Benefits of Management By Exception

Control Process

Control, particularly operational control is exercised by a process consisting of four major steps as shown in figure.

In order to exercise control, managers have to take four steps as indicated in Figure these steps are as follows:

• Setting performance standards
• Measuring actual performance
• Analyzing variance
• Taking corrective actions.

Setting Performance Standards: Every function in the organizations begins with plans which are goals, objectives, or targets to be achieved. In the light of these, standards are established which are criteria against which actual results are measured.

For setting standards for control purposes, it is important to identify clearly and precisely the results which are desired. Precision in the statement of these standards is important. In many areas, great precision is possible. However, in some areas, standards are less precise. Standards may be precise if they are set in quantities-physical, such as volume of products, man- hour or monetary, such as costs, revenues, investment. They may also be in qualitative terms which measure performance.

After setting the standards, it is also important to decide about the level of achievement or performance which will be regarded as good or satisfactory. There are several characteristics of a particular work that determine good performance. Important characteristics which should be considered while determining any level of performance as good for some operations are:

• output,
• expense, and
• resources

Expense refers to services or functions which may be expressed in quantity, for achieving a particular level of output. Resources refer to capital expenditure, human resources, etc. after identifying these characteristics, the desired level of each characteristic is deter- mined. The desired level of performance should be reasonable and feasible. The level should have some amount of flexibility also, and should be stated in terms of range-maximum and minimum as shown in figure.

Control standards are most effective when they are related to the performance of a specific individual. Because a particular individual can be made responsible for specific results However, sometimes accountability for a desired result is not so simply assigned; for example, the decision regarding investment in inventory is affected by purchase, rate of production, and sales. In such a situation, where no one person is accountable for the levels of inventories, standards may be set for each step that is being performed by a person.

Measuring Actual Performance: The second major step will control process is the measurement of performance. The step involves measuring the performance in respect of a work in terms of control standards. The presence of standard implies a corresponding ability to observe and comprehend the nature of existing conditions and to ascertain the degree of control being achieved.

The measurement of performance against standards should be on a future basis, so that deviations may be detected in advance of their actual occurrence and avoided by appropriate actions. Appraisal of actual or expected performance becomes an easy task, if standards are properly determined and methods of measuring performance which can be expressed in physical and monetary terms, such as production units, sales volume, profits, etc. can be easily and precisely measurable. The performance which is qualitative and intangible, such as human relations, employee morale, etc. cannot be measured precisely. For such purposes, techniques like psychological tests and opinion surveys may be applied. Such techniques draw heavily from intuitive judgment and experience, and these tools are far” from exact. According to Peter Drucker, it is very much desirable to have clear and common measurements in all key areas of business. It is not necessary that measurements are rigidly quantitative. In his opinion, for measuring tangible and intangible performance, measurement must be

• clear, simple, and rational,
• relevant,
• direct attention and efforts, and
• Reliable, self-announcing, and understandable without complicated interpretation or philosophical discussions.

Analyzing Variance: The third major step in control process is the comparison of actual and standard performance It involves two steps:

• finding out the extent of deviations, and
• Identifying the causes of such deviations.

When adequate standards are developed and actual performance is measured accurately, any variation will be clearly revealed. Management may have information relating to work performance, data, charts, graphs and written reports, besides personal observation to keep itself informed about performance in different segments of the organisation. Such performance is compared with the standard to find out whether the various segments and individuals of the organisation are progressing in the right direction.

When the standards are achieved, no further managerial action is necessary and control process is complete. However, standards may not be achieved in all cases and the extent of variations may differ from case to case. Naturally, management is required to determine whether strict compliance with standards is required or there should be a permissible limit of variation. In fact, there cannot be any uniform practice for determining such variations. Such variations depend upon the type of activity. For example, a very minute variation in engineering products may be significant than a wide variation in other activities.

When the deviation between standard and actual performance is beyond the prescribed limit, an analysis is made of the causes of such deviations. For controlling and planning purposes, ascertaining the causes of variations along with computation of variations is important because such analysis helps management in taking up proper control action. The analysis will pinpoint the causes which ate controllable by the person re-possible. In such a case, person concerned will take necessary corrective action.

However. if the variation is caused by uncontrollable factors the person concerned cannot be held responsible and he cannot take any action.

