Case study

The dynamic relation between management control and governance structure in a supply chain context Paula M.G. van Veen-Dirks Nijmegen School of Management, Radboud University Nijmegen, Nijmegen, The Netherlands, and

Peter J.A. Verdaasdonk Eindhoven University of Technology, Eindhoven, The Netherlands and Verdaasdonk Consulting, Best, The Netherlands Abstract Purpose – The purpose of this paper is to show that local management control systems within supply chain organisations and the governance of supply chains are intertwined and that local control systems and governance structure have an important effect on the functioning of the supply chain. Design/methodology/approach – The paper reports on a case study of a supply chain and examines how local management control systems within the participating organisations affect cooperation between the organisations in the supply chain. In the case study, a supply chain, including eight food manufacturers, two logistic service providers, and two retailers, is investigated. Findings – The behaviour of several entities in the chain is explained by examining the present local management control systems. The main conclusion is that these systems call for behaviour that is not congruent with the broad supply chain objective. Research limitations/implications – The research is based on a case study in one supply chain that has mainly a cost-minimisation objective. Further in-depth studies could be undertaken in supply chains with other objectives to further validate the findings. Practical implications – The paper demonstrates that the local management control systems may hinder the achievement of the supply chain objective. Possible design implications for both local management control systems and governance structures in the supply chain are outlined. Originality/value – The paper focuses on local information sharing concerns and on local performance measurement and incentive issues at the intraorganisational level but within a supply chain context. Keywords Supply chain management, Ethics, Performance management, Distribution management, Control Paper type Case study

from the anchor point of discreteness which underlies spot market transactions to a relational exchange, as the roles of supplier and buyer are no longer narrowly defined in terms of the simple transfer of ownership of products (Macneil, 1981). Supply chain cooperation appears as firms recognise cases where operating alone is not sufficient to resolve common problems and to achieve the desired goals (Barratt and Oliveira, 2001; Wagner et al., 2002). A supply chain is broadly defined as a system of suppliers, manufacturers, distributors, retailers and customers where material, financial and information flows connect participants in both directions (see Fiala, 2005). Despite the growing interest, both among practitioners and among researchers, in improving firm performance through the use of supply chains, achieving supply chain management success is not without obstacles (Elmuti, 2002). Despite the enticing benefits, organisations that partner in strategic supply chains continue to encounter barriers (Fawcett et al., 2008). These barriers exist both at the intra-organisational, and inter-organisational levels. The purpose of this study is to examine the benefits, the barriers and the potential bridges that exist at the inter- and at the intra-organisational level for firms that operate within a supply chain. In their survey of the supply chain management

1. Introduction In many organisations supply chain management is viewed as an important topic, because it is considered as a means to gain economic benefits in the current era of severe international competition. The general idea is that companies achieve supply chain benefits when they work together efficiently and effectively. A supply chain is fully coordinated when all decisions are aligned to accomplish a global system supply chain’s objective, which is to provide value to the end consumer in terms of products and services, and for each channel participant to garner a profit in doing so (Sahin and Robinson, 2002). Supply chain cooperation is about organisations and enterprises working together and can be viewed as a concept going beyond normal commercial relationships (Matopoulos et al., 2007). It is a departure The current issue and full text archive of this journal is available at www.emeraldinsight.com/1359-8546.htm

Supply Chain Management: An International Journal 14/6 (2009) 466– 478 q Emerald Group Publishing Limited [ISSN 1359-8546] [DOI 10.1108/13598540910995237]

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Management control and governance structure in a supply chain context

Supply Chain Management: An International Journal

Paula M.G. van Veen-Dirks and Peter J.A. Verdaasdonk

Volume 14 · Number 6 · 2009 · 466 –478

literature, Sahin and Robinson (2002) attribute lack of coordination in a supply chain to decision makers having incomplete information or incentives that are not compatible with system-wide objectives. In this paper, we concentrate on the design and use of management control systems in these firms within the context of the supply chain. Management control is the process by which managers influence other members of the organisation to implement the organisation’s strategies (Anthony and Govindarajan, 2007). A management control system (MCS) typically serves two roles: 1 information provision; and 2 motivation of individual managers within the firm (see, for example, Otley, 2003).

Based on the case study, it can be concluded that the current local management control systems do not support the chosen supply chain objectives. They even act as a barrier to the implementation of new initiatives. It appears that these control systems are not able to capture the complex and multifaceted nature of supply chain cooperation. Therefore, supply chain initiatives can only be implemented if the local systems are adjusted. Some possible changes in the local control management systems are put forward for the case study. Also the relation with the governance structure of the supply chain receives attention. Furthermore, some of the dynamics of this relationship are explored. The paper is organised as follows. In section 2, the relation between management control and supply chain management is discussed as well as the complications that may appear when dealing with management control in relation to a supply chain. Section 3 describes the research design of the case study and the associated questions in the field of control of cross-border company processes, whereas in section 4 the case study is described. In section 5, the management control problems are discussed as well as possible suggestions for improvement and finally the conclusions are stated in section 6.

