviation from standards.
4. Take Corrective Action, If Necessary: “What Changes Should We Make to Obtain Desirable Outcomes?”
There are three possibilities here: (1) Make no changes. (2) Recognize and reinforce positive performance. (3) Take action to correct negative performance.

When performance meets or exceeds the standards set, managers should give rewards, ranging from giving a verbal “Job well done” to more substantial payoffs such as raises, bonuses, and promotions to reinforce good behavior.

When performance falls significantly short of the standard, managers should carefully examine the reasons why and take the appropriate action. Sometimes it may turn out the standards themselves were unrealistic, owing to changing conditions, in which case the standards need to be altered. Sometimes it may become apparent that employees haven’t been given the resources for achieving the standards. And sometimes the employees may need more attention from management as a way of signaling that they have been insufficient in fulfilling their part of the job bargain.

Levels & Areas of Control
How are you going to apply the steps of control to your own management area? Let’s look at this in three ways:
First, you need to consider the level of management at which you operate—top, middle, or first level.
Second, you need to consider the areas that you draw on for resources—physical, human, information, and/or financial. Finally, you need to consider the style or control philosophy—bureaucratic, market, or clan, as we will explain.
Levels of Control: Strategic, Tactical, & Operational
There are three levels of control, which correspond to the three principal managerial levels: strategic planning by top managers, tactical planning by middle managers, and operational planning by first-line (supervisory) managers.
1. Strategic Control by Top Managers
Strategic control is monitoring performance to ensure that strategic plans are being implemented and taking corrective action as needed. Strategic control is mainly performed by top managers, those at the CEO and VP levels, who have an organization-wide perspective.

For example, Ford Motor Company CEO Alan Mulally and his senior managers meet every Thursday to review performance across the company’s global operations. They specifically review the performance of its suppliers because these companies have a significant effect on Ford’s profitability and quality. They ultimately determine which suppliers to keep and which ones to let go.

2. Tactical Control by Middle Managers
Tactical control is monitoring performance to ensure that tactical plans—those at the divisional or departmental level—are being implemented and taking corrective action as needed. Tactical control is done mainly by middle managers, those with such titles as “division head,” “plant manager,” and “branch sales manager.” Reporting is done on a weekly or monthly basis.
3. Operational Control by First-Level Managers
Operational control is monitoring performance to ensure that operational plans—day-to-day goals—are being implemented and taking corrective action as needed. Operational control is done mainly by first-level managers, those with titles such as “department head,” “team leader,” or “supervisor.” Reporting is done on a daily basis.

Considerable interaction occurs among the three levels, with lower-level managers providing information upward and upper-level managers checking on some of the more critical aspects of plan implementation below them.

Six Areas of Control
The six areas of organizational control are physical, human, informational, financial, structural, and cultural.
1. Physical Area
The physical area includes buildings, equipment, and tangible products.

Examples: There are equipment controls to monitor the use of computers, cars, and other machinery. There are inventory-management controls to keep track of how many products are in stock, how many will be needed, and what their delivery dates are from suppliers. There are quality controls to make sure that products are being built according to certain acceptable standards.

2. Human Resources Area
The controls used to monitor employees include personality tests and drug testing for hiring, performance tests during training, performance evaluations to measure work productivity, and employee surveys to assess job satisfaction and leadership.
3. Informational Area
Production schedules. Sales forecasts. Environmental impact statements. Analyses of competition. Public relations briefings. All these are controls on an organization’s various information resources.
4. Financial Area
Are bills being paid on time? How much money is owed by customers? How much money is owed to suppliers? Is there enough cash on hand to meet payroll obligations? What are the debt-repayment schedules? What is the advertising budget? Clearly, the organization’s financial controls are important because they can affect the preceding three areas.
5. Structural Area
How is the organization arranged from a hierarchical or structural standpoint? Two examples are bureaucratic control and decentralized control.
Bureaucratic control
Bureaucratic control is an approach to organizational control that is characterized by use of rules, regulations, and formal authority to guide performance. This form of control attempts to elicit employee compliance, using strict rules, a rigid hierarchy, well-defined job descriptions, and administrative mechanisms such as budgets, performance appraisals, and compensation schemes (external rewards to get results). The foremost example of use of bureaucratic control is perhaps the traditional military organization.
Bureaucratic control works well in organizations in which the tasks are explicit and certain. While rigid, it can be an effective means of ensuring that performance standards are being met. However, it may not be effective if people are looking for ways to stay out of trouble by simply following the rules, or if they try to beat the system by manipulating performance reports, or if they try to actively resist bureaucratic constraints.
Decentralized control
Decentralized control is an approach to organizational control that is characterized by informal and organic structural arrangements, the opposite of bureaucratic control. This form of control aims to get increased employee commitment, using the corporate culture, group norms, and workers taking responsibility for their performance. Decentralized control is found in companies with a relatively flat organization.
6. Cultural Area
The cultural area is an informal method of control. It influences the work process and levels of performance through the set of norms that develop as a result of the values and beliefs that constitute an organization’s culture. If an organization’s culture values innovation and collaboration, then employees are likely to be evaluated on the basis of how much they engage in collaborative activities and enhance or create new products.

