Organizational Output and Behavioral Controls

The Complexity of Transfer Pricing

In multi-divisional structures, divisions often trade with one another—for example, a technology division providing software to a manufacturing division. The internal price charged for these goods or services is known as the transfer price.

Transfer pricing is a frequent source of conflict. The supplying division wants a high transfer price to boost its own reported profits, while the receiving division wants a low price to keep its costs down. Because these prices are often just "moving numbers on a ledger," they can lead to intense negotiations that consume management time without actually improving the firm's overall performance.

Exam Tip: When analyzing a case study, look for "siloed" behavior. If a manager is hitting their ROI targets but the company as a whole is struggling, they may be optimizing their own output control at the expense of the firm's total value.

Behavioral Controls: Managing by Process

While output controls look at the end result, behavioral controls delineate the boundaries for employee actions. They define what is permitted, who has the authority to make decisions, and what specific procedures must be followed.

Budgeting and the Risk of Inertia

One of the most powerful tools for behavioral control is budgeting. Budgeting serves as a mechanism for cost control by projecting future expenditures and tracking actual spending against those projections.

While budgeting encourages employees to be cost-conscious, it can inadvertently lead to organizational inertia. This occurs when managers become more focused on protecting their allocated funds than on achieving strategic goals. For example, a manager might fear that if they under-spend this year, the organization will slash their budget for next year. Consequently, they may engage in "use it or lose it" spending, exhausting their entire budget by year-end just to protect future funding, even if that spending doesn't add value to the firm.

Formal Policies

To further regulate behavior and assign responsibility, organizations implement formal policies. These provide clear rules that reduce ambiguity and ensure consistency across the firm:

• Spending and Purchasing Policies: These define the hierarchy of authority, specifying exactly who has the power to approve expenditures at different monetary levels.
• Credit Policies: These establish the criteria for which customers are eligible to purchase goods on credit, helping to manage the firm's financial risk.
• Travel Policies: These set the standard rules for employee reimbursements, such as booking procedures and allowable expenses, ensuring that travel costs are managed predictably.

Summary Comparison

To master these concepts, it is helpful to view them as two different lenses through which a manager can view performance.

By balancing both, an organization can create a structure where employees are motivated to achieve high-level results while remaining within the ethical and operational boundaries required for long-term success.