They are specifically designed to mitigate the kind of coordination problems as described by Sahin and Robinson (2002), i.e. incomplete information and incompatible incentives. However, studies of management control usually focus on coordination within companies, whereas an important feature of this study is that it also includes the effect on the efficiency and effectiveness of the collaborative efforts between companies in a supply chain. Therefore, we also look at how these management control systems relate to the governance structure that is installed to regulate the hybrid organisations in the supply chain. The term governance structure refers to the package of practices used to regulate lateral relations that extend organisational boundaries. It includes the notion of control, but is a wider concept (Nooteboom, 1999). This study will focus on the (re-)design of management control systems within firms that operate in a supply chain. The main question to be addressed is how these local control systems affect the functioning of the supply chain. We argue that there is a relation between the control systems at the local organisational level and the governance structure at the level of the supply chain. The paper uses both transactions economics and organisational design theory to elaborate on this relation. The paper looks in detail to the control systems of companies acting in a supply chain and to the horizontal relations between the different entities in the chain. The paper uses case-based research to investigate both intra and interorganisational relations and the dynamic interplay between these two types of relations. Following Van der Meer-Kooistra and Vosselman (2000) and Thrane and Hald (2006), we believe that the management control aspects of interfirm transactional relationships are very complex. And case research is very suitable for the study of complex phenomena within a real-life context (Yin, 1989). In addition, this paper follows Hakansson and Lind’s (2004) call for more intensive case studies of business relationships where the role of different organisational units and the relationships between them are investigated in detail. The case study was carried out in a supply chain, including eight food manufacturers, two logistic service providers, and two retailers. We examined an initiative to collaborate between the participating companies. For this initiative it is clear that working and operating alone is not sufficient to resolve common problems and to achieve the desired goals. We investigated the barriers to this collaboration initiative and how the implementation problems coincide with the design of local management control system of the parties involved in the supply chain.

2. Management control and supply chain management As a result of implementing supply chain management practices, management processes now quite frequently transcend legal organisational boundaries. As a result, we must be careful to provide local management with the information relevant to ensure effective integration and coordination (Hopwood, 1996). One difficulty in achieving supply chain success is that typically management control practice has limited its scope to the boundaries of the firm. This limitation makes it difficult for the firm to take advantage of, for example, any cost-reduction synergies that exist across the supply chain. Such synergies can only be achieved by coordinating the cost-reduction activities of multiple firms. The objective of supply chain management is then to find lower-cost solutions than would be possible if the firm and its buyers and suppliers attempted to reduce costs independently (see, for example, Kulmala et al., 2002). In a supply chain, the implementation of potential improvement proposals that have an effect on supply chain performance has many implications and many hurdles have to be taken. If the supply chain leads to a reallocation of activities for example, it is possible that, at first, the costs and benefits are incorrectly divided among the individual players in the chain. Therefore, closer agreements must be made about this. In these situations, intention statements or contracts in which the cooperation and the partitioning of the costs and benefits have been regulated need to be established in advance. However, these contractual agreements are not always sufficient to achieve successful cooperation (Seal et al., 1999). Matters such as lack of faith, opportunism, and problems with measuring potential and real advantages appear to put the cooperation under pressure. This puts forward the question whether effective improvements in a supply chain can be reached only by specifying contracts. A specification in advance of desired behaviour is not always possible if we think within the context of supply chain management. While the role of the subcontractor in arms-length contracts is restricted to 467

Management control and governance structure in a supply chain context

Supply Chain Management: An International Journal

Paula M.G. van Veen-Dirks and Peter J.A. Verdaasdonk

Volume 14 · Number 6 · 2009 · 466 –478

providing clearly specified products under clearly defined conditions, the role of the subcontractor within supply chains is much more complex and many different dimensions are part of the game (Heide, 1994; Ittner et al., 1999). Many aspects of the collaboration between the parties must be settled and both information provision and motivation of the individuals involved have to be handled adequately to solve the problems that occur. The demand for coordination thus requires looking at management control issues with a more explicit awareness of interdependencies between firms in the supply chain. These systems have traditionally been designed for a combination of hierarchical modes of governance and traditional arms-length transactions (Gietzmann, 1996). However, the new hybrid organisations in supply chains are sufficiently different from markets or hierarchies to demand different modes of management control (Anderson and Sedatole, 2003). Hybrid organisations are organising activities through interfirm coordination and cooperation. Hybrid organisations exist because markets are perceived as unable to adequately bundle the relevant resources and capabilities (Teece and Pisano, 1994). Hybrids are also recognised by Williamson (1991) as a separate organisational form, as hybrid organisations are neither markets nor hierarchies.

Lambert, 2001). Therefore, a market mechanism (which essentially is a mechanism of rewarding/punishing and of exit threats) is always present in these hybrid relations. Management problems due to uncertainties in the environment and complexity in the production function are not recognised as such in transaction cost economics (Gietzmann, 1996). These latter in practice frequently necessitate decentralising the decision-making powers, leading to complex and thus costly management control. The coordination and motivation costs resulting from decentralisation are usually ignored in transaction cost economics, when alternative governance structures are examined. Also Milgrom and Roberts (1992) and Anderson et al. (2000) indicate that coordination and motivation costs may be more prominent than assumed in transaction cost economics, for instance in relation to the way in which make or buy decisions are made: those making the sourcing decision may not strictly maximise firm value if local (e.g. departmental) objectives conflict with firm goals. Organisational design theory offers specific insight into coordination and motivation issues within organisations and thus also provides insight into how a management control system may be used. Organisational design theory is mainly concerned with conflicts of interests between people working together in a hierarchy. This hierarchy is obviously present within the organisations acting in the supply chain. Consequently, we may well use the organisational design literature on coordination mechanisms to evaluate the individual behaviour within companies operating in a supply chain.