Example: Earlier (Chapter 12), we mentioned that Google, the search-engine company, which appeared as No. 1 on Fortune’s 2012 list of “100 Best Companies to Work For,” is a good example of an organization that promotes, measures, and rewards employee motivation. For instance, in a program called Innovation Time Off, engineers are encouraged to spend 20% of their workweek on pet projects, which has led to such new products as Gmail and Google News. Google’s tremendous revenue growth over the last decade is clearly driven by a set of cultural values, norms, and internal processes that reinforce creativity.

Measurement Management
Wouldn’t you, as a top manager, like to have displayed in easy-to-read graphics all the information on sales, orders, and the like assembled from data pulled in real time from corporate software? The technology exists and it has a name: a dashboard, like the instrument panel in a car.

“The dashboard puts me and more and more of our executives in real-time touch with the business,” says Ivan Seidenberg, former CEO at Verizon Communications. “The more eyes that see the results we’re obtaining every day, the higher the quality of the decisions we can make.”

Throughout this book we have stressed the importance of evidence-based management—the use of real-world data rather than fads and hunches in making management decisions. When properly done, the dashboard is an example of the important tools that make this kind of management possible. Others are the balanced scorecard, strategy maps, and measurement management, techniques that even new managers will find useful.

The Balanced Scorecard: A Dashboard-like View of the Organization
Robert Kaplan is a professor of accounting at the Harvard Business School.

David Norton is founder and president of Renaissance Strategy Group, a Massachusetts consulting firm. Kaplan and Norton developed what they call the balanced scorecard, which gives top managers a fast but comprehensive view of the organization via four indicators: (1) customer satisfaction, (2) internal processes, (3) innovation and improvement activities, and (4) financial measures.

“Think of the balanced scorecard as the dials and indicators in an airplane cockpit,” write Kaplan and Norton. For a pilot, “reliance on one instrument can be fatal. Similarly, the complexity of managing an organization today requires that managers be able to view performance in several areas simultaneously.” It is not enough, say Kaplan and Norton, to simply measure financial performance, such as sales figures and return on investment. Operational matters, such as customer satisfaction, are equally important.

The Balanced Scorecard: Four “Perspectives”
The balanced scorecard establishes (a) goals and (b) performance measures according to four “perspectives” or areas—financial, customer, internal business, and innovation and learning.
1. Financial Perspective: “How Do We Look to Shareholders?”
Typical financial goals have to do with profitability, growth, and shareholder values. Financial measures such as quarterly sales have been criticized as being shortsighted and not reflecting contemporary value-creating activities. Moreover, critics say that traditional financial measures don’t improve customer satisfaction, quality, or employee motivation.

However, making improvements in just the other three operational “perspectives” we will discuss won’t necessarily translate into financial success. Kaplan and Norton mention the case of an electronics company that made considerable improvements in manufacturing capabilities that did not result in increased profitability.

The hard truth is that “if improved [operational] performance fails to be reflected in the bottom line, executives should reexamine the basic assumptions of their strategy and mission,” say Kaplan and Norton. “Not all long-term strategies are profitable strategies…. A failure to convert improved operational performance, as measured in the scorecard, into improved financial performance should send executives back to their drawing boards to rethink the company’s strategy or its implementation plans.”

2. Customer Perspective: “How Do Customers See Us?”
Many organizations make taking care of the customer a high priority. The balanced scorecard translates the mission of customer service into specific measures of concerns that really matter to customers—time between placing an order and taking delivery, quality in terms of defect level, satisfaction with products and service, and cost.

Quiznos is a good example. The company uses a speed-dining approach to develop new products and test out different pricing strategies. The company invites groups of 25 people to a location in which they move from station to station and try out new menu options. This technique has reduced the time from test kitchen to market to six months, as opposed to the one year needed by a key competitor.

3. Internal Business Perspective: “What Must We Excel At?”
This part translates what the company must do internally to meet its customers’ expectations. These are business processes such as quality, employee skills, and productivity.

Top management’s judgment about key internal processes must be linked to measures of employee actions at the lower levels, such as time to process customer orders, get materials from suppliers, produce products, and deliver them to customers. Computer information systems can help, for example, in identifying late deliveries, tracing the problem to a particular plant. (ERP systems, mentioned earlier, can aid this technological boost.)

