Controllability is the degree of influence a specific manager has over costs, revenues, or related items for which he or she is responsible. A controllable cost is any cost primarily subject to the influence of a given responsibility center manager for a given period. A responsibility accounting system could either exclude all uncontrollable costs from a manager’s performance report or segregate such costs from the controllable costs. For example, a machining supervisor’s performance report might be confined to direct materials, direct manufacturing labor, power, and machine maintenance costs and might exclude costs such as rent and taxes paid on the plant.
In practice, controllability is difficult to pinpoint for two main reasons:
Executives differ in how they embrace the controllability notion when evaluating people reporting to them. Some CEOs regard the budget as a firm commitment subordinates must meet and that “numbers always tell the story.” Failing to meet the budget is viewed unfavorably. An executive once noted, “You can miss your plan once, but you wouldn’t want to miss it twice.” Such an approach forces managers to learn to perform under adverse circumstances and to deliver consistent results year after year. It removes the need to discuss which costs are controllable and which are uncontrollable because it does not matter whether the performance was due to controllable or uncontrollable factors. The disadvantage of this approach is that it subjects a manager’s compensation to greater risk. It also de-motivates managers when uncontrollable factors adversely affect their performance evaluations even though they performed well in terms of factors they could control.
Other CEOs believe that focusing on making the numbers in a budget puts excessive pressure on managers. These CEOs adjust for uncontrollable factors and evaluate managers only on what they can control, such as their performance relative to competitors. Using relative performance measures takes out the effects of favorable or unfavorable business conditions that are outside the manager’s control and affect all competing managers in the same way. The challenge is in finding the correct benchmarks. Relative performance measures, however, reduce the pressure on managers to perform when circumstances are difficult.
Managers should avoid thinking about controllability only in the context of performance evaluation. Responsibility accounting is more far-reaching. It focuses on gaining information and knowledge, not only on control. Responsibility accounting helps managers to first focus on whom they should ask to obtain information and not on whom they should blame. Comparing the shortfall of actual revenues to budgeted revenues is certainly relevant when evaluating the performance of the sales managers of Ritz-Carlton hotels. But the more fundamental purpose of responsibility accounting is to gather information from the sales managers to enable future improvement. Holding them accountable for sales motivates them to learn about market conditions and dynamics outside of their personal control but which are relevant for deciding the actions the hotels might take to increase future sales. Similarly, purchasing managers may be held accountable for total purchase costs, not because of their ability to control market prices, but because of their ability to predict and respond to uncontrollable prices and understand their causes.
Performance reports for responsibility centers are sometimes designed to change managers’ behavior in the direction top managers desire even if the reports decrease controllability. Consider a manufacturing department. If the department is designated as a cost center, the manufacturing manager may emphasize efficiency and de-emphasize the pleas of sales personnel for faster service and rush orders that reduce efficiency and increase costs. Evaluating the department as a profit center decreases the manufacturing manager’s controllability (because the manufacturing manager has limited influence on sales) but it motivates the manager to look more favorably at rush orders that benefit sales. She will weigh the impact of decisions on costs and revenues rather than on costs alone.
Call centers provide another example. If designated as a cost center, the call-center manager will focus on controlling operating costs, for example, by decreasing the time customer representatives spend on each call. If designed as a profit center, the call-center manager will cause customer-service representatives to balance efficiency against better customer service and lead to efforts to upsell and cross-sell other products. Hewlett-Packard, Microsoft, Oracle, and others offer software platforms designed to prompt and help call-center personnel turn their cost centers into profit centers. The new adage is “Every service call is a sales call.”
Many managers regard budgets negatively. To them, the word budget is about as popular as, say, downsizing, layoff, or strike. Top managers must convince their subordinates that the budget is a tool designed to help them set and reach goals. As with all tools of management, it has its benefits and challenges. Budgets must be used thoughtfully and wisely, but whatever the manager’s perspective on budgets—pro or con—they are not remedies for weak management talent, faulty organization, or a poor accounting system.