“Management control used by retailers operating in a highly competitive market”

“Management control used by retailers operating

in a highly competitive market”

Faculty: Faculty of Economics and Business

MSc: Business Administration

Specialization: Organizational & Management Control Supervisor: Prof. dr. ir. P.M.G. van Veen-Dirks

Supervisor 2: Dr. B. Crom

Supervisor Gall & Gall: Siger Spaans

Finance Manager Gall & Gall

Student name: Myrthe Hogendoorn

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ABBSSTTRRAACCTT

This master thesis is the result of a case study conducted at Gall & Gall B.V. This study is done in order to contribute to the existing literature about management control used within retailers. Due to the current market conditions, the margin risk for retailers is increasing. Purchase prices are rising, consumer confidence decreases and the liquor market becomes more competitive. After an extensive literature review, a conceptual model is designed in order to get more insights about the use of management control at retailers during the current economic crisis. This literature review has led to an investigation of three concepts of management control; responsibility accounting, management control systems and budgeting. After the literature review was finished, the three concepts mentioned above were studied during the case study at Gall & Gall. By conducting interviews, making observations and using documents, literature was linked to a real life context. Findings of this study indicate that the controllability principle - which is part of the concept of responsibility accounting - should not be applied when there is a margin risk for the company. Especially in these tough economic times, everyone involved in the organization, should be aware of the margin problem and this should absolutely not be ignored. Furthermore, an annual budget without any adjustments is no longer the only form of budgeting. More flexible forms of budgeting – like scenario or continuous budgeting - can be applied, in these turbulent times for the economy. Yet, to not lose ambition, the organization has to deal carefully with this more flexible forms of budgeting, to prevent that it is taking on the appearance of window-dressing. However, it is always a prudent idea to have a plan B up one’s sleeve, in case of an urgent situation. Moreover, management control systems - with the aim of evaluating the performance of the organization - should not only be financial oriented in economic hard times. Some performance measures, for example a bonus system, should stay financially oriented, to prevent discussion when one is applying non-financial metrics. For other performance measures, it seems more desirable to include non-financial measures as well.

KEYWORDS:

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PRREEFFAACCEE

After finishing my BSc. Business Economics, I decided to start the MSc. Business Administration – Organizational and Management Control. This master thesis is the last chapter of a great and interesting study time at the Rijksuniversiteit Groningen.

First of all, I would like to thank prof. dr. ir. P.M.G. van Veen-Dirks for being my supervisor. She gave me excellent guidance during this master thesis process, with interesting and very useful comments. Also, I experienced the conversations regarding the topic of this thesis as very interesting. Besides, I would like to thank dr. B. Crom for being my co-supervisor.

I was never able to write this master thesis without the knowledge I gained during my internship at the business control department at Gall & Gall B.V. Therefore, I am grateful that Gall & Gall gave me this opportunity to get in-depth knowledge about the company and the management problem described in this master thesis. I would like to thank Siger Spaans, who provided me with lots of interesting knowledge about the management problem. Also, I would like to thank the interviewees for their contributions to this master thesis.

Last but not least, my parents and my boyfriend brought me endless support during my study as a whole, where I would like to thank them for.

Hopefully, you will enjoy reading this master thesis.

T TAABBLLEE OOFF CCHHAAPPTTEERRSS A ABBSSTTRRAACCTT P PRREEFFAACCEE 1. ININTTRROODDUUCCTTIIOONN………....6

1.1. GALL & GALL………..6

1.2. MANAGEMENT PROBLEM…..……….7

1.3. RESEARCH OBJECTIVE..………...8

1.4. RESEARCH QUESTION AND SUBQUESTIONS…..…..………..8

1.5. RESEARCH METHODOLOGY.………..9 2. LILITTEERRAATTUURREE RREEVVIIEEWW……….….10 2.1. PRESSURE ON MARGINS………..…..10 2.1.1. Retailer margin………..…………..…10 2.1.2. Category management.………..………..…11 2.1.3. Consumer confidence………...12 2.2. MANAGEMENT CONTROL……….…13

2.2.1. Management control, strategy and competitiveness.………...…13

2.2.2. Responsibility accounting………...16

2.2.2.1. Responsibility centers……….16

2.2.2.2. The controllability principle………..17

2.2.3. Management control systems………..18

2.2.3.1. Typology of Ouchi……….19

2.2.3.2. Markets, bureaucracies and clans………19

2.2.3.3. Results, action, personnel and cultural controls………...20

2.2.3.4. The Balanced Scorecard Approach………...21

4.1. MANAGEMENT CONTROL……….…29

4.1.1. Responsibility accounting...……….29

4.1.2. Management control systems………..30

1

1.. ININTTRROODDUUCCTTIIOONN

ecause of the inflation of cost prices and more critical consumers, retail organizations are under pressure (Ahold, 2011; ING Economisch Bureau, 2011). Not only the cost price of raw materials are rising; costs of rent, electricity, gas and wages are increasing as well (CBS, 2011). Figure 1 shows the index numbers of consumer prices. Overall, consumer prices have increased, but as shown in Figure 1 the prices of alcoholic beverages and tobacco increased significantly more. Although consumer confidence recovers, wages cannot keep up with price increases. Because of that, it can be expected that consumer spending is just rising slightly. In addition, customers continue to opt for cheaper products. The combination of these facts create pressure on margins. Ahold is one of the retailers who has this problem. In Q1 of 2011, increasing inflation was not fully passed on to customers. This has led to pressure on margins (Ahold, 2011). Laurens Sloot, manager of the business school for retail sector EFMI, expects an increase in prices of vegetables, fruit, meat and sugar of 5% to 8%. Because of a more competitive market, not the entire increase in cost prices will fully be passed to consumers. Analysts expect that customer prices will increase 3% to 4% in the retail sector (Intoretail, 2011).

