Issues of Organizational Control in the Relationships between Large and Small Firms - Essay Example

I. Introduction This paper aims to assess the situation of Wooden Posts Ltd. From the analysis of the options that are available to the company, one of the options is recommended. The analysis is done by using financial tools such as the net present value method and equivalent annual annuities, as well as organisational control models, with reference to certain academic literature in order to explore the relevant concepts further. II. Body A. Situation Wooden Post Ltd is a family-owned company in the East Midland of the UK which manufactures and distributes fence posts, gate posts, and construction frames and timber. For the current, the company has a total market share of 21.2% in the UK market for timber, second to London Counties. The company has grown significantly over the years because of the marriage of the managing director, who was a sawmill owner to a wealthy forestry owner in the north of England. Being second in the total UK market, the company is poised for a position of growth as its prospects for the future. B. Complication Wooden Posts Ltd is poised for growth in the future. However, because of changes in the UK timber market the company is presented with three alternatives by an international business consultancy firm. According to the firm, because the market for the companys products may face a slow down in terms of growth, the company has two options to expand, and one option to withdraw or contract. As the timber market in the UK is forecast to face a slow down in terms of growth, the rivalry in the current competition is expected to become more intense. In order to address this, the first option Wooden Posts Ltd has is to acquire a competitor, London Counties, the player with the largest market share in the UK market. This will increase the companys total market share. This is also significant to the company, as Wooden Posts Ltd has faced challenges in terms of increasing costs in the companys production and distribution systems. The logistical problems that give rise to increasing costs can be addressed by expanding the companys facilities in the form of facilities that are owned by one of its competitors. Although this option presents some potential gains to the company in the form of industry consolidation and economies of scale, this option is considered very risk--one, because of the potential failure of mergers, and two, even the merger proves to be successful, it does not guarantee that gains from acquisition are huge enough to contribute to the increase in shareholders wealth. The second option to Wooden Posts Ltd is to improve the companys production and distribution system in the east and west regions of the United Kingdom. This can be done by entering a joint venture agreement with two other formidable players in the industry—Welshpool Company and Glens. Wooden Posts Ltd can enter the agreement to strengthen its position in the west of UK through Welshpool Company, with Glens in the north. Welshpool Company is the leading wooden post manufacturer in the north of London. Aside from all these, the joint venture also includes the improvement of facilities of Wooden Posts Ltd in its eastern operations. However, this has also presented some concerns such as potential management and operating complications. The third option of the company is to withdraw from the competition in the western region of the UK. Because the market is predicted to slow down in terms of growth prospects, the rivalry is expected to become more intense. In order to avoid these intense pressure, the companys third option is to close all its facilities in the western UK. This way, the company will be able to avoid an intense rivalry with London Counties. London Counties hold the western region of the UK and it has a significant cost advantage in its operations in that region. C. Frameworks for analysis The decision of the top management with regard to choosing among the three options is not only influenced by impartial financial evaluation tools. As mentioned in the case, the current organisational control mechanism of Wooden Posts Ltd for its top management is the 15% in shares as bonus in the next five years, on the basis of return on investment and profitability growth. As indicated in the organisational control models, a companys actions are determined only by the actions of the individuals that comprising it (Otley & Berry 1980, 241). In order to analyse the companys situation, there are two kinds of considerations that need to be addressed: the first one is the objective financial assessment of the three options. The second one is the actions that top management may commit with regard to the predictive model of the organisational control that is currently employed by Wooden Posts Ltd. The financial analysis should include common measures for capital budgeting in order to determine the value that each option will contribute to the company. These methods include determining the net present value of the respective options. The net present value aims to incorporate the economic costs to the company such as the opportunity cost of capital, and the value that an option can contribute to the wealth of the companys shareholders (Keown et al. 2005). However, because disparity arises from unequal lives of the options, in order to better compare the value that they contribute, the equivalent annual annuity method is employed. The equivalent annual annuity aims to convert the net present value into its an annuity figure to gain a