Transaction cost economics In transaction cost economics, the existence of alternative governance structures is explained by transaction costs (Williamson, 1975). Transaction costs may be expected to be high whenever transactions are sustained by assets with high specificity, and when transactions reoccur frequently and in an uncertain environment. The two main possibilities to economise on transaction costs are organisations (hierarchies) and hybrids (see also Vosselman and Van der Meer-Kooistra, 2006). A hierarchy will try to prevent and combat opportunism, facilitated by the hierarchy’s ability to avoid conflicts of interests and to overcome information asymmetry. There is a lot of reliance on managerial discretion. However, the hierarchy also entails costs: information processing, coordination and control do not come for free. Moreover, there is the risk of inefficiencies because of the absence of market forces. In a hybrid, an efficient governance structure can be designed in order to coordinate activities between organisations and to prevent and/or fight opportunism. This diminishes the risk of inefficiencies that is inherent in the hierarchy. These governance structures work together with management control devices within organisations participating in a hybrid relation. The management controls within companies have an influence on the behaviour of the people working within these companies and are therefore also an important part of the governance structure. In addition, although a relationship between economically independent parties is not based on a hierarchical relationship, the deployment of hierarchy-appropriate control devices can be (contractually) arranged (Vosselman and Van der MeerKooistra, 2006). A hybrid can be defined as “marketpreserving credible contracting modes that possess adaptive attributes located between classical markets and hierarchies” (Williamson, 2002). There always remains a market between companies in the supply chain in that real money payments take place that have an impact on the behaviour of the participating companies in the supply chain (see also

Information, motivation and organisational architecture Both effective information sharing (Fawcett et al., 2007) and alignment of the interests of the partners in the supply chain are very important to realise supply chain coordination (Simatupang and Sridharan, 2005, 2008; Lee, 2004). In a supply chain context the central question is how to realise full coordination. Organisational design theory indicates that lack of coordination occurs when decision makers have incomplete information or incentives that are not compatible with systemwide objectives. Two methods for accomplishing coordination are centralised decision-making and decentralised decision making utilising coordination mechanisms (Lee and Whang, 1999). Under the centralised decision-making approach, a single entity optimises the network. Coordination mechanisms seek to align available information and incentives such that decentralised decision makers act in the best interest of the system. Both vertical and horizontal information sharing as well as incentives within the company are important for management control (see, e.g. Van VeenDirks, 2006). A management control system thus comprises three important elements: 1 the allocation of decision rights; 2 the firm’s information structure; and 3 performance measures and incentives (see, e.g. Anand and Mendelson, 1997; Jensen and Meckling, 1992). Decision rights must coincide with relevant knowledge and information, since that helps to improve the quality of the decisions. In a hierarchy the two choice possibilities are as follows: 468

Management control and governance structure in a supply chain context

Supply Chain Management: An International Journal

Paula M.G. van Veen-Dirks and Peter J.A. Verdaasdonk

Volume 14 · Number 6 · 2009 · 466 –478

1 2

Local management controls may well be part of the interorganisational (contractual) arrangements. In addition, the governance structure also includes a market mechanism and the use of contracts between companies.

the information is communicated to the person with the decision rights; or the decision rights are allocated to the person with knowledge and information.

In the first situation, costs are incurred from information exchange and frequently we are confronted with restrictions in the recording capacity of the people involved. In the second situation, costs arise: monitoring expenditures, bonding expenditures and residual loss. The optimum degree of decentralisation is determined by balancing these costs. In a market system, collocation of decision rights and knowledge occurs either when those with the decision rights expend resources to acquire the knowledge or when those with knowledge buy the decision rights. When the cost of moving knowledge is higher than the cost of moving decision rights, knowledge holders will value the decision rights more highly and will purchase them (Jensen and Meckling, 1992). In a situation of hybrids, this market system will not always solve the control problems that exist. Those who have the decision rights in the supply chain will not always bear the costs or rewards of their actions, as not all transactions are spotmarket transactions. Therefore, a governance structure may be installed to ensure that supply chain objectives are pursued to a maximum level. The governance structure is a certain mixture of incentives working on the basis of a market mechanism, management controls within the participating companies, and inter-organisational controls that relate to the supply chain. A governance structure goes beyond the boundaries of organisations and thus also goes beyond the boundaries of a traditional MCS (Van der Meer-Kooistra and Scapens, 2008). Nevertheless, we see that also at the level of the supply chain, the chain members need to harmonise distributed decisions, information, and incentives amongst themselves in supporting their independent processes that contribute to mutual objectives (Simatupang and Sridharan, 2005, 2008). Accordingly, the governance structure includes similar elements as the management control systems within the companies, since it is used to coordinate vertical and horizontal relations both between and within organisations. In a hybrid, however, these elements always have to work within the context of a relationship between economically independent parties where a hierarchical relationship is absent. To conclude, the management control systems within the companies comprises the allocation of decision rights within the company, the information structure within the company, and performance measures and incentives within the company. The governance structure includes local management control within he participating companies, but should be extended to include inter-organisational controls such as allocation of decision rights over the supply chain, information exchange among members of the supply chain, and performance measures and incentives to ensure alignment with supply chain objectives. In addition, the market mechanisms of rewards/punishment and exit threats are part of the governance structure (see Figure 1). The main difference between management control and governance structure is thus that the management control elements of allocation of decision rights, information exchange and performance measures and incentives relate only to the internal functioning of a company when we are talking about management control, but relate to the whole supply chain when we are talking about governance structure.

