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Incentive research findings:
- - Reward works better than punishment
- - Personal rewards are relative or situations
- - Managers will mirror senior management’s attitude toward the performance management system
- - People are motivated by feedback
- - Incentives lose effectiveness as the time span between action and feedback increases
- - Motivation is weakest when incentive is perceived as unattainable or too easily attainable
- - Incentive is strongest when managers work with superiors to arrive at goals.
Manager’s Compensation Components:
- - Salary
- - Benefits
- - Incentive compensation
Pay and bonus study:
- - Bonuses 20% of base pay on average
- - Organizations with higher ratios of bonuses tend to have better subsequent financial performance
Ways to create a bonus pool:
- - Bonus equal t a set percentage of profits
- - Bonus is percentage of EPS after a predetermined level of EPS is attained
- - Define capital as shareholder equity and long-term liabilities and bonus equal to a percentage of profits before taxes and interest on long-term debt, minus a capital charge on the total of shareholder equity plus long-term debt
- - Define capital as equal to shareholder equity
- - Base bonus on increase in profitability over the preceding year/moving average
- - Base bonus on their profitability relative to that of their industry
Advantages of bonus pool carryover:
- - More flexible; payment not determined by a formula and BOD can use judgment
- - It can reduce the magnitude of swings
Disadvantage of bonus pool carryover:
- Bonuses relate less directly to current performance
Advantages of deferred payment plan:
- - Managers can estimate, with reasonable accuracy, their cash income for the coming year
- - Deferred payments smooth he manger’s receipt of cash
- - A manager who retires will continue to receive payments for a number of years
- - The deferred time frame encourages decision makers to think long term.
Disadvantage of deferred payment plan:
- Deferred amount not available to the executive in the year earned
Long-term incentive plan popularity affected by:
- - Changes in income tax law
- - Changes in accounting treatment
- - State of the stock market
right to buy a number of shares of stock at, or after, a given date in the future (exercise date) at a price agreed upon at the time the option is granted. (direct managers energies toward long-term)
Stock option advantages:
- - Stock options and their upside potential tend to attract highly talented employees
- - Employees will volunteer innovative ideas only if they can profit from them
- - Companies can pay employees lower salaries and bonuses because of stock option program
- - The value of the stock options does not reduce the bottom line
- - Stock options are intended to encourage employees to focus on the long term
Phantom stock plan
awards managers a number of shares for bookkeeping purposes only and at the end of a specified period, the executive is entitled to receive an award equal to the appreciation in the market value of the stock since the date of the award.
Stock appreciation rights
right to receive cash payments based on the increase in the stock’s value from the time of the award until a specified future date.
Performance Share Plan
awards a specified number of shares of stock to a manager when specific long-term goals have been met.
Performance Share Plan Characteristics:
- - Based on performance the executive can control
- - Award doesn’t depend on an increase in stock price
- - Disadvantage is bonus based on accounting measures of performance
Performance Units Plan
a cash bonus is paid when specific long-term targets are attained
Proposals to ensure BOD is not at CEO’s mercy:
- - Prevent directs from selling their stock for the duration of their term to encourage them to ask the tough questions of CEOs without fear of adversely impacting short-term stock prices.
- - Set mandatory limits on the tenure of directors to avoid their becoming too entrenched with management
- - Hold an annual performance review of directors
- - Avoid having the CEO of the corporation act as the chairman of the board
Arguments for expensing stock options:
- - About 75% of CEO and top management compensation represent stock options
- - Treating stock options as an expense would result in a more accurate earnings picture, restoring investor confidence
- - Under current accounting rules, companies feel that stock options are free, and hence they overreward CEOs with options. But options dilute shares and have real costs.
- - Treating options as an expense would prevent top management from playing accounting games to pump-up short-run stock prices in order to cash their options
- - There are double standards at present because companies are allowed to expense the difference between issue price and exercise price, of options for income tax purposes but a similar requirement does not exist for financial reporting.
