Management Control Systems 03/06/2014 04:55:00

Session 1:

Formal systems/Information based systems to implement organizations
strategies.

Hold/Alter organizations activities

Levers of Control (How does an organization control its resources such as
Capital and People given a chosen strategy----It is not a strategy
formulation exercise). Quintessential Example: Narendra Modi

Belief System : (Core values of the organization conveyed through
mission statement, vision statement) that provides the employees
the freedom to be creative. For example: IE provides students with
the ability to choose different ways of implementing learning such
as ICP, Internship for a greater good. (Top down)

Boundary System : Giving limits to the freedom. Be creative but
within the limits, dont jump guns. Decide how you deploy your
resources but also how you do not deploy your resources. (Top
Down)

Diagnostic Control System : Tells you anytime you digress from
the strategy. Gives you a warning signal

Interactive Control System : Futuristic system that helps
organizations deal with unforeseen circumstances. Generally you
are dealing with ambiguous and uncertain circumstances, so it
helps to analyse the current strategy and readjust it or rethink
about a new strategy

Delegation of Decision Rights
Differentiate between delegation of tasks and delegation of decision rights.
DoT is simple but DoDR is a bit tricky.

Delegation of Task: It is a Behaviour Control. Whip and Carrot approach. Go
and knock at the doors (This is a task).

Delegation of DR: When you ask for an outcome and there is no clear
defined way to reach the outcome. I want an increase in sales of 10% (This
is an outcome and there is no defined way to accomplish it).

Problems: A manager can delegate the DR to the assistant manager but the
AM can fail because of two reasons: Incompetency or Self-Interest.
Incompetency can be obviated by terminating the employees. Self-Interest
can be obviated by aligning the goals of the employee with that of
companys.

NUCOR Case:
Steel Company in the US
Worst performing
High labour cost/Steel unions
Overcapacity/low exports for the US Steel
High Competition for imported Steel
Not an Integrated Steel manufacturer but a Mini-mills (Steels from
Scrap)
-- So basically a Low-Cost strategy

Explanations:
1.) Industry Level: Not an attractive industry
2.) Country Level: Not a good country to start a steel business (already a
developed country)
3.) Intra-Industry Structure
MM > ISM
NUCOR >>>>> Others
4.) Internal Mechanisms
Differentiated Strategy: No
Value Chain partner: Not Really
Internal Organization: There you go ;) MCS rules the roost.
Everything was aligned with the low-cost strategy.



Session 2:

Budget as a control mechanism

Profit Centres have two categories
Cost Centres: Input Costs (Minimize Cost): Performance measure
= Budgeted Cost Actual Cost

Revenue Centres: Outputs Revenues (Maximize Revenues):
Performance measure: Actual Revenue Budgeted Revenue

Natural Cost Centre:
Factory => Budgeted Costs (Budgeted # units * Budgeted Cost) => Sales
Budget => Difference must only be in the number of units. Any budget vs
Actual variance should only be in the #units. Uncontrollable part is #units
whereas Manager related variance is controllable.
Here we are dealing with efficiency and financial performance measures.

Artificial Cost Centre:
Legal
Accounting
Marketing
Information System

Here we are not dealing with efficiency but effectiveness i.e. Qualitative and
non-financial performance measures. But sometimes red-tapism is prevalent
in these cost centres and their existence is dubious and questionable.

Incremental Budget: Based on last years budget and multiply it by some
number. They are not a good management control mechanism since it does
not reflect efficiency but people tend to

Zero-based: Everything is clearly defined and is aimed at reducing costs. It
is applicable to project based companies or in the times of crisis because it is
very effective in controlling costs. The downside is that it is very time
consuming.

Vershire Company Case:

Session 3:
1.) Sourcing: Freedom to buy from inside/outside
2.) Transfer Pricing: What prices are inside
Retail Price
Market Price
Cost Price (Variable Costs or Total Costs)
3.) Intervention

North Country Auto:


Session 4:
Profit Centre
Increase Compensation
Profit margin
Decision Rule is maximizing divisional profits

Sourcing, Sales and Prices, Intervention

If it is a regular order then you dont deal with variable costs rather
deal with Total Costs. You deal with the variable costs only when it
is a special cost.

How much and How to?

- Many times company wide profits KPIs cannot work because of lack of
information about the profitability of other divisions.
- Hence, the management can force divisions to share information but that
also has downsides since you are destroying their bargaining power. Hence
this option is also out.

As you decentralize more and more, the control also looses muscle.

Right now it represents only 5% of the overall revenue but if it was 90% of
the revenue then it does not remain the division wide problem, and you have
to integrate the two divisions because then cost matters and not the profits.

Dont jump in the melee, take a step back and let divisional
managers handle the issues especially when it is not a significant
part of the companys revenues.