100 105 110 115 120 125 Total expenditures

Alcoholic beverages and tobacco

Figure 1 – Consumer prices (CBS)

1.1. GALL & GALL

This thesis will focus on Gall & Gall B.V., one of the operating companies of Ahold Europe. Gall & Gall is a wine and liquor retailer in the Netherlands. With a market share of 37%, Gall & Gall is the largest player in the liquor market.

Gall & Gall is founded in 1884 by Maria Gall. When she died in 1920, her two sons took over the shop and changed the name into Gall & Gall. In 1989, Gall & Gall became part of Ahold N.V. Ahold is an international retailing group, headquartered in Amsterdam, the Netherlands. The concern can be divided into two geographical areas, namely Ahold Europe and Ahold USA.

In the beginning of 2010, an organizational restructuring took place within Ahold Europe, with the goal of fulfilling potential growth in new and existing markets. This new organizational structure ensures that day-to-day operational tasks for the individual brands, e.g. Gall & Gall, are separated from company-wide support functions, such as Finance, Information Management, Real Estate, Sourcing, Human Resources Expertise & Services and Franchise Account Management, which are called the Centers of Excellence. Ahold’s brands can now focus fully on their core business.

A more extensive description of Gall & Gall is given in Section 3.

1.2. MANAGEMENT PROBLEM

Gall use? Are these MCS designed in a way that the organization can react properly to the margin problem?

This thesis will examine which MCS are used by retailers and how the use of these MCS can be optimized, in order to cope with the risk of an inflationary environment. Because of my internship at the business control department of Gall & Gall, it is possible to conduct a case study on this problem.

1.3. RESEARCH OBJECTIVE

The main objective of this research is to develop a conceptual model providing insights in the use of MCS at retailers in highly competitive markets. To what extent are risks of an inflationary environment taken into account in the MCS? For example, it is interesting to see if a specific budgetary system will be more effective in organizations with a competitive environment. Conducting qualitative research at Gall & Gall - which is part of Ahold N.V - will test the conceptual model. The results will give suggestions for retailers to improve their management control systems to deal with the margin risks.

1.4. RESEARCH QUESTION AND SUB-QUESTIONS

To succeed in the research objective as stated above, a research question is formulated:

“How can the design of management control systems for retailers be optimized in highly competitive markets?”

In Section 2, a comprehensive literature review provides the reader theoretical background in the concepts of MCS. Additionally, this section will explain the theory behind retailer margins and category management. The following sub-questions are composed:

 What is a retailer’s margin and what does a competitive market means for this margin?  Which MCS can be distinguished?

 What is the relationship between MCS, strategy and the degree of competitiveness in the market?

 What is responsibility accounting and how can the controllability principle be described? Is this principle of importance when applying MCS?

The first two paragraphs in Section 2 will provide the basis for the conceptual model, that will be presented in the last paragraph of Section 2. Section 3 will embrace the case study conducted at Gall & Gall. The results of this case study and their analysis are presented in Section 4. In Section 5, conclusions and recommendations are given. Finally, in Section 6, the limitations of the research will be described, as well as some suggestions for further research.

1.5. RESEARCH METHODOLOGY

The research objective presented in section 1.3 shows that this thesis attempts to find out which MCS are used by retailers and examines how the MCS in competitive markets can be optimized. This study goes beyond a description of a particular phenomenon and is instead looking for the ‘why’ and ‘how’ questions (Bloomberg, Cooper & Schindler, p.10, 2008). This thesis attempts to explain the reasons for particular choices of MCS, therefore this research can be considered as an explanatory research (Bloomerg, Cooper & Schindler, 2008).

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2.. LILITTEERRAATTUURREE RREEVVIIEEWW

ection 2.2 discusses management control, including management control systems, responsibility accounting and budgeting. Section 2.3 concludes with a conceptual model that is designed specifically for this research.

2.1. PRESSURE ON MARGINS

This paragraph provides background information to clarify the research question and therefore, it discusses elements related to an inflationary environment. This will include an explanation of a retailer margin and it will describe what the influence of consumer confidence on the margin can be.

2.1.1. Retailer margin

One of the characteristics of the consumer retail market is the intense rivalry among the competitors (Lal & Narasimhan, 1996). According to Ailawadi & Harlam (2004), there are several determinants of retail margins, which can be grouped into three sets.

First of all, there are variables that reflect manufacturer market power (Ailawadi & Harlam, p. 150, 2004). Chintagunta (2002) mentions three factors driving retail prices. Manufacturer actions is one of them, which consist of wholesale prices and side payments (i.e. payments that are not observed). When national brand manufacturers become larger, i.e. the herfindahl index will increase, their market power will also increase. Therefore, it can be expected that retailers are forced to take lower margins on these large brands. In addition, if the margin of large brands will go down because of a high herfindahl index, it is necessary that the private label decreases their margins as well, to keep a sufficient price differential with national brands.

means that the margin cannot be too high. As can be expected, the margins on luxury products are normally higher than the products of a discounter.

Degree of service

Price distance High Low

High 1 Luxury 2 Dangerous area where retailer sometimes ends up

Low 3 The most challenging

quadrant in which every retailer would

like to be

4

Discounter

Table 1 – price/service matrix

When a retailer offers a unique private label, it is meant to create customer loyalty. Because of this uniqueness, it is possible to keep the margin relatively high. But, as the number of competing retailers that offer a private label increases, the competition between the retailers will also increase. It is possible that the customer chooses for another retailer’s private label, which means that it is needed to lower the margin (Ailawadi & Harlam, 2004).