Arguments against expensing stock options:
- - Unlike salary, stock options do not involve outlay of cash, so expensing them would unduly penalize earnings
- - Valuing stock options involves assumptions and estimates which could be subject to manipulation
- - Treating options as an expense will dampen earnings and reduce stock price
- - Cash-strapped startups use options to attract human talent
- - Stock options are disclosed in footnotes to the balance sheet
Financial incentives for BU mangers:
- - Salary increases
- - Bonuses
- - Benefits
- - Perqs
Psychological and Social Incentives for BU managers:
- - Promotion possibilities
- - Increased responsibilities
- - More autonomy
- - Better geographical location
- - Recognition
Fixed and Variable Reward Mix
recruit good people, pay them well, and then expect good performance
Fixed and Variable Reward Mix
recruit good people, expect them to perform well, and pay them well if performance is actually good
the level of performance at which a maximum bonus is achieved
the level below which no bonus awards will be made
Profit center financial criteria:
- - Contribution margin
- - Direct business unit profit
- - Controllable business unit profit
- - Income before taxes
- - Net income
Investment center performance decisions
- - Definition of profit
- - Definition of investment
- - Choice between ROI and EVA
Adjustments for Uncontrollable Factors
- - Expenses that result from decisions made by executives above the BU level
- - Effects of losses caused by “acts of nature” and accidents not caused by the manager’s negligence
Advantages of Short-term Financial Targets
- Induces managers to search for different ways to perform existing operations and initiate new activities to meet the financial targets.
Shortcomings of short term financial targets
- - Could encourage short-term actions that are not in the company’s long-term interests
- - Managers might not undertake promising long-term investments that hurt short-term financial results
- - Managers may be motivated to manipulate data to meet current period targets
Weaknesses of supplementing financial criteria with additional incentive mechanisms
- - Managers have difficulty seeing the connection between their efforts and rewards in a multi-year scheme
- - If a manager retire or is transferred during the multi-year period, implementing such a plan becomes more complex
- - It is more likely that factors beyond the manager’s control will influence the achievement of long-term targets
Scorecard non-financial criteria
- - Sales growth
- - Market share
- - Customer satisfaction
- - Product quality
- - New product development
- - Public responsibility
Advantages of relying on objective formulas:
- - Reward systems can be specified with precision
- - There is little uncertainty or ambiguity about performance standards
- - Superiors can’t exercise favoritism in assessing the performance of subordinate managers.
Disadvantages of relying on objective formulas:
- Likely to induce managers to pay less attention to the performance of their BU along dimensions that are important but difficult to quantify
Numerical indicators of the unit’s performance are less valid measures when
- - BU manager inherits problems created by a predecessor
- - When the BU is highly interdependent with other units and, therefore, its performance is influenced by the decisions and actions of outside individuals
- - When the strategy requires much greater attention to longer-term conditions
how contracts and incentives can be written to motivate individuals to achieve goal congruence
Agency theory assumes
- - all individuals act in their own self-interest
- - managers prefer more wealth to less, but that marginal utility, or satisfaction, decreases as more wealth is accumulated
an agent’s preference for leisure over effort
deliberately withholding effort
Risk-adverse agents value increases from a risky investment
at less than the expected value of the investment.
Divergent preferences associated with compensation and perquisites arise
whenever the principal can’t easily monitor the agent’s actions.
because the principal has inadequate information about the agent’s performance, the principal can never be certain how the agent’s efforts contributed to actual company results.