Measurement of performance.’ analysis of deviations and their causes may be of no use unless these are communicated to the person who can take corrective action. Such communication is presented generally in the form of a report showing performance standard actual performance, deviations between those two, tolerance limits, and causes for deviations. As soon as possible. Reports containing control information should be sent to the person whose performance is being measured and controlled. The underlying philosophy is that the person who is responsible for a job can have a better influence on final results by his own action. A summary of the control report should be given to the superior concerned because the person on the job may either need help of his superior in improving the performance or may need warning for his failure. In addition, other people who may be interested in control reports are

• executives engaged in formulating new plans: and
• staff personnel who are expected to be familiar with control information for giving any advice about the activity under control when approached.

Taking Corrective Actions: This is the last step in the control process which requires that actions should be taken to maintain the desired degree of control in the system or operation An organization is not a self-regulating system such as thermostat which operates in a state of equilibrium put there by engineering design. In a business organisation, this type of automatic control cannot be established because the state of affairs that exists is the result of so many factors in the total environment. Thus some additional actions are required to maintain the control. Such actions may be on the following lines:

• Improvement in the performance by taking suitable actions if the performance is not up-to the mark: or
• Resetting the performance standards if these are too high and unrealistic; or
• Change the objectives, strategies and plans if these are not workable.

Evaluation and Control Criteria In putting the control process in operation, two basic issues are involved what to control and how to control. The first issue is related, to the identification of those factors on the basis of which degree of business success is determined. The second issue involves the use of various control techniques.

Criteria of Business Success

The success of any organization, whether business or non- business measured in terms of its objective achievement. Since an organization May pursue a number of objectives simultaneously, and these may be expressed: in different forms. There are a number of criteria which are used for control.

These criteria are grouped into two categories: intervening criteria and end-result criteria as shown in figure.

Causal factors are those that influence the course of development in an organisation. These are independent variables and affect intervening criteria and through these, end-result criteria. For example, strategy formulation and its implementation affect various product, customer, and personnel related criteria. These, in turn, affect different end-result criteria which are used, generally, to measure business performance.

Intervening Criteria: Intervening criteria are those factors which are reflected as the internal state of the organisation. These are caused by causal factors and, therefore, cannot be changed independently except by changing causal factors; in this case type of strategy and its implementation. For example, personnel attitudes and morale, an intervening criterion, cannot be changed unless there is a suitable change in organisational design, systems, and leader- ship-all being elements of strategy implementation. Intervening criteria are, generally grouped into three categories: product, customer, and personnel related. An illustrative list of intervening criteria is given below.

Product Related Criteria

• Product quality and performance
• Product cost and price
• New products introduced

Customer related criteria

• Customer service
• Customer satisfaction
• Customer loyalty

Personnel related criteria

• Attracting and retaining human talent
• Personnel ability and skills
• Personnel motivation and attitudes to work

End-result Criteria: End-result criteria are those factors which are caused by causal and intervening factors and are often in terms of the criteria in which organisational success is measured. These factors are highly dependent and, therefore, cannot be changed except by changing the factors responsible for these. End-result criteria are grouped in four categories: rate of growth, profitability, shareholder value, and social performance. Given below is the illustrative list of these factors:

Rate of Growth

• Sales growth
• Market share
• Asset increase

Profitability

• Profit-sales relationship
• Return on value added
• Return on investment

Shareholder Value

• Dividend payment
• Bonus shares
• Market price of shares

Social performance: Satisfaction of various stakeholders. After identifying the factors to be evaluated, another issue comes in the form of fixing standard in respect of these factors. Since many factors are in qualitative form and others are in quantitative form, both qualitative and quantitative standards are set for evaluation and control.

At this stage, it will be worthwhile to understand the criteria that are used by companies for strategic evaluation and control. Table presents the findings of a study of 72 companies on the criteria used by these companies.

