How formal control mechanisms for rapidly growing
entrepreneurial firms are designed and implemented
Emy Brekveld
University of Groningen
Student number: S4184122
Email: e.w.brekveld@student.rug.nl
Date: June 6, 2020
Abstract:
Purpose: The purpose of this paper is to investigate how formal control mechanisms are designed and implemented for fast-growing entrepreneurial firms.
Methodology: Within this research, a case study conducted for Phone Inc. Employees from different departments are interviewed and this information is analyzed through a process coding method.
Findings: A dissimilarity of design and implement formal control is found between the operational and supporting departments. Formal control can be introduced by the demarcation of tasks, functions, departments, and responsibilities. Thereafter, being formalized through meetings, protocols and, systems. Finally, being adapted through ambiance, collaboration and, motivation and reinforced through easy access to all the information, training and, provision of feedback.
Research limitations/applications: This research is based on a single case study, which limits generalizability and, findings from the interviews could be easily interpret differently. Practical implications: Formal control mechanisms could be designed and implemented in fast-growing entrepreneurial firms by introduce demarcation of tasks, functions and,
departments and formalize procedures and systems, with the purpose to gain scalability control.
Keywords: Management control, fast-growing entrepreneurial firms, formal control mechanisms
1.1 Introduction
Since failures in management control could explicitly lead to financial losses, reputation damage, and sometimes even to bankruptcy, effective management control is crucial for firm performance (Mafi, 2014). Recent theoretical and empirical research found out that
management control systems are important to innovate (Davila et al., 2009). Secondly, control systems are significant for organizations to align employee capabilities, activities and,
performance (Cardinal et al., 2004). Nevertheless, Ferreira and Otley stated that management control systems are typically complex and intertwined. Therefore, organizational control is assumed to be one of the most fundamental challenges of management.On top of that, it is seen as the critical success factor for organizational tasks, such as HRM or Research and Development (Kreutzer et al., 2016).
A lot of existing papers and research specifically investigate the purpose of MCS in large or long-existing firms (Langefield-Smith, 1997). In recent years, the literature showed an increase in complexity with management control in small and medium-sized enterprises. Despite the fact that several studies underlining the importance of management control, only a few small organizations are using it (Garengo et al., 2005). A reason for this could be that an organization has to face obstacles when they create control systems. The substitution process from informal to formal control mechanisms does not ensure balance. In fact, it could even lead to problems because managers are heavily weighted on the formal control mechanisms and let go of the informal ones (Cardinal et al., 2004). That paper illustrates the difficulty of balancing management control. In line with this research, Pesalj stated that there is a lot of research conducted about management control in large companies. However, there is recently more interest in management control in smaller and growing entrepreneurial firms (Pesalj et al., 2016). In contrast, Bedford, Malmi and, Sandelin (2016) conclude in their paper
‘Management control effectiveness and strategy’ that management control is not always needed to achieve effectiveness. Organizations can also achieve effective control when they combine different ways of management control (Bedford et al., 2016). Next to this, research has argued that management control systems may present a hindrance to the creation of innovative companies (Haustein et al., 2014).
are facing with their management control systems. And how are those management control systems designed and implemented? This study contributes a case study regarding the design and implementation of management control mechanisms in fast-growing entrepreneurial firms. To further examine the growing pains rapidly growing entrepreneurial firms are facing when implementing formal control, we use a case study of Phone Inc. Phone Inc. is
experiencing growing pains in their control and due to interviewees with employees from different organizational levels, we are going to do research. The following section develops the theoretical background of management control systems, followed by a method section. The findings from the interviews are being discussed and finally, the conclusion and discussion with limitations and directions for future research.
1.2 Literature review
Management control
The environment in which organizations operate is constantly changing and therefore difficult to predict. Organizational control is, therefore, one of the management’s fundamental
challenges (Kreutzer et al., (2016). However, control can be exercised at different levels in an organization. Management control concerns the control of corporate-level managers over the mid-level managers. Corporate control applies to the CEO and the members of the upper layer within management and operational control, which controls the members of the lower layers in the organization (Helsen et al., 2017). Management control is a process of guiding
activities and performance to achieve the organizational goals (Kreuzer et al., (2016).
