Chapter 1:
MODERN CORPORATION OVERVIEW1
1.1 INTRODUCTION
Business firms exist to serve needs of one or more segments of the society. In the
words of Peter Drucker2, the greatest management thinker, the purpose of a business
firm is to ‘create customers’. Business firms create customers who pay a price that is
adequate enough to cover the cost of producing the products and services and
generate surplus that enables the firm to return the capital and provide expected return
on capital to the providers of financial capital to the firm. A firm that fails to create
and retain customers for its products and services cannot survive.
Except for a limited number of products and services, customers enjoy wide choices
of providers of the same product or similar products. For example, individuals and
organisations have a choice to use the road transport or rail transport or air transport
for moving goods from one location to another. Similarly, they enjoy wide choices of
products and services that serve the same needs. For example, individuals have many
1
© Asish K Bhattacharyya, Chairman, Riverside Management Academy Private
Limited, Kolkata
Peter Ferdinand Drucker (November 19, 1909 – November 11, 2005) was an
Austrian-born American management consultant, educator, and author, whose
writings contributed to the philosophical and practical foundations of the modern
business corporation.
2
1
choices for enjoying their leisure. Therefore, in the market place business firms
compete with each other for creating and retaining customers. Customer-centric firms
that are innovative in developing new products and services, and new processes
succeed in the market place.
Public sector enterprises (PSEs) are conceived as instruments to achieve socioeconomic goals for the development of the nation. For example, in India, PSEs were
created at a point in time when private capital was scarce and heavy investment was
required to manufacture products that was necessary to create infrastructure to bring
the nation on the path of economic and social development. Therefore, initially,
financial performance was not a criterion to measure the success of PSEs. However,
in recent years, when private capital is available in abundance, financial performance
is included in the performance metrics, as PSEs, which are not in the core sector,
should not burden the state exchequer. Moreover, the government has decided to
divest a part of its investment n selected PSEs. Therefore, except a few PSEs, for
example, those operating in the defence sector, PSEs are managed like business firms
operating in the private sector.
Firms earn profit not because that their objective is to earn profit. They earn profit
because they provide goods and services that are valued by customers. While creating
value, firms create both positive and negative externalities. Positive externalities are
the benefits that accrue to those who are neither customers of the company nor
directly involved in the value creation activities, such as, employees and suppliers of
goods and services to the firm. For example, a large business firm benefits the local
community because of job creation and increased economic and social activities. It
also takes up certain activities under ‘corporate social responsibilities’ (CSR) that
benefit both the firm and the local community. Negative externalities refer to costs
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and pains that are borne by those who are neither customers of the company nor
directly involved in the value creation activities. A responsible firm endeavours to
minimise negative externalities and compensate those who suffer due to unavoidable
negative externalities created by it.
1.2 VISION AND MISSION
There is no clarity on what is the difference between the mission and the vision of
companies. Some hold the view that the ‘mission statement’ of a company articulates
the purpose of the organisation, while the ‘vision statement’ articulates the desired
future state of the organisation. According to them the ‘mission’ reflects the values
and expectations of major stakeholders and decides the scope and boundaries of the
organisation. There are successful companies, which articulate only the mission,
while there are others, which articulate both the mission and vision. We shall use the
‘vision and mission’ together without making an effort to distinguish between the
vision and mission.
Every visionary firm articulates its core purpose, which is the reason for its existence,
in its vision and mission statement. The core purpose of visionary firms is much more
deep and meaningful than simply making money. It attracts and inspires people to
work for the firm. Although the core purpose of a firm is not carved on stone, but it
does not change over a very long period, say, over a period of hundred years. Even if
a visionary firm does not articulate its vision and mission, we may derive the same
from its way of working and other statements that it issues from time to time.
Vision, Mission and Values: Examples
TCS
Mission
Our mission reflects the Tata Group's longstanding commitment to providing
excellence:

To help customers achieve their business objectives by providing innovative,
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best-in-class consulting, IT solutions and services.