4. Innovation & Learning Perspective: “Can We Continue to Improve & Create Value?”
Learning and growth of employees is the foundation for innovation and creativity. Thus, the organization must create a culture that encourages rank-and-file employees to make suggestions and question the status quo and it must provide employees with the environment and resources needed to do their jobs. The company can use employee surveys and analysis of training data to measure the degree of learning and growth.
Strategy Map: Visual Representation of a Balanced Scorecard
Since they devised the balanced scorecard, Kaplan and Norton have come up with an improvement called the strategy map.34 A strategy map is a visual representation of the four perspectives of the balanced scorecard that enables managers to communicate their goals so that everyone in the company can understand how their jobs are linked to the overall objectives of the organization. As Kaplan and Norton state, “Strategy maps show the cause-and-effect links by which specific improvements create desired outcomes,” such as objectives for revenue growth, targeted customer markets, the role of excellence and innovation in products, and so on.

An example of a strategy map for a company such as Target is shown on the next page, with the goal of creating long-term value for the firm by increasing productivity growth and revenue growth. Measures and standards can be developed in each of the four operational areas—financial goals, customer goals, internal goals, and learning and growth goals—for the strategy.

Measurement Management: “Forget Magic”
“You simply can’t manage anything you can’t measure,” said Richard Quinn, then-vice president of quality at the Sears Merchandising Group.

Is this really true? Concepts such as the balanced scorecard seem like good ideas, but how well do they actually work? John Lingle and William Schiemann, principals in a New Jersey consulting firm specializing in strategic assessment, decided to find out.

In a survey of 203 executives in companies of varying size they identified the organizations as being of two types: measurement-managed and non-measurement-managed. The measurement-managed companies were those in which senior management reportedly agreed on measurable criteria for determining strategic success, and management updated and reviewed semiannual performance measures in three or more of six primary performance areas. The six areas were financial performance, operating efficiency, customer satisfaction, employee performance, innovation/change, and community/environment.

The results: “A higher percentage of measurement-managed companies were identified as industry leaders,” concluded Lingle and Schiemann, “as being financially in the top third of their industry, and as successfully managing their change effort.” (The last indicator suggests that measurement-managed companies tend to anticipate the future and are likely to remain in a leadership position in a rapidly changing environment.) “Forget magic,” they say. “Industry leaders we surveyed simply have a greater handle on the world around them.”

Why Measurement-Managed Firms Succeed: Four Mechanisms of Success
Why do measurement-managed companies outperform those that are less disciplined? The study’s data point to four mechanisms that contribute to these companies’ success:

Top executives agree on strategy. Most top executives in measurement-managed companies agreed on business strategy, whereas most of those in non-measurement-managed companies reported disagreement. Translating strategy into measurable objectives helps make them specific.

Communication is clear. The clear message in turn is translated into good communication, which was characteristic of managed-measurement organizations and not of non-measurement-managed ones.
There is better focus and alignments. Measurement-managed companies reported more frequently that unit (division or department) performance measures were linked to strategic company measures and that individual performance measures were linked to unit measures.

The organizational culture emphasizes teamwork and allows risk taking. Managers in measurement-managed companies more frequently reported strong teamwork and cooperation among the management team and more willingness to take risks.

Four Barriers to Effective Measurement
The four most frequent barriers to effective measurement, according to Lingle and Schiemann, are as follows:

Objectives are fuzzy. Company objectives are often precise in the financial and operational areas but not in areas of customer satisfaction, employee performance, and rate of change. Managers need to work at making “soft” objectives measurable.

Managers put too much trust in informal feedback systems. Managers tend to overrate feedback mechanisms such as customer complaints or sales-force criticisms about products. But these mechanisms aren’t necessarily accurate.

Employees resist new measurement systems. Employees want to see how well measures work before they are willing to tie their financial futures to them. Measurement-managed companies tend to involve the workforce in developing measures.

Companies focus too much on measuring activities instead of results. Too much concern with measurement that is not tied to fine-tuning the organization or spurring it on to achieve results is wasted effort.

Are There Areas That Can’t Be Measured?
It’s clear that some areas are easier to measure than others—manufacturing, for example, as opposed to services. We can understand how it is easier to measure the output of, say, a worker in a steel mill than that of a bellhop in a hotel or a professor in a classroom. Nevertheless, human resource professionals are trying to have a greater focus on employee productivity “metrics.” In establishing quantifiable goals for “hard to measure” jobs, managers should seek input from the employees involved, who are usually more familiar with the details of the jobs.
Budgets: Formal Financial Projections
A budget is a formal financial projection. It states an organization’s planned activities for a given period of time in quantitative terms, such as dollars, hours, or number of products. Budgets are prepared not only for the organization as a whole but also for the divisions and departments within it. The point of a budget is to provide a yardstick against which managers can measure performance and make comparisons (as with other departments or previous years).
Incremental Budgeting
Managers can take essentially two budget-planning approaches. One of them, zero-based budgeting (ZBB), which forces each department to start from zero in projecting funding needs, is no longer favored. The other approach, the traditional form of a budget, which is mainly used now, is incremental budgeting.