Session 5:
Profit Equation
Sales
- VC
=C.M.
- FC
= Direct Divisional Profit
- Overheads
= Divisional Profit after Overheads
- Tax
= PAT (Profit after Tax)

Assets: Working Capital (Managers manage this everyday in that they are
always concerned about the Inventory, Accounts Receivables)

If you tie bonuses of the managers to ROA then you have to take the
payments in your hands so that the smart managers do not monkey
around with it. Because they might control the working capital by
negotiating payment terms with the suppliers (basically lengthen the
payment schedule so that accounts payable remains the same and Current
Liabilities increase thereby decreasing the Working capital and increasing the
Profits and hence ROA increase.
Or He might not pay at all or try to decrease the assets in some way or the
other to increase ROA

Gross Value Vs Book Value of the assets: If Gross Value then managers will
replace old assets to enhance efficiency and hence discard the assets before
its life. If Book Value, they will not replace the machine because the asset
will depreciate and will increase ROA (not because they have improved on
profits but because the assets have been decreasing consistently)

Bonuses contingent upon Residual Income will facilitate more goal
congruence and not the ROA.

R.I. (Residual Income) = Actual Profit Minimum Profit
Tie the bonuses on Residual Income

ROA: Milwankee (25%), Columbus (38%), Atlanta (8%), Tucson (15%),
Reno (42%)

Smartest manager: Reno
Dumbest Manager: Atlanta

Now if new opportunities arrive the dumbest one will send every opportunity
that generates ROA more than 8% and if he gets 45% one and the Smartest
one gets 35%, 36% and 39%, he will not send it to the Corporate head. So
you are basically leaving the capital budgeting decision in the hands of the
dumbest one.

Also when you compare ROA, you need to check whether it is a
measurement issue or an industry issue because consulting projects are
supposed to have higher ROA because they dont use any asset because
human capital is not counted as assets but a different project might be
profitable but a capital intensive one, then ROA Is bound to be low. So
comparison across industries is tricky, so be careful.

Session 6:
Strategic Planning & Budgeting
-Strategic Planning is less used for control and is Long term to medium term
Non Financial measures

-Budgeting is annual or shorter and is used as a control mechanism.
Financial measures
Expectations

Allied Office
Allied office is an office products company. We are only concerned about
Total Forms Control (TFC)
Sell forms to the consumers so basically it is a printing press.
Price = Cost + Margin (it is a commodity so it makes sense)

Cost Structure = Materials + Labour (Major contribution in the cost structure
is the Master. So the general tendency is to keep making as many copies as
you want because master cannot be reused. So you have high fixed costs
and the only way to reduce it to manufacture large volumes)

Now they want to change. They came up with another strategy
Any form, Any # of forms, Anytime, Anywhere
Results: Sales increase but the profits went down

Product Hierarchy can be:
From Commodity Commodity + Service Service Trans Services
1:1 Experience

ABC: In ABC we deal with variable overheads and not fixed overheads. But
the upside is that we can find out the non-value added activity and can
remove it.

Activities involved:
Storage
Picking & Packaging
Purchase Order Entry
Desktop Delivery
Reporting


Low Cost High Cost
High Price Dream Customers Premium Customers
Low Price Price Sensitive Nightmare

I cant price storage since it is not a customer driven problem but is a
production driven problem.
Pick and Pack and Order taking also cannot be priced

The only thing that can be priced is the desktop delivery because this is the
only added value.

If you change from one model to another, you have to think it through. In
this case if you decide to do away with Customer B, sales people will vie for
customer A but will get low revenues because the services portion of the
cost is removed. This will decrease the commissions of sales people thereby
decreasing in the number of good sales people.

Sometimes we should look to open up the value chain and should
understand the repercussion of our decisions.

Budgets are contracts that can be used for
Outcomes (short term performance, Control Mechanism, Financial
measures) Established Industries
Behaviours (Long term performance, Not a Control mechanism,
Planning tool, non-financial measures) For new products

Budget Actual = Variance (this is your performance measure)
Expectations Actual Performance = Performance Measure

Therefore Variance analysis is a very disciplined and effective approach in
performance measures.

Session 7:
Individual/Separable effect if each action (factor) on cost profit ceteris
paribus
Variance Analysis
Sales Variance = Budgeted Sales - Actual Sales

Price Variance = (Budgeted Price Actual Price)*Actual Volume
Volume = (Budgeted Volume Actual Volume)*Budgeted Price

For Example:
BP = $2/unit
BV = 1000 units
Budgeted Sales = 2000
AP = $1.5/unit
AV = 1500 units
Actual Sales = 2250

Production Volume may not be equal to Sales Volume since there is an
inventory as well.