the agent knows more about the task than the principal
misrepresentations of a general nature from an agent to a principal
Two ways of dealing with divergent objectives
- - Monitoring
- - Incentives
No arrangement ensures complete goal congruence because of
- - Risk preference differences
- - Asymmetry of information
- - Costs of monitoring
even an efficient system of incentive alignments will still result in some divergence of preferences
incentive compensation costs, the monitoring costs, and the residual loss
Limitations of agency theory:
- - No discernable practical influence
- - It implies managers in nonprofit and government organizations inherently lack the motivation necessary for goal congruence
- - Models are no more than statements of obvious facts expressed in mathematical symbols
- - The elements in the models can’t be quantified
- - The model vastly oversimplifies the real-world relationship between superiors and subordinates
- - The models contains only a few elements and disregards
- o Personalities of participants
- o Agents who are not risk adverse
- o Nonfinancial motives
- o Principal’s trust in the agent
- o Agent’s ability on the present assignment and for future assignments
structure and process depend upon various external and internal factors, such as size, environment, technology interdependence, and strategies
Linking controls to strategy logic:
- - Different organizations generally operate in different strategic contexts
- - Different strategies require different task priorities, key success factors, skills, perspectives, and behaviors for effective execution
- - Control systems are measurement systems that influence the behavior of people whose activities are being measured
- - Thus, a continuing concern in the design of control systems should be weather the behavior induced by the system is consistent with the strategy
Corporate strategy is a continuum:
- - with “single industry” strategy at one end and
- - “unrelated diversification” at the other end.
In Single industry/functionally organized – senior managers are responsible for
- - developing the company’s overall strategy to compete in its chosen industry
- - functional strategies in such areas as R&D, manufacturing, and marketing.
On unrelated diversification end, managers more autonomous because
- - Unlike in a SI industry firm, senior managers of UD firms may not have the knowledge and expertise to make strategic and operating decisions for a group of disparate Bus.
- - There is very little interdependence across Bus in a conglomerate
The size of a conglomerate’s coproate staff compared with that of a same-sized SI firm tends to be
Promoting from within or by laterally transferring executives from one BU to another is less likely to benefit a
- conglomerate, given the unrelated nature of its varied BUs
A conglomerate may not have the single cohesive, strong corporate culture that a SI firm often has
A conglomerate may not have the single cohesive, strong corporate culture that a SI firm often has
Different corporate strategies imply the following differences in the context in which control systems need to be designed:
- - As firms become more diversified, corporate level managers may not have significant knowledge of or experience in the activities of the company’s various Bus
- - SI and RD firms possess corporatewide core compentencies on which the strategies of most of the BUs are based.
Given the low level of interdependence conglomerates tend to use
- vertical strategic planning systems
Because of the high level of interdependencies, strategic planning systems for RD and SI firms tend to be
- both vertical and horizontal.
Horizontal dimensions incorporated into the strategic planning process by:
- - A group executive might be given the responsibility to develop a strategic plan for the group as a whole that explicitly indentifies synergies across individual BUs within the group.
- - Strategic plans of individual BUs could have an interdependence section, in which the general manager of the BU identifies the focal linkages with other BUs and how these linkages will be exploited
- - The corporate office could require joint strategic plans of individual BUs could be circulated to managers of similar BUs to critique and review.
Budgeting Systems Characteristics in Conglomerates:
- - BU managers have somewhat greater influence in developing their budgets since they, not the corporate office, possess most of the info. About their respective product/market environments.
- - Greater emphasis is often placed on meeting the budget since the chief executive has no other informal controls available
The usual transfer pricing policy in a conglomerate is to
- - give sourcing flexibility to BUs
- - use arms length market prices.
Incentive Compensation Policy Differences
- - Use of formulas
- - Profitability measures
Strategy of BU depends on
- - Its mission
- - Its competitive advantage
- - Build
- - Hold
- - Harvest
- - Divest
Two ways to compete:
- - Low cost
- - Differentiation
Control-mission “fit” developed based on
- - The mission of the BU influences the uncertainties that general managers face and the short-term trade-offs they make
- - Management control systems can be systematically varied to help motivate the manager to cope effectively with uncertainty and make appropriate short-term versus long-term trade offs.
- - Different missions often require systematically different management control systems.
