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A Complete Guide to Control Mechanisms in Business

Businessmen in office

Starting a business is not terribly difficult. For instance, according to the Small Business Administration, 552,600 new employer firms were launched in 2009 alone. Staying in business, however, is another matter altogether. According to the same SBA report, 660,900 firms closed in 2009, and overall only 51 percent of firms managed to stay in business for five years or more. In such a difficult and competitive market, businesses need effective control mechanisms to create and maintain a viable share of the market.

Control mechanisms fall into two major categories – regulatory and discretionary. Regulatory control mechanisms are rules enforced by a governing body. Discretionary control mechanisms are those that are imposed and enforced by executives and managers within the firm. Regulatory controls are imposed upon the business by external governing bodies – be they governmental, quasi-governmental, or charities. This is in essence a cost of doing business in such industries.

Discretionary controls are controls that are imposed on the business by the central management of the firm. One can impose control either by command and punishment or by providing incentives. In the latter scenario, businesses can internalize the effects of a control and reduce the costs associated with regulatory control mechanisms.

Regulatory Controls

Regulatory control, whether from a governmental, quasi-governmental, or charity source, is cost of doing business that is imposed upon the firm in order to maintain its freedom to operate. The most common regulatory controls are taxes, licenses, and permits. Taxes, for instance, are a cost of doing business. If a business does not like paying taxes, it can attempt to lobby the government or quit the business. In the United States, every citizen has a voice in how federal, state, and local governments operate, and each citizen can change the way local, state, and federal governments operate by voting. Since citizens in the US all have a say in how their government works, taxes are generally considered to be a fair cost of doing business.

Licenses and permits, on the other hand, are something altogether different. A license or permit grants a business or individual permission to do something which would otherwise be illegal. For instance, issuing a hunting license implies that hunting would otherwise be illegal. In some instances, the license or permit is limited in time and scope. For instance, a driver’s permit is valid only during the term of the permit and only for the purpose for which the permit was issued. It would be wrong for a driver’s permit to entitle its holder to vote on election day.

Regulatory controls take on many other forms and guises, but all have the same basis – freedom to operate is granted by a regulatory body which also restricts that freedom to operate in order to control the business to some extent. In doing business, a business must decide how much it is willing to pay for the regulatory control imposed on it and how much risk it can afford to take in order to operate the business. The higher the cost of regulatory control, the higher the cost of the product or service sold, and this cost is often passed on to the consumer in the form of a higher price.

Discretionary Controls

Discretionary controls are controls that are imposed on the business by the central management of the firm. One can impose control either by command and punishment or by providing incentives. In the latter scenario, businesses can internalize the effects of a control and reduce the costs associated with regulatory control mechanisms.

Command and punishment is a simple control mechanism which comes in many forms, but always involves specifying the proper procedure for doing something or the desired result and then punishing those who do not correctly follow the procedure or reach the desired result. In this type of control mechanism, the firm must punish people who stray from the procedure or fail to reach the desired target. The elements of command and punishment are simple, yet inflexible.

Providing incentives, on the other hand, is a more dynamic control mechanism which, when used correctly, can internalize the effect of a control and reduce the costs associated with regulatory control mechanisms. For example, a business can give employees shares in the firm or have employees receive bonuses based on performance in order to increase motivation and productivity. Firms can also use a blend of command and punishment with incentives to inspire maximum performance, while keeping costs under control.

Business as a Zero-Sum Game

Finding a Balance

Business is not a zero-sum game. If one wins, the other loses. Business is a non-zero sum game. If one wins, the other does not necessarily lose. Business is an opportunity for gain based on an action that is beneficial to the consumer. Any action that benefits the consumer increases the size of the total pie and gives the business the opportunity to profit by doing something that is beneficial to the consumer.