standard measure of value among the options (Keown et al. 2005). Aside from these financial considerations, these options come with organisational control considerations. In order for an organisation to succeed as a whole, coordination and integration of activities among its units need to be ensured (Rosengren 1967). According to Otley and Berry, the main aim of organisational control is to ensure a sort of self-regulation where the internal agency, in the case of Wooden Posts Ltd, its top management, will be able to exercise a control within the system itself (1980). In the three choices presented in the case, all those require coordination among the subunits. Aside from financial considerations, coordination becomes an overriding concern, and control becomes the means for ensuring the collective contribution of organisational units (Baumler 1971). Otley and Berry has presented a conceptual model of organisational control which consists of four requirements: objective, a predictive model, measures and choice of action (1980). According to them, “In attaining overall organisational control, the predictive model used by the control system must include a representation of the models used by individuals and groups within the organisation who are attempting to control outcomes to their own advantage (Otley & Berry 1980).” Thus, the measures used in order to reward these individuals and group will determine the choice of action that they will undertake in order to ensure coordination of activities for the success of the organisation as a whole. This includes [developing] trust-based relationships and [establishment of] an environment that favours the achievement of goals by reducing information asymmetry (Caglio & Ditillo 2006). Thus, managing knowledge is also an important component of organisational control (Turner & Makhija 2006). In order to ensure coordination among the individual managers within the organisation, according to Ouchi & Maguire, developing output measures which are tailored to serve the specialised needs of an individual manager is also necessary as included in the model of Otley and Berry; those measures can serve both the organisational and departmental needs (1975). This framework can be used in order to assess the potential impact of the three options for strategic consideration. D. Alternative courses of actions i. Option 1: Acquisition of London Counties The first option of Wooden Posts Ltd, which is the acquisition of London Counties has a net present value of 221,581,200. This value has been derived by adding the significant cash flows per year and getting their present value with 10% as the hurdle rate, for ten years. In order to eliminate the disparity among the different options under the net present value method, equivalent annual annuity is used. This determines the value that the option provides the company on an annuity basis. For option 1, the present value annuity factor for 10 years for the 10% hurdle rate is 6.1446. By dividing the NPV by this, the EAA of option 1 amounts to 38,081,126.84—the value that the option provides to the company on an annual basis. This figure, however is very optimistic and does not incorporate the risks of uncertainty in the form of certainty equivalent coefficients (Keown et al. 2005). Although the potential returns are enormous, it has to be taken into account that this figure may not reflect the true valuation of the business undertaking because it can be very optimistic. The top management must have included other information, both with regard to financial and non-financial analyses. For instance, risks in the form of economic predictions as well as the markets response and correlation of activities to it should be included in order to even out the predicted cash flow. The figure that is used in analysing option 1 includes a significant cash flow of 40,000,000 from London Counties operations. This is the highest point in the range of cash flow that London Counties can generate. In order for Wooden Posts Ltd to achieve this, ensuring coordination is crucial. Because coordination becomes an overriding concern, organisational control should be incorporated in the analysis. The objective behind option 1 is to ensure growth of the company by acquiring a formidable competitor which will not only increase its asset base, but will enable it to capture a larger part of the total market in the UK. The combined market share of the two companies is roughly 49% of the UK market. The predictive model in this case is the model of mergers and acquisitions. One consideration that top management should include in its analysis is how it will manage the integration of the two companies in order to achieve its objective. For one, the cultures of the two companies are different, and culture plays a significant role in the intra-company integration process (Cori 1995). Most mergers fail, not because of lack of strategic fit or under performance of each of the entities, but because the management has failed in this part—achieving integration among the two merged companies (Davis & Stout 1992). With the two companies having distinct norms for doing things, how can the top management address potential conflicts? The acquisition of London Counties also requires selling some of its assets and shutting down some of its facilities such as its London office. This cannot come without potential resistance on the part of the managers of the London Counties. Organisation-wide training and knowledge management regarding the merger is a crucial part of organisational control in order to facilitate