To make it a joy for all stakeholders to work with us.
Values
Our values: Leading change, Integrity, Respect for the individual, Excellence,
Learning and sharing.
PHILIPS
Mission
Improving people’s lives through meaningful innovation
Vision
At Philips, we strive to make the world healthier and more sustainable through
innovation. Our goal is to improve the lives of 3 billion people a year by 2025. We
will be the best place to work for people who share our passion. Together we will
deliver superior value for our customers and shareholders.
Behaviours

Eager to win

Take ownership

Team up to excel
For example 3M introduces itself as a global innovation company that never stops
inventing. It writes “Every day at 3M, one idea always leads to the next, igniting
momentum to make progress possible around the world.” 3Mgives, the corporate
philanthropy arm of 3M writes3:
3
http://solutions.3m.com/wps/portal/3M/en_US/Community-Giving/US-Home/aboutus/ extracted on September 20, 2015
4
“3M is a science and technology company that creates. For decades, 3M scientists
and engineers have developed products that solve problems. 3M is also a company
that cares – improving lives each day. The mission of 3Mgives: To Improve Every
Life through Innovative Giving in Education, Community and the Environment –
mirroring our corporate vision:
3M Technology Advancing Every Company
3M Products Enhancing Every Home
3M Innovation Improving Every Life”
From the above we may easily infer that technology and innovation for improving the
performance of other firms and standard of living are at the core of 3M’s operation
and that has not changed for decades.
Another component of vision and mission is ‘core values’. Core values do not change
over a long period, say over a period of hundred years. Visionary firms do not deviate
from core values even in situations of adversity. Every member of the organisation
has high level of commitment to those values and holds the same even when the firm
or the individual is passing through a crisis situation.
Vision and mission defines the corporate philosophy and determines the culture of the
firm. It is aimed at internal stakeholders. It is not a set of verbose statements for
external consumption. Every member of the internal stakeholder groups is committed
to the vision and mission and takes it as the guidepost.
Vision and mission does not set goals that are to be achieved.
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1.3 BHAG (BEE HAG) – ENVISIONED FUTURE
Collins and Parras4 have introduced the concept BHAG (pronounced BEE-hag and
short hand for Big, Hairy, Audacious Goals). According to Collins and Parras, a firm
should establish vision-level BHAG and ‘envisioned future’ should be a component
of the vision and mission statement. BHAG are goals that the firm plans to achieve in
next ten to thirty years. Those goals are achievable, but achieving them poses a ‘huge
and daunting challenge’. Ultimately the firm may not achieve those goals, but they
inspire employees to make extraordinary efforts to achieve them. Employees believe
that those are achievable with a bit of luck. For example, PHILIP’s vision includes the
statement ‘our goal is to improve the lives of 3 billion people a year by 2025.’
Public documents like ‘vision and mission’ usually do not include BHAG. But highly
successful firms develop BHAG and clearly articulate the same to all internal
stakeholders.
BHAG is not core like purpose of the firm and its values. Therefore, it does not last
forever or for a long period, say hundred years. Firms reset BHAG after earlier
BHAG are achieved. It is very difficult to achieve hundred percent of BHAG.
Therefore, firms reset BHAG after the end of the time horizon for which the BHAG
was established even if it achieves less than hundred percent of the target. Failure to
reset BHAG might lead to complacency.
1.4 STRATEGY
Vision and mission is not strategy. Vision and mission, including values, is core of a
business firm. Strategy is not core. It changes with changes in the internal and
external environments. However, strategy reflects corporate philosophy and corporate
Collins, James C. and Parras, Jerry I. Building your company’s vision. Harvard
Business Review, September 1996
4
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culture, which are core and do not change with changes in the internal and external
environments. It is said that success comes from one percent vision and 99 percent
alignment. Therefore, strategy execution is as important or even more important than
strategy formulation to achieve success.
Two-levels of strategy
A multi-business firm has two levels of strategy. The corporate strategy, which
applies to the whole enterprise, is about deciding the portfolio of businesses and the
way the corporate office supports each business to create value that is higher than the
value that the business could create on stand alone basis.
Business strategy focuses on individual business. It is about winning in the market.
1.4.1 NATURE OF STRATEGY
Strategy provides long-term direction to the firm to achieve BHAG. In a dynamic
environment, the time frame of strategy is usually shorter than that of BHAG. The
time frame of the strategy depends on the business environment in which the firm
operates. Firms do not decide a time frame for formulating new strategy. They review
current strategy on on-going basis, may be yearly.
Strategy is about building business portfolio and positioning the business in the