“Build” units tend to face greater environmental uncertainties than “harvest” units
“Build” units tend to face greater environmental uncertainties than “harvest” units
"Build" units tend to face greater environmental uncertainties than "harvest" units
- - Build strategies typically are undertaken in the growth stage of the product life cycles, whereas harvest strategies typically are undertaken in the mature/decline stage of the product life cycle
- - An objective of a build BU is to increase market share
- - On both the input side and the output side, build manaers tend to experience greater dependencies on external individuals and organizations than do harvest managers.
- - Build BU are often in new and evolving industries; thus, build managers are likely to have less experience in their industries.
The share-building strategy includes:
- - Price cutting
- - Major R&D expenditures
- - Major market development expenditures
Budgets are relied on less in build units than in harvest units
- - In contrast to harvest units, budget revisions are likely to be more frequent for build units because their product/market environment changes more frequently
- - Build unit managers may have greater input and influence than harvest unit managers in formulating the budget
In designing an incentive compensation package for BU managers, the following questions need to be resolved:
- - What should the size of incentive bonus payments be relative to the general manager’s base salary?
- - Should the incentive bonus payments have upper limits?
- - What measures of performance should be used when deciding the general manager’s incentive bonus awards?
- - If multiple performance measures are employed, how should they be weighted?
- - How much reliance should be placed on subjective judgments in decidingon the bonus amount?
- - How frequently should incentive awards be made?
Short-term focus performance criteria:
- - Cost control
- - Operating profits
- - Cash flow from operations
Long-term focus performance criteria:
- - Market share
- - New product development
- - Market development
- - People development
Choosing a differentiation approach increases uncertainty because
- - Product innovation is more critical for differentiation BUs
- - Low-cost BUs typically tend to have narrow product lines to minimize inventory carry costs and benefit from scale economies
- - Low-cost BUs typically produce no-frill commodity products, and these products succeed primarily because they are priced lower than competing products
Management control in service industries is different than in manufacturing companies.
- - Absence of inventory buffer
- - Costs of many service organizations are essentially fixed in the short run
- - The key variable is the extent to which current capacity is matched with demand
- o Stimulate demand in off-peak periods by marketing efforts and price concessions
- o If feasible, service organizations adjust the size of the workforce to the anticipated demand
- - Difficulty in controlling quality
- - Labor intensive
- - Multi-unit organizations
Goal of professional service organization is to
- provide adequate compensation to the professionals.
Special characteristics of professional service organizations:
- - Goals
- - Professionals
- - Output and input measurement
- - Small size
- - Marketing
Management Control Systems for Services
- - Pricing
- - Profit centers and transfer pricing
- - Strategic planning and budgeting
- - Control of operations
- - Performance measurement and appraisal
Financial Services Sector General Observations
- - These firms account for 5% of GDP, but their importance in the overall performance of the economy is considerably greater
- - 30 years ago, firms specialized in a single industry and tended to compete in a single country
- - Financial services firms have used the information technology revolution to innovate new products and discover new methods of trading
- - The need for controls in the financial services sector has become paramount
- - During the 1990s, new forms of financial instruments (derivatives) designed by financial service firms sometimes resulted in millions of dollars of losses for the clients
- - The corporate scandals during 2002 have created a huge push for investment banks to spin off their research departments
Arguments for spin off
- - This separation will ensure objective research data
- - At present, cost of research is being subsidized by investment banks if investors have to pay for it, they will demand higher-quality research
- - Investors confidence will improve if they are convinced that research is unbiased.