Fixed Costs are uncontrollable (Risk Before), whereas Variable costs are
controllable (Control Damage)

Margin = Selling Price Variable Cost
BEP = FC/(C.M. in percentage)

High FC and Low Variable Costs will increase the BEP and the margin but the
multiplier effect will also be high

Low FC and High VC, the BEP and the margin will be less but the multiplier
will also be less

You can make a profit at BEP in production because the implicit
assumption is the production volume equals sales volume but they
may not be the same.

Product Market Strategy
Margin/Turnover = (Profit/Sales) * (Sales/Assets)

Profit, Cash Cycle, ROE: Three most important ways to create shareholder
value
ROE is a Financing Strategy

Think about the need before implementing any system
Marketing Strategy 03/06/2014 04:55:00
Unilever Case

Problem:
The company wants to make inroads into low-income households market
that poses few germane questions
Should the company fight in the lower-end of the market where even
small players with a lower cost structure struggled to make profits?
Should the company launch a new brand or position its already existing
cheaper brands?
Ideal marketing mix for lower end consumers?
Marketing Strategy?

4Cs

Company Consumers

Collaborators

Competitors

Context (PEST)
Consumer
goods
Well
known
company
with 45
brands of
detergents
81%
market
share of
detergent
powder
with 75%
market
share in
NE
detergent
market
Low-
income
Consumers
48 million
(53% of
whom are
below 1-2
times
average
national
income)
Dependent
on
agriculture
28% Own
washing
m/c in NE
(67% in
SE)
Generalist
Wholesalers
but are
sometimes
dependent
on small
wholesalers
Specialized
Distributors
with
exclusive
rights to sell
Unilevers
detergent in
certain
regions
Since it is a
big
component
P&G (15%
market
share)
and 17.5
in NE
detergent
market
Ace (11%
market
share)
Cheaper
Local
Brands
Tax Incentives
for companies
investing in NE
Water is soft
which
facilitates
more foam
formation
which
basically
removes one
key advantage
of the
detergent
powder
73% think
bleach is
necessary
in NE (18%
in SE)
Use bars of
laundry
soap and
use the
detergent
only for
good
fragrance
5 times a
week in NE
vs 3.9 time
a week in
SE
Women
consider it
pleasurable
of the
product cost
and the
decision
cannot be
reversed,
the choice
of
distributors
is vital



4Ps

Product

Price

Place Promotion
Detergent
powder
OMO
(Favourite
brand)

Minerva (only
Low price
(52%) OMO at
$3 /kg
(17%) Minerva
at $2.4 /kg
(6%)
Campeiro at
Northeast of
Brazil
Rural
Cant use products
for low-income
people which will
alienate them from
the brand and will
leave them with a
perception that the
brand sold as
both detergent
powder and
laundry soap)
and

Campeiro
(companys
cheapest
brands)
Low Margin

Solutions:
Large packet
or sachets
Right
attributes to
control price
1.7 /kg product is of inferior
quality
Cannot make it
aspirational which
will jeopardise the
existing consumers
Explaining to the
small stores where
the most of the
target customers go
and rely on their
advice
70% ATL (lower cost
per contact and
increased visibility)
and 30% BTL
or 70% BTL (overall
reduced cost but
higher cost per
contact and lower
visibility) and 30%
ATL


6 Product attributes looked before effecting purchase:
1. (24%) Perceived power more cleanliness per quantity of product,
whitening and productivity
2. (20%) Smell, and softness
3. (16%) Ability to remove stains w/o need of for laundry soap and
bleach
4. (16%) Consistency and granularity of the powder (Ease of
dissolving)
5. (13%) Packaging: simple, easily recognizable
6. (11%) Impact on colours (Fading) ---Least preferred metric

Market (Northeast)
1. Detergent Powder:
$ 106 million
42000 tons
Growing at a rate of 17%
Barriers to entry are high because its capital intensive
Average revenue $2520 per ton

2. Laundry Soap
102 million
81250 tons
Growing at 6%
Barriers to entry are lower since it is easy to produce
Average revenue $1250 per ton
Used to remove tough stains
No fragrance
Top 4 have 38% market share with Minerva at 19% selling @
$1.7/kg
P&G is absent in this segment leaving only local brands as big
competitors out of which the biggest one being ASA with its brand
Bem-te-vi enjoying 11% market share and sold @ $1.2 /kg and
Flora Fabril with 6%

Concerns of entering low-income segment
o Cannibalisation of high-margin brands with low-margin ones
o Starting of price war
o Brand dilution since its been operating in premium segment
o Will result in repelling top students and brand managers
o Whether they have right skills and organization to compete in this
market
o Cost-benefit trade off??
o Brand repositioning or brand extension?


