GROWING PAINS IN CONTROL

GROWING PAINS IN CONTROL

Formalizing control in rapidly growing entrepreneurial firms

Hanna Brunner S2515792

h.a.brunner@student.rug.nl Thesis supervisor: dr. A. Bellisario

24-06-2019

Master thesis

MSc Organizational & Management Control MSc Accountancy & Controlling (Controlling track)

Faculty of Economics & Business University of Groningen

Word count: 13452

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ABSTRACT

A substantial part of existing management control research focuses on well-designed management control systems (MCSs) in large and long-existing companies, while literature on the emergence of formal control systems in growing entrepreneurial firms is still scarce. Although literature states that an effective MCS is crucial for organizational growth and survival, which is especially challenging for entrepreneurial firms with fewer resources and experience, relatively little is known about the transition between informal and formal control. Understanding how managers address growing pains by formalizing control can help entrepreneurs in implementing a MCS that aligns with their informal system. An in-depth single-case study was conducted in a telecom company in the e-commerce business to study how rapidly growing entrepreneurial firms structure and operate formal control. The findings of this study show that growing entrepreneurial firms formalize control to monitor and retain coherence amongst the growing number of employees and departments by stimulating knowledge sharing and uniformity. However, the trust that founders have in their employees and their informal attitude restrains the implementation of formal control, resulting in reliance on informal control, or in some cases a ceremonial use of formal control.

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TABLE OF CONTENTS

1. INTRODUCTION……….. 4

2. THEORETICAL BACKGROUND………... 6

2.1: Exercising control in organizations………. 6

2.2: Growing pains and the transition from informal to formal control………. 8

2.3: The transition in growing entrepreneurial firms……… 10

3. METHODS……….……….. 12

3.1: Research approach & case company……….……… 12

3.2: Data collection……….……….. 13

3.3: Data analysis……….………. 14

4. FINDINGS……….………... 16

4.1: Coherence & monitoring……….……….. 17

4.2: Trust in employees and firm……….………. 21

4.3: Founders’ informal attitude……….……….. 24

5. DISCUSSION……….……….. 27

6. CONCLUSION……….………... 30

7. REFERENCES……….……… 32

8. APPENDICES……….………. 37

Appendix 1: Interviewee characteristics……….……….. 37

Appendix 2: Interview protocol……….………... 38

Appendix 3: Informed consent agreement……….………... 39

Appendix 4: Organizational chart……….……… 40

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1. INTRODUCTION

Existing management control literature focuses on well-established management control systems in large and long-existing firms (Langfield-Smith, 1997). However, an underexposed part of literature relates to the emergence of these controls in start-ups and fast-growing organizations (Luft & Shields, 2003). During start-up, founders often have direct and informal interactions with the small number of employees as present, and as a result, most start-ups rely solely on informal controls (Flamholtz & Randle, 2012). Nevertheless, growing entrepreneurial firms are often quickly presented with problems related to their informal systems, defined as growing pains, and experience difficulties in transitioning successfully to a formal MCS that aligns with their existing informal system (Davila, 2005). Moreover, research shows that a lack of an effective MCS can impede further growth and even result in organizational failure (Greiner, 1998).

Recent organizational developments have shown that top managers are increasingly involved with trying to control how lower level employees execute strategic activities to ensure that strategic objectives are met, and formal controls are seen as an effective tool to steer these employees in the right direction (Marginson, 2002). Nonetheless, until now no studies have touched upon how managers address growing pains by making the transition between informal and formal control in growing companies. Moreover, most of existing management control literature focuses on formal control (Ferreira & Otley, 2009; Simons, 1994; Kaplan & Norton, 1996), ignoring the importance of informal control within firms (Anthony & Govindarajan, 2003). However, research shows that a company culture with strong values and beliefs can act as the basis of control in a firm (Ouchi, 1979), and studies have shown that this is especially relevant for entrepreneurial firms, in which informal control, in the form of group norms and culture, is often more important than formal control (Collier, 2005). Moreover, the formalizing of control poses a challenge for entrepreneurial firms in particular, as the lack of managerial capacity and experience of entrepreneurs is shown to be one of the biggest obstacles to implementing a formal MCS (Garengo, Biazzo & Bititci, 2005). More importantly, the choices entrepreneurial firms make regarding the implementation of a formal MCS are vital to their success and their survival in the new and uncertain market they entered (Merchant & Ferreira, 1985). It is thus crucial to gain more understanding on this transition. Therefore this study aims to fill this gap, by answering the following research question: “How do managers of rapidly growing entrepreneurial firms structure and operate formal controls?”.

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In short, the findings show that growing entrepreneurial firms implement formal controls to ensure coherence amongst and monitoring of the growing number of employees. Furthermore, the implementation of formal controls is restrained by the trust founders have in their employees and their informal attitude towards aspects of formalization, stressing the importance of informal control in the formalization process.

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2. THEORETICAL BACKGROUND

2.1 Exercising control in organizations

Organizational control consists of the mechanisms used by managers to make sure that employees work towards the objectives of the firm (Ouchi, 1979). Controls can be used to encourage, enable or force employees to do what is best for the firm (Merchant & Van der Stede, 2007), and have a central purpose of goal congruence between the employees and the firm (Anthony & Govindarajan, 2003). Merchant and Van der Stede (2007) classified the reasons behind why controls are needed in three categories: a lack of direction of employees, when employees do not know what is expected from them by management, motivational problems, when employees are not motivated to pursue the interests of the firm, and personal limitations, due to for instance a lack of knowledge, training or experience. As a result, managers use control activities in an effort to align capabilities, decision-making and performance of employees with the goals of the firm (Sitkin, Cardinal & Bijlsma-Frankema, 2010). Thus, companies that are “in control” are companies that have a high probability of achieving their organizational goals (Merchant & Van der Stede, 2007). Organizational control is seen as a fundamental challenge for businesses and it is critical to firm success (Kreutzer, Cardinal, Walter & Lechner, 2016).