Third, and last, determinants which are of importance considering retailer margins are consumer and category characteristics. The margin of a particular category depends on several factors. One is the average amount of money spend on the product in that category. In addition, the frequency of how often a product is sold is important in order to determine a proper margin. It is also important to take into account the number of customers who buy a product in a particular category (Ailawadi & Harlam, p. 153, 2004). The choice for a specific category role can only be made after considering the market positioning and strategy (Grievink & van Groesen, p. 109, 2008). Then, it can be decided which category roles are the most successful in achieving the (financial) goals. In the next paragraph, category management and category roles are described more extensively.

2.1.2. Category management

2001). Instead of improving the performance of an individual brand, now the retailer can, together with the manufacturer, improve the performance of a whole product category. The category management process consists of several steps (Basuroy & Mantrala, 2001). In the appendix, figure B illustrates this process.

In the first phase, the retailer assigns products to various categories. These categories can be, for example, based on consumer usage. The following step, category role, is meant to provide the categories with a specific role. Examples of these roles can be; destination categories (customers come into the store specifically to purchase that category); routine categories (products that the customer purchases on regular basis but can also be found in other shops); convenience categories (these are products that are perceived as ‘useful’. This category strengthens the full-service position of the shop) and seasonal/occasional categories (these product are purchased infrequently, or with a seasonal cycle). Then, we turn to the category assessment. In this stage, historical data is gathered for developing insights for managing a category. In the next step, the category scorecard, category management will interface with management control. In this step, performance measures are established to evaluate for example target gross margins. The fifth step, category strategies, involves the marketing strategies for the various categories. These categories can have a traffic builder strategy, where the aim is to get customers to the shop. Another strategy can be profit-generating. Category tactics, one of the final steps, is to determine prices and promotions. Hereafter, a review takes place, which is the overarching step, and involves the monitoring of the category. It also includes the actions taken to ensure that the category management process delivers maximum value (Radhakrishnam, 2002; Basuroy & Mantrala, 2001).

When assigning the categories to different roles and thus managing the categories more precisely, it brings a major advantage for the organization. Looking from the perspective of the customer - instead of the perspective of the product - creates greater customer value.

2.1.3. Consumer confidence

that the expectations people have about income and non-stock market wealth growth feeds this consumer confidence (Ludvigson, p.30, 2004).

2.2. MANAGEMENT CONTROL

According to Merchant & van der Stede (2007), control systems can be divided into two main subjects; strategic control and management control. Strategic control is about the external environment, whereas management control involves the internal environment. This thesis shall focus on aspects of management control. Anthony (1965) defines management control as: “the process by which managers ensure that resources are obtained and used effectively and efficiently in the accomplishment of the organization’s objective”.

2.2.1. Management control, strategy and competitiveness

The definition of management control according to Anthony (1965) suggests that there exists a strong link between management control and the organization’s objective. In order to design the management control systems (MCS) in an appropriate way, it is necessary for a company to have a clear understanding of their objective. After defining the objective, the strategy is determined in order to meet this objective (Merchant & van der Stede, 2007).

to formalize beliefs, set boundaries on acceptable strategic behavior, identify and assess critical performance variables, and stimulate discussion about strategic uncertainties (Simons, p. 169, 1994).

This system has some shortcomings; if the external environment changes - for example new regulation or an increase of commodity prices - it says nothing about what kind of actions can be taken by a firm. Consequently, operating and capital budgets as defined in the third step of the system, cannot be changed after completing this phase.

Earlier research described several strategic variables. In 1978, Miles and Snow distinguished between different strategy types based on the changes in products and markets. Prospectors can be described as organizations that are always looking for new market opportunities; their focus is on marketing and product innovation. On the other hand, defenders are primarily focusing on production and engineering, with a minimal focus on new market opportunities. A third type, the analyzers, can be described as organizations that combine the best elements of both types. (Miles & Snow, 1978; Langfield-Smith, 1997). The reactors, described as a fourth and failing group, are inconsistent with their strategy, technology, structure and process. That is why Miles and Snow (1978) do not consider the reactors as a real strategic type. Miles and Snow (1978) believe that it is difficult for prospectors to implement an advanced planning system because they have to deal with changing market demands. Miles and Snow (1978) recommend implementing flexible control systems, with a focus on problem finding instead of problem solving. Contrary, defenders should employ more formal MCS, focusing on reducing uncertainty (Langfield-Smith, p. 213, 1997), but opportunities must not lose sight.

X

√

√

X

?

?

Another categorization concerns strategic positioning (Porter 1980, Porter 1985, Langfield-Smith, 1997). Competitive advantages can be achieved in three ways: cost leadership, focus or differentiation. While cost leadership aims to minimize the costs, a differentiation strategy pursues to produce products which are highly valued by customers (Langfield-Smith, 1997). An organization with a focus strategy facilitates a small group in the market, with special needs that are not provided by other firms in the industry (Langfield-Smith, 1997). Porter is convinced that a choice between the three options is important, in order to prevent a ‘stuck in the middle position’ (Langfield-Smith, 1997). In figure 3, the most logical combinations between the strategy types, positioning and missions are presented by a check mark. The questionable combinations show a question mark and the impossible combinations, according to Langfield-Smith, are designated by an X-mark (Langfield-Smith, p. 213, 1997).

