Business management systems

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The term systems refers to management systems, which include any of the formally organized procedures that pervade a business. Three types of systems may be distinguished: execution systems, monitoring systems, and control systems.

1. Execution systems focus directly on the basic processes for conducting the firm’s business. They include systems that enable products to be designed, supplies to be ordered, production to be scheduled, goods to be shipped, cash to be applied, and employees to be paid.

2. Monitoring systems are any procedures that measure and assess basic processes. They can be designed to gather information in different ways to serve a number

of internal or external reporting purposes: to meet SEC or other regulatory requirements, to control budgets, to pay taxes, and to serve the strategic and organizational intent of the company.

3. Control systems are the means through which processes are made to conform or are kept within tolerable limits. At the broadest level, they include separation of duties, authority limits, product inspection, and plan submittals.

As can be seen from this brief description, systems pervade the conduct of business. For that very reason, systems provide ample opportunity for strategies to fail. In most companies, the major emphasis is on execution systems. But creating systems that support strategies and organizational intent requires top management to include monitoring and control systems in addition to executing systems in strategic thinking and to focus on systems in strategy implementation. It means, as part of the strategic planning, answering such key questions as: What are the critical success factors? How do they translate into operational performance? How should that operational performance be measured and motivated?

How should information about financial performance be derived? What business cycles are important? How should systems support them? What is the role of financial controls and measures? Where should control of information reside? How should strategic objectives and organizational performance be monitored and modified? How should internal and external information be linked? In short, integrating all systems with strategy requires great vision the ability to see the firm as an organic whole. Unfortunately, too many systems managers lack vision or clout and too many executives lack the understanding or the inclination to make this integration happen.

Techniques for Systems Design To create systems that support strategic and organizational intent, top management must include systems in strategic thinking and focus on systems in strategy implementation. Once critical success factors have been identified and translated into operational measurements, good systems design techniques are needed to ensure that those factors and measurements are appropriately accommodated by all systems. Following are some guidelines for good systems design:

1. Design an effective information-capturing procedure Data should be captured close to the source, and source documents should be linked. For example, at one company, data processing personnel collected information on raw materials from receiving reports two days after delivery and entered that information into purchasing control and inventory management systems. Two days later, accounting gathered information on the same delivery from invoices, this time entering it into accounting systems. The failure to link source documents led to apparent inventory discrepancies. Purchasing and inventory processes focused on inventory codes and quantities; accounting processes dealt with accounting codes and monetary amounts, which were available only at the end of the month. These problems required a three-part solution: placing terminals at the receiving dock, where receiving clerks could enter operating information; using internal links to accounting codes; and creating a reconciliation proof on which quantities and amounts were entered as invoices were received.

2. Manage commonly used data elements for firm-wide accessibility and control If a multidivisional firm allows each unit to code inventory discretely, stock that is commonly used cannot be traded and rebalanced. Traditionally, auto dealers maintained independent inventory controls. By contrast, Ford Motor Company has worked to keep its inventory records consistent and thus accessible to dealers so that imbalances at one lead to opportunities for another.

3. Decide which applications are common and which tolerate distributed processing Typical considerations here include pinpointing the need to share data, determining the availability of hardware and software offerings that make a distributed approach feasible, and investigating the effect of geographical distance. Once a particular application or function is judged appropriate for a distributed approach, it must be integrated into an information network.

4. Manage information, not reports Systems are often developed with end reports in mind, focusing on output, not content. If needs change or if developers and users misunderstand each other, the results can lead to frustration at best or the inability to modify output at worst. When the development focus is on content, on information that has been strategically identified as critical to success, users can tailor the presentation of output to their purposes. For example, in one company with a well-constructed receivables database, one manager chose to compare cash collections to target amounts, another used days outstanding, and a third used turnover ratios.

5. Examine cost-effectiveness Questioning the value of a system and of the work required to support it is healthy. But such questioning must be handled properly. As an example, to escape merely chipping away at existing processes through cost reduction, Procter & Gamble developed its elimination approach, which is based on the key “if” question: If it were not for this [reason], this [cost] would be eliminated. Designing and maintaining systems that focus on strategic intent and that assess performance in terms of that intent is crucial to the success of a strategy. In fact, a lack of integration between systems and strategy is an important reason why sound strategic and organizational concepts get bogged down in implementation and do not achieve the results their creators intended. Soundly designed and managed systems do not happen casually: they emerge only with top management involvement and with a clear vision of the importance of systems to strategic outcomes.

EXECUTIVE REWARD SYSTEMS Executive compensation and strategy are mutually dependent and reinforcing. A good reward system should have three characteristics:9 (a) it should optimize value to all key stakeholders, including both shareholders and management alike (the so-called agency problem); (b) it should properly measure and recapture value; and (c) it should integrate compensation signals with those implicit in strategy and structure. Although these issues are generally addressed from the perspective of plan implementation, they also have an important but rarely noted strategic dimension. And that strategic dimension actually has a make-or-break impact on plan effectiveness.