A management control system is comprised of all mechanisms, processes and systems (formal and informal) to assist management in planning, formulation and implementation of strategy, ongoing operational control and organizational learning, in order to maximize the probability that organizational goals and objectives will be met (Ferreira & Otley, 2009). Within this definition, MCSs are viewed as providing support for a large amount of ongoing management activities, such as planning, analysis, rewards, penalties, and control, but also for organizational learning and strategic processes (Mintzberg, 1978).

A MCS can comprise both formal and informal controls (Ferreira & Otley, 2009). According to Simons (1994), a formal MCS can be defined as: “the formal, information-based routines and procedures managers use to maintain or alter patterns in organizational activities” (p. 57). Formal controls refer to the written procedures, systems and rules that are visible and objective (Cardinal, Sitkin & Long, 2004). In a formal MCS responsibilities are clearly defined and communicated, strategies and objectives result in periodically set budgets for responsibility centers, and responsibility centers are rewarded or punished according to measured performance (Anthony & Govindarajan, 2003).

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Within the management control literature, many authors have attempted to categorize the different types of controls in systems or frameworks to depict reality as accurate as possible. Most of them however have presented them with a strong focus on formal control (Anthony & Govindarajan, 2003). To provide an overview of the aspects of which a MCS is comprised, Ferreira and Otley (2009) created an extended version of the framework originally proposed by Otley (1999), which consists of the following 8 aspects of a MCS: 1. vision and mission, 2. key success factors, 3. organizational structure, 4. strategies and plans, 5. key performance measures, 6. target setting, 7. performance evaluation and 8. reward systems. Although these aspects focus largely on formal controls, the authors do state that these systems operate within their organizational culture and relevant contextual factors, which should also be taken into account when analyzing MCSs.

Moreover, Simons (1994) proposes the Levers of Control framework, in which four systems should manage the tension between ongoing measuring and monitoring and the attention for emergent strategies and innovations. In this framework, the beliefs system controls core values which guide creative ideas and shared beliefs throughout the organization, the boundary system controls for possible risks that need to be avoided, the diagnostic control system uses critical performance variables to monitor, analyze and reward performance, and the interactive control system controls for strategic uncertainties by encouraging learning and strategy development. Although informal control procedures such as culture, group norms, and socialization are also very important aspects of a MCS, the author clearly states that this framework is only concerned with formal routines and procedures (Collier, 2005). The incorporation of core values and shared beliefs does however indicate that such informal values are in fact important in the design of a formal system (Simons, 1994).

Other authors have proposed frameworks for understanding the MCSs of organizations that do incorporate informal controls. For instance, Merchant and Van der Stede (2007) have developed their typology of three types of control: input, process and output controls. Firstly, input controls help to find the right people and let them manage themselves according to organizational values (Lueg & Knapik, 2016). Input controls consist of personnel controls (such as job selection and training) and cultural controls (such as shared values and beliefs, and tone at the top). Secondly, process controls help to determine accountability and make decisions, and consist of action controls, such as for instance procedures, job descriptions and rules. Thirdly, output controls consist of result controls and are for instance setting targets and rewarding if targets are met (Merchant & Van der Stede, 2007). Thus, Merchant and Van der Stede (2007) clearly do share the opinion that informal (cultural) controls play an important role in guiding employees in doing what is best for the firm.

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control, in the form of organizational trust, is present, the need for coordination, monitoring or enforcement is decreased (Berry, Coad, Harris, Otley, & Stringer, 2009).

Moreover, generally when control procedures are implemented, informal and formal controls are simultaneously present in organizations (Anthony & Govindarajan, 2003), and informal controls and formal controls are said to be equally effective for achieving firm objectives (Ouchi, 1979). More importantly, authors find that the effectiveness of formal controls that are implemented in a firm rely on the informal controls that are also present in that organization (Otley, 1980; Flamholtz, 1983), and that organizational control is most effective when informal and formal control procedures are well integrated (Sitkin, Cardinal, Bijlsma-Frankema, 2010). Kreutzer et al. (2016) affirm this, and find that when formal and informal controls both are present they complement each other and have a positive impact on performance. Furthermore, Henri (2006) finds that managers have to take into account the informal values on which the firm relies before implementing formal control procedures such as performance management systems, as the design and use of these formal systems depends on the organizational culture. When a company is a start-up, informal controls are often the only controls that are used to make sure that the strategies and objectives of the firm are met (Davila, 2005). Research has shown that the implementation of formal control is crucial to gaining organizational growth, but how the transition between informal and formal control in growing companies takes place has not been touched upon until now (Flamholtz & Randle, 2012), which will be discussed further in the following paragraph.

2.2 Growing pains and the transition from informal to formal control

In the start-up phase of most firms, coordination is driven by informal communications between employees, and the director of the company can oversee and control their day-to-day operations personally (Flamholtz & Randle, 2012). As these start-ups only have a small number of employees, direct interactions are possible and related governance costs are minimal (Davila, 2005).

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The motivation and vision of employees is likely to be aligned with that of the founder when there is a limited amount of employees during start-up. Unfortunately, when the firm grows and its number of employees grows accordingly, many start-ups begin to experience problems regarding the informal controls (Davila, 2005). With a larger employee base, the amount of interactions between them increases more drastically and the ability of the manager to oversee every aspect of the business decreases. As a result, costs of governance increase, more time is spent on control, less time is spent on value-adding activities, and thus the efficiency of communication decreases quickly (Bhide, 1999). Moreover, growing organizations are not only confronted with changes within the company, but also with the rapidly increasing complexity of the business environment in which they operate. When the internal systems of start-ups are not yet adapted to this increased complexity of coordination and communication, firms often experience problems, commonly defined as growing pains (Miller & Friesen, 1984).

Having growing pains is not the cause of a problem, it is rather one of the consequences of being out of control. Examples of growing pains are poor communication between members of the organization, low efficiency and redundancy of effort, little or unclear responsibility, and a lack of understanding of the vision and strategy of the company. The latter is a growing pain commonly present in rapidly growing firms in which employees lose track of where the company is heading, and is often the result of inadequate communication or strategic planning (Flamholtz & Randle, 2012).