According to Mafi (2014), management control is necessary to guide employee behavior and includes processes for the internal focus; planning, organize and, controlling (Mafi, 2014). Langefield-Smith (2007) underlines this definition. MCS is defined as all the devices or systems which are used by the manager to ensure the employee behavior is in line with the objectives and strategies from the organization. Measurement instruments can be aimed at objects of control. Merchant and Van der Stede (2003) presented results control, action control, personnel control and, cultural control. Results control focuses controlling on the results. Employees can be rewarded or punished for achieving this result. Action control is the control that is established during the execution of the tasks. According to Merchant and Van der Stede, this type of control consists of behavioral constraints, action accountability and, redundancy. Personnel control consists of the selection and placement of the employees, training, job design and, the provision of the necessary resources. Cultural control is to encourage mutual monitoring, based on shared values and beliefs which guide behavior within an organization (Helsen et al., 2017).
Formal vs. informal MCS
Ouchi (1979) supports informal control as informal clan control, which means the designing and selecting mechanisms for socialization, which establish and maintain the values, norms and, culture within an organization (Kreuzer et al., 2016). Informal control systems refer to unwritten, unofficial forms of control and, serve as an artifact of the
organizational culture (Kreuzer et al., 2016). Hence, these mechanisms are more difficult to measure (Langefield-Smith, 1997). Tiwana (2014) has concluded in her paper which is called ‘Systems Development Ambidexterity: Explaining the Complementary and Substitutive Roles
of Formal and Informal Controls’ that formal and informal control mechanisms could be both
complements and substitutes. Informal control mechanisms could strengthen the influence of formal control behavior. Though, informal control could weaken the influence of formal outcome control. On the other hand, combining informal and formal mechanisms enhance the development flexibility (Tiwana, 2014).
Management control systems (MCS) are adopted to substitute informal management, which requires constant personal interaction. As companies grow, direct control and
observation are too costly. The motivation and monitoring within the firm have to happen through appropriate management control systems. Without formal control mechanisms, communication becomes too costly as well. Davila and Foster (2007) investigated the
adaptation from MCS in early-stage start-up companies. Their research conducted that growth and the adoption of MCS reinforce each other (Davila and Foster, 2007).
direction. (2) Motivational problems, which can lead to fraud. (3) Personal limitations, which can be caused by a lack of training, experience, or knowledge (Mafi, 2014).
In order to have good management control, organizations could obtain high profitability of success. Meaning that the organization controls the situation, environment and, the
organization itself, which means no internal surprise will occur (Mafi, 2014). This is one of the reasons why management control becomes a topic of interest. In the last few years, there has been done a lot of research about management control mechanisms. Davila did in 2005 research about ‘the emergence of management control systems; formalizing human resources
in small growing firms.’ Ferreira and Otley (2009) wrote a paper about the design and use of
performance management systems and Glancey (1998) did research about the determinants of growth and profitability in small entrepreneurial firms.
Characteristics of fast-growing firms
Young entrepreneurial firms are the potentially major players in the economy of tomorrow. However, not all young entrepreneurs are able to succeed (Wirtz, 2011). What still is difficult to understand is the use of formal and informal control mechanisms in fast-growing
entrepreneurial firms. Berry et al., (2009) wrote a paper about the emerging themes in management control and investigated management control in new forms of organizations; internal and external hybrids. The paper concluded the key challenge for management control, which is to develop concepts and systems to gain both horizontal and vertical relationships (Berry et al., 2009). The use of management control techniques increases when firms move on to the next stage in the life cycle. Organizations in later stages put more emphasis upon
life cycle consists of five stages; birth, growth, mature, revival and, decline. Within the first stage, organizations are small and fully controlled by the owners. Management activities are minimized, the communication is frequent and informal, and the organizational structure is also informal. Firms in the growth stage rely on formal rules, procedures to ensure
organizational efficiency, which is purpose due to the expansion of activities (Silvola, 2008). Though, the growth stage in the life cycle model assumes slow growth.
Haustein et al., (2014) did research about the MCS in innovative companies and came to the conclusion that indirect (informal) control mechanisms seem to be better suited.
Informal mechanisms seem to activate the group and the formal mechanisms can be
interpreted by employees as boundaries to be innovative and creative (Haustein et al., 2014). Existing research about the MCS only focuses on the medium and large firms where formal systems have been established for a long time. During growth, MCS plays an important role because a lot of processes can be controlled which saves time for managers. Growing organizations are quickly faced with the challenge to successfully make the transition from informal to formal control systems (Davila, 2005). If fast-growing organizations are not responding to their growth, they can feel growing pains. The presence of growing pains can suggest that there is a lack of a formal structure, in which functions and responsibilities are clearly defined, or that individuals do not understand how to manage their time (Flamzholtz and Randle, 2012).
1.3 Research question
To addition the gap, this study will answer the following research question:
1.4 Method
To shed light on how formal control mechanisms for rapidly growing entrepreneurial firms are designed and implemented, we chose to undertake a case study. To be specific, we are going to undertake an inductive case study within Phone Inc. An inductive case study is useful when there is a gap in existing theory that does not explain under investigation.