Contrary to the dominant view of Porter, Hill (1988) suggests that there may exists a combination strategy of cost leadership and differentiation. Differentiation can be a way for a firm to create a low-cost position, in order to have a sustainable competitive advantage (Hill, p. 401, 1988; Langfield-Smith, 1997). According to Hill (1988), there are only some circumstances in which both strategies are compatible. Because there regularly is no exclusive low-cost position, a firm is forced to pursuit both a low-cost strategy and a differentiation strategy, to achieve sustainable competitive advantage. The simultaneous use of both strategies is most desirable when a firm has superior performance in a mature market (Hill, p. 411, 1988). If firms try to pursue different strategies simultaneously, there is a need for a more comprehensive performance measurement system. This system consists of efficiency, financial and customer-focused performance measures (Lillis & van Veen-Dirks, 2008). Performance measurement systems consisting of more measures than only financial measures will be discussed extensively in section 2.2.3.4.

X

X

?

√

X

X

Build Hold Harvest

Build Hold Harvest

Cost leadership Differentiation

Prospector Defender

2.2.2. Responsibility Accounting

In the use of management control, responsibility accounting is an important characteristic (Baiman & Noel, p. 486, 1985). The term is defined as “a reporting system that classifies accounting (and often other) information about an organization’s activities according to the managers who are responsible for them” (Merchant & van der Stede, p. 271, 2007).

2.2.2.1. Responsibility centers

Control is inevitably a hierarchical matter, but it is impossible for one manager to take all decisions. Therefore, organizations are split into responsibility centers (Scarlett, 2007). The manager of a specific responsibility center is assigned with a certain objective and is allowed some discretion in achieving this (Scarlett, 2007; Melumad et al., 1992). Financial responsibility centers are centers in which the assessment is based on financial terms (Selto, Antle & Demski, 1988; Merchant & van der Stede, p. 271, 2007). Cost centers are business units whose managers are held accountable for some elements of costs. There is a distinction between standard cost centers and discretionary cost centers. Standard cost centers can easily be linked to outputs. In discretionary cost centers, the relation between inputs and outputs is often unclear; this makes it harder to control these departments. Usually, these discretionary cost centers have a great focus on subjective measurement. For a firm, it is important to attract and retain customers. For that reason, a firm has revenue centers whose managers - mostly sales managers - are held accountable for generating revenue. Profit centers are responsible for the profit, but are not accountable for the investments made to produce them (Selto, Antle & Demski, 1988; Merchant & van der Stede, p. 271, 2007). Responsibility centers where the investments are taken into account as well, are called investment centers. A firm can use several measures to assess the managers of investment centers, which can be the return of capital employed (ROCE), the return on equity (ROE) and other measures. In table 2, the responsibilities where the managers are held accountable for are shown (Merchant & van der Stede, 2007).

Income statement

center Cost center Profit center Investment center Revenue X X X

Gross margin X X

Operating expenses X X X

EBIT X X

Income tax expenses X X

Interest expenses X X

Net income X X

Table 2 – responsibility centers

2.2.2.2. The controllability principle

An important aspect when designing a MCS, concerns the evaluation of the managers. The controllability principle states that the performance evaluation of a manager should be based only on elements that are under the manager’s control (Selto, Antle & Demski, 1988; Burkert, Fischer & Schäffer, 2011; Merchant & van der Stede, 2007). In times of crisis acting in highly competitive markets, there is a high chance of unexpected events. Managers can protect themselves for non-controllable events that can occur. For example, it is possible that the sales are disappointing, due to lower consumer confidence. A manager can anticipate on this possible bad result, by means of budgetary slack. When a manager does so, the revenues in the budgetary process are intentionally underestimated and/or costs are intentionally overestimated. Another possibility is the use of earnings management, which ensures that the company results appear to be better than the company actually performs. Such behavior of a manager can be avoided when applying the controllability principle, which ensures that the manager only is held accountable for the controllable events. The previous section discussed the responsibility centers, which are of importance when applying the controllability principle. As explained above, it seems desirable to implement the controllability principle, because it avoids disagreeable behavior, like earnings management or budgetary slack (Burkert, Fischer & Schäffer, p. 144, 2011).

are fully shielded from the uncontrollable factors, managers spend less attention to these events (Claes, p. 35, 2011). Therefore, in the evaluation of managers, the uncontrollable factors should be considered and this should not be ignored (Claes, p. 35, 2011). The question is whether the controllability principle should be fully applied or not. The conclusion given by Burkert et al. (2011) has to do with hierarchy. When it concerns a top manager, it is likely to not fully apply the controllability principle. Because applying the principle can result in the risk that uncontrollable factors are not taking into account by anyone even if they are of great importance. Therefore, top managers should feel responsible for the everything which can influence the performance of the organization; controllable or not. At the lower management level, the controllability principle should be applied, to prevent for role stress. It may happen that the (lower level) manager can get a feeling of incompetence if, non-controllable events occur and the evaluation is based only on the end result (Claes, p.37, 2011).

2.2.3. Management control systems

In order to succeed in what the business is working for, good management control is essential (Merchant & van der Stede, 2007). MCS are “the formal, information-based routines and procedures used by managers to maintain or alter patterns in organizational activities” (Simons, p. 185, 1994). Optimal control exists when the control losses – “the difference between the performance that is theoretically possible given the strategy selected and the performance that can be reasonably expected with the MCSs in place” (Merchant & van der Stede, 2007, p. 11) – are smaller than the costs of implementing more controls.

2.2.3.1. Typology of Ouchi

Ouchi (1977) assumes that if you want to control an organization, you have to monitor something. Ouchi creates a split between output and behavior controls. This distinction results from the knowledge about the transformation process and the availability of measuring outputs. When evaluators can perfectly track the transformation process, but it seems difficult to measure output, it is likely that one chooses behavior controls. If the transformation process is unknown by the evaluators, but it is possible to measure the output, output measurement is a more appropriate way to control the organization. In table 3, clan control is shown as a control when neither the ability to measure output, nor the knowledge about the transformation process is known. Clan control relies on values, beliefs, corporate culture and shared norms to regulate employee behaviors. An organization that uses clan control requires trust among their employees. Given minimal direction and standards, employees are assumed to perform well. Behavior or clan controls are examples of ‘soft controls’ (Turner & Makhija, 2006). When applying soft controls, the intention is to influence the motivation or to increase the loyalty from your personnel (Turner & Makhija, 2006).