Arguments against spin off
- - The cost of research will go up if they are set up as separate firms
- - The best research analysts will join investment banks due to the higher pay scales, thereby leaving independent research firms with lower caliber employees
- - To keep costs down, research departments may issue short reports instead of a rich, detailed analysis of stocks as is the current practice
- Special characteristics of financial services industry:
- - Monetary assets
- - Time period for transactions
- - Risk and reward
- - Technology
- Health Care Organizations Special Characteristics
- - Difficult social problem
- - Change in mix of providers
- - Third-party payers
- - Professionals
- - Importance of quality control
- Nonprofit Organizations Special Characteristics
- - Absence of a profit measure
- - Contributed capital
- - Fund accounting
- - Governance
- Management Control System Considerations for Nonprofit Organizations
- - Product pricing
- - Strategic planning and budget preparation
- - Operation and evaluation
- There are three special problems of global organizations
- - Cultural differences
- - Transfer pricing
- - Exchange rates
- shared values, assumptions, and norms of behavior
Hofstede’s four dimensions of culture
- - Power distance
- - Individualism/collectivism
- - Uncertainty avoidance
- - Masculinity/femininity
the extent to which power is unequally distributed and centralized
High power distance cultures
- - Philippines
- - Venezula
- - Mexico
Low power distance cultures
- - Israel
- - Denmark
- - Austria
extent to which people define themselves as individuals or as part of a larger group
Highly individualistic countries
- - U.S.
- - Australia
- - Great Britain
Highly collective cultures
- - Saudi Arabia
- - Venezula
- - Peru
the extent to which people feel threatened by ambiguous situations.
Highest uncertainty avoidance cultures
- - Japan
- - Portugal
- - Greece
Lowest uncertainty avoidance cultures
- - Singapore
- - Hong Kong
- - Denmark
the extent to which dominant values emphasize assertiveness and materialism
Highly “masculine” cultures
- - Austria
- - Switzerland
- - Italy
Highly “feminine” cultures
- - Sweden
- - Norway
- - Netherlands
- - Denmark
Hall’s cultural classification scheme:
- - "low-context” cultures
- - “high-context” cultures
- - Germany
- - Switzerland
- - Scandinavia
- - North America
- - Great Britain
people get down to business quickly and negotiate as efficiently as possible.
people attempt to establish personal relationships before getting down to business and where negotiations are slow and ritualistic
- - China
- - Korea
- - Japan
- - Saudi Arabia
Cultural inferences for control systems:
- - Individualistic cultures – employees are likely to prefer rewards based on individual performance
- - Collectivistic cultures – employees prefer group-based rewards
- - Low-power distance – decentralization in decision making and greater participation in budget preparation might be preferred
- - High-power distance cultures – centralized decision making and less participation in budget preparation might be preferred
- - Low-uncertainty avoidance – subjective performance evaluation
- - Low-context cultures – formal planning and control systems
- - High-context cultures – building interpersonal familiarity and trust essential led to informal controls
Transfer pricing Foreign operations considerations
- - Taxation
- - Government regulations
- - Tariffs
- - Foreign exchange controls
- - Funds accumulation
- - Joint ventures
Constraints on transfer pricing
- - To minimize taxes, U.S. multinationals transfer assets to low-income tax countries
- - U.S. multinationals move their “paper” corporate office to Bermuda, which doesn’t have corporate income tax.
- - Companies transfer intellectual property (such as patents) to Ireland, a low-tax country
Section 482 tries to ensure that
- financial transactions between the units of a controlled taxpayer are conducted as if the units were uncontrolled taxpayers
a company that can control transactions between domestic and foreign profit centers
independent entities dealing with one another at arm’s length
In a case of dispute, Section 482 of the IRC permits the company to
- - select whatever permissible alternative it wishes
- - place the burden of proof on the IRS to show the company’s method is unacceptable.
