Chapter 13 Outline

Control Systems

A major task of a firm's leadership is to control the various subunits of the firm--whether they be defined on the basis of function, product division, or geographical area--to ensure their actions are consistent with the firm's overall strategic and financial objectives. Firms achieve this with various control systems. In this section, we review the various types of control systems used, and then we will see that appropriate control systems vary according to international strategies.

Types of Control Systems

Four main types of control systems are used in multinational firms: personal controls, bureaucratic controls, output controls, and cultural controls. In most firms, all four are used, but their relative emphasis tends to vary with the strategy of the firm.

Personal Controls

Personal control is control by personal contact with subordinates. This type of control tends to be most widely used in small firms, where it is seen in the direct supervision of subordinates' actions. However, it also structures the relationships between high-level managers in large multinational enterprises. The CEO may use a great deal of personal control to influence the behavior of his or her immediate subordinates, such as the heads of worldwide product divisions or major geographical areas. These heads may use personal control to influence the behavior of their subordinates, and so on down through the organization. For example, Jack Welch, CEO of General Electric, has regular one-on-one meetings with the heads of all of GE's major businesses (most of which are international). He uses these meetings to probe the managers about the strategy, structure, and financial performance of their operations. In doing so, he is essentially exercising personal control over these managers and over the strategies they favor.

Bureaucratic Controls

Bureaucratic control is control through a system of rules and procedures that direct the actions of subunits. The most important bureaucratic controls in subunits within multinational firms are budgets and capital spending rules. Budgets are essentially a set of rules for allocating a firm's financial resources. A subunit's budget specifies with some precision how much the subunit may spend. Headquarters uses budgets to influence the behavior of subunits. For example, the R&D budget normally specifies how much cash the R&D unit may spend on new-product development. R&D managers know that if they spend too much on one project, they will have less to spend on other projects. Hence, they modify their behavior to stay within the budget. Most budgets are set by negotiation between headquarters management and subunit management. Headquarters management can encourage the growth of certain subunits and restrict the growth of others by manipulating their budgets.

Capital spending rules require headquarters management to approve any capital expenditure by a subunit that exceeds a certain amount (at GE, $50,000). A budget allows headquarters to specify the amount a subunit can spend in a given year, and capital spending rules give headquarters additional control--control over how the money is spent. Top managers can be expected to deny approval for capital spending requests that are at variance with overall firm objectives and to approve those that are congruent with firm objectives.

Output Controls

Output controls involve setting goals for subunits to achieve; expressing those goals in terms of relatively objective criteria such as profitability, productivity, growth, market share, and quality; and then judging the performance of subunit management by their ability to achieve the goals.¹⁸ The kinds of goals subunits are given depends on their role in the firm. Self-contained product divisions or national subsidiaries are typically given goals for profitability, sales growth, and market share. Functions are more likely to be given goals related to their particular activity. Thus, R&D will be given new-product development goals, production will be given productivity and quality goals, marketing will be given market share goals, and so on.

As with budgets, goals are normally established through negotiation between subunits and headquarters. Generally, headquarters tries to set goals that are challenging but realistic, so subunit managers look for ways to improve their operations but are not so pressured that they will resort to dysfunctional activities to do so (such as short-run profit maximization). Output controls foster a system of "management by exception"; as long as subunits meet their goals, they are left alone. If a subunit fails to attain its goals, headquarters management is likely to ask some tough questions. If they don't get satisfactory answers, they are likely to intervene in a subunit, replacing its top management and looking for ways to improve its efficiency.

Output controls are typically reinforced by linking management reward and incentive schemes. For example, if a worldwide product division achieves its profitability goals, its managers may receive a significant pay bonus. The size of the bonus might reflect the extent to which a subunit exceeds its goal so that subunit management has an incentive to optimize performance.

Cultural Controls

We touched on the issue of cultural controls in the previous section when we discussed organization culture as a means of facilitating cooperation. Cultural controls exist when employees "buy into" the norms and value systems of the firm. When this occurs, employees tend to control their own behavior, which reduces the need for direct supervision. In a firm with a strong culture, self-control can reduce the need for other control systems.

McDonald's is a good example of a firm that actively promotes organizational norms and values. McDonald's refers to its franchisees and suppliers as partners and emphasizes its long-term commitment to them. This commitment is not just a public relations exercise; it is backed up by actions, including a willingness to help suppliers and franchisees improve their operations by providing capital and/or management assistance when needed. In response, McDonald's franchisees and suppliers are integrated into the firm's culture and become committed to helping McDonald's succeed. One result is that McDonald's can devote less time than would otherwise be necessary to controlling its franchisees and suppliers.

Cultural control is very difficult to build. Substantial investments of time and money are required to cultivate organizationwide norms and value systems. As we saw earlier, this involves defining and clarifying the company mission or vision, disseminating the desired norms and value systems through management education programs, leading by example, and adopting appropriate human relations policies. Even with all these devices in place, it may take years to establish a common, cohesive culture in an organization.

Control Systems and Strategy in the International Business

The key to understanding the relationship between international strategy and control systems is the concept of performance ambiguity.