Issues are constantly arising in which the interests of the businessman – or his hired representatives – clash with those of the consumer. How these issues are resolved affects the long-term viability of the business. A businessman may have to constantly fight for his share of the market against competitors. For instance, the cost of an airline ticket includes the expense of competing against other airlines by providing better service or flying to more convenient airports. A businessman may also have to limit his profit by providing services for a lower profit because of the threat of new businesses entering a market and stealing his market share. For instance, cable TV services may feel that their only chance of retaining customers is by offering lower prices than their competitors. In doing so, they end up taking a loss on every television set sold in order to maintain their market share. Ultimately, businesses have to strike a balance between providing goods and services and making a profit. Businesses cannot pursue a policy of total customer satisfaction, no matter how much that approach is theoretically justified.

Businesses have other costs to consider when pursuing a course of action that is beneficial to the consumer. Businesses must consider the time and the cost involved in the production of a product and in introducing it to the market. From the time that the business conceives of an idea and decides to act upon it, it must shepherd the product through the various stages of development and marketing. This process can involve years of work and great expense before a product is ready for the consumer. Businesses may shun investments they would like to make in products which would help the consumer that are not guaranteed to succeed.

Businesses also have to consider the value to the consumer of the potential benefits of a business’ action against the cost and the risk of the investment. For example, all of the costs of developing and marketing the Segway were recouped by selling more than $80 million worth of product, using a business model developed by a company funded by venture capitalist firms, most of which sold below cost.

Sometimes businesses must subject their products to regulatory and punitive action. In doing so, they have to weigh the benefits, the costs, the risks, and other factors, including factors extrinsic to the business. What is good for the consumer is not necessarily good for profits. Similarly, what is good for the profit is not necessarily good for the consumer. When businesses have to make decisions on how to allocate scarce resources and how to compete and cooperate with other businesses, they have to weigh all the different variables and decide how they want to allocate their resources and create value for their stakeholders.

Regulatory Control

Regulatory control is control imposed by a central authority which often seeks to provide for the general welfare and ensure that no one takes advantage of another. Creating laws and codes is one method of implementing control. In such circumstances, one can put forth only the rules and not specifics of how they should be carried out. On the other hand, an exact set of procedures must be followed, regardless of whether or not one supports the control imposed.

Planning and Controls

A planner is a planner is a planner, regardless of whether she plans for the military, a museum, or a business. The important concept in planning is not who plans or how she plans, but what are the criteria for evaluating a plan, and how can she implement her plan in a manner that will make the plan work.

The first issue to consider is the identity of the owner of the plan. One must decide if it is necessary to have a planner at all, or if the plan should be carried out in accordance with a procedure that already exists. It does not take a planner to have a museum follow the procedures necessary for keeping and preserving its exhibits. However, it requires a planner to run a government, a business, or a military campaign.

The second issue to consider is what criteria are necessary in order to evaluate whether a plan is successful or not. One has to consider what it is that you intended to do in the first place. For example, if a state wants to raise revenues, then what should be done in order to increase the revenue of the state from its present level to a level that is acceptable for the state? Likewise, one has to consider how one will evaluate whether or not the plan worked, and if it did not, why, and then find something else that will work.

The third issue to consider is how one goes about implementing the plan. What are the steps necessary to complete the plan, and what are the constraints one may face on those steps? Were you able to accommodate the constraints that will inevitably arise? For example, if one creates a plan for a holiday celebration, how will one deal with the constraints of limited staff, money, space, people who could not get the day off, and the like? One has to consider how one will schedule the steps, determine the sequence of events, monitor progress, and schedule time to revisit and revise the plan as necessary.

Business Planning

All business must have a plan in order to operate. If a business fails to plan, it’s plan is to fail. Business plans can be used to create a framework in which a business can function. It gives the business owners and managers a strategy to follow. It also serves as a tool to plan a yearly budget. According to the Small Business Administration, when writing a business plan, start with no more than a one-page overview that states what your business will be, how you plan to run it (financials), key contacts, how it will be capitalized, how you will market it (key strategy and marketing), and a financial snapshot to show yourself and others that you are serious about your business.

The first and foremost objective of every business is to make a profit. That is the only way to stay in business. This means that a company should constantly be considering its profits or potential profits. Managers can look at the firm’s past performance to indicate the likelihood that the firm will obtain the expected revenue and profit. This will serve as a guide when making decisions about future operations. It is impossible to operate a profitable firm if there are no profits to be made and the likelihood of obtaining profits is very low. Every firm should examine its market conditions on a regular basis. It should identify any changes in the environment which may affect its ability to make a profit. Corporations can use a general planner to help the company plan its advertising, production, market strategy, and future financial goals.