Knowledge of the transformation process

Ability to measure outputs

High 1 Behavior or output

measurement 2 Output measurement Low 3 Behavior measurement 4 “Clan” control

Table 3 – typology of Ouchi

2.2.3.2. Markets, bureaucracies and clans

use of formal controls, like hierarchy of authority, rules, policies and reward systems. Legitimate authority is also required when applying bureaucratic controls. It means authority which is recognized as legitimate by both parties. Clan controls, as earlier described, are used when an organization has shared norms, values and beliefs. Therefore, traditions are informational requirements to be able to apply clan controls. In table 4, the distinction between the different types of controls (market, bureaucracy and clan controls) is listed.

Table 4 – Social and informational prerequisites of control

2.2.3.3. Results, action, personnel and cultural controls

Merchant & van der Stede (2007) distinguish between four types of controls. With result controls, an organization rewards employees for generating good results (Merchant & van der Stede, 2007). This concept is similar to output control, thus in accordance with the definition of Ouchi and other literature. According to Jaworski (1993), output control occurs as a result of performance standards that are set, monitored and evaluated (Jaworski, 1993; Cravens et al., 2002). The rewards that are linked to the results can be monetary rewards, but do not have to be. Other forms of rewards are promotions, recognition and autonomy (Merchant & van der Stede, p. 25, 2007). The organization is not telling how the employees must act, but instead, they have to decide by themselves what actions they must take in order to achieve a particular result. For a company operating in times of crisis, it is difficult to apply this result controls. When implementing these controls, employees can be punished for something they do not deserve.

Action controls can be implemented as supplement for, or replacing, result controls. In contrast, action controls are controls which ensure that employees act in a prescribed manner (Jaworski 1993; Merchant & van der Stede, 2007). A related concept is “process control”. This concept is used when managers will have an influence on the activities considered as important (Jaworski, 1993). Action controls can be split into several categories. Behavioral constraints make it

Type of control Social Informational requirements requirements

Market

Bureaucracy

Clan

impossible for an employee to do things that are prohibited. Preaction reviews can be set in order to review proposed action. Action accountability means that an organization can hold employees accountable for the actions they take (Merchant & van der Stede, p. 76, 2007).

“Personnel controls build on employees’ natural tendencies to control and/or motivate themselves” (Merchant & van der Stede, p. 83, 2007). Several methods to implement personnel control is through job design, training and selection and placement of employees. Personnel controls are implemented to achieve several purposes, like the clarification of the expectations of a particular job. Another purpose can be to obtain certainty that an employee has the right abilities to succeed in his/her job. A way to achieve this is to offer training sessions.

Cultural controls are established to align the group norms and values. In order to succeed in this, organizations can offer the possibility for employees to rotate jobs. This helps to improve the socialization of employees throughout the organization (Merchant & van der Stede, 2007).

2.2.3.4. The Balanced Scorecard Approach

Other studies also indicate that one must not rely only on financial performance measures. Baker et al. (1994) assume that objective performance measures are inadequate and they suggest that compensation plans based only on objective financial performance measures create “distorted incentives” (Baker et al., p. 1127, 1994). Matejka et al. (2009) studied how employment horizon matters affect the choice of performance measures in incentive contracts and conclude that the emphasis on non-financial performance measures is greater in loss making than in profit making firms (Matejka et al., p. 903, 2009). In contrast, several other studies suggest the opposite. Moers (p. 67, 2005) examined the impact of performance measure diversity and the use of subjective performance measures on performance evaluation bias. Performance measure diversity is described as the “use of multiple performance measures for incentive purposes” (Moers, p. 68, 2005). The use of the Balanced Scorecard is characterized by multiple performance measures and a more frequent use of subjectivity. Moers (2005) states that increasing the number of performance measures and using subjectivity in the evaluation of performance can lead to evaluations that make it more complicated to differentiate among employees. Therefore, it is doubtful whether a Balanced Scorecard - that includes a large number of performance measures - is effective as a performance measurement if a manager has discretion in weighting these measures (Moers, p.79, 2005).

2.2.4. Budgeting

Budgeting can be a form of action control, with the purpose of planning. One goal of a budget is to think ahead and plan future actions (Merchant & van der Stede, p. 330, 2007). When consumer demand decreases, it is risky to think and plan forward, because there is a time span between preparing the budget and actually executing the plans. Another purpose of budgeting is to motivate the employees and the manager(s). In order to succeed in the performance evaluation, one has to achieve the goals, which are translated into targets. When unexpected events occur, for example decreasing consumer confidence, it is not fair to only judge the employees on the basis of these targets. Therefore, it seems reasonable to take also other forms of controls into account when evaluating employees, as explained in the previous section.

High competition

Pressure on margin

EBIT risk

• On top level management: no strict controllability principle

Responsibility accounting

• Application of a combination of controls, for example BSC • Use of non financial controls in

times of crisis Management Control Systems • Continuous budgeting • Scenario budgeting Budgeting

matters when confronted by unexpected events” (Frow et al., p. 444, 2010). With continuous budgeting, the performance of a firm is continuously monitored. If the firm recognizes any risks, the firm may deviate from the norm or plans. Through the use of continuous budgeting, it is now possible for a company to revise the plans and eventual reallocate some resources in order to meet the strategic objective.