The Agency Problem The agency problem refers to the potential conflict of interest between shareholders and their agents, the executives charged with implementing corporate strategy. The executives of a corporation serve as agents of the corporation’s shareholders. Yet, though both executives and shareholders are stakeholders in a corporation, their interests do not coincide. In fact, they naturally diverge on three counts: risk position (e.g., shareholders stand last in line among claimants to the resources of the corporation, whereas executives have the right to payment of salaries and benefits before the claims of shareholders are met); ability to redeploy (e.g., shareholders can freely redeploy their investments; the executives’ human capital invested in the course of a career may not be easily redeployable at full value); time horizon (e.g., shareholders embrace long time horizons to earn competitive returns; time horizons of executives are usually shorter). These differences lead to differences in the ways each group measures the risks and rewards of any corporate action. In general, the differences in risk evaluation make a company’s executives more averse to risk than are its shareholders.

Resolving the agency problem requires bridging the gap between the inherently divergent interests of shareholders and the executives entrusted with the responsibility of safeguarding and increasing shareholder investments. Though executive compensation plans can and should help resolve this problem, they often compound it. Most incentive plans, for example, are based on improvements in short-term earnings; therefore, they actually inhibit the very risk decisions required to provide highly competitive returns to shareholders. New and creative ways of compensating executives must be developed to synchronize their interests with those of shareholders.

The Value Problem From the company’s viewpoint, the value issue is twofold. One aspect revolves around the need to reward executive performance in a way that is systematically related to the market value of the corporation. The other is the need to create incentive plans for managers of individual business units. In this article, our major concern is with creating incentive plans for managers of individual business units.

Compensation planning for individual business units is illustrated with reference to a hypothetical company, Hellenic Corporation. Hellenic Corporation consists of four businesses: Alpha, Beta, Gamma, and Delta. Alpha operates in a promising market but needs to increase market share rapidly. Beta is an efficient, well-run business that already has the largest share of a mature market. Gamma, once a top performer, has suffered recently from serious management mistakes; nevertheless, it has the potential to be a winner again. Delta is a mediocre performer in a mediocre market; moreover, its business is largely unrelated to the other businesses of the corporation. Hellenic’s strategic plan calls for Alpha to grow rapidly, for Beta to capitalize on its well-established position, for Gamma to turn itself around, and for Delta to be divested. This plan maximizes the value of the corporation as a whole. Each division is vital to the corporation’s success; however, the management objectives of the chiefs at Alpha, Beta, Gamma, and Delta differ from one another and influence the market value of the firm in distinct ways.

This conflict, however, does not mean that shareholder value is an impractical standard for determining executive reward. Even when a manager’s performance is related only indirectly to shareholder value, increasing shareholder value need not be abandoned as the aim of executive compensation planning. The challenge is to craft a plan that links performance to value in a way that is consistent with the corporation’s long-term strategy. To do this requires tailoring a specific compensation package for the manager of each business unit. The determinants of compensation at Alpha must be different from those at Beta, which again must be different from those at Gamma and at Delta.

This overall plan can be created by analyzing how risk and time horizons in executive pay plans suit the strategic objectives of each business unit. For example, the top manager at Alpha is engaged in a very long-term project. Exceptional growth and profitability are planned, and the risks incurred in executing the plan are considerable. These circumstances call for a pay package geared to the entrepreneurial challenges facing Alpha. Accordingly, the time horizon is very long and the risk posture is high. At Beta, where the prime objective is to maximize returns from a well-established market position, the time horizon and risk posture are moderate. At Gamma, the turnaround candidate, the time horizon is short and the risk posture is very high. At Delta, being managed for window dressing, the time horizon is short and the risk posture is low. In addition, other special sell-off compensation arrangements (e.g., a percentage of the sale price) may be needed.

The Signaling Problem A signal is simply an inducement to action. Because pay is clearly a powerful inducement to action, compensation systems are powerful signaling devices. Other signaling devices include financial controls, the planning process, and the top management succession plan. All these factors convey messages about what a corporation expects and what it values. Collectively, these signals shape the corporation’s culture and determine the actions it takes in given situations. When management sends consistent signals through all channels, it adheres to a clear strategic track. Unfortunately, conflicting internal signals are common, and compensation is frequently the area of greatest dissonance. Companies must tackle the signaling problem directly. Winners should be paid like winners, and poor performers must not be rewarded. Briefly, executive compensation plans require more risk taking based on real value. Incentive plans should be designed to induce risk taking. They should make executives think like owners. That is, the plan must bring the interests of executives in line with the interests of shareholders. By resolving the problems of agency and value, by ensuring that high levels of risk taking reap commensurate rewards, and by eliminating conflicting signals, companies can put in place the kinds of incentives required to create exceptional value for owners and agents alike.