To solve this problem, we see that growing companies often decide to formalize procedures and control mechanisms into a formal MCS (Sandino, 2004). Studies show that firm size and age drive the emergence of formal MCSs (Davila, 2005), and that when complexity of control and administration increases, firms adapt to this process by increasing their use of systems that analyze the environment, and provide communication and control structures (Miller & Friesen, 1983). Moores and Yuen (2001) looked at this problem from a lifecycle-perspective, and also find that in the growth phase of a company-lifecycle firms show the highest need for a formal MCS.

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unintentional mistakes, and theft (Merchant & Van der Stede, 2007). Thus, research provides clear explanations of when and why these formal systems are adopted in growing organizations. However, literature seems to remain silent on how this transition takes place. That is: from the implicit, informal controls, as used when the company is small and interactions are direct (Davila, 2005), to the explicit, formal controls, as needed when the company increases in size and, thus, direct monitoring is no longer possible (Bhide, 1999). More importantly, existing literature on implementation of formal MCSs differs from the growth-context as studied in this thesis, where an old MCS is not replaced with a new one (Sandino, 2007) but in which a formal MCS was never present to begin with and the new system is rather replacing an informal one.

While existing studies focused mostly on large and mature companies, studies on the emergence of these systems in growing start-ups, often founded by entrepreneurs – so called entrepreneurial companies - is still quite scarce (Garengo, Biazzo & Bititci, 2005). However, entrepreneurial companies might constitute an excellent example of the growing pain problem in organizations, as these companies need to influence the behaviors of employees to be aligned with the firms’ goals, vision and values, just as well as bigger companies but, also, by doing this with fewer resources and experience (Pešalj, Pavlov & Micheli, 2018). For this reason, this thesis will focus on the formalizing of control in growing entrepreneurial firms in specific, which will be explored in more depth in the following paragraph. 2.3 The transition in growing entrepreneurial firms

Entrepreneurs can take the opportunity of new and creative ideas by starting new companies, but whether the entrepreneur succeeds in building its idea into an organization is highly uncertain (Davila, Foster & Oyon, 2009). In most cases, entrepreneurs have little experience in management and often enter highly competitive markets. On the other hand, entrepreneurs that succeed in building a professional organization have shown to generate substantial growth, value creation and employment opportunities for society (Wang & Poutziouris, 2010). Entrepreneurial firms are defined as organizations that are founded by one or more entrepreneurs deciding to start their own business (Goedhuys & Sleuwaegen, 2000), in which ownership and control are typically in the same hands (Glancey, 1998), and are often described as proactive, innovative and risk-taking firms (Covin & Miller, 2014).

The types of management control that are used in a company are contingent on the organizational context and its culture (Chenhall, 2003). Solely using formal control is said to be constraining for entrepreneurial firms that are innovative or need to remain flexible to operate in uncertain and changing environments (Adler & Borys, 1996). Some authors suggest that formalization reduces employee commitment when the company only relies on rules and procedures (Walton, 1985), and when this leads to lower employee motivation this can even result in less innovation, which can be very harming for entrepreneurial companies (Thompson, 1965).

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entrepreneurial companies lose track of the firm’s vision and strategy, the implementation of formal controls can be a useful instrument to help managers implement emerging strategies and retain a competitive advantage in the market (Simons, 1990). Thus, the formalizing of control clearly poses a challenge for growing entrepreneurial firms, and the successful implementation of a MCS is said to be crucial for future growth (Greiner, 1998). More importantly, the risk of being “out of control” is much more apparent for growing entrepreneurial firms than for large companies with more resources, experience, and well-designed formal structures (Stinchcombe, 2000).

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3. METHODS

3.1 Research approach & case company

Until now, studies have not investigated how rapidly growing entrepreneurial firms formalize controls (Sandino, 2007), which makes this research avenue relatively new. Since a qualitative study is most useful to gain in-depth knowledge and rich insights about a fairly new phenomenon (Creswell, 1998; Edmondson & McManus, 2007; Gioia, Corley & Hamilton, 2012), a case-study is most suited to explain the formalization process and why and how this process occurs in its real-life setting (Yin, 1994). A case-study approach can include a single or multiple cases and levels of analysis (Eisenhardt, 1989). In this research a single case-study was conducted to study in depth the formalization process of rapidly growing entrepreneurial firms, including different levels and departments within the company: founders, team managers, coordinators, operational level, controllers, etc. Single case-studies are useful when a rich understanding of the unit of analysis is wanted and can result in a more in-depth exploration of a phenomenon than multiple-case studies can due to time constraints (Yin, 2003).

Because this study focuses on rapidly growing entrepreneurial firms, a Dutch telecom company (hereafter referred to as Phone Inc.) has been selected as the unit of analysis. Phone Inc. was founded by two entrepreneurs roughly ten years ago selling phones and phone subscriptions within the e-commerce business and grew substantially during the last years. Nowadays the firm has over 400 employees, 300 million revenues in 2018, and seven stores throughout the Netherlands. Moreover, the organization is characterized by its employees as having a very informal culture. For this reason, this company is especially relevant for doing an in-depth study of the formalization process of entrepreneurial companies, exposing the difficulties entrepreneurs experience and the choices they make regarding the transition from informal to formal control (Davila, 2005).

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including the founders of the company, to find common patterns between different organizational roles and perspectives within Phone Inc. (Patton, 1990).