Another form of budgeting that can be used during higher competition periods is scenario budgeting. The main difference between continuous budgeting and scenario budgeting is the moment when examining potential risks (Kruik, p. 12, 2011). Using scenario budgeting, a manager estimates potential risks before the deviation of the plan. Doing so, the manager imagines several scenarios. A major advantage of this principle is that it stimulates the motivation of the employees and the management team, when the variable compensation is also linked to the new, feasible plans.

2.3. CONCEPTUAL MODEL

EBIT (Earnings Before Interest and Taxes) and gross margin are terms related to a company’s revenue. The revenues minus the operating expenses is called operating income. When you add up the non-operating income, it will result in the EBIT. Logically, when the gross margin goes down, the EBIT decreases. As we have seen in previous sections, by means of control systems, this margin risk should be mitigated. Which MCS fits best in an organization that operates in a highly competitive market in times of inflation, where the margin risk is high? In figure 4, the conceptual model is illustrated.

Figure 4 – Conceptual model: impact of a highly competitive market on the retailers’ MCS

More competitive players in the market and more price-conscious consumers, cause a highly competitive market. This highly competitive market creates a risk to the margin of a company, with the result that the company may have a lower EBIT. On the left side of figure 4, this inference is figuratively presented. What is the influence of a highly competitive market for the MCS, when you are operating as a retailer? Three aspects have to be taken into account when designing a retailer’s MCS.

Firstly, when competition is high, the controllability principle should not be applied strictly to top-level managers, in order to not totally ignore the risks. Lower level managers benefit from the use of the controllability principle. The use of this principle can prevent role stress, as explained in section 2.2.2.2. Secondly, the way of budgeting depends largely on the degree of competitiveness in the market. As we have seen in section 2.2.4, continuous budgeting and scenario budgeting can contribute to a better management of a company. Thirdly, MCS should not rely on result controls only. In times of crisis, it is important to have a good mix of several controls, because of the risks of unexpected events. In these economic crisis times, it is vital that one can rely on their personnel. Therefore, it is also extremely important to take personnel and culture controls into account. In addition, from the perspective of the informativeness principle -especially in times of crisis - the use of the Balanced Scorecard is recommended. Doing so, as described in section 2.2.3.4, not only financial targets are taken into account, also the perspectives of the customer, internal business processes and learning & growth are considered. Furthermore relative performance measurements become increasingly important, next to absolute performance measurements.

3

3.. THTHEE CCAASSEE SSTTUUDDYY

s mentioned in the introduction, this thesis shall focus on one single case; the wine and liquor retailer Gall & Gall. This section describes the structure and strategy of the company and it focuses on the way the organization deals with risks. What about the responsibility centers and the application of the controllability principle? Is there a budgetary system? If so, is the way of budgeting the correct way to do it when the environment is volatile as it is now? What kinds of MCS are applied?

General Manager Commercial Manager Operations Manager Supply Chain Manager Finance Manager HR Manager 3.1. STRUCTURE

For Gall & Gall, the first step to be made is the decision of what kind of brand is pursued. When the brand forming process is done and perspicuous, the format division investigates which price is desired in the wine and liquor market. In addition, they will make choices about the overall appearance of the stores. This division is responsible for the realization and maintaining of the format policy. It is the merchandising division that ultimately establishes the purchasing and selling prices. This department negotiates with importers and other suppliers. The Commercial Manager of Gall & Gall is responsible for the three above mentioned divisions. Besides the commercial side that has just been discussed, it is important that the products reach the store. Replenishment ensures that this process runs smoothly. Responsible for this is the Supply Chain Manager. At last, fulfillment is the final part of the process, in which the responsible manager has to ensure that everything in stores is as it should be. The manager of this functional area is the Operations Manager. Gall & Gall’s Centers of Excellence are intended to support the core business and serve as a source of value creation. The three above-mentioned managers together with the Finance Manager, the Human Resource Manager and the General Manager form the Management Team of Gall & Gall (figure 5). Figure 6 illustrates the structure of Gall & Gall.

Figure 5 – structure Management Team Gall & Gall

3.2. STRATEGY

According to figure 7, it is clear that recently only one competitor was more expensive than Gall & Gall. In contrast, several competitors are operating under the price level of Gall & Gall. This, together with decreasing consumer confidence – as explained in Section 1 – has led to a strategy, focusing on being an “accessible” store, while offering “special” products and services. These

two components seem to be incompatible, but Gall & Gall will pursue to excel in both strategic pillars. Being “accessible” can almost be translated to a cost leadership positioning. Offering “special” products and services is a more differentiation positioning. (Porter, 1980; 1985). Literature seems to be divided in relation to strategy positioning. Porter (1980, 1985) is convinced that these two strategic pillars are not reconcilable, while Hill (1988) suggests that a combination strategy between both cost leadership and differentiation is possible. However, as mentioned in Section 2.2.1, there are few circumstances in which the combination strategy is compatible. In line with Hill (1988), because Gall & Gall is a firm with superior performance in a mature market, it is possible to pursuit both strategies simultaneously.

In order to meet the goal to be accessible, four projects are introduced last year which should result in a lower price level, including a lower price perception which is even more important for Gall & Gall. In the beginning of 2011, the first campaign was introduced to communicate the strategy to the customers. The campaign is called ‘always 100 wines below five Euros, which still is a big success. A few weeks later, the second campaign was added, which is called ‘the best bargain of the Netherlands’. This statement guarantees the customer to have the best deal with the lowest price. ‘Sterk blijvend in prijs verlaagd’ is the third project, which has a double meaning. It

states that the liquor prices are strongly reduced; the joke is that the Dutch word for strong is the same as liquor. Last but not least, Gall & Gall have introduced her own store brand. Since October 2011, Gall & Gall offer 41 new products, all store brands. With this newcomer, Gall & Gall is the first retailer in the wine and liquor market with a store brand. With all these initiatives, Gall & Gall emphasizes the accessibility of the stores and hopes to create a lower price perception.