Besides, it is very useful for asking ‘how’ and ‘why’ questions. At the same time, the context and experiences of the actors and especially the managers are critical (Barratt, 2011). This method will enable us to investigate how the control mechanisms within the fast-growing firm Phone Inc. are designed and implemented.
Case study description – Phone Inc.
Phone Inc. is a Dutch organization operating in the telco industry. Roughly ten years ago, Phone Inc. was founded by two entrepreneurs to sell phones and phone subscriptions within the e-commerce business. Nowadays, Phone Inc. has over 400 employees and in 2018 they had 300 Million Euros of turnover and seven stores located in the Netherlands.
Data collection
Interviewee role Department Experience
Business Developer (operational) Business Development 6 years
Team leader (operational) Customer Service 8 years
Head of Purchasing/Sales (executive)
Purchasing/Sales 7 years
Controller (executive) Finance & Control 6 years
Team leader (operational) Sending & Delivery 8 years
Founder (executive) Management 11 years
Table 1: Interviewees Phone Inc. These six interviews are selected because firstly, they are from different departments within Phone Inc. This way we can get information from different points of view. Because we are going to investigate how control mechanisms are designed and implemented, we took the departments who work the most with control anyway; business development and finance & control. A distinction is also made in the executive or operational levels. Secondly, if there was a choice between two team leaders within the same department, we chose the one with the longest experience because they have gone through the most changes during the years. Lastly, the founder is one of the six interviewees because he can give us the ‘why’ behind some questions about implementing, or not implementing, control mechanisms within Phone Inc.
Data analysis
themes; introduce, formalize, and effect. The concepts demarcation and necessity are the bases for the first theme; introduce. Formalize and control are led to the second theme, formalization and adaptation and reinforcement shape the third theme, which is called the effect. These three themes indicate the process which a fast-growing organization is going through.
First-order codes Second-order codes Themes
1. Task descriptions 2. Function descriptions 3. Department descriptions 4. Responsibilities 5. Control function 6. Control department 7. Recording formal control 8. Recording informal control 9. Motivation 10. Ambiance 11. Collaboration 12. Access to information 13. Training 14. Feedback
15. Targets, mission & vision
1. Demarcation 2. Necessity 3. Formalize 4. Control 5. Adaptation 6. Reinforcement Introduce Formalization Effect
Table 2: Coding method
1.5 Findings
As mentioned in chapter 1.4, six interviews are selected to gain knowledge about how MCS is designed and implemented in fast-growing entrepreneurial firms. The six interviewees are employees who work for Phone Inc. for a minimum of six years. The coding method led to three overarching themes which we are going to analyze below; introduce, formalize and, effect.
Introduce. The beginning of implementing formal control mechanisms in a firm is
process in progress for introducing formal control mechanisms. Nevertheless, it is remarkable that the introducing process for the operational department is different from the supporting departments. The operational department started working with formal control mechanisms sooner. They have introduced the formal control mechanisms by the demarcation of the tasks, functions, and responsibilities and classifying different departments. ‘The customer service department was fast-growing and to still achieve the scalability, we divided the members within this department into three levels; levels 1, 2, and 3. We divided these levels into specializations. This way, members need 1/3 of the knowledge which ensures we can train new members faster’ (Business Developer). Next to the demarcation of the tasks, Phone Inc. has added a hierarchy within the operating departments. ‘A few years ago, you were a staff member or a supervisor, there was nothing in between. Right now, we have team leaders, coordinators, and staff members who are divided into levels 1, 2, or 3. Secondly, one year ago, a manager layer has intervened with an operational manager. The operational manager guides and coaches the team leaders’ (Team leader sending & delivery).According to the founder of Phone Inc., the reason behind the hierarchical structure and clearer function descriptions in the operational department is because of the guidance needs of the team, the part-timers, and the scalability of the much bigger divisions. ‘The work is crystallized more clearly. It is clearer what members have to do and we have a different character in terms of the amount from colleagues’ (Founder). These quotes show that introducing formal control mechanisms start with the need for scalability and to work efficiently. To still be controlled, they must be appointed team leaders and managers.
department for those tasks; the finance & control department’ (Head of Purchasing/Sales). Besides, department business development is introduced to make other departments more efficient. ‘The business developers are concerned with the efficiency and the scalability of our division’ (Team leader sending & delivery). These supporting departments are deployed, so the operating departments can focus on their own tasks. Controllers are introduced to gain control of every division. Despite this, there is no direction team within Phone Inc. ‘In other organizations, they have a direction team of approximately 5 people; someone from HR, finance, marketing, sales, and someone in general. Our two founders replace all those people and are doing the whole direction by themselves’ (Controller, finance & control).