Incremental budgeting allocates increased or decreased funds to a department by using the last budget period as a reference point; only incremental changes in the budget request are reviewed. One difficulty is that incremental budgets tend to lock departments into stable spending arrangements; they are not flexible in meeting environmental demands. Another difficulty is that a department may engage in many activities—some more important than others—but it’s not easy to sort out how well managers performed at the various activities. Thus, the department activities and the yearly budget increases take on lives of their own.

Fixed Versus Variable Budgets
There are numerous kinds of budgets, and some examples are listed below. In general, however, budgets may be categorized as two types: fixed and variable.
Fixed Budgets
Fixed budgets—where resources are allocated on a single estimate of costs. Also known as a static budget, a fixed budget allocates resources on the basis of a single estimate of costs. That is, there is only one set of expenses; the budget does not allow for adjustment over time. For example, you might have a budget of $50,000 for buying equipment in a given year—no matter how much you may need equipment exceeding that amount.
Variable Budgets
Variable budgets—where resources are varied in proportion with various levels of activity. Also known as a flexible budget, a variable budget allows the allocation of resources to vary in proportion with various levels of activity. That is, the budget can be adjusted over time to accommodate pertinent changes in the environment. For example, you might have a budget that allows you to hire temporary workers or lease temporary equipment if production exceeds certain levels.
Financial Statements: Summarizing the Organization’s Financial Status
A financial statement is a summary of some aspect of an organization’s financial status. The information contained in such a statement is essential in helping managers maintain financial control over the organization.

There are two basic types of financial statements: the balance sheet and the income statement.

The Balance Sheet: Picture of an Organization’s Financial Worth for a Specific Point in Time
A balance sheet summarizes an organization’s overall financial worth—that is, assets and liabilities—at a specific point in time.

Assets are the resources that an organization controls; they consist of current assets and fixed assets. Current assets are cash and other assets that are readily convertible to cash within 1 year’s time.

Examples are inventory, sales for which payment has not been received (accounts receivable), and U.S. Treasury bills or money market mutual funds. Fixed assets are property, buildings, equipment, and the like that have a useful life that exceeds 1 year but are usually harder to convert to cash. Liabilities are claims, or debts, by suppliers, lenders, and other nonowners of the organization against a company’s assets.

The Income Statement: Picture of an Organization’s Financial Results for a Specified Period of Time
The balance sheet depicts the organization’s overall financial worth at a specific point in time. By contrast, the income statement summarizes an organization’s financial results—revenues and expenses—over a specified period of time, such as a quarter or a year.

Revenues are assets resulting from the sale of goods and services. Expenses are the costs required to produce those goods and services. The difference between revenues and expenses, called the bottom line, represents the profits or losses incurred over the specified period of time.

Ratio Analysis: Indicators of an Organization’s Financial Health
The bottom line may be the most important indicator of an organization’s financial health, but it isn’t the only one. Managers often use ratio analysis—the practice of evaluating financial ratios—to determine an organization’s financial health.

Among the types of financial ratios are those used to calculate liquidity, debt management, asset management, and return. Liquidity ratios indicate how easily an organization’s assets can be converted into cash (made liquid). Debt management ratios indicate the degree to which an organization can meet its long-term financial obligations.

Asset management ratios indicate how effectively an organization is managing its assets, such as whether it has obsolete or excess inventory on hand. Return ratios—often called return on investment (ROI) or return on assets (ROA)—indicate how effective management is in generating a return, or profits, on its assets.

Audits: External Versus Internal
When you think of auditors, do you think of grim-faced accountants looking through a company’s books to catch embezzlers and other cheats? That’s one function of auditing, but besides verifying the accuracy and fairness of financial statements it also is intended to be a tool for management decision making. Audits are formal verifications of an organization’s financial and operational systems.
External Audits—Financial Appraisals by Outside Financial Experts
An external audit is a formal verification of an organization’s financial accounts and statements by outside experts. The auditors are certified public accountants (CPAs) who work for an accounting firm (such as PricewaterhouseCoopers) that is independent of the organization being audited. Their task is to verify that the organization, in preparing its financial statements and in determining its assets and liabilities, followed generally accepted accounting principles.
Internal Audits—Financial Appraisals by Inside Financial Experts
An internal audit is a verification of an organization’s financial accounts and statements by the organization’s own professional staff. Their jobs are the same as those of outside experts—to verify the accuracy of the organization’s records and operating activities. Internal audits also help uncover inefficiencies and thus help managers evaluate the performance of their control systems.
Total Quality Mgmt
The Ritz-Carlton Hotel Co., LLC, a luxury chain of 77 hotels worldwide in 25 countries that is an independently operated division of Marriott International, puts a premium on doing things right. First-year managers and employees receive 250-310 hours of training. The president meets each employee at a new hotel to ensure he or she understands the Ritz-Carlton standards for service. The chain has also developed a database that records the preferences of more than 1 million customers, so that each hotel can anticipate guests’ needs.