After implementing the new strategy, Gall & Gall already managed to reduce the prices below the level of the independent entrepreneurs in the liquor market (see figure 6). Offering more special products, for example a broadening in the offer of gifts, pursues the more differentiation strategy, the other strategic pillar of Gall & Gall.

3.3. PRESSURE ON MARGINS

Within Gall & Gall, each period consists of four weeks, like in all other operating companies of Ahold N.V. Each period is followed by a meeting where the result is discussed using the profit and loss statement (P&L). This meeting is held with the four business controllers from Gall & Gall, the finance manager of Gall & Gall, two employees from financial reporting Ahold and two accountants of Accounting Plaza. Accounting Plaza provides the financial administration for all Ahold operating companies in the Netherlands. Next to presenting and discussing the P&L, it is compared with forecast and budget numbers. Last few periods, it appears that the gross margins are disappointing.

What does this means for Gall & Gall? Are the MCS that are in use designed to properly handle the pressure on margins? In the following section, an overview is given of the MCS of Gall & Gall.

3.4. DATA COLLECTION

During my internship, I gained access to a variety of information sources. Several semi-structured interviews were conducted to provide valid and reliable information, which will be used in the analysis of the conceptual model. Topics investigated and covered during the interviews include: the severity of the margin risk within Gall & Gall, the design of management control systems, responsibility accounting (including the application of the controllability principle) and the way of budgeting. In order to get full understanding of the problem and to get different points of view, I interviewed three people each with a different role in the organization. The interviewees were; the finance manager, the buying and merchandise manager and the business controller commerce. An interview guide is used in order to be sure that the same issues are covered in each interview. This interview guide can be found in the Appendix.

As a supplement on the interviews, observations serve as a source of information. As intern at the business control department of Gall & Gall, I fully participated in the team. My team included four business controllers and a finance manager. Hence, next to participating I was observing, which can be called participant observation (Bloomberg, Cooper & Schindler, p. 351, 2005). I attended department meetings, with my team, people from financial reporting and people from management reporting. In addition, I was fully involved with each period closing and attended all of the corresponding meetings. Also, I attended ad hoc meetings with several other colleagues, for example with the department of Franchise Account Management, the Format department, category managers and marketers of Gall & Gall.

4. RESULTS AND ANALYSIS

4.1 MANAGEMENT CONTROL

hold takes a structured and consistent approach to risk management and internal control by aligning strategy, policies, procedures, people, and technology to manage the uncertainties that the company faces” (Ahold Annual Report 2010, p.32, 2011). This is a phrase out of the Ahold Annual Report 2010. In this section, the conceptual model presented in section 2.3 is linked to the case study at Gall & Gall. It will be interesting to examine to what extent this control framework is implemented in the organization of Gall & Gall. In addition, the MCS of Gall & Gall, including the budgetary process, are scrutinized. Who is involved in the budgetary process? Is it a traditional budgetary process? What is the consequence when the external environment changes, as explained in previous sections? Who is responsible for which outputs? Is the controllability principle applied? In the following sections, these questions will be answered and analyzed regarding the conceptual framework.

4.1.1. Responsibility Accounting

In section 3.1, the structure of Gall & Gall is explained. Each manager in the Management Team of Gall & Gall has its own responsibilities, which leads to various responsibility centers in the company. The commercial manager leads three people; the marketing manager, the format manager and the buying and merchandise manager. These four people, including the commercial manager, are responsible for revenues - the turnover - of Gall & Gall, which makes the departments ‘revenue centers’. The task of the merchandise and buying manager is to manage the margin. In the previous section, we have seen that the margin is under pressure. The controllability principle states that the manager is just held accountable for controllable events. In my opinion, risk on the margin partially is uncontrollable due to changes in the market. These changes are beyond the reach of the Management Team, and thus, the risk on the margin can be seen an uncontrollable event. However, according to the buying and merchandise manager, it is not wise to fully apply the controllability principle, even if the merchandise team has to deal with pressure on margins. When the controllability principle is fully applied, motivation will be lost. The finance manager and the business controller commerce support this view. The finance manager adds to this that it will be extremely difficult to draw a borderline, between functions which require the controllability principle or not . In the view of the finance manager, everyone

should be aware of the problem, not only the manager on top level. The business controller commerce supports this view and adds that employees at a lower level can see this margin problem as a challenge. They can ask themselves: ‘what can I do to achieve this goal?’. Of course, for a manager, it is important to manage the different people in the team in the right way to achieve the desired results.

4.1.2. Management control systems

Several MCS are used within Gall & Gall to evaluate the performance of the organization. Financial measures are used in the bonus system. Five criteria are used to determine the height of the bonus, which are; sales growth, identical sales growth (the sales growth in the same store as last year), EBIT, cost efficiency and working capital. During the interviews, it appeared that the current bonus system is adequate for Gall & Gall and it is not wise to involve other considerations, like non-financial measures. One can think of customer satisfaction, but the danger of taking these kinds of measures into account, is that it creates discussion whether one has reached the goal or not. With the current financial measures, there is no room for discussions. Because of the margin risk, which can lead to a lower EBIT, it is advisable to take relative performance measures into account, in addition to the absolute performance measures like the sales growth, EBIT and cost efficiency. An ideal way to do so is to use market share numbers as a performance measure. Gall & Gall is operating in a declining market, but Gall & Gall itself has a growing market share. This is a good indicator to deduce that Gall & Gall is performing very well in a declining market. In this way, the category managers, the buying and merchandise manager, and the management team of Gall & Gall can be assessed in a more reasonable manner, given the difficult market conditions. A difficulty is that the market share numbers are distributed well after the current period, which causes a delay in the performance measure. In the future, it will be possible to obtain this data earlier, due to technical developments.