These quotes show that the needs for introducing formal control mechanisms start at the point where the firm needs to be more scalable. This leads to the demarcation of the tasks, functions, and departments. At the same time is appointing, in this case, coordinators, team leaders, and operational managers of interest to still ensure control within the organization.
However, a few interviews showed that this process is not the same in every department. The supporting departments have another way of introducing formal control mechanisms. The interviewees show these departments do not have a hierarchy and there are no supervisors to control and coach team members. ‘We structured the tasks in our
Purchasing/Sales). In addition, the supporting departments have a flat organizational structure. The reason behind this is because the founder does not like strict hierarchies
because managers are going to act as managers. And because of a hierarchy, it is possible that some employees move into the background, which is not convenient at the supporting
departments’ (Founder).
Overall, introducing formal control mechanisms start to be of interest when, firstly, the firm wants an overview and control over the functions and departments. Secondly, the
demarcation of functions and tasks is to be scalable and efficient. The same applies to
subdivide the departments within the firm. Every department has their own tasks and there are departments like finance & control and business development who works for every other department. However, it is remarkable that there is a clear dissimilarity between the operational and the supporting departments when introducing formal control mechanisms. The supporting departments have a flat organizational structure with less formal
responsibilities. On the other hand, the operational departments have more hierarchy and there are more layers in the management. According to the interviews, this is because the operating departments are much bigger, plus it is easier to demarcate their tasks and functions.
Formalize. An important part of formal control mechanisms is to formalize the control
mechanisms because every individual within the organization gets access to this formal control. We can describe formalization as the recording of everything that has to with formal control; appointments, systems, procedures. As we already mentioned, there is a dissimilarity between the operating and the supporting department of Phone Inc. The operational
The operation departments have formalized weekly structural meetings, day, week and monthly reports, protocols for the proceedings, systems, and an electronic learning
environment. To be more consistent, work more efficiently, and to learn new employees the proceedings faster, there are formalized protocols, which can be found in a knowledge base. ‘For the operational department protocols are very important. We have invested a lot of time to implement the right tools. Secondly, for the knowledge base, we taught the department how it works and how to use the right templates for the protocols’ (Business Developer). The day, week, and monthly reports are formalized, wherefore the team leaders, coordinators,
operational manager, and the founders have control over the divisions. The daily reports are specifically for the evening shift but are additionally send to the coordinators’ operational manager and the founders. ‘We report what happened that day; what did we do and what do we still have to do. It is a handover for the night shift. It is a report for the coordinators, founders, and the operational manager’ (Team leader sending & delivery). The weekly reports consist of the daily numbers and are sent to the founders. The department receives feedback from the founders in the weekly meeting. The structural meetings are with all the team leaders, coordinators, and with the operational manager. Within those meetings, the week reports are being discussed and the departments receive feedback. Nevertheless, the
supporting departments are not reporting to other departments or the founders. ‘No, we do not send reports to the controller or founders because we are not working in the operation. We are doing projects, and the founders are strictly involved. Besides, our work is difficult to
quantify’ (Business developer). However, the controllers from the finance & control
and it is my job to monitor if everyone is busy with the task with the highest priority’ (Controller).
Next to the recording of the formal control mechanisms, Phone Inc. does also has informal control mechanisms. The most important one is the social control in the functions and in the departments. ‘Unconsciously, there is social control. We give each other feedback’ (Business Developer). ‘We work with the 4-eyes principle, every important or complex decision is being checked by a minimal 4 eyes within our department’ (Head purchasing & sales). Social control is an example of recording informal control mechanisms. Another important example of an informal control mechanism is freedom in decision-making. ‘Based on trust, we get freedom and responsibility for our decisions’ (Business developer). On the other hand, the founders are strictly involved with every important decision. ‘We do not have much freedom in our decisions, because the founders always decide’ (Controller).
Overall, the interviews show that the formalization consists of determining protocols to gain control. There are formal mechanisms that ensure that everyone knows what they have to do, what everyone is doing in the firm and the meetings are for questions. This has all to do with working consistent, efficient, and still gain control.