Because of this diligence, the Ritz-Carlton has twice been the recipient (in 1992 and in 1999) of the Malcolm Baldrige National Quality Award. This award was created by Congress in 1987 to be the most prestigious recognition of quality—the total ability of a product or service to meet customer needs—in the United States. It is given annually to U.S. organizations in manufacturing, service, small business, health care, education, and nonprofit fields. (That the award actually means something is shown by a study that found that hospitals that received the honor significantly outperformed other hospitals on nearly every count.)

The Baldrige award is an outgrowth of the realization among U.S. managers in the early 1980s that three-fourths of Americans were telling survey takers that the label “Made in America” no longer represented excellence—that they considered products made overseas, especially in Japan, to be equal or superior in quality to U.S.-made products. As we saw in Chapter 2, much of the impetus for quality improvements in Japanese products came from American consultants W. Edwards Deming and Joseph M. Juran. As we mentioned, two strategies for ensuring quality are quality control, the strategy for minimizing errors by managing each stage of production, and quality assurance, focusing on the performance of workers and urging them to strive for “zero defects.”

Deming Management: The Contributions of W. Edwards Deming to Improved Quality
Previously, Frederick Taylor’s scientific management philosophy, designed to maximize worker productivity, had been widely instituted. But by the 1950s, scientific management had led to organizations that were rigid and unresponsive to both employees and customers. W. Edwards Deming’s challenge, known as Deming management, proposed ideas for making organizations more responsive, more democratic, and less wasteful. These included the following principles:
1. Quality Should Be Aimed at the Needs of the Consumer
“The consumer is the most important part of the production line,” Deming wrote. Thus, the efforts of individual workers in providing the product or service should be directed toward meeting the needs and expectations of the ultimate user.
2. Companies Should Aim at Improving the System, Not Blaming Workers
Deming suggested that U.S. managers were more concerned with blaming problems on individual workers rather than on the organization’s structure, culture, technology, work rules, and management—that is, “the system.” By treating employees well, listening to their views and suggestions, Deming felt, managers could bring about improvements in products and services.
3. Improved Quality Leads to Increased Market Share, Increased Company Prospects, & Increased Employment
When companies work to improve the quality of goods and services, they produce less waste, fewer delays, and are more efficient. Lower prices and superior quality lead to greater market share, which in turn leads to improved business prospects and consequently increased employment.
4. Quality Can Be Improved on the Basis of Hard Data, Using the PDCA Cycle
Deming suggested that quality could be improved by acting on the basis of hard data. The process for doing this came to be known as the PDCA cycle, a plan-do-check-act cycle using observed data for continuous improvement of operations.
Core TQM Principles: Deliver Customer Value & Strive for Continuous Improvement
Total quality management (TQM) is defined as a comprehensive approach—led by top management and supported throughout the organization—dedicated to continuous quality improvement, training, and customer satisfaction.

In Chapter 2 we said there are four components to TQM:
Make continuous improvement a priority.
Get every employee involved.
Listen to and learn from customers and employees.
Use accurate standards to identify and eliminate problems.

2 Core Principles of TQM
These may be summarized as two core principles of TQM—namely, (1) people orientation—everyone involved with the organization should focus on delivering value to customers—and (2) improvement orientation—everyone should work on continuously improving the work processes. Let’s look at these further.
1. People Orientation—Focusing Everyone on Delivering Customer Value
Organizations adopting TQM value people as their most important resource—both those who create a product or service and those who receive it. Thus, not only are employees given more decision-making power, so are suppliers and customers.
This people orientation operates under the following assumptions.

Delivering customer value is most important. The purpose of TQM is to focus people, resources, and work processes to deliver products or services that create value for customers.

People will focus on quality if given empowerment. TQM assumes that employees (and often suppliers and customers) will concentrate on making quality improvements if given the decision-making power to do so. The reasoning here is that the people actually involved with the product or service are in the best position to detect opportunities for quality improvements.

TQM requires training, teamwork, and cross-functional efforts. Employees and suppliers need to be well trained, and they must work in teams. Teamwork is considered important because many quality problems are spread across functional areas. For example, if cellphone design specialists conferred with marketing specialists (as well as customers and suppliers), they would find the real challenge of using a cellphone for older people is pushing 11 tiny buttons to call a phone number.

Special Purpose Team
Teams may be self-managed teams, as described in Chapter 13, with groups of workers given administrative oversight of activities such as planning, scheduling, monitoring, and staffing for their task domains.

Sometimes, however, an organization needs a special-purpose team to meet to solve a special or onetime problem. The team then disbands after the problem is solved. These teams are often cross-functional, drawing on members from different departments. American medicine, for instance, is moving toward a team-based approach for certain applications, involving multiple doctors as well as nurse practitioners and physician assistants.