4.1.3. Budgeting

changing circumstances. In between, it is not possible to change the budget. Every day, financial employees of the Gall & Gall headquarters receive an e-mail with a daily sales overview; this overview is presented in Appendix I. In this overview, the sales are compared with budget numbers and the latest forecast input. Also, the amount of transactions, sales per transaction and the number of liters sold is presented. This kind of result control is meant for motivating people and to monitor the performance of the firm.

The overall result of Gall & Gall largely depends on December sales, with the huge peak during Christmas and New Year’s Eve. Each week during December, the finance manager together with business control discusses the latest estimate for the total result of that year. That means the actual results of period 12 year-to-date plus the latest estimate of the final period, period 13. Thus, through the year, Gall & Gall operates with only four moments on which the budget can be modified. The business controller commerce and the finance manager support this way of budgeting. They indicate that there already exist four forecast moments, to adapt the budget. In addition, it is of great importance to have a plan B up one’s sleeve. However, to not lose the ambition, scenario budgeting or continuous budgeting should not be implemented in such an extreme form as explained in section 2.2.4. The buying and merchandise manager agrees with this point of view. Nonetheless, the way of budgeting as it is now, includes too many changes made in the original budget. He sees the current method of budgeting with the four forecast moments as window-dressing. If the actual results of previous periods were good, you cannot see the good performance in return through the adjustment in the budget. Vice versa, when the performance were bad in previous periods, you cannot see it back in the latest forecast, which could lead to unawareness of the merchandise team. According to the interviewees, for Gall & Gall, a traditional budget without any adjustments is not prudent. However, extreme forms of flexible budgets, like scenario budgeting and continuous budgeting, are not advisable according to the interviewees.

5

5.. COCONNCCLLUUSSIIOONNSS AANNDD RREECCOOMMMMEENNDDAATTIIOONNSS

indings of this study indicate that the controllability principle - which is part of the concept of responsibility accounting - should not be applied when there is a margin risk for the company. Especially in these tough economic times, everyone involved in the organization, should be aware of the margin problem and this should absolutely not be ignored. It is part of the manager’s work to cope with the changing environment, but the management team cannot do this without the dedication of the other employees. Therefore, also the lower level employees should be aware of the problem and should do their best to perform as good as possible as organization.

Management control systems, with the aim of evaluating the performance of the organization, should not only be financial oriented in economic crisis times. Some performance measures, for example a bonus system, should stay financially oriented, to prevent discussion when applying non-financial metrics. For other performance measures – for making decisions regarding promotions for example – it seems more desirable to include non-financial measures as well. An alternative for absolute performance measures, is the use of relative performance measures. Especially in economic hard times, for example market share information can give management an adequate picture of how the organization performs.

Furthermore, an annual budget without any adjustments is no longer the only form of budgeting. More flexible forms of budgeting – like scenario or continuous budgeting - can be applied, in these turbulent times for the economy. Yet, to not lose ambition, the organization has to deal carefully with this more flexible forms of budgeting, to prevent that it is taking on the appearance of window-dressing. However, it is always a prudent idea to have a plan B up one’s sleeve, in case of an urgent situation. During next year, retailers are definitely facing challenges due to lower consumer confidence and higher prices. It can be a solution to think of a form of continuous budget or scenario, to prevent the organization for unexpected risks. However, it must be ensured that the motivation will not be lost.

6. LIMITATIONS AND SUGGESTIONS FOR FURTHER RESEARCH

n this study, the examination of management control used by retailers is limited to only three general concepts; responsibility accounting, management control systems and budgeting. A suggestion for further research can be to pick out one of these concepts and study this concept more thoroughly than is done in this study. Also, there may be other concepts which are of

F

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APPENDIX I – MANAGEMENT REPORTS

Figure A – Daily Sales report Gall & Gall

Appendix III – Interview guide

List of interviewees:

1. Buying and merchandise manager (Tuesday January 17th, 2012: 11.00 – 12.00) 2. Finance manager (Tuesday January 17th, 2012: 14.30 – 15.30)

3. Business controller commerce (Friday January 20th, 2012: 11.00 – 12.00) Interview guide:

Introductie scriptie onderwerp

We zien dat de afgelopen maanden het risico op een verlaagde marge enorm is toegenomen. De prijzen gaan omhoog en de consument wil goedkope producten. Hoe merkt Gall & Gall hier iets van?(Groei webshops? Doorbelasting hogere inkoopprijzen?)

Strategie

Gall & Gall heeft in feite een joint strategy.”Toegankelijk” en “speciaa”l willen zijn toch totaal verschillende strategische visies. Hoe kijk jij hier tegen aan? Brengt deze

combinatie strategie moeilijkheden met zich mee voor jouw functie en voor de druk op de marge?

Management Control Systemen

Tijdens mijn literatuuronderzoek heb ik onderzoek gedaan naar het gebruik van management control systemen in economisch slechte tijden. Met management control systemen worden systemen bedoeld die informatie gebruiken om de performance van een organisatie te evalueren. Een voorbeeld hiervan is het bonus systeem, hierbij zijn binnen Gall & Gall 5 financiële performance maatstaven bepalend voor de hoogte van de bonus. In de literatuur wordt in economisch slechte tijden ook het gebruik van niet-financiële maatstaven geadviseerd (hierbij kun je denken aan klanttevredenheid en kwaliteit). Wat is jouw visie hierop?

(5 maatstaven: sales growth, sales growth ID, EBIT, cost efficiency, working capital).

Budgeting