3.2 Data collection

During the study full access to the organization was granted, which allowed for studying multiple sources of evidence. Firstly, 12 semi-structured interviews were held with employees of the organization with different kinds of functions and specialisms (as shown in Appendix 1). Before these interviews, two pilot interviews were held with two members of the organization to gain an understanding of how the company evolved in the last years, and to discover what were the main management control issues and changes as relevant for this research. The first pilot interview was held with a team leader from the subscriptions department, who started working at Phone Inc. 8 years ago when the company only had 20 employees, and was very well informed on the changes that had been made within Phone Inc. since start-up. The second pilot interview was held with a controller who started working at Phone Inc. 6 years ago, who helped setting up the Finance and Control department, and who was very knowledgeable on management control in general, and the changes related to management control within Phone Inc. After the pilot interviews the interview questions as shown in the Interview protocol (Appendix 2) were derived from the frameworks by Ferreira & Otley (2009) and Merchant & Van der Stede (2007), making sure that all management control aspects relevant to Phone Inc. as discovered during the pilot interviews were incorporated. The interview protocol was reviewed by an outsider who was not knowledgeable on the management control topic to make sure that the questions were well formulated and easy to understand.

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was not met during the interview, a follow-up interview was held. Each interview was recorded, and after each interview this recording was transcribed and analyzed so that gained knowledge from the first interviews could guide the subsequent interviews to provide deeper insights in the formalization process at Phone Inc.

To be able to provide validation of the results, the interviews were verified with other sources of data (i.e. triangulation) to increase the qualitative reliability of the study (Trotter, 2012), which was done with observations and archival data. From February onwards, I worked at the Finance department of Phone Inc. for two days a week, which gave me the possibility to compare the results of the interviews with an extensive amount of observations within the firm. During this period, I did observations of meetings of the financial department, the controlling department, meetings between the pricing department and the controlling department and meetings between the different departments related to external partnerships, at most of which one (or both) of the founders were present. I also participated in the efficiency training given to all new employees of the company. Moreover, I was given the possibility to collect archival data, and to compare the data from the interviews and observations with internal reports of the different operational departments, internal reports from the controlling department, reports from the marketing and pricing department, written protocols and procedures from different departments, company rules, documents about the company culture, and archival data about the growth of the company during the years. The data collection process was continued until theoretical saturation was reached, meaning that the collection of more data would not lead to new insights (Gioia, Corley & Hamilton, 2012).

3.3 Data analysis

The interviews were transcribed without changing the words as said by the interviewees. If follow-up interviews were held these were added to the original transcript of this particular interviewee. The observations and archival data collected were used to gain a richer understanding of the stories told by the employees. The transcripts were coded and analyzed using Atlas.ti.

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4. FINDINGS

This section illustrates the way in which Phone Inc. structured and operated formal controls as described by the participants who were interviewed. In the framework below the main concepts and themes are shown as derived from this analysis, which will be explained in depth in the following paragraphs.

Table 1. Framework of main findings formalization process Phone Inc.

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firm and are the sole owners of the company. As shown in Appendix 4, the organization still has quite a flat hierarchical structure. The operational departments are structured more vertically, in which coordinators, team leaders and one operational manager are involved with the coordination of the departments and the communication to the founders. The supporting teams that are present on the other hand have direct contact with the founders and are directly accountable to them. Three overarching themes were derived from the interviews with employees of Phone Inc. to be of most important influence on the structuring of formal control within the firm: coherence and monitoring, trust in employees and the firm, and the informal attitude of the founders. Although the control procedures of Phone Inc. have gotten a more formal structure when compared to start-up, the informal controls during this process have had, and still have, a great impact on the formalization process and the firm itself, which will be discussed in more detail in the following paragraphs.

4.1 Coherence & monitoring

As derived from the interviews, the main use for which formal controls are put in place within Phone Inc. is to ensure coherence amongst the growing number of employees and to monitor the performance of the growing departments. Firstly, when the number of employees grew within Phone Inc., the firm wanted to make sure that the knowledge of employees was uniform and the firm could monitor this, assuring the coherence of knowledge throughout the firm when it increased in size. As a result, Phone Inc. implemented formal controls to manage and share the knowledge of the firm. During start-up knowledge of employees was not shared or written down, which could lead to problems, as explained by a coordinator from the subscriptions department.

“Back then we had this one colleague, who always did the subscriptions for Vodafone. And at a certain moment she left the company, and then we discovered that a lot of people did not know how to do that, they

never learned how to do that because this colleague always did it.”

Moreover, knowledge was also not stored in a way in which could be assured that the knowledge was still up to date and changes were noticed by everyone.

“We used to have some type of Wikipedia website, on which a lot of outdated information was stored. And we just worked from our mailbox, which was not very good because you would not know if everyone had

received the e-mail and if there were any changes, so that just happened from colleague to colleague.” Thus, to solve this problem, Phone Inc. implemented a knowledge database, in the form of a Google Drive, to share with other colleagues within the firm, as explained by the head of Purchasing.

“It’s mainly to support our purchasers. Mike and I do a lot of decisions by heart based on information we gathered during the years, based on suppliers, knowledge we have. But for someone to join us he would

also need to be able to make those decisions”.

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protocols for all routine-based tasks, as explained by a team leader of the Customer Service department in the following statement.

“It’s about explaining a way of working that needs to be done in a certain way. So to make sure that everyone uses the same method of working. So we do not have one colleague sending e-mails [to

customers] in this way, and others in that way, you want them to be along the same lines.”

As illustrated by this quote, formal process controls were implemented by the firm to make sure that every employee worked in a coherent and uniform way, within the firm and also to external parties. Moreover, as the number of employees grew quickly at operational departments, it became more difficult to objectively assess the knowledge level of different employees.

“That actually happened without any structure. Basically when someone stood out and made few mistakes, and you were such a small group that you knew if someone was good or not. Then all of the sudden they would say: you are ready to take on more tasks from now on, which could be very confronting for people

who had been working there for a longer time.”

“You can do that really well with a team of 8 persons because then you know exactly at what level people are. But at a certain moment the team is getting bigger and you cannot oversee everything yourself. Then

you can’t assure that people actually have the knowledge”.

Thus, during start-up, it was easy to oversee the knowledge level of a small group of employees, but as the teams grew it became more difficult to monitor this, and a more objective evaluation was desired. As a result, Phone Inc. started giving job-related trainings and exams at operational departments.