Acceptable intercompany pricing methods (descending order of priority)
- - Comparable uncontrolled price method
- - Resale price method
- - Cost-plus method
Comparable uncontrolled price method:
Transfer price = price paid in comparable uncontrolled sales +/- adjustments
Resale price method:
- Transfer price = applicable resale price – appropriate markup +/- adjustments
- Appropriate markup = applicable resale price X appropriate gross profit percentage
- Transfer price = costs + appropriate markup +/- adjustments
- Appropriate markup = cost * appropriate gross profit percent
- Appropriate gross profit percent = gross profit percent (expressed as a percent of cost) earned by seller or another party on uncontrolled sale similar to controlled sale
Implications of Section 482
- 1. Although there are legal restrictions on a company’s flexibility in transfer pricing, there is considerable latitude within those restrictions
- 2. In some instances, the legal constraints may dictate the type of transfer prices that must be employed
Policies for dealing with transfer prices:
- - Deal at arm’s length
- - Minimize costs/maximize cash flow
If uneconomic transfer prices are used, it is important to guard against
- managers making decisions not in the company’s best interests.
Whenever minority interests are involved, subsidiaries must
- deal with each other at arm’s length because the minority parties have a legal right to a fair share of the corporation’s profits.
- - Translation exposure
- - Transaction exposure
- - Economic exposure in exchange rates
the price of one currency in terms of another currency
the number of units of the home currency that are needed to buy one unit of foreign currency
the number of units of the foreign currency that are needed to buy one unit of the home currency
Spot exchange rate
the nominal exchange rate that prevails on a given rate.
Real exchange rate
spot exchange rate after adjusting for inflation differentials between the two countries in question.
Forward exchange rate
exchange rates known today at which transactions can be entered into for completion at some future point in time.
The dollar is said to have undergone depreciation relative to the foreign currency if
- the number of dollars required to buy a unit of foreign currency rises.
Purchasing power parity
the theory that in the long run, identical products and services in different countries should cost the same based on the belief that exchange rates will adjust to eliminate the arbitrage opportunity of buying a product or service in one country and selling it in another.
additional depreciation of currency values in excess of the inflation differential between the two countries.
In the broadest terms, real exchange rate changes create
- changes in the cost competitiveness of a domestic manufacturer against its foreign competitors.
Translation exposure to exchange rates
the income statement and balance sheet exposure on MNEs to changes in nominal exchange rates because MNEs must consolidate their accounts in a single currency, although their cash flows are denominated in multiple currencies.
Transaction exposure in exchange rates
exposure that the firm has in its cross-border transactions when such transactions are entered into today, but payments to settle the transaction are made at some future time.
the exchange rate exposure of the firm’s cash flows to real exchange rate changes. (also called operating exposure or competitive exposure)
3 Choices of Metric in setting and tracking budgets:
- - Initial exchange rate (exchange rate prevailing when budget is set)
- - Ending exchange rate (exchange rate prevailing at the time budgets are tracked)
- - Projected exchange rate (exchange rate projected when budget is set)
Important issues in control systems design for performance evaluation
- - Should subsidiary managers be held responsible for the effect of exchange rate fluctuations on their bottom line?
- - Should the parent company use the home-country currency or should it use the local currency in performance evaluation? Further, should it use the initial exchange rate, the projected exchange rate, or the ending exchange rate in setting and tracking budgets?
- - Should the parent company distinguish between the effects of different types of exchange rate exposure while evaluating the performance of the subsidiary manager? If yes, how?
- - How should different types of exchange rate exposure affect the evaluation of the economic performance of the subsidiary, as distinct from the evaluation of the manager in change of the subsidiary?
a foreign subsidiary that incurs all costs and sells in its own country not engaging in any cross-border transactions
If the same metric is used to set and track the budget, then
- - the choice of metric is irrelevant
- - the resulting performance reflects the operating performance of the manager, independent of translation effects.