2. Improvement Orientation—Focusing Everyone on Continuously Improving Work Processes
Americans seem to like big schemes, grand designs, and crash programs. Although these approaches certainly have their place, the lesson of the quality movement from overseas is that the way to success is through continuous small improvements. Continuous improvement is defined as ongoing small, incremental improvements in all parts of an organization—all products, services, functional areas, and work processes.

This improvement orientation has the following assumptions.
It’s less expensive to do it right the first time. TQM assumes that it’s better to do things right the first time than to do costly reworking. To be sure, there are many costs involved in creating quality products and services—training, equipment, and tools, for example. But they are less than the costs of dealing with poor quality—those stemming from lost customers, junked materials, time spent reworking, and frequent inspection, for example.

It’s better to do small improvements all the time. This is the assumption that continuous improvement must be an everyday matter, that no improvement is too small, that there must be an ongoing effort to make things better a little bit at a time all the time.

Accurate standards must be followed to eliminate small variations. TQM emphasizes the collection of accurate data throughout every stage of the work process. It also stresses the use of accurate standards (such as benchmarking, as we discuss) to evaluate progress and eliminate small variations, which are the source of many quality defects.

There must be strong commitment from top management. Employees and suppliers won’t focus on making small incremental improvements unless managers go beyond lip service to support high-quality work, as do the top managers at Ritz-Carlton, Amazon.com, and Ace Hardware.

Applying TQM to Services
Manufacturing industries provide tangible products (think jars of baby food), service industries provide intangible products (think child care services). Manufactured products can be stored (such as dental floss in a warehouse); services generally need to be consumed immediately (such as dental hygiene services). Services tend to involve a good deal of people effort (although there is some automation, as with bank automated teller machines). Finally, services are generally provided at locations and times convenient for customers; that is, customers are much more involved in the delivery of services than they are in the delivery of manufactured products.
Customer Satisfaction: A Matter of Perception?
Perhaps you’re beginning to see how judging the quality of services is a different animal from judging the quality of manufactured goods, because it comes down to meeting the customer’s satisfaction, which may be a matter of perception. (After all, some hotel guests, restaurant diners, and supermarket patrons, for example, are more easily satisfied than others.)
The RATER Scale
How, then, can we measure the quality of a delivered service? For one, we can use the RATER scale, which enables customers to rate the quality of a service along five dimensions—reliability, assurance, tangibles, empathy, and responsiveness (abbreviated RATER)—each on a scale from 1 (for very poor) to 10 (for very good). The meanings of the RATER dimensions are as follows:

Reliability—ability to perform the desired service dependably, accurately, and consistently.

Assurance—employees’ knowledge, courtesy, and ability to convey trust and confidence.

Tangibles—physical facilities, equipment, appearance of personnel.

Empathy—provision of caring, individualized attention to customers.

Responsiveness—willingness to provide prompt service and help customers.

Some TQM Tools & Techniques
Several tools and techniques are available for improving quality. Here we describe benchmarking, outsourcing, reduced cycle time, ISO 9000 and ISO 14000, statistical process control, and Six Sigma.
Benchmarking: Learning from the Best Performers
We discussed benchmarking briefly in Chapter 10. As we stated there, benchmarking is a process by which a company compares its performance with the best practices of high-performing organizations. For example, at Xerox Corp., generally thought to be the first American company to use benchmarking, it is defined as, in one description, “the continuous process of measuring products, services, and practices against the toughest competitors or those companies recognized as industry leaders.”
Outsourcing: Let Outsiders Handle It
Outsourcing (discussed in detail in Chapter 4) is the subcontracting of services and operations to an outside vendor. Usually this is done because the subcontractor vendor can do the job better or cheaper. Or, stated another way, when the services and operations are done in-house, they are not done as efficiently or are keeping personnel from doing more important things.

For example, despite its former (2004-2009) well-known advertising campaign, “An American Revolution,” Chevrolet outsources the engine for its Chevrolet Equinox to China, where it found it could get high-quality engines built at less cost. And when IBM and other companies outsource components inexpensively for new integrated software systems, says one researcher, offshore programmers make information technology affordable to small and medium-size businesses and others who haven’t yet joined the productivity boom.

Outsourcing is also being done by many state and local governments, which, under the banner known as privatization, have subcontracted traditional government services such as fire protection, correctional services, and medical services.