“Now for every job function we have a training of 3 or 4 weeks. And every quarter we do a quarter exam. So you have to answer questions and based on those categories we see where someone is scoring badly,

and then the advice can be doing a training for those things.”

As this quote illustrates, the firm formalized input controls at all operational departments to get more insight in the level of knowledge of employees, and monitor this in a more objective way, assuring coherence between the knowledge of the growing number of employees and departments in the firm. The need for coherence and monitoring is also reflected by the formal controls that were implemented within Phone Inc. to oversee and coordinate a larger employee base. When the number of employees within operational departments increased quickly, it became more difficult to monitor what every employee was doing. As a result, a formalized hierarchical structure was introduced within these departments, as explained in the following quotes.

“The difficulty was that we work with a lot of part-timers at the operational divisions. So if someone only works for 12 hours a week in the evenings, you do not see this colleague very often”.

“We now work with levels. We have level 1, 2 and 3. And level 3 colleagues are the most experienced colleagues, who also coordinate the rest of the team. Before there was no such structure, we were still with a really small team, 4 or 5 people a day, and everyone knew what was expected from them. When the teams

grew, we needed a coordinator to divide tasks between people.”

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teams, but also with the ideas of the founders. Moreover, these operational departments also implemented formalized job descriptions, in which they formalized what tasks belonged to which level.

“It got a lot clearer what a level 1 colleague had to do, before that was not really written down. And sometimes certain things were expected from you at that moment that were not really agreed upon for you

to do. It became much clearer what you need to do and what responsibilities belong to your role.” In order to coordinate a larger group of employees at operational departments, this process control was implemented due to which responsibilities were more clearly divided amongst employees. As a result, it became easier to monitor if the actions of employees were coherent with the firm’s goals. Moreover, as operational departments grew, team-leaders noticed that personal contact with part-timers decreased due to a scarcity of team leaders, and as a result the bond with the firm was less strong for those employees compared to employees that worked there fulltime or had a longer job tenure. To solve this problem, individual evaluations and coaching were introduced at operational departments, as explained in the following quotes.

“We felt that the fact that colleagues were easier to leave the company was also partly explained by the fact that they felt less involved in the firm. So we decided to divide the department in more specializations and coach-groups, to make smaller groups of colleagues and make it clearer for employees to see who they

can talk to”.

“We see now that colleagues are going to higher functions more quickly and are taking more responsibility for their individual progress”

As these quotes illustrate, Phone Inc. implemented result controls at operational departments to monitor the progress of a larger number of employees in a more personal way, and to improve the firm bond and tenure of all employees, thus improving the coherence amongst them. Furthermore, when Phone Inc. grew in size, the directors became involved with more employees, departments and tasks and as a result the distance between the directors and departments grew as they could not be directly involved anymore in every decision that was made. As a result of this distance, the founders felt that they needed to monitor more closely if departments were still making the right decisions, and that teams within departments were operating in a coherent way. In order to do this, daily (for operational departments) or weekly (for operational and supporting departments) reports were introduced to stay up to date of what the teams were involved in and how they were performing, as illustrated in the following quotes.

“Until 2017 he [the founder] was still in contact a lot with operators and a few times a week he would be on the phone over relatively small issues, and that is not the case anymore. He is still involved in the signing of year-contracts of course, but most things are now done by other people. The reports are there so

he still stays up to date of what is happening.”

“Yes, that is really their vision on reporting. That reports are more like a to do list for the person himself to see if he/she is up to date or not with the work, instead of that it is actually useful for them to keep track on

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Thus, the founders use these reports as formal result controls, to monitor how the growing departments have performed, but also in the form of process controls, to inform the employees about the work they still have to do. By doing this, the founders could monitor whether the divisions worked in coherence with their ideas and goals without having to be directly involved in the daily work. Moreover, as the operational teams were growing more quickly than the supporting teams, an operational manager was put in place between the operational departments and the founders, who did the evaluation meetings with team-leaders of operational teams to monitor how they were functioning, to discuss the reports with team-leaders, and to communicate these results to the founders.

“We started as one very small team close to each other, but that became a team with a lot of small teams within. Where all operational department should have been one team, there were 4 separate teams with

different cultures in each department, and they wanted to merge and combine those more”. “Those reports are discussed with the operational manager. He was put at that position last year. So earlier we had more direct contact with the founders, and now we discuss everything with the operational

manager, who talks to the founders about the most important parts”.

Thus, by implementing a formal leadership role in between the founders and the operational departments, this made it possible to monitor these departments more distantly and for the founders to divide their attention to more tasks. Simultaneously, this also increased the coherence between these departments, by giving them one manager as contact point and, thus, more uniform leadership. Moreover, within supporting divisions the direct contact with the founders also decreased, as direct contact for every decision or problem was not effective anymore. To solve this, Phone Inc. implemented structural meetings with the founders for all supporting teams, in which reports and other relevant issues are discussed.

“The reports are about the structural tasks we perform, so the things that really need to happen. And besides that, we also have a lot of non-structural tasks, and those are discussed during the meeting” “Mainly to see what is on your to do list, if you looked into something and you want to discuss that, to see

what your plan is, anything really.”

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“It’s obviously much easier when you have protocols if you want to look up something. Otherwise you need to explain everything verbally. It takes a lot of time and you could give your own twist to it which you don’t

want.”

“On operational level you can write everything down, and right there is where we can make a difference compared to our competition, by standardizing.”

Thus, by formalizing process controls, Phone Inc. assured that all new colleagues attained the same way of working, and they were much faster up to speed. Moreover, implementing protocols also made the firm able to standardize routine tasks, which made it possible to perform these tasks with less mistakes and as efficient as possible, in order to stay competitive. Furthermore, the focus on efficiency is also illustrated by the training that was implemented for every employee, in which was explained what kind of working method was supposed to be used within Phone Inc., which focused on prioritizing tasks and efficiency, as illustrated in the following quotes of one of the founders and a senior purchaser:

“Prioritizing, keeping track of what needs to happen, what are structural tasks, what are one-time projects, how do they relate to each other, how do we need to prioritize those. That is something we spent an

enormous amount of attention on within supporting teams”.