Effect. Fast-growing entrepreneurial firms are substituting the informal control
describe the ambiance within Phone Inc. as informal. ‘We have an informal contract with the whole organization, even with the founders’ (Business Developer). The collaboration within Phone Inc. can be characterized as a flexible, team effort, open and direct in the
communication, and access. ‘For small projects, I can follow my own ideas and completion and if I have questions, I can ask one of the founders. It is always positive to let a second person think along. However, if I start with a big project, I always consult with the founders’ (Business Developer). ‘It is a team effort, everyone is equal to each other’ (Head of
Purchasing & sales). The quotes show, Phone Inc. still has an informal ambiance and
collaboration. The motivation of the employees to work for Phone Inc. is mostly, because of the work they are doing, although the freedom in decision-making, appreciation, and trust is playing a motivational role. ‘I really feel appreciated for the work I am doing here. At the same time, the personal progression I make ensures that I feel motivated to do my best … I do not need anyone to tell me we need to reach a specific target to feel motivated’ (Team leader customer service). ‘We are a fast-growing company, so the variety in the tasks is what motivates me. Besides, the informal ambiance within the department, it is always sociable’ (Team leader sending & delivery).
very formal. This makes sure the employees are also working more formally. Besides, the possibility of education ensures the demarcation of responsibilities and function descriptions. The provision of feedback is also of interest for the reinforcement of the formal control mechanisms, to keep the way of working with them worthy. ‘Right now, we become coached on how we do our work … The operational manager coaches the team leaders’ (Team leader sending & delivery). ‘Every two weeks, the team leaders have a meeting with the operational manager to discuss how it goes and where you should pay attention to’ (Team leader
customer service). And when the interviewees are asked about their personal feedback, they answer the following: ‘I can only tell you this for myself, there is not a protocol for personal feedback. Once a year I request a conversation by the founders to ask them how they think I am doing my job’ (Business Developer). These quotes show, within Phone Inc. the provision of feedback for departments and functions is well organized. Nevertheless, there is not a formal possibility to receive personal feedback because if anyone wants a performance appraisal, they have to ask it by themselves.
Overall, employees are motivated because of the work they are doing and because they receive trust and freedom in their decision-making. The collaboration within the organization consists of team effort and flexibility which is formal. However, the ambiance and the
communication within the organization is still informal. Concepts that reinforce the formal control mechanisms are access to information, training, and provision of feedback which are mostly formal. Access to information is widely through systems, protocols, and knowledge bases. The provision of feedback is only for the team leaders, who receive coaching from the operational manager. If employees want feedback, they have to ask for a performance
1.6 Conclusion & discussion
Primarily, this research examines how formal control mechanisms are designed and
implemented in fast-growing entrepreneurial firms. Specifically, this study extends the current perspective of management control by especially focusing on fast-growing firms. The
findings of this study contribute to the understanding of management control by identifying the process of introducing, formalize, and the effect of design and implement formal control.
Accordingly, the findings of this research, show that introducing formal control starting to be of interest when the organization wants an overview and therefore still gains control over the functions and departments. It is remarkable that there is a dissimilarity between the operating and the supporting departments. The supporting departments have a flat
organizational structure with less formal responsibilities. The operating departments have more capacity and personnel, and therefore made use of hierarchy. Additionally, since their tasks are more consistent, they have more layers in the management. The formalization of formal control consists of determining fixed protocols, meetings, systems, schedules, and reports to still gain control and work consistent and efficient. Our findings presented that the effect of implement formal control consists of two parts; adaptation and reinforcement. The ambiance is still informal, although the collaboration and decision-making are formal after the formalization. Concepts that reinforce the formal control mechanisms are access to
information, training, and the provision of feedback.
started when the organization want an overview and control over the growing organization by demarcation of tasks, responsibilities and departments, systems, protocols and schedules. However, this study shows in practice, that there is a dissimilarity between bigger
departments who can elaborate on their tasks and smaller departments who work mostly on a project basis. This contribution confirmed both as extend on current research.
Second, Bisbe & Otley (2004) stated in their paper that management control will ensure innovation. In line with this, our study contributes that the demarcation of tasks,
responsibilities, and departments ensure fixed meetings with team leaders from different departments. Within those meetings, improvements will be discussed. Besides, because of the demarcation, there is a special department for control and for research and development which can set this innovation easily in motion.
Subsequently, Otley and Soin (2014) stated that management control is a process of guiding organizations, with the purpose to achieve short- and long-term goals. Our study claims contractionary, that formal control is introduced to gain an overview and control, not to specifically achieve goals. Finally, Davila and Foster (2007) are saying that management control is necessary to motivate. In contrast, the individuals in the fast-growing organization in our case study are motivated because of the job they are doing, they do not need
management control to be motivated.
In order to generate qualitative data from the interviewees, it was necessary to choose the employees who work at Phone Inc. the longest. Hence, these employees have been
and, because we investigate different employees from different departments, the findings are interpretive because I have categorized the interviews and try to identify patterns. At the same time, because we investigate one single case study it has less generalizability.
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