change management within the company. The company must therefore set up a reward system that will emphasise on measures of progress as regards integration and change implementation, especially for the managers of the London Counties. The managers in charge of shutting down the facilities should therefore be rewarded according to certain measures in order to facilitate the changes. These rewards would determine the choice of actions for these people involve; and how they will cooperate in the desired integration and coordination efforts by the top management of Wooden Posts Ltd. ii. Option 2: Joint venture with Welshpool Company and Glens The companys second option is to upgrade its facilities in its western and eastern operations. A very attractive prospect is forming a joint venture with Welshpool Company to gain position in the west area of the UK, and with Glens in order to gain position in the north area of the UK. The initial investment will amount to 50,000,000 which is to be spread over three years, from years 1 to year 3. The initial outlay includes the upgrade of eastern facilities of the company which amounts to 20,000,000 in year 0. The total cash flows amount in year 0 is -20,000,000; -16,666,667 in years 1 and 2; -1,666,667 in year 3, and 15,000,000 from years 4 to 10. These cash flows are discounted back using the 8% hurdle rate, for the period of 10 years. This leaves a net present value to the company of 10,952,000. Using the annuity factor for the 8% hurdle rate, in the period of 10 years and dividing the NPV by this figure, the EAA for option 2 is 1,632,166.44. The potential return is smaller than option 1. The objective of option 2 is to strengthen the operations of Wooden Posts Ltd in the western and eastern regions of the UK. In order to accomplish this, one major prospect to the company is entering a joint venture with Welshpool Plc and Glens. The predictive model in this case is that of a joint venture. From the point of view of organisational control, a joint venture is facing a smaller risk in terms of integration. For one, joint ventures are created as a separate entity from the companies. The joint venture does not require the level of integration of a merger—the two different cultures need to struggle in order to determine which norms to follow. In the form of joint ventures, the participating company creates another company where these partners contribute to the formation of norms, or the culture within the new entity (Makhija & Ganesh 1997). However, in order for a joint venture to be successful, the participants should learn the new norms which is a result of mutual agreement among the players, and integrate these norms into their own respective norms in order to ensure easier integration among the three participants; this would facilitate shared learning. Potential conflicts may arise from lack of cooperation of managers from the different participating companies due to perceived differences. The top management of Wooden Posts Ltd, in order to address this should determine measures for the joint venture entity, in the form of performance appraisals that reward managers to cooperate with each other. The choice of action of these managers from the three participating companies will depend on the rewards that the organisational control system will set up, as a way to persuade and influence them to achieve coordination. iii. Option 3: Shutting down of the companys operations in the western area of the UK The third option for the company is a withdrawal strategy—closing down the companys western operations in order to avoid market pressures because of the predicted slow down of the market. As Wooden Posts Ltd focuses on its eastern operations and closes its western operations the companys cash flow from proceeds are estimated as 45,000,000, which is spread over a period of three years. However, this does not come without costs; the closure costs associated with it amounts to 14,000,000, which is also spread over the period of three years. This provides an additional 26,629,000 in net present value, which amounts to 10,332,932.37. An estimated 6% erosion in terms of sales and loss in market share is also predicted as a consequence of this option. Future erosion of cash flows due to decreased market share should also be included in the analysis. This financial analysis does not incorporate the financial implications of organisational control that is associated with this option. One consideration is the morale of the marketing director, as expressed in his concern for the dissolution of his marketing team in the western region. Also, the companys reputation will be hurt by the low moral of downsized employees due to the huge job cuts. A solution to this is to incorporate voluntary early retirement program to the change management. The choice of action on the part of the employees depends on these sorts of incentive system in order to achieve measures of managers that are responsible for implementing this option. III. Recommendation Top management should proceed in the decision by incorporating additional information to the analysis. This additional information comes in order to aid both financial considerations of the analysis as well as non-financial considerations. All the three options require some organisational control system such as provisions for change management, employee training, company-wide orientation and information dissemination regarding the changes, early retirement program for cutting down on jobs without hurting employee morale and company reputation, rewards systems, etc. However, the