Factor	Average
Value added   Return on value added ROV A/ROI Attracting and retaining talent Number of future managers developed New product development Improved service to customers Competitive return to shareholders Maximization of shareholders’ value	2.32   1.56 2.21 2.25 2.06 2.20 2.65 2.25 2.14

Measured at 4-point scale: The above study shows the various factors for strategic evaluation and control in general form Let us take the case of factors used for measuring a company’s performance. Financial Express, a daily financial newspaper, uses the following criteria for selecting the best company of the year as shown in Exhibit

Exhibit: Criteria for performance measurement used by Financial Express

• Export revenue for competitiveness,
• Cash plough back/total debt for capability to reduce debt,
• Profit after tax/net worth for profitability
• Plough back to net worth for capability to use internal accruals,
• Interest cover for ability to serve lenders,
• Gross profit/sales for profit margin,
• Earnings before depreciation, interest and tax/total assets for ability to use assets,
• Profit after tax/assets for profitability in using assets,
• Debt/equity for capital gearing,
• Increase in assets for growth,
• Increase in sales for growth.

At the second stage, the publication uses six different criteria for judging the companies. These are: Earning before depreciation, interest and tax/net assets, profit after tax/net worth; growth in assets, growth in sales, gross profit/sales, cash plough back/net worth.

Let us see what criteria (quantitative) companies use for measuring their performance. Exhibit presents criteria used by Hindustan Lever Limited.

Exhibit:

• Hindustan Lever: Use of quantitative criteria for performance measurement In terms of ratios:
• Profit after tax/sales
• Earnings per share (EPS)
• Dividend per share (DPS)
• Gross gearing-debt/equity
• Interest cover (times)
• Return on capital employed (RGCE)
• Return on net worth (RONW)
• Fixed assets turnover.(times)
• Working capital turnover (times)

In absolute terms:

• Sales
• Exports
• Contribution to exchequer
• Market price of share
• Market capitalization

The company uses these criteria for ten years on comparative Besides, the company uses various qualitative criteria also.

Exhibit presents the criteria used by Reliance Industries to measure its performance.

Exhibit

Reliance Industries: Criteria used for performance measurement

• In terms of ratios:
• Sales per share
• Net profit margin
• Earnings per share
• Cash earnings per share
• Book value per share
• Debt: equity ratio
• EBDIT/sales
• Return on net worth
• Equity dividend
• Payout ratio

In absolute terms

• Total sales
• Export and deemed export
• Taxes paid to the Government
• Market capitalization

Management by Exception: One of the most important ways of tailoring controls for efficiency effectiveness is to make sure that they are designed to point out exception In other words, by concentrating on exceptions from planned performance controls based on the time-honored exception principle allow managers detect those places where their attention is required and should be give. This implies the use of management by exception particularly in controlling aspect. Management by exception is a system of identification a communication that signals to the manager when his attention is needed. From this point of view, management by exception can be used in other management processes also though its primary focus revolves around controlling.

• Management by exception has six basic ingredients: measurement, projection, selection, observation, comparison, and decision-making.
• Measurement assigns values to past and present performances: This is necessary because without measurement of some kind, it would be impossible to identify an exception.
• Projection analyses those measurements that are meaningful to organisational objectives and extends them into future expectations.
• Selection involves the criteria which management will use to follow progress towards organizational objectives.
• Observation stage of management by exception involves measurement of current performance so that managers are aware of the current state of affairs in the organization.
• Comparison stage makes comparison of actual and planned performance and identifies the exceptions that require attention and reports the variances to management.
• Decision-making prescribes the action that must be taken in order to bring performance back into control or to adjust expectations to reflect changing conditions, or to exploit opportunity.

Thus, it can be observed that management by exception is inseparable from other management essentials in many ways. However, the major difference lies in the fact that the superior’s attention is drawn only in the case of exceptional differences between planned performance and actual performance. In other cases, decisions are taken by subordinate manager. However, what is exceptional requires the completion of whole process.

There are various areas where precepts of management by exception are used such as statistical control of product quality, economic order quantities and order points for control of inventories and supplies, break-even points for determining operating levels, trends in ratios of indirect to direct labour used in apportioning overhead, attitude surveys for gauging employee morale, etc. The use of management by exception is prevalent because of the following factors:

• Management by exception saves executives’ time because they apply themselves on fewer problems which are important. Other details of the problems are left to subordinates.
• It concentrates executives’ efforts on major problems. Instead of spreading managerial attention across all sorts of problems, it is placed selectively where and when it is needed. Thus, it ensures better utilization of managerial talents.
• It facilitates better delegation of authority, increases span of management and consequently provides better opportunities for self-motivated personnel in the organization. It lessens the frequency of decisions at the higher levels of management which can concentrate on.