“People get disturbed by a lot of unnecessary things. While you can do that differently and more effectively with something very simple, such as a meeting or keeping a list with discussion points.”

Thus, by implementing this formal input control the firm could assure that every employee worked in the same uniform way, as preferred by the founders, retaining coherence of the growing number of employees. Moreover, when the company grew, the founders also wanted to get a clearer insight in the performance of the firm, and started doing a monthly closing, as illustrated in the following quote:

“Mostly to get more grip, knowing better how it’s going with the firm, because all costs are getting bigger, if it goes wrong it would hurt more, you know. Earlier we could oversee everything, we didn’t do a lot of marketing, but when you spend millions on marketing it would come in hand to know, if you’re a million off

that would be bad.”

As the costs grew, the founders could monitor more easily each month how the growing firm was doing by implementing this formal result control and prevent the risk of being out of control.

Thus, by implementing formal controls used to manage and share knowledge in the firm, oversee and coordinate a larger employee base, monitor more distantly, and assure the efficiency of a larger employee base Phone Inc. was able to assure that when the firm grew in size, new employees were working in a coherent way compared to existing employees, teams worked coherently compared to those in other departments and actions of employees were still coherent with the ideas and goals of the founders.

4.2 Trust in employees and firm

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their employees and the firm. Firstly, some teams within the firm still have a lot of freedom and autonomy, and this is given to them because of the strong trust the founders have in those teams to operate autonomously. Thus, having strong informal controls present reduced the need to implement formal controls in those teams. For instance, the amount of formal controls implemented in the supporting teams compared to those in operational divisions is significantly lower, as illustrated by the following quote of the senior purchaser:

“That didn’t change much, no. As a purchasing team we get a lot of freedom, that is really a matter of trust. We buy a lot of mobile phones, which has only grown in de last years. And the decisions we make are

about a lot of money. So it’s important you make the right considerations, but you do not need to discuss that with the founders. We can make that decision all by ourselves. And that is very important for the work

that we do, because we have to make fast decisions. When a price is good, we have to be able to buy and not to have to discuss it first.”

This quote illustrates how employees of the supporting teams are given a lot of autonomy and trust within the organization. Moreover, this quote also shows how the firm chooses to use informal controls, in the form of trust, instead of formal controls in places where it can provide employees with the necessary flexibility and fast decision-making they need to stay competitive in the market. The firm did not implement the use of any formal goals, budgets or strategies to control its employees, and uses that in its advantage, as illustrated in the following quote:

“But it’s also the strength of this company that we do not have those [formal goals]. Because now you can quickly change the course by going another direction. Which can be very good for our profitability in the

market we’re in, being flexible.”

This quote shows how trust in employees replaces the need to implement formal controls, which provides the firm with the flexibility to quickly respond to a changing market. Furthermore, the founders of Phone Inc. emphasize in their contact with employees that they earn their trust because they are the person with the most expertise on their subject, under the condition of full transparency.

“We also make mistakes, and they do not react negatively. They tell us: good that you told us, and you didn’t keep it to yourself, and we can all learn from this. So that’s why that bond of trust is very strong.

That you feel like you can make a mistake.”

“I think in this way they try to train us in taking more responsibility, so they can start making less decisions on the long term because it is becoming too much.”

These quotes illustrate how the founders influence employees to make the best decision autonomously, by implementing informal controls such as trust. Moreover, within supporting divisions there is no clear line of which decisions need approval of the founders, and which decisions employees can make themselves, as mentioned in the following quote.

“It can be difficult to determine when to decide something yourself or to put it on the Monday meeting and asking for input. We are quite free, and I wouldn’t be able to show you a line of where you do or do not do

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As this quote illustrates, employees are given the trust to make that decision themselves, and the strong informal control that is present here has again reduced the need to implement a formal control. Furthermore, the interviews show that the trust the founders have in their employees is also reflected in the strong intrinsic motivation of employees as present within Phone Inc. As the founders have trust that every employee within Phone Inc. is intrinsically motivated to improve, and that the vision of the employees aligns with the vision of the founder, this limited the amount of formal controls implemented. For instance, Phone Inc. has not introduced any formalized sales or purchasing targets or bonuses.

“We do not work with targets for purchasers because the founders see that other companies are really getting destroyed by that, if for instance a seller deliberately sells phones to us at a low price to reach their

target. They feel like people at Phone Inc. work from intrinsic motivation to make the right choices, and those people they want to find, and they assume that in that case that automatically works well and you do

not need a target to make that happen.”

As this quote illustrates, the founders have trust in the motivation of their employees to work hard without any external motivations, which reduced the need to implement formal controls such as targets. Furthermore, although several interviewees stated they were not fully aware of what the vision and objectives of the founders are, many stated that they were intrinsically motivated to improve the firm, and to become the best in the market, as illustrated by the following quote.

“Basically those [vision and objectives] are not public, they are in the heads of the founders. And the general idea of everyone is to get bigger, get more volume, do things smarter and more efficient. But it’s not very clear like: we need to have this amount of subscriptions this month, things were never expressed like that. The idea was always just to do the best we can to do things as efficient as possible and then it will

go well.”

As the strong intrinsic motivation of employees as expressed in this quote actually aligns with the vision of the founders, this might explain why the lack of transparency about a vision did not result in any problems or lack of motivation among employees. Several employees even stated that when there were no formal controls present as implemented or communicated by the founders, they implemented them themselves.

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“It’s often more to confirm how they already think the firm is going.”

“We monitor some things, such as net profits, solvency, etcetera, but the follow-up is often limited”. As these quotes illustrate, the main purpose of the monthly closing is to affirm the trust of the founders in the firm. Furthermore, the trust in employees seems in some cases to decouple formal controls from actual decision making or corrective action, as illustrated by the following quotes.

“We communicate guidelines, but we are not very firm on them, we don’t use them to punish people.” “Since two years coordinators can see statistics [of how individual employees perform], but I don’t think

people actually look at that, because you will just notice if someone works hard or not”.