Reduced Cycle Time: Increasing the Speed of Work Processes
Another TQM technique is the emphasis on increasing the speed with which an organization’s operations and processes can be performed. This is known as reduced cycle time, or reduction in steps in a work process, such as fewer authorization steps required to grant a contract to a supplier. The point is to improve the organization’s performance by eliminating wasteful motions, barriers between departments, unnecessary procedural steps, and the like.
ISO 9000 & ISO 14000: Meeting Standards of Independent Auditors
If you’re a sales representative for Du Pont, the American chemical company, how will your overseas clients know that your products have the quality they are expecting? If you’re a purchasing agent for an Ohio-based tire company, how can you tell if the synthetic rubber you’re buying overseas is adequate?
At one time, buyers and sellers simply had to rely on a supplier’s past reputation or personal assurances. In 1979, the International Organization for Standardization (ISO), based in Geneva, Switzerland, created a set of quality standards known as the 9000 series—”a kind of Good Housekeeping seal of approval for global business,” in one description. There are two such standards:
ISO 9000
The ISO 9000 series consists of quality-control procedures companies must install—from purchasing to manufacturing to inventory to shipping—that can be audited by independent quality-control experts, or “registrars.” The goal is to reduce flaws in manufacturing and improve productivity. Companies must document the procedures and train their employees to use them. For instance, DocBase Direct is a web-delivered document and forms-management system that helps companies comply with key ISO management standards, such as traceable changes and easy reporting.

The ISO 9000 designation is now recognized by more than 100 countries around the world, and a quarter of the corporations around the globe insist that suppliers have ISO 9000 certification. “You close some expensive doors if you’re not certified,” says Bill Ekeler, general manager of Overland Products, a Nebraska tool-and-die-stamping firm.61 In addition, because the ISO process forced him to analyze his company from the top down, Ekeler found ways to streamline manufacturing processes that improved his bottom line.

ISO 14000
The ISO 14000 series extends the concept, identifying standards for environmental performance. ISO 14000 dictates standards for documenting a company’s management of pollution, efficient use of raw materials, and reduction of the firm’s impact on the environment.
Statistical Process Control: Taking Periodic Random Samples
As the pages of this book were being printed, every now and then a press person would pull a few pages out of the press run and inspect them (under a bright light) to see that the consistency of the color and quality of the ink were holding up. This is an ongoing human visual check for quality control.

All kinds of products require periodic inspection during their manufacture: hamburger meat, breakfast cereal, flashlight batteries, wine, and so on. The tool often used for this is statistical process control, a statistical technique that uses periodic random samples from production runs to see if quality is being maintained within a standard range of acceptability. If quality is not acceptable, production is stopped to allow corrective measures.

Statistical process control is the technique that McDonald’s uses, for example, to make sure that the quality of its burgers is always the same, no matter where in the world they are served. Companies such as Intel and Motorola use statistical process control to ensure the reliability and quality of their products.

Six Sigma & Lean Six Sigma: Data-Driven Ways to Eliminate Defects
“The biggest problem with the management technique known as Six Sigma is this: It sounds too good to be true,” says a Fortune writer. “How would your company like a 20% increase in profit margins within one year, followed by profitability over the long-term that is ten times what you’re seeing now? How about a 4% (or greater) annual gain in market share?”

What is this name, Six Sigma (which is probably Greek to you), and is it a path to management paradise? The name comes from sigma, the Greek letter that statisticians use to define a standard deviation. The higher the sigma, the fewer the deviations from the norm—that is, the fewer the defects. Developed by Motorola in 1985, Six Sigma has since been embraced by General Electric, Allied Signal, American Express, and other companies. There are two variations, Six Sigma and lean Six Sigma.

Six Sigma and lean Six Sigma may not be perfect, since they cannot compensate for human error or control events outside a company. Still, they let managers approach problems with the assumption that there’s a data-oriented, tangible way to approach problem solving.

Six Sigma
Six Sigma is a rigorous statistical analysis process that reduces defects in manufacturing and service-related processes. By testing thousands of variables and eliminating guesswork, a company using the technique attempts to improve quality and reduce waste to the point where errors nearly vanish. In everything from product design to manufacturing to billing, the attainment of Six Sigma means there are no more than 3.4 defects per million products or procedures.

“Six Sigma gets people away from thinking that 96% is good, to thinking that 40,000 failures per million is bad,” says a vice president of consulting firm A. T. Kearney. Six Sigma means being 99.9997% perfect. By contrast, Three Sigma or Four Sigma means settling for 99% perfect—the equivalent of no electricity for 7 hours each month, two short or long landings per day at each major airport, or 5,000 incorrect surgical operations per week.

Six Sigma may also be thought of as a philosophy—to reduce variation in your company’s business and make customer-focused, data-driven decisions. The method preaches the use of Define, Measure, Analyze, Improve, and Control (DMAIC). Team leaders may be awarded a Six Sigma “black belt” for applying DMAIC.

Lean Six Sigma.
More recently, companies are using an approach known as lean Six Sigma, which focuses on problem solving and performance improvement—speed with excellence—of a well-defined project.65
Xerox Corp., for example, has focused on getting new products to customers faster, which has meant taking steps out of the design process without loss of quality.