financial implications of these non-financial considerations that are part of setting up an organisational control are not yet included in the information that top management provides, thus these financial figures that are used for the analysis are understated. Given the available information, the financial analysis shows that option 1 indeed has the greatest potential. However, as indicated above, this analysis has not incorporated the people side of the decision, which will eventually further lessen the cash flows when these costs are incorporated, in line with ensuring integration and coordination among the company activities. Option 1 has the biggest rewards among the other options, although it has the greatest number of challenges in order to make it successful, as in the case of many mergers and acquisitions. IV. Conclusion Strategic issues that involve financial techniques rarely stand alone in terms of analysis; the human part of the processes need to be included in order to better assess the true costs and benefits of a certain strategic option. As with the concept of organisational control, a companys subunit or department does not stand alone; in order to realise the benefits of a certain financial undertaking, integration of the whole company is crucial. Financial valuation tools are useful, but they do come with limitations. The accuracy of a financial analysis depends on the inputs; in this case, the cash flows and the hurdle rate. If cash flow estimates are far from accurate as well as precise, this defeats the purpose of valuation. Financial valuation tools can be helpful in analysing certain financial decision, but they are helpful only to the extent of information that they cover. Aside from financial considerations, the realisation of the returns that these evaluation tools project depend on the implementability of the decision, with regard to considerations on the behaviour of the people within the organisation. organisational control provides a framework for integration and coordination of a companys activities, therefore this concept should also be employed for analysing and deciding financial undertakings. The assignment has made me see the implementation side, or the human side of undertaking financial decisions. Because of the computational and technical aspect of finance, it is easy to assume that capital budgeting decisions are just a product of input calculations. By understanding the concept of organisational control, which shows how coordination and integration is crucial for any financial or strategic decision, I come to appreciate financial concepts and how they aid a company in practice. Integrating organisational behaviour into financial decisions is important in order for the benefits of the decision to be realised by the whole organisation. However, I need a deeper understanding of organisational control models in order to provide more insightful implications as regards assessment of financial situations. References Baumler, John V. 1971. "Defined Criteria of Performance in Organizational Control." Administrative Science Quarterly 16, no. 3: 340-350. Business Source Premier, EBSCOhost (accessed November 11, 2009). Caglio, Ariela, and Angelo Ditillo. 2006. "Inter-organisational control. (cover story)." Financial Management (14719185) 27-28. Business Source Premier, EBSCOhost (accessed November 11, 2009). Cori, Enrico. 1995. "Issues of organizational control in the relationships between large and small firms." European Accounting Review 4, no. 2: 390-393. Business Source Premier, EBSCOhost (accessed November 11, 2009). Davis, Gerald F., and Suzanne K. Stout. 1992. "Organization Theory and the Market for Corporate Control: A Dynamic Analysis of the Characteristics of Large Takeover Targets, 1980-1990." Administrative Science Quarterly 37, no. 4: 605-633. Business Source Premier, EBSCOhost (accessed November 11, 2009). Keown, A. J., Martin, J. D., Petty, J. W., & Scott, Jr., D. F. 2005. Financial Management: Principles and Applications. New Jersey: Pearson Education, Inc. Makhija, M. V., & Ganesh, U. 1997. The relationship between control and partner learning in learning-related joint ventures. Organization Science, 8: 508–527. Business Source Premier, EBSCOhost (accessed November 11, 2009) Otley, D. T. & A. J. Berry. 1980. “Control, organisation and accounting.” Accounting, Organizations and Society, Volume 5, Issue 2, Pages 231-244. ISSN 0361-3682, DOI: 10.1016/0361-3682(80)90012-4. (accessed November 9, 2009) from http://www.sciencedirect.com/science/article/B6VCK-45W4H7K-1G/2/95f82eb6a33660d4e8650e09b14d5d47 Ouchi, William G., and Mary Ann Maguire. 1975. "Organizational Control: Two Functions." Administrative Science Quarterly 20, no. 4: 559-569. Business Source Premier, EBSCOhost (accessed November 11, 2009). Pérez, Bernabé Escobar, José María González González, and Antonio Lobo Gallardo. 2008. "Organisational Control System in a Continuous Improvement Environment: Special Reference to the Role of Management Accounting." Journal of Accounting, Business & Management 15, no. 1: 1-32. Business Source Premier, EBSCOhost (accessed November 11, 2009). Rosengren, William R. 1967. "Structure, Policy, and Style: Strategies of Organizational Control." Administrative Science Quarterly 12, no. 1: 140-164. Business Source Premier, EBSCOhost (accessed November 11, 2009). Turner, Karynne L., and Mona V. Makhija. 2006. "THE ROLE OF ORGANIZATIONAL CONTROLS IN MANAGING KNOWLEDGE." Academy of Management Review 31, no. 1: 197-217. Business Source Premier, EBSCOhost (accessed November 11, 2009). Read More