3. Research design A case study has been carried out in a supply chain of eight food manufacturers, two logistic service providers, and two retailers were investigated. This food supply chain actively seeks to improve the functioning of the supply chain. However, potential improvements are not always pursued. Implementation of the proposed initiatives was a complex issue relating to many different aspects, including information systems development. In addition, allocation of decision rights and performance measurement within the participating companies proves to be a complicated matter. Research questions The main research question for the case study is whether the local management control systems encourage behaviour that is congruent with supply chain objectives. For this purpose, we need an understanding of the following issues: RQ1. Process description. What processes take place within the supply chain? RQ2. Present management control systems. How does the MCS function within the organisations concerned? We investigate the information availability in relation to decision rights and the performance measurement and incentive system. RQ3. Improving the supply chain. Which problems play an important role with regard to the functioning of the supply chain? What potential supply chain initiatives can be identified? RQ4. Behaviour explained from a management control perspective. In what way do the local management control systems support or hinder the implementation of improvement proposals in the supply chain? How can behaviour of local units in these improvement initiatives be explained from an analysis of the MCS in place? Data collection The research in the food supply chain arises out of a larger project called KLICT II. This project was carried out in collaboration between Dutch Universities, food manufacturers, logistic service providers, retailers, and a consultancy firm. The goal of the KLICT II project was related to different aspects of implementation of a specific supply chain improvement project called “Supply Chain Synchronisation” (SCS). One aspect was related to the management control systems of the participating organisations. The research question was if present management control systems of the participating organisations enable the SCS concept. In the KLICT II project, three types of parties are discerned: the food manufacturers, the logistic service providers, and the retailers. All the food manufacturers supply the retailers, by making use of the logistic service providers. The research output is based on a series of 16 interviews conducted with sales managers, logistics managers, purchasing managers and controllers of the companies involved in KLICT II. Of the 16 interviews, 12 have been 469

Management control and governance structure in a supply chain context

Supply Chain Management: An International Journal

Paula M.G. van Veen-Dirks and Peter J.A. Verdaasdonk

Volume 14 · Number 6 · 2009 · 466 –478

Figure 1 Conceptual model: organisational controls and supply chain governance

conducted at four different manufacturers, three at two different retailers, and one at a logistic service provider. The research team has conducted interviews that lasted between one and two hours. During the interviews, notes were taken that were translated into interview reports. The interviewees checked the interview reports. For some interviews, a follow up by telephone or e-mail was used to clarify some of the responses given. The data concerning the supply chain and the interviewees have been made anonymous to protect the privacy of the people involved.

Process description The case study in the food chain researched consists of eight food manufacturers, two logistical service providers and two retailers. In current practice the main supply process in the food chain is as follows (see Figure 2). The various plants of the given food manufacturers replenish their regional warehouses. These regional warehouses are either owned or governed by the manufacturers or by a logistic service provider. The regional warehouses subsequently supply the distribution centres of several retail chains. The retailers then take control of the supply of their own retail outlets. In this paper we describe the eight food manufacturers as one position in the supply chain; and the two retailers are described as one position too. The two retailers can be seen as the focal firms in the supply chain. Since the logistic service providers carry out the distribution activities for the manufacturers: from the manufacturing plants to the regional warehouse of the manufacturers and then to the distribution centre of the retailer, the activities are more closely related to those of the manufacturers and described in relation to the position of the manufacturers. In addition, the logistic service providers operate from dedicated sites close to the location of the manufacturers. By dedicating

4. Case study In this section the case study material will be presented. The description starts with the processes in the food supply chain (RQ1), followed by the management control systems in place at the companies involved in the supply chain (RQ2). Then, an analysis is made of problems that occur in the supply chain and/or opportunities that exist to improve the functioning of the supply chain (RQ3). Subsequently, we discuss how the design of the local management control systems impedes the implementation of improvement initiatives (RQ4). This discussion is continued in section 5. 470

Management control and governance structure in a supply chain context

Supply Chain Management: An International Journal

Paula M.G. van Veen-Dirks and Peter J.A. Verdaasdonk

Volume 14 · Number 6 · 2009 · 466 –478

Figure 2 The food supply chain and the departments within the companies

description of the management control system in place. The other companies, however, use similar management control systems (decision rights allocations and performance measures are very much alike). We discern the sales department and the logistical department within the food manufacturers and the purchasing department and the logistical department within the retailers (see also Figure 2).

these assets, the logistic service providers reduce their ability to replace the particular manufacturer (Wathne and Heide, 2004). This creates incentives for behaviours that support the relationship. In these food supply chains it has become common practice to frequently reorder and deliver (daily or even more often) to reduce inventory out of the downstream supply chain (Deloitte, 2004). The retail outlets are replenished within eight to 12 hours. As a consequence, the food manufacturer is required to replenish the retail distribution centre within eight to 24 hours. This forces the food manufacturer to deliver from regional stock. As a result of this policy, large stocks (of non-perishable items) are stored at the regional warehouse of the manufacturer. The two retailers are different in size and have also differences in assortment. The first retailer is a relatively small but fast growing retail company with over 60 outlets. It uses frequent price promotions. The assortment covers about 12,000 articles. The second retailer is the second largest retail company in The Netherlands with almost 500 outlets. It has an everyday low price strategy. This retailer has a much broader assortment than the first one with about 25,000 articles. The eight manufacturers represent a variety of product groups, from cosmetics to coffee, from paper to pet food. Some of the largest product groups are the following: baby food, beverages, butter, cheese, sauce, and snack food. All eight manufacturers see the two retailers as key accounts. The two retailers could be considered as focal companies in the supply chain.

Management control system – food manufacturer The main financial result indicator of the sales department is the profit margin realised. This profit margin is defined as the actual sales prices of the products sold minus a specific transfer price between the supply organisation and the sales organisation of the manufacturer of the products sold. This transfer price only includes the manufacturing costs and does not include the logistical costs from the manufacturer to the retailers. This implies that the logistical costs do not play a role in the financial result indicator of the sales department. Because of a lack of a sophisticated cost allocation model, the food manufacturer is not able to allocate the logistical costs to customers. The logistical costs are measured at the logistical department level. These costs are only one element of the performance measurement system of the logistical department. The other element is the service levels that are agreed upon with the customers. Although the logistical department sees these logistical costs as important, they are more committed to the service levels. Each year the sales department negotiates the sales conditions for the coming year with their customers. An important part of the negotiations of course is the sales price. This sales price directly influences the performance of the sales department. Furthermore, during these negotiations, logistical agreements are made, including specific service levels. The logistical department does not take part in these negotiations. They only provide input regarding the service levels to the sales departments. Of course the outcome of these negotiations determines the costs that will have to be incurred. The logistical department communicates at irregular intervals with the logistical department of the customers.