As these quotes show, informal control, in the form of trust in employees, is often regarded more highly than the actual numbers as reported. Next to that, several employees stated that although some formal controls were introduced, they were not always strictly adhered to, as mentioned by a purchaser.

“Well they are rules, but if we want to deviate from those... Our policy is that we keep a two-week inventory. But we can also have four weeks, or ten, or just one. That depends on how we read the market

and think this is the right thing to do”.

Clearly the trust in employees to decide what is the best thing to do seems to decrease the way in which formal controls are adhered to, giving them the autonomy to deviate from rules or policies.

Thus, the interviews show that the trust the founders have in the firm and its employees has resulted in fewer formal controls within some teams, giving them freedom and autonomy to make decisions and relying on their intrinsic motivation to improve, and has even resulted in a rather informal way of using some of the formal controls that have been implemented.

4.3 Founders’ informal attitude

The collected data from the interviews shows that the attitude of the founders also had a large impact on the formalization process within Phone Inc. Firstly, the founders of the firm have clearly put a lot of effort in their direct involvement with a lot of the teams, and this informal attitude has resulted in fewer formal controls and a stronger reliance on informal controls. The supporting departments are still directly accountable to the two founders, and within those departments formal controls are limited, as illustrated in the following quote.

“The risk is now managed by the fact that every contract we make is seen by the founders, so the direct contact minimizes that. For instance, the marketing expenditures, they have an idea about that and that is

all thought of by one of the founders and discussed with them during the process”.

As this quote shows, supporting teams still have a lot of direct contact with the founders, which has reduced the need to implement more formal controls. Moreover, the direct involvement of the directors and their informal contact with employees has also reduced the need to implement formalized evaluation meetings within the supporting departments, as shown in the following quote.

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for a financial issue with a provider, he [the founder] would tell me afterwards how I did it and what I

could improve.”

As the founders have promoted a culture in which feedback is given in a direct and informal way, this reduced the need for other formal controls to evaluate colleagues in these departments. Furthermore, the firm did not introduce formal steering on KPIs, as explained by one of the founders.

“We do not believe in focusing on one KPI. What I do believe in is that you use a performance indicator to see if something is going well, and as a starting point to see if you need to improve something or if there is

a problem. For instance, if sick leave is 10%, it could also be that a manager is not behaving well, or something is wrong with ventilation, but you don’t know that, so you need those numbers to see what is

going on behind the scenes.”

The founders of Phone Inc. are of the opinion that strict steering on KPIs will lead to bad decisions, and they want to be involved in the firm on a more highly detailed level. Thus, the founders’ informal attitude, reflected by their direct involvement and focus on informal processes backing up formal reports, has influenced their decisions to not steer on KPIs. Moreover, the informal attitude of the founders is also reflected in their opinion about formalization. As the founders of the firm share some very strong ideas about certain aspects of formalization, this withheld them from implementing those formal controls, and again shows how the informal attitude of the founders increased the reliance on informal controls. For example, within supporting teams job titles and descriptions are not formalized, as the founders want to promote equality within the firm, as illustrated in the following quote.

“It’s a team effort, just like at your [Finance] department, so everyone is equal to one another”. For instance, within the Controlling team all colleagues have the title “Controller”, and no difference is made between experienced and unexperienced colleagues, as explained by the founder.

“People are going to think, ok, I’m a junior so I know it less well than a medior, which makes people not contributing in the way that is needed or that is useful. […] So if you implement a really hierarchical leadership structure, and say ok, you are the senior, she is the medior, he is the junior, and you are the servant, then you will start acting like that. So I think you need job titles when they are really necessary,

and when they are not necessary it’s better to leave them out”.

As this quote illustrates, the founders have the opinion that these differences in job titles make people restrain from doing the best they can, regardless of your experience. This quote also shows the general opinion of the founders about formalization, and the fact that they intend to limit formal controls to the extent that it is only implemented when it is not efficient to work without them. Moreover, the fact that Phone Inc. did not implement any sales or purchasing targets is related to the fact that the founders have the opinion that such types of formal controls make employees work out of extrinsic motivation, at the expense of the firm, as illustrated by the following quote:

“They [the founders] share the philosophy that targets make people act in a way that only favors their position, so what is good for their target, and that is basically the opposite of what the firm stands for, you

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As this quote shows, the founders want people to contribute out of intrinsic motivation, in a way that is good for the firm, and this informal attitude restrained them from implementing formal controls. Furthermore, the informal attitude of the founders is also reflected in the ideas and opinions the founders share about the market and their customers. The interviews show that the founders feel that some things cannot be predicted or steered, and that it is better to rely on informal controls in those cases. For instance, Phone Inc. chose not to make use of budgets, as illustrated in the following quote.

“We do not use budgets because we do not know how the market will look, that is really hard to say. Manufacturers come to us and say: we have model x, for this price, how many can you sell? And then we

reply that we have no idea, nobody can say that.”

This statement shows that the founders are of the opinion that the market cannot be predicted, and thus, to remain flexible, formal controls such as budgets are not used, trusting that employees will make the right decisions. Furthermore, the lack of formal goals within the firm is grounded in a similar opinion, as shown in the following quotes:

“That is really difficult to predict on forehand. I mean last year we had a prognosis, in 2017 we had 200 million of revenues, so we said in 2018 we think it will be 240, and it became 300 million. So I think those targets work better in older companies, in which the market is more saturated, where you can predict what

will happen better, it’s just too dynamic.”

“Those visions and plans, to have that clear. With a firm that grows 50% a year you never know which parts will become the bottleneck.”

These statements show that the informal attitude the founders have is that it is too difficult to predict the future of a rapidly growing firm, and that it is better to refrain from doing that in that case, thus relying on informal controls instead of formal controls. Furthermore, the opinion that the founders share about customers influenced the reason behind not implementing sales targets.

“We find it really important to give an objective advice, and I think when you work with targets people will often sell stuff that the customer did not need, or a way too expensive phone.”