Performance Ambiguity

Performance ambiguity exists when the causes of a subunit's poor performance are ambiguous. This is not uncommon when a subunit's performance depends partly on the performance of other subunits; that is, when there is a high degree of interdependence between subunits within the organization. Consider the case of a French subsidiary of a US firm that depends on another subsidiary, a manufacturer based in Italy, for the products it sells. The French subsidiary is failing to achieve its sales goals, and the US management asks the managers to explain. They reply that they are receiving poor-quality goods from the Italian subsidiary. So the US management asks the managers of the Italian operation what the problem is. They reply that their product quality is excellent--the best in the industry--and that the French simply don't know how to sell a good product. Who is right, the French or the Italians? Without more information, top management cannot tell. Collecting this information will be expensive and time consuming, and it will divert attention away from other issues. Performance ambiguity raises the costs of control.

Consider how different things would be if the French operation were self-contained, with its own manufacturing, marketing, and R&D facilities. Then the French operation would lack a convenient alibi for its poor performance; the French managers would stand or fall on their own merits. They could not blame the Italians for their poor sales. The level of performance ambiguity is a function of the extent of interdependence of subunits in an organization.

Strategy, Interdependence, and Ambiguity

Now let us consider the relationship among international strategy, interdependence, and performance ambiguity. In multidomestic firms, each national operation is a stand-alone entity and can be judged on its own merits. The level of performance ambiguity is low. In an international firm, the level of interdependence is somewhat higher. Integration is required to facilitate the transfer of core competencies. Since the success of a foreign operation depends partly on the quality of the competency transferred from the home country, performance ambiguity can exist.

In global firms, the situation is still more complex. In a pure global firm, the pursuit of location and experience curve economies leads to the development of a global web

Table 13.1

Interdependence, Performance Ambiguity, and the Costs of Control for the Four International Business Strategies

		Performance	Costs of
Strategy	Interdependence	Ambiguity	Control
Multidomestic	Low	Low	Low
International	Moderate	Moderate	Moderate
Global	High	High	High
Transnational	Very high	Very high	Very high

of value creation activities. Many of the activities in a global firm are interdependent. A French subsidiary's ability to sell a product depends on how well other operations in other countries perform their value creation activities. Thus, the levels of interdependence and performance ambiguity are high in global companies.

The level of performance ambiguity is highest of all in transnational firms. Transnational firms suffer from the same performance ambiguity problems that global firms do. In addition, because they emphasize the multidirectional transfer of core competencies, they also suffer from the problems of firms pursuing an international strategy. The extremely high level of integration within transnational firms implies a high degree of joint decision making, and the resulting interdependencies create plenty of alibis for poor performance. There is lots of room for finger-pointing in transnational firms.

Implications for Control

The arguments of the previous section and the implications for the costs of control are summarized in Table 13.1. The costs of control might be defined as the amount of time top management must devote to monitoring and evaluating subunits' performance. This will be greater when the amount of performance ambiguity is greater. When performance ambiguity is low, management can use output controls and a system of management by exception; when it is high, they have no such luxury. Output controls do not provide totally unambiguous signals of a subunit's efficiency when the performance of that subunit depends on the performance of another subunit within the organization. Thus, management must devote time to resolving the problems that arise from performance ambiguity, with a corresponding rise in the costs of control.

Table 13.1 reveals a paradox. We saw in Chapter 12 that a transnational strategy is desirable because it gives a firm more ways to profit from international expansion than do multidomestic, international, and global strategies. But now we see that due to the high level of interdependence, the costs of controlling transnational firms are higher than the costs of controlling firms that pursue other strategies. Unless there is some way of reducing these costs, the higher profitability associated with a transnational strategy could be canceled out by the higher costs of control. The same point, although to a lesser extent, can be made with regard to global firms. Although firms pursuing a global strategy can reap the cost benefits of location and experience curve economies, they must cope with a higher level of performance ambiguity, and this raises the costs of control (in comparison with firms pursuing an international or multidomestic strategy).

When we survey the control systems that corporations use to control their subunits, we find that irrespective of their strategy, multinational firms all use output and bureaucratic controls. However, in firms pursuing either global or transnational strategies, substantial performance ambiguities limit the usefulness of output controls. As a result, these firms place greater emphasis on cultural controls. Cultural control--by encouraging managers to want to assume the organization's norms and value systems--gives managers of interdependent subunits an incentive to look for ways to work out problems that arise between them. The result is a reduction in finger-pointing and, accordingly, in the costs of control. Development of cultural controls may be a precondition for the successful pursuit of a transnational strategy, and perhaps of a global strategy as well.¹⁹

		Strategy
Structure and Controls		Multidomestic	International	Global	Transnational
Vertical Differentiation		Decentralized	Core competency centralized; restdecentralized	Some centralized	Mixed centralized and decentralized
Horizontal Differentiation		Worldwide area structure	Worldwide product division	Worldwide product division	Informal Matrix
Need for coordination		Low	Moderate	High	Very high
Integrating mechanisms		None	Few	Many	Very many
Performance ambiguity		Low	Moderate	High	Very high
Need for cultural controls		Low	Moderate	High	Very High

Table 13.2

A Synthesis of Strategy, Structure, and Control Systems