Present management control systems This study leaves out all the specific details of each manufacturer-retailer relationship and concentrates on some specific issues related to the intra- and inter-organisational controls needed to align the interests of all organisational entities involved in the supply chain. Therefore, we use a combination of one food manufacturer (FM1), logistic service provider (LSP1) and retailer (R1) to come to the main 471

Management control and governance structure in a supply chain context

Supply Chain Management: An International Journal

Paula M.G. van Veen-Dirks and Peter J.A. Verdaasdonk

Volume 14 · Number 6 · 2009 · 466 –478

During these contacts specific operational logistical issues are discussed. For instance, a retailer always orders 19 boxes of a specific product, whereas a full pallet contains 20 boxes. Removing one box from a pallet results in extra costs. When such behaviour is monitored, the logistical department of the manufacturer makes an agreement with the logistical department of the retailer about a slight change of the ordering policy (full pallets), to reduce costs.

that the overall inventory in the supply chain drops to the minimum by applying this concept. This is one element in the SCS concept. To move the inventory along the supply chain in the cheapest possible way, it should be moved in the largest possible quantities, i.e. using full pallets and in full truckloads. That way both handling and administrative overhead are minimal. Furthermore, time pressure should be minimal, so as to create optimal conditions for the levelling of workload over time. SCS implies that manufacturers immediately send a per cent of the production batch to the distribution centre of the retailers. A following shipment of (100 2 a) per cent is sent, when a per cent has been used up by the retailer. This implies that only two shipments from the manufacturer to the distribution centre of the retailer per production batch occur. During the KLICT I project, simulations were made that prove this concept would result in lower costs for the supply chain as a whole. These lower costs in the supply chain are related to less handling, less administrative costs, less transportation costs, and lower inventory levels. After this project a new project was initiated, called KLICT II. The aim of this project was to look at specific implementation issues. The study shows that the advantages of supply chain synchronisation were recognised by the parties involved in the supply chain after KLICT I. However, it is also clear from the interviews that synchronisation is seen as a small but difficult step on the way to full integration. Full integration is identified with an integral VMI-system, where integral relates to full information about the production planning at the manufacturer, and stock levels. Complete synchronisation is seen as very complex, because all processes in the chain need to be linked then. The customer logistics manager of one of the food manufacturers (company FM2) indicates:

Management control system – retailer The main financial result indicator of the purchasing department of the retailer is purchase savings. Purchase savings are determined as the difference between the purchase prices of the goods bought last year and the actual purchase prices. The logistical costs do not play a role at the purchasing department. The logistical costs are a financial result indicator of the logistical department of the retailer. These costs are seen as an important result indicator (more than those at the manufacturer). Furthermore, the performance of this department is measured in relation to the service level achieved further in the retail chain (retail outlets). The purchasing department makes an agreement about the purchase conditions with the sales department of the manufacturer. Again, the logistical department provides input for these negotiations, but does not attend the meetings. Specific logistical issues are discussed in the irregular meetings with the logistical department of the manufacturer. Improving the supply chain The KLICT II project ensues from an earlier project for which a research group consisting of two Dutch universities and a consulting firm has approached the members of this food supply chain to initiate a new method of supply chain cooperation in a project named KLICT I. In this research project a new supply chain concept was designed: SCS. The idea behind SCS was to create a retail distribution chain with the overall absolute minimum costs (Deloitte, 2004). With the current products portfolio, where manufacturers might produce hundreds of different products, it is taken for granted that most products cannot be produced daily. To produce efficiently, these products are produced in certain batches. The majority of these products are produced only once a week, biweekly, once a month, or even less. From a supply chain perspective, once a batch of products has been produced, the inventory is available and its costs are borne. So, the challenge then is to make this inventory effective as soon as possible and to move the inventory along the supply chain in the cheapest possible way. In the current situation, the inventory is sent to the retailer in relatively small transportation batches, just to fulfil the service level required and to minimise the inventory at the retailer. From a supply chain perspective the stocks left at the manufacturer are quite ineffective. Stocks can run out at the stores, where there is plenty of stock in the warehouses of the manufacturer. Furthermore, the set-up of logistical processes in this chain is quite inefficient due to the relatively high transportation costs and materials handling costs (Martens, 2003). The efficiency (lower costs) and effectiveness (higher service levels) of this food chain can be improved by means of this SCS concept. In this concept, the inventory is made effective as soon as possible by moving it downstream in the supply chain immediately after production. Simulation shows

The first important benefit comes from working with full pallets. The second important benefit comes from stock reduction that follows from supply chain synchronisation. One of the questions is however, how far you want to go with these concepts. Is it desirable to synchronise all processes if this results in linking the whole supply chain?