A high-end, $200,000 machine that can print 100 pages a minute traditionally has taken three to five cycles of design; removing just one of those cycles can shave up to a year off time to market. The grocery chain Albertsons Inc. announced in 2004 that it was going to launch Six Sigma training to reduce customer dissatisfaction and waste to the lowest level possible.

The Keys to Successful Control Systems
Successful control systems have a number of common characteristics: (1) They are strategic and results oriented. (2) They are timely, accurate, and objective. (3) They are realistic, positive, and understandable and they encourage self-control. (4) They are flexible.
1. They Are Strategic & Results Oriented
Control systems support strategic plans and are concentrated on significant activities that will make a real difference to the organization. Thus, when managers are developing strategic plans for achieving strategic goals, that is the point at which they should pay attention to developing control standards that will measure how well the plans are being achieved.

Example: Global warming is now shifting the climate on a continental scale, changing the life cycle of animals and plants, scientists say, and surveys show more Americans feel guilty for not living greener. A growing number of companies are discovering that embracing environmental safe practices is paying off in savings of hundreds of millions of dollars, as we saw with Subaru of Indiana

2. They Are Timely, Accurate, & Objective
Good control systems—like good information of any kind—should …

Be timely—meaning when needed. The information should not necessarily be delivered quickly, but it should be delivered at an appropriate or specific time, such as every week or every month. And it certainly should be often enough to allow employees and managers to take corrective action for any deviations.

Be accurate—meaning correct. Accuracy is paramount, if decision mistakes are to be avoided. Inaccurate sales figures may lead managers to mistakenly cut or increase sales promotion budgets. Inaccurate production costs may lead to faulty pricing of a product.

Be objective—meaning impartial. Objectivity means control systems are impartial and fair. Although information can be inaccurate for all kinds of reasons (faulty communication, unknown data, and so on), information that is not objective is inaccurate for a special reason: It is biased or prejudiced. Control systems need to be considered unbiased for everyone involved so that they will be respected for their fundamental purpose—enhancing performance.

3. They Are Realistic, Positive, & Understandable & Encourage Self-Control
Control systems have to focus on working for the people who will have to live with them. Thus, they operate best when they are made acceptable to the organization’s members who are guided by them. Thus, they should …

Be realistic. They should incorporate realistic expectations. If employees feel performance results are too difficult, they are apt to ignore or sabotage the performance system.
Be positive. They should emphasize development and improvement. They should avoid emphasizing punishment and reprimand.

Be understandable. They should fit the people involved, be kept as simple as possible, and present data in understandable terms. They should avoid complicated computer printouts and statistics.

Encourage self-control. They should encourage good communication and mutual participation. They should not be the basis for creating distrust between employees and managers.

4. They Are Flexible
Control systems must leave room for individual judgment, so that they can be modified when necessary to meet new requirements.
Barriers to Control Success
1. Too Much Control
Some organizations, particularly bureaucratic ones, try to exert too much control. They may try to regulate employee behavior in everything from dress code to timing of coffee breaks. Allowing employees too little discretion for analysis and interpretation may lead to employee frustration—particularly among professionals, such as college professors and medical doctors. Their frustration may lead them to ignore or try to sabotage the control process.

2. Too Little Employee Participation
As highlighted by W. Edwards Deming, discussed elsewhere in the book, employee participation can enhance productivity. Involving employees in both the planning and execution of control systems can bring legitimacy to the process and heighten employee morale.

3. Overemphasis on Means Instead of Ends We said that control activities should be strategic and results oriented. They are not ends in themselves but the means to eliminating problems. Too much emphasis on accountability for weekly production quotas, for example, can lead production supervisors to push their workers and equipment too hard, resulting in absenteeism and machine breakdowns. Or it can lead to game playing—”beating the system”—as managers and employees manipulate data to seem to fulfill short-run goals instead of the organization’s strategic plan.

4. Overemphasis on Paperwork
A specific kind of misdirection of effort is management emphasis on getting reports done, to the exclusion of other performance activity. Reports are not the be-all and end-all. Undue emphasis on reports can lead to too much focus on quantification of results and even to falsification of data.
Example: A research laboratory decided to use the number of patents the lab obtained as a measure of its effectiveness. The result was an increase in patents filed but a decrease in the number of successful research projects.

5. Overemphasis on One Instead of Multiple Approaches
One control may not be enough. By having multiple control activities and information systems, an organization can have multiple performance indicators, thereby increasing accuracy and objectivity.
Example: An obvious strategic goal for gambling casinos is to prevent employee theft of the cash flowing through their hands. Thus, casinos control card dealers by three means. First, they require prospective hires to have a dealer’s license before they are hired. Second, they put them under constant scrutiny, using direct supervision by on-site pit bosses as well as observation by closed-circuit TV cameras and through overhead one-way mirrors. Third, they require detailed reports at the end of each shift so that transfer of cash and cash equivalents (such as gambling chips) can be audited.