“I always hear that colleagues really like it that we don’t use sales targets. This way they can actually do a good offer to a customer, thinking together with the customer and actually helping. And that, for them, is

what motivates.”

As these statements illustrate, the opinion of the founders about giving an independent and fair advice to customers has reduced the need for targets. By not implementing a formal control in this specific part of the firm, the founders rely on informal controls that employees will do the best they can to sell a product that the customer actually want, more than that they need a formal control to motivate them.

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5. DISCUSSION

The findings of this study show that Phone Inc. structured and operated formal controls in order to assure coherence and monitoring within a rapidly growing firm, and that the trust of the founders in their employees and the firm together with their informal attitude towards formalization restrained them from implementing formal controls, relying on informal controls in those parts of the organization. In this chapter these findings will be discussed in light of existing literature.

The existing body of literature on management control states that formal controls are implemented to motivate, enable or enforce employees in working towards the objectives of the firm (Merchant & Van der Stede, 2007), aligning the goals of employees with those of the firm (Sitkin, Cardinal, Bijlsma-Frankema, 2010). This study however suggests that the reason behind why formal controls are implemented within growing entrepreneurial firms, such as Phone Inc., is grounded more in retaining coherence amongst employees and departments in a rapidly growing company, rather than having to motivate or enforce employees in doing what is best for the firm. In line with the study of Davila (2005), the founders of Phone Inc. seem to rely on the assumption that the employees still share the vision of the founders. As a result, formal controls were mostly implemented to retain coherence amongst employees when the company was growing in size, assuring that this vision is also transferred to new employees when the firm expands and all employees share the same knowledge and understand where the firm is heading. Thus, for the implementation of formal controls in entrepreneurial firms the focus lies on knowledge sharing and uniformity, assuring coherence amongst employees, rather than having to encourage or motivate employees.

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informal control is strong, a MCS in its most formal way might not be necessary in growing entrepreneurial companies. The lack of formal controls in some departments has clearly not hindered the survival of Phone Inc., as the firm has grown over 50% in the last year. In addition, the findings show that when formal controls are implemented, the strength of the informal controls as present influences the way in which they are used and adhered to. Although existing literature states that when both formal and informal controls are present they complement one another (Kreutzer et al., 2016), the findings from this study show that informal control, in the form of organizational trust, can also weaken the use and effectiveness of implemented formal controls, resulting in formal controls that are not strictly adhered to or controls that do not lead to corrective action or decision-making. This is illustrated in the monthly closing as implemented by the case company. As the founders have a lot of trust in the firm, this monthly closing often lacks any follow-up or decision-making, and is mainly used to reaffirm the idea the founders already have about the firm, exposing a rather informal use of formal control. As studied by Collier (2005), informal control is often found to be more important than formal control within entrepreneurial firms. The findings from this thesis add to this research, and show that when the informal controls as present are strong, the implementation of formal controls can sometimes result in a rather ceremonial use of formal controls.

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6. CONCLUSION

A large part of management control research focuses on well-designed MCSs, while the emergence of formal control in growing entrepreneurial companies is relatively neglected in literature (Luft & Shields, 2003). However, during growth entrepreneurial firms quickly face difficulties with their informal systems (Flamholtz & Randle, 2012), and the transitioning to a formal system that aligns with their existing informal system is essential for their survival in the market (Merchant & Ferreira, 1985), as they have to do this with little experience and fewer resources than older, well-established companies (Pešalj, Pavlov & Micheli, 2018). For this reason, this research aimed to contribute to the management control literature, by studying how rapidly growing entrepreneurial firms operate and structure formal controls. An in-depth single-case study was conducted, from which several relevant insights were gathered.

The findings indicate that growing entrepreneurial firms formalize control to monitor a larger employee base and retain coherence in a growing organization. Controls are implemented to assure a uniform way of working throughout the firm while relying on the intrinsic motivation of employees, rather than having to motivate or enforce employees to do what is best for the firm. When employees still share the vision of the founders and the founders’ trust in the employees and the firm is high, this can restrain firms from implementing formal controls or result in a ceremonial use of controls. The findings show that the informal attitude of the founders also has a large share in this, in which the opinion of founders about formalizing control can reduce the amount of formal controls implemented, relying on informal control. Overall, informal control seems to be highly important during the formalization process of growing entrepreneurial firms. When informal control is strong, this can even relieve the firm of some of the negative consequences of growing pains, such as motivational problems or a lack of direction amongst employees. Furthermore, the findings show that formal controls are not implemented at the same speed in every department, which suggests that the formalizing of control in growing companies is not an even process throughout the organization.

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been working at a firm since start-up often share the vision of the founders and show a high firm bond (Davila, 2005), the findings of this study might have been biased by participants for whom the informal control is stronger than for employees who have a shorter job tenure. However, the interview with the participant that had the shortest job tenure (2 years) did not show any significant differences compared to those with a very long job tenure, thus limiting this risk. Thirdly, the interviewing and coding of this study was done by one researcher, resulting in a possible bias in the gathering of data and the analysis of the findings (Mays & Pope, 1995). Moreover, the data gathered in this study was based on experiences and recollections of members of the organization, and no long-term effects were measured. Future studies could use longitudinal research to investigate whether the scarcity of formal controls in parts of the case company and other entrepreneurial firms is still effective on the long run, and how this is related to profitability. Furthermore, existing literature shows that especially in small firms the replacement of the founders by new directors has a positive impact on the implementation of formal controls (Greiner, 1998). However, within Phone Inc. the founders are still the sole owners of the firm and are very involved in its daily business. Future studies could investigate more deeply how formal control systems evolve in firms in which the founders are not replaced by a new CEO. Lastly, while the findings of this study show that some formal controls as implemented in the case company were used in a ceremonial way, this research did not go very deeply into the reasons behind why this occurred. Future research could focus more on what factors hinder the effective use of formal controls after implementation and the way in which these controls are used for decision-making or corrective action (Garengo, Biazzo & Bititci, 2005).

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