One important part that was considered in the KLICT II project, which was clearly related to the implementation issues that were considered, was the allocation of the costs and benefits of this new method of cooperation. The SCS concept lowers the cost of the total supply chain. When taking a closer look, we see that the costs of the retailer increase whereas the costs of the manufacturer decrease, still leaving a net advantage. Figure 3 gives a graphical representation of the benefits (where plus is a reduction in costs and minus is an increase in costs). As a result, compensation to the retailer has to take place. Compensation could take place based on the performance of the retailer in the chain. In this way, the retailer can see the SCS concept as a service for which the manufacturer has to pay. However, this requires a detailed recording of the performance of the retailer. A retailer could well purchase 5,000 to 30,000 articles. For each article a detailed registration would be necessary. In this chain, however, neither the manufacturer nor the retailer keeps a record of the logistical performance at such a detailed level. For this reason, compensation is sought through a discount on the sales price. In this way the sales department gives a discount to the retailer when the rules of the SCS concept are adapted. The interest costs and the risk of keeping the stock will move to the retailer, when the inventory is moved downstream to the retailer. This has led to a long discussion between the 472

Management control and governance structure in a supply chain context

Supply Chain Management: An International Journal

Paula M.G. van Veen-Dirks and Peter J.A. Verdaasdonk

Volume 14 · Number 6 · 2009 · 466 –478

Figure 3 Effects on local management control systems

logistical department increase due to the new supply chain concept (costs of inventory increase). This results in a poorer performance of the logistical department. The logistical department therefore calls for more transparency in the structure of the price that is agreed on and for allocation of the money that is received as a consequence of an improvement in the logistical activities. The logistics buyer responsible for logistics at the retailer distribution centre of the large retail company brings forward the following problem (company R1):

manufacturer and the retailer. A logistics manager at one of the food manufacturers (company FM3) indicates this as follows: After a long discussion it has been decided that the extra interest costs for the retailer will be compensated by the manufacturer. It has also been considered to delay the payment by the retailer until the moment that the retailer moves the inventory from the retailer distribution centre to the retail outlet. However, the basic idea is that also the retailer moves the inventory downstream in the supply chain as quickly as possible, so then this delayed payment is not very helpful for the retailer.

Following this approach of compensation to the retailer, both parties (manufacturer and retailer) trust that each party complies with the rules of the SCS concept in such a way that the savings for the total supply chain are realised. Of course the performance of the parties involved regarding the principles of the SCS concept is monitored, but not exactly measured. If this were to be put into practice, the cost and benefits could be equally divided over the different parties in the supply chain. Also the logistic service provider could experience some consequences of the SCS concept. The account manager of the logistic service provider indicates that there is a reduction in handling costs (company LSP1):

The purchasing department receives discounts for the fact that we work with full truckloads and full pallets. So I have discussed this with central management, but they don’t want to install a system for internal allocations to deal with this situation. But how can I be held responsible for my results then?

At the food manufacturer, the performance of the total organisation increases. Part of the benefits of the SCS is paid to the retailers but some of the benefits can still be kept. When the different departments are considered, one can see that the financial performance of the sales department decreases due to a decrease in sales prices; the performance of the logistical department is increased due to lower logistical costs. The sales department now has to lower its margins to decrease logistical costs that they are not formally responsible for. The logistics manager at one of the manufacturers (company FM2) puts it as follows:

SCS leads to a reduction in handling and also to less turnover. This may affect our profit when we do not reduce our costs. However, at our company we believe that what is good for our customers is also good for our company.

Behaviour explained from a management control perspective In this section, we discuss the effects of this compensation on the management control systems of the separate parties involved in this supply chain. When the compensation takes place through the adjustments in sales prices/purchase prices, the following effects on the management control systems can be found. First, we can see that with compensation the benefits of the SCS concept are more equally divided over the parties in the chain. As a result both parties are encouraged to participate in the project. When the management control systems of the different departments are taken into account, interesting insights can be obtained. With regard to the retailer, the purchasing department sees an improvement in its main performance indicator. Because of lower purchase prices the financial result indicator increases. The costs of the

The whole organisation is structured in such a way that the factories and the logistical department have nothing to do with sales. The advantages are to some extent only beneficial for the logistical department, because there will be less material handling costs and lower inventories. The sales department, however, feels the pain of the discounts for the retailer.

In Figure 4 the effects of these actions on the management control systems are presented. Let us take a look at an example to illustrate the processes described above. Suppose that applying the SCS concept leaves a total chain result of e608. This result consists of a decrease in logistical costs of e3,779 for the manufacturer and an increase of the logistical costs of e3,171 for the retailer. It is clear that in this project the retailer has to be compensated. The compensation is carried out through a decrease in the sales prices of the products involved. If the manufacturer lowers his prices by 473

Management control and governance structure in a supply chain context

Supply Chain Management: An International Journal

Paula M.G. van Veen-Dirks and Peter J.A. Verdaasdonk

Volume 14 · Number 6 · 2009 · 466 –478

Figure 4 Numerical example of effects on local management control systems

considered as relatively high. On the one hand, it is evident that asset specificity in the food supply chain is quite low, as the food manufacturers work with a lot of different retailers. On the other hand, it can be noticed that transactions reoccur frequently and that the environment is quite uncertain especially with regard to product demand. As a consequence, a hybrid structure seems to be a suitable option for the food supply chain. The case study focuses on the implementation issues related to a specific supply chain initiative. In order to realise the initiative, a collaborative effort of the companies participating in the supply chain is necessary. We have seen in the case study that the advantages that are related to the implementation of the initiative are recognised by the parties involved. We have also observed in the case study that a lot of attention has been paid to a compensation structure that allows an equal division of the net benefits of the supply chain initiative over the parties involved. This mutuality of benefits is considered as one of the critical elements for the establishment and maintenance of supply chain relations in the literature (see, for example, Barratt and Oliveira, 2001). More specifically, the case focuses on the barriers to supply chain initiatives that may exist at the intra-organisational level within firms that participate in the supply chain. The main question in the paper is how the local management control systems may form a possible barrier to the successful functioning of the supply chain. In the remainder of this paper we will discuss this question concentrating on issues relating to information exchange and decision rights and performance measurement.