Business and Political Planning

According to the Small Business Administration, if you own multiple (more than one company) companies, the different company plans must be coordinated. The plans should have enough information to give you a good overview of your company and identify any potential risks or opportunities in each business. This allows you to be in a position to respond quickly to changes.

Balancing the Desire to Create Value and the Need to Make a Profit

By their very nature, markets are highly competitive, and businesses must constantly monitor their competitive environment in order to survive, let alone prosper. Businesses must decide which goods and services to sell and in what quantities and which trade-offs are best for them. Businesses must constantly look for ways to improve the quality of their goods and services. Customers are more likely to purchase a product or service that is perceived as being of higher quality because of the perception that it will cost more. As a result, however, it costs more to produce this “higher quality” good. Customers are also more likely to purchase goods at a higher price if there is high demand for them. High demand may make the higher price more acceptable to a consumer.

Some businesses recognize that quality sells, and they are willing to put money into research and design in order to create better products. Other businesses decide to save on costs by using cheaper materials or cutting down on production costs in order to keep their products affordable for the mass market.

Whether a business chooses to put more money into product quality or quantity, it must decide what matters most to it. It can choose to make fewer products but offer them at higher price but with better quality, or it can make more products to sell at a lower price. Businesses must determine the cost-benefit analysis of making either choice.

Strategic Objectives and Strategies

Strategic planning may involve evaluating where you are, where you want to be, and how to get there, whether it is across the continent or across the desk. According to the Small Business Administration, to be successful, a plan must include an overall strategic objective and strategies to achieve the objective.

A strategic objective is the long-term desired outcome of the plan. Once you have defined your objectives, you can devise the strategy, or how to attain the objective. This strategy may include short-term objectives.

Objectives and strategies may involve taking risks and analyzing the risks involved. Before taking a risk, you have to know what you want, why you want it, your alternatives, how you will get it, how you will measure success, and the consequences if you fail.

Financial Controls

A company must have control over its assets. One method used for control is to separate the ownership of assets from the management of assets. This is done by creating an entity, or corporation, in which the owner has direct control over the rest of the corporation’s assets as well as some other investors or stockholders.

While a company may be owned by investors on paper, the president is the boss of the firm. He or she is responsible for the day-to-day activities of the corporation. This president must report regularly to the owners. In order to run the corporation effectively, he or she must follow a set of rules and control systems.

Corporations have two basic types of financial controls: internal controls and external controls. Internal controls are first checks and tests that the corporation does to see if its own business practices are efficient and working properly. External controls are second-party checks done by an outside auditor, lawyer, or accountant. The external controls are done to check the internal controls.

Internal controls are done at the corporate level by the corporate officers. They include:

  • Authorization of expenses
  • Two-signature rule for checks
  • No cash in registers
  • Physical control of assets

External controls are separated into two categories: financial and operational. Financial controls relate to how the money flows in and out of the business and to how much the owners have invested in the business. Operational controls relate to the day-to-day business operations, including sales and customer service.

Internal Profit and Loss Statement

In order to run a profitable business, businesses normally use financial control statements to aid in management decision-making processes. Financial control statements are more commonly known as profit and loss statements.

According to the Small Business Administration, a profit and loss statement includes a calculation of the company’s performance over a set period (monthly, quarterly, yearly, etc.) and is often referred to as a “statement of operations” or a “statement of earnings.”

Numerous variations of the profit and loss statement exist. The most common one is called the basic format of profit and loss statement. This format is the usual basis for comparison with other businesses with similar operations. The basic format has four principal elements:

The income statement allows the users to identify the components of income or loss and the changes in these constituents over a period of time. A company pays more attention to profit. Profit is the difference between revenue and expense. The profit and loss statement is a profit statement because it is concerned with the overall performance of a business.

The other two statements are the operating statement and the cash flow statement.

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