Problems Using Translation Gain/Loss in Evaluating the Subsidiary Manager’s Performance:
- - It would make the subsidiary manager responsible for factors that are beyond their control
- - It does not get rid of the translation gain/lossIt will not account for other types of exchange rate exposure that subsidiaries face
- - It will confound the performance of the manager and the subsidiary
Under economic exposure, it would be appropriate for the control system to evaluate the subsidiary manager on
- decisions that would have enabled the subsidiary to respond to real exchange rate changes.
a subsidiary that sells most of its products in its own country but imports most of its inputs from outside that country
a subsidiary that sells most of its products outside its own country, but purchases most of its inputs within the country.
any transaction by which risk associated with future cash flows is reduced
Reasons hedging transactions are best done by the parent company:
- - In most MNEs, there are payables and receivables in different parts of the overall firm that may naturally hedge each other if information on all such transactions is collected and dealt with at one central location (reduces transaction costs)
- - The parent company probably has better access to a wider (and perhaps more sophisticated) range of hedging instruments across a greater range of maturities, than a subsidiary typically has
- - There is no reason to presume that the manager of a subsidiary can forecast exchange rates any better than the corporate treasurer
If the long-term economic performance of the subsidiary (after incorporating exchange rate effects) continues to be poor, even though the performance of the manager is excellent, the parent company should address the more basic question:
- Does it make continued economic sense for the MNE to carry one operations in that country?
In designing performance evaluation systems of MNE subsidiaries, companies could use the following guidelines:
- - Subsidiary managers should not be held responsible for translation effects
- - Transaction effects are best handled through centralized coordination of the MNE’s overall hedging needs
- - The subsidiary manager should be held responsible for the dependence effect of exchange rates resulting from economic exposure
- - Evaluations of the subsidiary as a basis for a decision to locate operations in a coutry or to relocate operations from a country should reflect the consequences of translation, transactions, and economic exposure
A survey of companies found inconsistencies with the guidelines developed:
- - Most of the control systems were developed in the 1950s and 60s, when exchange rates were fixed
- - Many companies may not distinguish between the financial performance of the subsidiary
SFAS #52 requires the
- - all-current method for translating the balance sheet.
- o All BS items are translated at the exchange rate in effect on the BS date.
- o Conversion or translation gains/losses are reported as direct credits or changes to shareholders’ equity
- o they do not effect net income for the year.
- o Income statement items are translated at the exchange rate in effect on the date when the income or expense items are recognized, except that companies can use weighted average exchange rates if using the actual exchange rate is too complicated.
a set of activities intended to accomplish a specified end result of sufficient importance to be of interest to management
Characteristics of Projects
- - Single objective
- - Organization structure
- - Focus on the project
- - Need for trade-offs (scope, schedule, costs)
- - Less-reliable standards
- - Frequent changes in plans
- - Different rhythm
- - Greater environmental influences
- - Exceptions
where members of a project team have two bosses: the project manager and the manager of the functional department to which they are permanently assigned.
Two general types of contracts:
- - Fixed price
- - Cost reimbursement
the contractor agrees to complete the specified work by a specified date at a specified price.
the sponsor agrees to pay reasonable costs plus a profit
Fixed-price contract characteristics
- - Price is bid by contractor
- - Price includes an allowance for contingencies
- - Appropriate when the scope can be closely specified in advance and uncertainties are low
completion dates or cost targets or both are defined in advance and the contractor is rewarded for exceeding these targets
Hybrid contract use:
- - Direct costs may be reimbursed under a cost-reimbursement contract because of the high degree of uncertainty
- - The contractor’s overhead costs may be covered by a fixed-price contract
Fixed-price contract for overhead advantages:
- - Motivates the contractor to control these costs
- - Avoids the necessity of checking on the reasonableness of individual salary rates, fringe benefits, bonuses, and other amenities
- - Reduces the contractor’s tendency to load the overhead payroll with less qualified personnel
- - Encourages the contractor to complete the work as soon as possible so supervisory personnel will be freed for other projects
Fixed-price contract for overhead disadvantages:
- - May motivate the contractor to skimp on
- o Supervisory personnel
- o A good control system
- o Other resources that help get the project completed in the most efficient manner
a measureable increment of work, usually of fairly short duration
an unambiguous, identifiable completion point for a work package
Work package characteristics:
- - Each should be the responsibility of a single manager
- - Similar work packages should be defined in the same way so that cost and schedule information can be compared
- - If industry or company standards for work packages have been developed, definitions used in these standards should be followed.