e3,475, the benefits of the chain project are equally divided between the partners involved. When the cost and benefits are allocated to different players in the supply chain through an adjustment in the sales/ purchase price, an interesting process occurs. The present MCS encourages the department to increase its own performance, but does not stimulate cooperation in a supply chain to achieve specific supply chain goals. This causes a problem, because, based on financial result controls, the account manager of the sales department of the manufacturer does not have a real drive to make the SCS concept a success during the negotiations. Although the SCS concept would work out for the best of the supply chain, and would also work out well for the partners involved (after installing an appropriate compensation mechanism), it works out much more negatively for the account manager of the manufacturer’s sales department. Given the incentive structure of the account manager, interference with the negotiations to make the SCS concept fail is to be expected. The same holds for the logistics managers of the retailer, because due to the SCS concept the financial performance of the department decreases. With specific actions (order quantities that differentiate from the alpha concept, manipulating demand forecasts, manipulating stock levels, etc.), the logistical department could also hinder the SCS concept.

5. Discussion The case study has enabled us to examine the food supply chain and its governance structure including the local management control systems. The companies in the food supply chain may be considered as hybrids. It is clear that prices are not set on the spot market, but are part of a negotiation process that takes place between food manufacturers and retailers. In this negotiation process price is only one of the aspects that is to be agreed upon. A hybrid is one of the possibilities to economise on transaction costs, which is appropriate when transaction costs are high but not extremely high (Vosselman and Van der Meer-Kooistra, 2006). Transaction costs in the food supply chain may be

Information exchange It is very important for the management of the supply chain relation that information exchange actually takes place (Seal et al., 1999). In the case study, we see that information exchange between the parties involved is very important. For both the logistical department and the sales department of the manufacturer, it is very important to develop a strategy relating the potential benefits of the SCS concept and the maximum amount of discount that can be given to the retailer. The logistical department in particular should be able 474

Management control and governance structure in a supply chain context

Supply Chain Management: An International Journal

Paula M.G. van Veen-Dirks and Peter J.A. Verdaasdonk

Volume 14 · Number 6 · 2009 · 466 –478

to give insight into the benefits that can be gained with the SCS concept. A similar discussion could take place at the retailer between the purchasing department and the logistical department about the estimations of the increases in logistical costs made by the logistical department. We see that information asymmetry is present in both companies between the two departments. Information asymmetry is also present between the retailer and the manufacturer with regard to the potential logistical benefits. Therefore, the parties in the supply chain would need to talk about a model that is accepted by all parties, which could serve as a reference model to calculate the costs and benefits. The companies are working on a system of menu-based pricing, a communication device about costs and cost structures. In these menus, it is indicated how much can be earned by working together on certain activities. However, one of the difficulties of such a model would be that it also incorporates confidential information. It is therefore considered as a threat by some parties involved in the chain, since it could be used in the negotiations by the other party. In addition, the case study shows that cost information alone is not sufficient to optimise the supply chain. Also, the exchange of other types of information between the parties involved in the supply chain is complicated. The necessary information concerning transportation costs had to be completed with information on stocks and delivery reliability and that exchange of this information is indeed an issue. This is not only an issue for the exchange of information between companies but also for information flows between departments of one company. Although the necessary information is often available somewhere within the companies involved, the transfer of this information to the people with the decision rights is problematic. In the case study, we notice that a dialogue takes place between for instance the purchasing department and the logistical department of the retailer, to enable both parties to formulate a better strategy concerning stock levels and transportation sizes. Unfortunately, however, the performance criteria that are used have a negative effect on the outcome of these dialogues. The performance measures contribute to the undesirable situation that the different departments are busy maximising their own performance, but not the performance of the whole organisation, not to mention the performance of the whole supply chain. We can therefore conclude that in spite of the broad availability of the required information for all parties, the incentives seem to be lacking to proceed with effective chain integration.

Therefore, we must conclude that the management control systems have been designed in such a way that the sales department of the manufacturer and the logistical department of the retailer are not fully motivated to work in line with the supply chain initiative. One way to improve the situation would be to design the performance measurement system such that both departments within one company are evaluated using a common objective. A disadvantage of this system would then be that a part of this common objective is largely “uncontrollable”, since the decision rights are much narrower than this objective. The advantage, however, is that initiatives to increase cooperation in the supply chain will come about much earlier if the departments are effectively evaluated on such a common objective. Another possibility would be to allocate the decision rights related to the supply chain to one of the two departments in each company. However this would lead to the fact that for instance the purchasing department would have to acquire all required logistical knowledge or that the logistical department would have all the required purchasing knowledge. This approach would then probably become too costly. Alternatives could be to centralise decision making (for example within a department of supply chain management, which would include both purchasing and logistics) or to work with a problem-solving team (a supply chain team). If the decision making is centralised then the performance measurement - and appraisal -system must also be adapted. For example, an integrated objective could be defined for a department supply chain management and this department would then be assessed on both logistical and purchase costs. These costs would have to be built up of a combination of purchase costs, transportation charges and stock-keeping costs. In this way local and optical optimisation efforts could be prevented. If this centralisation would be considered too far-reaching, then as a minimum the supply chain objectives should be communicated through the whole organisation. Subsequently, it is essential to create a control system where new initiatives are taken up at a more central level (for example by a supply chain coordinator). This person should focus especially on making sure that the proposed initiative results in positive effects. Since it is impossible to specify all bits and pieces completely in advance in a contract, it seems worthwhile to make agreements concerning the working method to be followed in case of improvement options, which would lead to a cost reduction for the manufacturer and/or the logistic service provider. A more comprehensive form of change in the chain would be to allocate the decision rights with respect to the transportation sizes to the manufacturer. We would then get a vendor-managed inventory (VMI) system (see, for example, Kulp, 2002). The advantage of such a system is that it is possible for every decision to take into account the total supply chain costs. Kulp indicates that an important success factor when using VMI systems is the willingness of the customer to communicate accurate and reliable information on stock levels to the subcontractor who has the decision rights. In this case that would mean that the retailers would have to communicate the necessary information to the manufacturer. The manufacturer could then take into account this information as well as its own information with respect to the cost structure of the transportation orders already planned. However, in the interviews it becomes clear