market place. It is about constructing alternative course of actions and making hard
choices of what activities to do. It is also about deciding what activities not to do.
‘Cohesiveness’ is the guiding principle. Therefore, firms decide not to do activities
that are incompatible with chosen activities. They also decide not to do activities that
are incompatible with the image or reputation of the firm. Strategy is about making a
tradeoff between different options available before the firm and achieving coherence
between different chosen activities. The aim is to create competitive advantage over
competitors. A firm enjoys competitive advantage when the activities chosen by it are
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unique or it does activities differently from the way competitors perform those
activities. The position is sustainable when activities or the process as a whole is
inimitable.
Strategy by Design
Often the term ‘strategic planning’ is used to denote that strategy formulation is a
rational planning process. The top management designs the strategy to fit the firm’s
strength and weaknesses with the opportunities and threats in the external
environment. Others implement the strategy.
The process of setting strategy requires analysing data, developing perceptions and
forming judgements. It involves analysing the current strategy (called position audit),
appraising the corporate resources and capabilities, analysing the external
environment (political, economic, socio-cultural, technological, environment and
legal, in short PESTEL), analysing strengths, weaknesses, opportunities and threats
(SWOT analysis), developing strategic options, and choosing the best option.
Emergent Strategies
Strategy that firms follow might not be the same that was planned. Firms realise
intended strategies only when the external environment is stable. That is seldom the
case. Strategy emerges in the course of doing business and most often from local
units.
Management deliberately creates conditions for ideas and strategies to emerge. It
continues with the current strategy until it detects structural discontinuity in the
environment. It develops the skill for early detection of those discontinuities.
Management assesses the impact of discontinuity on the current strategy. Based on
that assessment, it changes the strategy. Usually it allows new strategic initiatives
throughout the organisation and intervene when a clear pattern emerge. It reconciles
change with continuity and checks radical change in the strategy.
Other Perspective
Sometime, strategy reflects the pattern of decision making within the firm. A coherent
strategy (or strategic approach) emerges out of series of decisions, such as launching
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of a new product or service, a decision to acquire a business, or a significant
investment decision.
Strategy may also be viewed as building resources and core competencies (unique
systems and processes that are inimitable) to build competitive advantage over
competitors.
Realised Strategy
Realised strategy is a combination of intended strategy (planned strategy) and
emergent strategy. Henry Mintzberg writes5:
In practice, of course, all strategy making walks on two feet, one deliberate,
the other emergent. For just a purely deliberate strategy making precludes
learning, so purely emergent strategy making precludes control. Pushed to the
limit, neither approach makes much sense.
Likewise, there is no such thing as purely deliberate strategy or a purely
emergent one. No one organisation – not even the ones commanded by those
ancient Greek generals – knows enough to work everything out in advance, to
ignore learning en route. And no one - not even a solitary potter – can be
flexible enough to leave everything to happenstance, to give up all control.
1.5 BUSINESS STRATEGY
1.5.1 PLAYING TO WIN
Lafley et al.6 has explained strategy as answers to the following five questions:
(i) What is your winning aspiration? Articulate the purpose of your enterprise and its
motivating aspiration.
(ii) Where will you play? Choose the playing field where you can achieve the
aspiration.
(iii) How will you win? Choose the way you will win on the chosen playing field.
5
Mintzberg, H. Crafting Strategy. Harvard Business Review, 65(4): 66-75 (1987)
Lafley, A.G. and Martin, Roger L. Playing to win. Harvard Business Review Press
(2013)
6
9
(iv) What capabilities must be in place? Map the set and configuration of capabilities
required winning in the chosen way.
(v)What management systems are required? Design the systems and measures that
enable the capabilities and support the choices.
The model presented by Lafley et al. can be applied in formulating both the corporate
strategy and the business strategy.
Winning Aspirations
Winning aspirations are statements of ideal future. They should be well defined. They
define the scope of the business (firm). A firm wins in the market place with
customers and against the very best. Therefore, winning aspirations usually focus on
customers. They are articulated in the vision and mission statements of the firm. For
example, the vision statement of Hindustan Unilever Limited is:
“We meet everyday needs for nutrition, hygiene and personal care with brands that
help people feel good, look good and get more out of life.”
Winning aspirations can also be viewed as ‘envisioned future’ discussed above.
Where to Play
Answer to the question ‘where to play’ defines the choice of:

Markets;

Consumers and customers;

Channels;

Product categories; and

Segments in the value chain.
Winning aspirations broadly defines the firm’s activities. ‘Where to play’ choices
narrow down the competitive field.
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How to Win
Answer to the question ‘how to win’ defines the choice of what to do to create and
deliver unique value, which is distinct from competitors, to consumers and customers
sustainably. ‘How to win’ choice should fit with the choice for ‘where to play’.
Choices for ‘How to win’ and ‘where to play’ should be decided together.
What Capabilities
Answer to the question ‘what capabilities’ maps the activities and competencies that
are critical to support ‘where to play’ and ‘how to win’ choices. Core capabilities
should support and reinforce one another. They together create the competitive
advantage over competitors.
What Management Systems
Answer to the question ‘What management systems’ identifies the management
systems that foster, support and measure the strategy. They must be purposefully
designed to support the choices and capabilities.
1.5.2 STRATEGY DIAMOND
Some authors present the five elements of strategy in the form of strategy diamond.
The elements are arenas, vehicles, differentiators, staging and pacing and economic
logic. All the five elements should be coherent. Coherence is essential to win in the
market place.
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Arenas
Staging and
Economic logic
Vehicles
pacing
Differentiators
Arenas
Firms choose arenas by answering the question where to win. Arenas must be very
specific. Choice of arenas determines what the firm shall do and what it shall not do.
Vehicles
Vehicles are the means of participating in target arenas. A firm may choose from
various vehicles such as internal development, joint ventures, alliances, acquisitions
and licensing/franchising. Making a choice is similar to answering the question ‘how
to win’.
Differentiators
Differentiators are features and attributes of the products and services that are being
offered by the firm. Differentiators create competitive advantage. Customers choose
firm’s products and services over those of competitors because of differentiators.
Examples of differentiators are image, customisation, technical superiority, price and
speed to reach the market. In order to be successful, a firm has to choose the
differentiators early. Choosing differentiators involve tradeoffs among various
opportunities available before the firm. The firm should be consistent in choosing
differentiators.
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Staging
Staging refers to timing and pace of strategic moves to enter new arenas. The choice
depends on availability of capabilities and other resources, including financial
resources. It also depends on the likely strategic moves of competitors. For example,
a firm, which aspires to become an international player, has to decide the timing and
pace of entering international markets based on emerging opportunities and available
capabilities and other resources.
Economic Logic
The core objective of a business firm is to earn a return on investment that is higher
than the cost of capital. Economic logic refers to how the firm will create economic
value for shareholders. Developing the economic logic requires understanding both
costs and revenues arising from various strategic options available before the firm.
1.6 STRATEGY FORMULATION
Rumlet7 identifies the following three critical steps in formulating and implementing
strategy:

Diagnosis,

Formulation of a guiding policy and

Developing a set of coherent actions
Diagnosis
Diagnosis is answering the question ‘what is going on here?’ Diagnosis classifies the
situation, linking facts into patterns and calls attention to crucial aspects of the
situation. Diagnosis aims at developing different perspectives of the situation and to
gain insights. Different perspectives may be developed on the same situation. For
example, one perspective on the emergence of a new technology might be to consider
it as a threat, while the other perspective might be to consider the same as an
7
Rumlet, Richard. Good strategy bad strategy. Profile Books Limited, London (2012)
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opportunity. Different perspectives lead to different guiding policies. Therefore, it is
important to develop the right perspective. It requires in-depth analysis of the
situation. Factors that are observable on the surface might not be the real factors,
which have caused the situation.
Diagnosis defines a domain of actions.
Guiding policy
Good guiding policies define a method of dealing with the situation diagnosed by the
strategist. A guiding policy creates advantage by anticipating the actions and reactions
of others, exploiting the natural or created imbalance in a situation (e.g., under- or
over-served customers, unfulfilled demand and gap between the position of a
competitor and its capabilities) and creating policies and actions that are coherent.
Guiding policy does not set out the goal. Examples of guiding policy are ‘to provide
complete turnaround solutions to underperforming firms’, ‘to provide natural leather
handcrafted accessories to those who value designer products’, and ‘to produce
motorcycles that are evocative and engaging and great fun to ride for global mid-size
motorcycle market’. Guiding policy guides the choice of actions.
Coherent Actions
Actions, such as resource allocation and policies, which are undertaken, should be
consistent and coordinated. Only coordinated actions provide the advantage that is
necessary to win in the market place. For example, a low cost producer keeps the cost
low by adopting large number of interrelated policies and activities.
Formulation of a good strategy is not enough to achieve targets set in ‘envisioned
future’. Effective execution of the strategy is equally important, if not more important.
It requires clear articulation of the strategy in simple terms to enable everyone who is
associated with the execution of the strategy to understand the same. It should clearly
spell out the course of actions, what to do and what not to do.
Assumptions underlying the strategy should be debated to ensure that the assumptions
are realistic and are valid at the time of execution. If the reality is different from
underlying assumptions, the strategy should be revisited.
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1.7 STRATEGY IMPLEMENTATION
Strategy implementation requires identification of resource gap and the need for
investments. It is important to allocate adequate resources to the business. Similarly,
gap in capabilities and competencies should be identified early and necessary
capabilities and competencies should be developed with speed.
Appropriate systems and structures should be put in place to support the execution of
the strategy.
A rigorous framework for monitoring the progress of the strategy should be
developed. Firms develop systems of strategic control and management control
systems to monitor the progress strategy implementation. Strategic control system
evaluates the validity of the strategy in changing environment. The focus of the
strategic control is on the external environment. The management control primarily
focuses on the internal environment. For example, a model similar to balanced
scorecard may be developed to monitor performance and to identify the gap between
the strategy and performance to enable the management to take necessary actions to
bridge the gap. The performance should be compared with financial and non-financial
targets of the long-term plan.
Proper incentive schemes should be put in place to motivate and encourage
employees to execute the strategy and to build execution capabilities.
1.8 CORPORATE STRATEGY
“Corporate strategy cannot succeed unless it truly adds value—to business units by
providing tangible benefits that offset the inherent costs of lost independence and to
shareholders by diversifying in a way they could not replicate.”8
Multi-business firms has three choices:

Where to compete (choice of businesses)

What to own (choice of firm boundaries)

How to organise (choice of structures, processes and incentives)
Porter, Michael, E. ‘From competitive advantage to corporate strategy’. Harvard
Business Review, May-June 1987
8
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Choice of Businesses
Expansion on new business should either benefit the existing business or the new
business. Benefits arise either from cost-side synergies or revenue-side synergies.
Cost-side synergies
Cost-side scope economies might arise from centralizing procurement, combining
staff functions, economies in distribution and logistics, or common production
platforms.
Revenue-side synergies
Revenue-side scope economies arise from the convenience of one-stop shopping,
bundling, or cross- selling. Businesses are related when they share either activities
that are unique to the firm or resources (e.g., a common brand, reputation, specific
knowledge or expertise, managerial talent, or a common culture) that are unique to the
firm.
Choice of Boundaries
A firm needs to decide whether it will expand through ownership of the new business
or by some other kind of arrangement. Expansion through ownership is justified only
in a situation where the market or the contract fails. Firms choose expansion through
ownership only if it can create higher value in the business or enhance its share in the
value being created by the business.
Absence of market
When the firm develops a new product, it might be required to develop the whole or
some parts of the value chain simultaneously. For example, when an automobile
manufacturer introduces a vehicle manufactured using the state-of-the-art technology,
it has to provide after-sales services, at least in initial years. In later years the market
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expands and other firms (independent players) get attracted to other parts of the value
chain.
Relationship specific investment
Investment in assets that have no use other than supplying goods or services to a
particular customer has hold up cost. Writing a long and elaborate contract reduces
the hold up cost. However, in certain situations, it might be difficult to write such
contracts. In those situations, the firm favours to own the customer’s business to avoid
the problem of redistribution of value being created in the business.
Coordination
In some businesses cost of coordination between different parts of the value chain is
high. For example, where the demand for the product is volatile, coordination cost is
high. In that situation a single firm would favour owning up different parts of the
value chain.
Resolving double marginalization problem
Where both upstream and downstream businesses enjoy monopoly power, all firms
endeavour to extract monopoly margin form customers. As a result the price for the
end product goes up and adversely affects the demand for the product. Vertical
integration resolves this problem because a single firm decides the transfer prices that
optimise the profit of the firm. Customers also benefit from such vertical integration.
Choice of Organisation
It is important to assess the tension that might arise because different businesses are to
be structured differently to extract the full potential value from the business. For
example, a business requires autonomy, while the other requires centralisation of
some activities. Similarly, it is appropriate to have different incentive schemes for
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employees should be different for different business. Even it might be difficult to
develop a common culture.
1.9. CONTROLS
Firms set BHAG, which are goals to be achieved in a period of ten to thirty years. In
order to achieve those goals they formulate strategy and plans. Usually, they prepare a
plan for next five to seven years, which is called the corporate plan. Every year they
formulate an annual plan, which is called budget. Budget is aligned with the corporate
plan, which establishes targets based on the intended strategy. If, the strategy is
changed to address the changes in the external and internal environments or because
the current strategy is not producing the desired results, the corporate plan is revised
to reflect the revised strategy. The annual budget is a short-term plan to achieve longterm goals set out in the corporate plan.
An effective control system accommodates the emergent strategy. The control system
ensures that employees are working diligently to implement the intended strategy,
while encouraging them to take advantage of unexpected opportunities that emerge in
the course of implementing the intended strategy. For example, Honda’s managers in
U.S.A. had identified customers’ interest in 50 cc motorcycles that they used to drive
to the work place and started selling those motorcycles. The intended strategy was to
sell 250 cc and 305 c motorcycles. But increase in sales of small motorcycles turned
the emergent strategy into a sustainable strategy. However, it is important to set the
boundaries within which employees are allowed to search for opportunities. Vision
and mission, values and strategy define the boundaries for searching opportunities in
order to avoid dissipation of energy and for keeping risks within the acceptable level.
An effective control system takes into account the human aspect of management. It is
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capable of reconciling the tension between the individual’s inherent temptation to
work for self-interest and his/her innate desire to contribute in achieving the collective
goals.
1.9.1 OBJECTIVES
The word ‘objective’ is synonym of the word ‘goal’. The dictionary meaning of goal
is ‘something that you are trying to do or achieve’. COSO9 classifies objectives in the
following four categories:

Strategic – high-level goals, aligned with and supporting its mission 

Operations – effective and efficient use of its resources 

Reporting – reliability of reporting, both internal and external 

Compliance – compliance with applicable laws and regulations 
Strategic objectives
Strategic objectives flow from vision and mission of the firm. They are high-level
goals. Firm that prepares BHAG, sets strategic objectives to achieve goals that the
firm aspires to achieve in a period of ten to thirty years. Firms set strategic objectives,
which are long-term objectives, and formulate the strategy to achieve the same.
However, setting strategic objectives and formulation of strategy are not sequential
activities. Both reflect firm’s choice of activities.
Examples of strategic objectives are: double the revenue over the corporate plan
period; achieve 30 percent market share in India at the end of the corporate plan
period; be recognised as the most preferred employer in India; be recognised as a
responsible company; achieve 12 per cent average return on invested capital during
9
The Committee of Sponsoring Organisations of the Treadway Commission (COSO).
Enterprise Risk Management – Integrated Framework. 2004
19
the plan period; and achieve number three position in India at the end of the corporate
plan.
It is preferable to establish quantitative targets that are measurable. But it might not be
possible to establish precise quantitative targets for all objectives. For example, it is
difficult
to
establish
precise
target
for
the
objective
‘improve
internal
communication’.
Operations objectives
Operations objectives flow from strategic objectives. While strategic objectives are
established at entity-level and business-level, operations objectives are established for
divisions, subsidiaries, operating units and functions. Failure to achieve operational
objectives results in failure to achieve strategic objectives.
Operations objectives relate to improving financial performance, productivity, quality,
environmental practices; innovation; and customer and employee satisfaction.
Examples of operations objective are: reduce material cost by 10 percent; reduce rework hours by 10 percent; reduce internal rejection rate of the finished product to two
percent; reduce customers’ rejection rate of the finished product to zero percent;
increase sales from new customers to 10 percent; maintain debt-equity ratio at 0.5:1
and reduce employee turnover rate to 12 percent.
Operations category of objectives includes safeguarding of assets from physical loss,
fraud, inefficiency, and poor business decisions.
SMART
Many use the term objective to refer to quantitative targets established to
communicate employees what results the management expects them to achieve and to
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measure the performance of individual employees, different units of the firm and the
firm (as a whole) against established targets. Objectives should be SMART.