GO:
Big Market 50 million
If we dont go, P&G will occupy
Leverage experience in India
Focus on customers who may be growing







Supply Chain Management 03/06/2014 04:55:00
Cost (under-stocking) = Opportunity Cost = 1 0.2
Cost (over-stocking) = 0.20 0.0 (salvage value)

C.R. = (1 0.2)/{1 0.2 + 0.2-0} = 0.8

P(Demand < Supply) = Cost (under-stocking)/(cost(under stocking) + cost
(over-taking))

If we introduce retailer
Price retailer = 1.00
Cost retailer = 0.80

Price (you) = 0.80
Cost (you) = 0.20

Critical Ratio (you) = Cost under stocking/{Cost under-stocking + Cost
overstocking} = (0.80 0.20)/(0.80 0.20 + 0.20 0) = 0.75

Critical Ratio (retailer) = (1 0.8)/{1 - 0.8 + 0.8} = 0.2
Managing People at Work 03/06/2014 04:55:00
Session 10

Hewlett Packard abandons pay-for-performance plans
Because costs of these programs are higher than the benefits. Instead
effective leadership, clear objectives, coaching or training were better
investments. Why? Let us explore now

Higher performance means search for managerial practices that will enhance
competitiveness === MONEY!!! :P

Problems with traditional compensation systems:
Pay becomes entitlement
Benefits are given for tenure
Base pay is function of levels and not performance
Merit increases do not differentiate performance sufficiently
Even bonuses becomes entitlement


Pay for Performance:
Efficiency improves in 2 out of 3 programs
ROI is 134%
Those using showed twice the return than those not using it
Problems:
Destructive effect on
o Intrinsic motivation
o Self-esteem
o Teamwork
o Creativity
Motivate employees to focus on doing to gain rewards. Sometimes
at the expense of doing other things that would help the
organization

Two barriers to implementing this system
Linking performance to effort
o Difficulty in measuring performance
o Uncontrollable factors being paid for that performance
o Managers and peers are uncomfortable with ratings
employees differently

Linking pay to performance
o Employees can come to rely on the additional compensation
o Employees are biased toward overestimating their own
contribution
o Corporate budgets for bonuses limits payout
o Managers can lose commitment to the pay system if it pays
out more than anticipated due to problems in payout
standards and if there are changes in performance standards
due to changes in technology and organizational
arrangements and unanticipated learning curves.
CULTURE shapes the policies implemented to pay-to-performance
Discourages opportunism
Top managers lead by example by reinforcing this culture
Long-term careers in which reputation is a valuable commodity
Corporate Finance 03/06/2014 04:55:00
Session 5:
Asset beta/Unlevered contains only business/operational risk
Equity/Levered beta contains business + financial risk

Ba = Be/[1 + (D/E)*(1-t)]

So unlevered first and then use different debt equity ratios to calculate
Equity beta and cost of equity capital

Value = FCF*(1+g)/[WACC g]

Actual Tax Shield = 5559*0.36 = 5977*t
*


If we do not change the tax rate then we are overestimating the tax
shield.

Session 6:
Dividend Cash Assets goes down That means Equity also goes down
Leverage goes up

If you have been doling out dividends but stop paying in the next fiscal year,
then it gives a negative sign in the market that the firm must have stopped
to grow.
Every cash flow is discounted depending upon its type such as interest
payments are discounted at r
d
and the dividend will be discounted as r
e
, the
cash flows will be discounted at WACC.

After paying the dividend, the stock price will go down by the same amount
since that dollar amount has been taken out of the expected cash flow and
will change the calculations of the potential investor. Present Value concept

If declaration provides new information then it will attract market reaction
such as if the company announces dividend unexpectedly then the reaction
will result in increase in the share price, but if it is a regular process then the
stock price will not change but will fall on the ex-dividend date.

Return on stock = (Share Price1 Share Price0)/P0 + D1/P0 = (P1 P0 +
D1)/P0

(Share Price1 Share Price0) is known as Capital Gains

Re = Risk free rate + Beta*(market risk premium)

For Diageo:
Re = 5.83 + 0.55*5% (CAPM) = 8.58%

Dividend yield for Diageo = 5%

=> Dividend as a percentage of total return for Diageos shareholder =
5/8.58% = 58%

So Diageos shareholders are receiving their 58% of the return in form of
dividends.

Dividend Policy is very important for Diageo, when dividend is such a big
chunk of the returns. Which is why Diageo did not want to cut the dividends
and would rather cut the CapEx and Marketing Expenditures.

Stock Price is the present value of the expected dividends from now to
infinity and if you take out a portion of the dividend the P.V. goes DOWN!!!!

Signalling implications of the dividend policy matters and not the
mathematics of it. Check the slide of Dividend Irrelevance

Free Cash flow is the cash available to pay to shareholders and bondholders
So FCFE is calculated after deducting interest payments (considering debt
cushion) and any change in debt.