Decision rights and performance measurement Initially, the costs and benefits of the supply chain initiative are unequally divided across the supply chain. As a result, compensation to the negatively affected company has to be arranged. Lowering the sales prices of the products involved would be a possible way to compensate the retailer. However, this would still lead to an imbalanced spread of the costs and benefits across the departments within the companies involved in the supply chain. In the case study, we see that the decision rights are rather low down in the organisation, i.e. at the sales and the logistical departments of the manufacturer and at the purchasing and the logistical departments of the retailer. Because of the performance measurement system, the departments only pursue their own local objectives; purchase savings, stock reductions, etc. 475

Management control and governance structure in a supply chain context

Supply Chain Management: An International Journal

Paula M.G. van Veen-Dirks and Peter J.A. Verdaasdonk

Volume 14 · Number 6 · 2009 · 466 –478

that the manufacturers still see a lot of problems with VMI. As an example, the logistics manager of one of the manufacturers (company FM1) indicates the following disadvantage:

more than one department within the participating companies. In addition, cooperation between companies needs mutual approval and assistance. The case study provides evidence that the present management control systems are not in accordance with the complicated nature of supply chain management. This leads to supply chain initiatives not being implemented, mainly due to a lack of commitment at the part of the local units involved. It becomes clear from the case study that the governance of the supply chain and the intra-organisational controls are intertwined in a very delicate manner. Subtle changes in governance focused on more collaboration require thoughtful adjustments in local management control. When the demand for mutuality of benefits requires inter-organisational compensation, then also the intra-organisational division of the benefits should be considered. Clearly both the intra-organisational and the inter-organisational level should be taken into account simultaneously. Also other possible suggestions are made for improvement, such as using a common supply chain strategy as a basis for the MCS, to allocate decision rights differently, to install an action control system, and to redesign the performance measurement system. This could, however, lead to considerable additional (monitoring) costs. Subsequently, effectively measuring the success of these suggestions could become the subject of future research. In addition, the case study illustrates, in a similar way as in Thrane and Hald (2006), that the local control system within the organisations participating in the supply chain, while helpful in integrating external relations, fragmented the focal firm. Conflicts of interest between departments within the firm are created by the control system that is in place within the food manufacturers and within the retailers. These conflicts of interest impede a good coordination of activities also at the level of the whole supply chain. As Thrane and Hald (2006) indicate in their paper, boundaries between companies acting in a supply chain are ever-changing. This makes it more difficult to clearly distinguish between intra and inter-firm relations. Control systems for intra-organisational control become more and more related to the governance structure of the inter-organisational relation. Future lines of research could then look at how internal coordination may enhance or hinder cooperation with external parties acting in the supply chain. Is it necessary that external integration comes at the expense of internal coordination and vice versa? And, if so, how can these trade-offs be managed or improved?

With the introduction of VMI the job levels of the people involved in inventory planning will be raised. It is definitely more difficult to manage inventory than to deal with orders.

A good monitoring of the performance of the manufacturer and a system for partitioning of the achieved supply chain advantages is thus essential for such a system to be able to succeed. A related option would be to install third-party or “maestro” coordination (Bitran et al., 2007). These maestros are neutral third parties that can coordinate the entire network and align the incentives for all participants. The authors anticipate this role for logistic service providers. Another possibility is to differentiate in performance indicators between the departments. The sales department could then be made responsible for the total margin per customer (including the logistical costs) and the logistical department purely for logistical parameters such as service levels. Consequently, the retailer could choose for a similar set-up: the purchasing department would be made responsible for the purchasing costs including the costs for logistics, and the logistical department for the logistical parameters. However, the use of margin per customer as a performance indicator requires an advanced costing system, which is able to trace logistical costs to specific customers. Such a system is not available to these manufacturers at present. Furthermore, there is a risk that the sales/purchasing departments would become responsible for a part of the costs that they cannot directly influence. A related option would be to create an internal market between the logistical department and the sales department and between the logistical department and the purchasing department. Departments would then negotiate about the price that they are willing to pay or receive for working with the SCS concept. A major disadvantage of introducing this internal market option would however be that it leads to many administrative costs.

6. Conclusions This paper follows from the observation made in the supply chain literature that organisations which partner in strategic supply chains continue to encounter barriers at the intraorganisational and inter-organisational levels. In this paper, a case study is described that reflects on the cooperation between several parties in a supply chain context. Specifically the case study examines a potential barrier that may exist at the intra-organisational level, namely the design and the use of the MCS within the companies that participate in the supply chain. The analyses have revealed that the local control systems unfavourably influence the achievement of the supply chain objective. The underlying question addressed in this research is whether cooperation in a supply chain necessitates changes in local management control. On the basis of the study, it can be concluded that the current governance structure including the local control systems in the companies that were investigated do not promote the chosen supply chain objectives. The will to strive for improvements at the level of the supply chain will only come about if the local management control systems are adjusted. Supply chain initiatives usually require actions in

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Paula M.G. van Veen-Dirks and Peter J.A. Verdaasdonk

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Supply Chain Management: An International Journal

Paula M.G. van Veen-Dirks and Peter J.A. Verdaasdonk

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Corresponding author Paula M.G. van Veen-Dirks can be contacted at: [email protected]

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