S: specific (clear and well defined),

M: measurable or observable,

A: attainable,

R: relevant (result-oriented goal that drive the organisation), and

T: time-bound (grounding the goal within a time frame, target date)
1.9.2 STRATEGIC CONTROL
Strategic control evaluates whether the current strategy is valid in the changing
business environment (PESTEL). The objective is to suggest changes that are
necessary to reach the goals set out in BHAG. The focus is primarily external to the
firm. The bard of directors and the top management is responsible for strategic
control.
1.9.3 MANAGEMENT CONTROLS
Merchant and Stede10 explain management control as follows:
Management control involves addressing the general question: Are our
employees likely to behave appropriately? This question can be discomposed
into several parts. First, do our employees understand what we expect from
them? Second, will they work constantly hard and try to do what is expected
of them; that is, will they implement organisation’s strategy as intended?
Third, are they capable of doing a good job? Finally, if the answer to any of
these questions is no, what can be done to solve the management control
problems? All organisations who must rely on their employees to accomplish
10
Merchant, Kenneth A. and Stede, Wim A. Van der. Management Control Systems.
Person Education Limited. 2007. Pp. 7.
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organisational objectives must deal with these basic management control
issues.
Vision and mission (including values) and strategy creates believes and boundaries to
direct the employees and other resources in achieving the goal of the firm. Values and
strategy, which articulates what to do and what not to do, define the space within
which employees should search for opportunities. Assurance services and internal
audit provide assurance to the board of directors and the management that employees
are behaving appropriately and are striving hard to achieve operational objectives.
‘Diagnostic controls’ is the most important component of a management control
system.
Under ‘Diagnostic controls’, actual performance (output) on each key performance
indicator (KPI) is measured against the target and variance is analysed to understand
root causes and for taking corrective actions. Identification of Key Success Factors
(also called, key performance variables) precedes formulation of KPIs. The set of
KPIs should cover both lag indicators and lead indicators and should balance longterm and short-term goals. ‘Diagnostic controls’ system necessarily requires a formal
information system.
1.9.4 INTERNAL CONTROL AND ASSURANCE SERVICES
COSO defines internal control as follows11:
Internal control is a process, effected by an entity’s board of directors,
management, and other personnel, designed to provide reasonable assurance
regarding the achievement of objectives relating to operations, reporting and
compliance.
11
Committee of sponsoring organisations the Treadway Commission. Internal control
- integrated framework. 2013. Pp. 1
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Firms in achieving the strategic objectives assume and manage risks. Internal control
mitigates risks that are assumed by the firm.
In the three line of defence model, internal audit is the third line of defence in risk
management. Operational managers, who own and manage risks, provide the first line
of defense. They also are responsible for implementing corrective actions to address
process and control deficiencies. Various assurance services provide the second line
of defence. Most common assurance services are: a risk management function that
monitors effectiveness of the risk management by operational managers; a
compliance function that monitors compliance with applicable laws and regulations;
and controllership function that monitors financial risks and financial reporting issues.
1.10 GOVERNANCE STRUCTURE
The top management (CEO and his team) is responsible for managing the firm. It
delegates decision-making authority to managers operating at different levels in the
organisation. The extent and pattern of delegation depend on the size and structure of
the organisation. Assurance services provide reasonable assurance to the top
management that managers are taking decisions within the powers delegated to them
and are operating effectively to achieve operations objectives.
The board of directors (or an equivalent body) oversees the functioning of the top
management. The regulators and stakeholders hold the board of directors (Board)
responsible for the performance of the firm and its acts and omissions. In particular,
the Board is held responsible for strategy control, internal control, risk management,
independence of auditors (including internal auditor), and compliance. Therefore, the
level of intervention of the Board in the management of the firm is at a level higher
than the level that is required to oversee the management. The actual level of
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intervention depends on the trust of the Board on the CEO and the situation. Usually
Board’s intervention increases when the firm passes through a difficult situation.
Internal audit is an assurance service to the Board. It provides reasonable assurance to
the Board that the control systems and other assurance services are adequate and
operating effectively.
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