Cost account characteristics:
- - Established for administrative and support activities
- - Have no defined outputTheir estimated costs usually are stated as per unit of time
Items established in advance for projects:
- - Chart of accounts
- - Rules for charging costs to projects
- - Approval authorities and their specific signing powers
- - Which cost items will be charged directly to work packages?
- - What will be the lowest level of monetary cost aggregation?
- - Should cost commitments be recorded, in addition to actual costs incurred?
- - How, if at all, will overhead costs and equipment usage be allocated to work packages?
In the planning phase, the project planning team takes as a starting point the rough estimates used as the basis for the decision to undertake the project and refine them into:
- - Detailed specifications for the product
- - Detailed schedules
- - A cost budget
- - A management control system
- - An underlying task control system
- - An organization chart
A plan for planning includes:
- - Description of each planning task
- - Who is responsible for it
- - When it should be completed
- - The interrelationship among tasks
The final plan consists of
- - Scope
- - Schedule
- - Cost
states the specifications of each work package and the name of the person or organization unit responsible
states the estimated time required to complete each work package and the interrelationships among work packages
set of relationships among work packages
stated in the project budget (control budget)
Project planning tools basic steps:
- - Estimating the time required for each work package
- - Identifying the interdependencies among work packages
- - Calculating the critical path
A network diagram consists of
- - A number of nodes
- - Lines joining these nodes to one another (activities)
a subgoal that must be completed to accomplish the project
the sequence of event that has the shortest total time to complete the project
Management control implications of critical path
- - Special attention must be paid to those activities that are on the critical path and less attention needs to be paid to slack activities
- - Attention should be given to possibilities for reducing the time required for the project
- - It may be desirable to reduce critical path times by increasing costs, but additional money should not be spent to reduce the time of slack activities
estimates of the cost of activities that are known to be going to occur
the estimator does not know that they are going to occur
Other planning phase activities
- - Material is ordered
- - Permits are obtained
- - Preliminary interviews are conducted
- - Personnel are selected
Sponsor and project manager concerns:
- - Is the project going to be finished by the scheduled completion date?
- - Is the completed work going to meet the standard specifications?
- - Is the work going to be done within the estimated costs?
- - Trouble reports
- - Progress reports
- - Financial reports
reports on both trouble that has already happened and anticipated future trouble.
compare actual schedule and costs with planned schedule and costs
accurate reports of project costs that must be prepared as a basis for progress payments (C-R contracts) and necessary as a basis for financial accounting entries (F-C contracts)
Informal sources of information:
- - Talking with workers
- - Talking with staff
- - Regularly scheduled and ad hoc meetings
- - Informal memoranda
- - Personal inspection
Plan revision question:
- Is it better to track future progress against the revised plan or to track against the original plan?
instead of providing a firm benchmark against which performance is measured, it may be stretched to cover up inefficiencies
examining costs incurred and management actions which may be substandard.
Project evaluation parts
- - An evaluation of project management
- - An evaluation of the results obtained from the project
A common error in analyzing costs is
- To assume the budget represents what the costs should have been
At best the budget estimates
- What the costs should have been based on the information that was available at the time it was prepared
Reasons decisions made at the time may have been entirely reasonable
- - Manager may not have had all the information at the time
- - Other problems had a higher priority
- - Manager based decision on personality considerations, trade-offs, etc.
Indications of poor management
- - Diversion of funds or other assets
- - Unauthorized changes
- - Manager’s failure to tight a control system that permits others to steal
- - Evidence manager regards overly tight controls as much less important than an excellent product completed on schedule
- - Reviews conducted during the project were inadequate
- - Timely action not taken on reviews
Criteria for which projects should be evaluated
- The project should be important enough to warrant the considerable expenditure of formal evaluation
- - Results should be quantifiable
- - Effects of unanticipated variables should be known
- - Results should have a good chance of leading to action